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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-KSB
(Mark one)
[X] Annual Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act
of 1934. For the fiscal year ended: December 31, 1997
OR
[_] Transition Report Pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934. For the transition period from: ____________________ to
____________________________
Commission File Number: 000-23267
DEPOMED, INC.
(Name of Small Business Issuer in its Charter)
California 94-3229046
(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
1170 B Chess Drive, Foster City, California 94404
(Address of principal executive offices) (Zip Code)
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Issuer's telephone number, including area code: (650) 513-0990
Securities registered pursuant to Section 12(b) of the Act: None
Securities registered pursuant to Section 12(g) of the Act: Common Stock, no par value
Common Stock Purchase Warrants, no par value
(Title of class)
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Check whether the issuer (1) filed all reports required to be filed by Section
13 or 15(d) of the Securities Exchange Act of 1934 during the past 12 months (or
for such shorter period that the registrant was required to file such reports),
and (2) has been subject to such filing requirements for the past 90 days.
Yes X No
--- ---
Check if disclosure of delinquent filers pursuant to Item 405 of Regulation S-B
is not contained herein, and will not be contained, to the best of registrant's
knowledge, in definitive proxy or information statements incorporated by
reference in Part III of this Form 10-KSB or any amendment to this Form 10-KSB.
_____
The issuer's revenues for its most recent fiscal year were $604,876.
The aggregate market value of the voting stock held by non-affiliates of the
registrant on February 28, 1998, based upon the closing price of the Common
Stock on the Nasdaq SmallCap Market for such date, was approximately
$41,000,000.
The number of outstanding shares of the registrant's Common Stock on February
28, 1998 was 6,463,438.
DOCUMENTS INCORPORATED BY REFERENCE
(1) Portions of the Proxy Statement to be filed with the Securities and
Exchange Commission on or prior to May 4, 1998 and to be used in connection
with the Annual Meeting of Shareholders expected to be held June 18, 1998
are incorporated by reference in Part III of this Form 10-KSB.
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DEPOMED, INC.
1997 FORM 10-KSB REPORT
TABLE OF CONTENTS
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Page
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PART I................................................................................ 1
Item 1. BUSINESS............................................................... 1
Item 2. PROPERTIES............................................................. 12
Item 3. LEGAL PROCEEDINGS...................................................... 12
Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.................... 12
PART II............................................................................... 14
Item 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER
MATTERS................................................................ 14
Item 6. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS.................................................. 16
Item 7. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA............................ 21
Item 8. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE................................................... 21
PART III.............................................................................. 22
Item 9. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT..................... 22
Item 10. EXECUTIVE COMPENSATION................................................. 22
Item 11. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT......... 22
Item 12. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS......................... 22
Item 13. EXHIBITS AND REPORTS ON FORM 8-K....................................... 23
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The statements in this Annual Report on Form 10-KSB and other statements
made by DepoMed, Inc., a California corporation ("DepoMed" or the "Company"),
from time to time that are not historical are forward-looking statements which
involve risks and uncertainties. Actual results, events or performance may
differ materially from those anticipated in any forward-looking statements as a
result of a variety of factors, including those set forth under "Factors That
May Affect Future Results" and elsewhere in this Annual Report on Form 10-KSB.
Readers are cautioned not to place undue reliance on these forward-looking
statements which speak only as of the date hereof. The Company undertakes no
obligation to publicly release the result of any revisions to these forward-
looking statements that may be made to reflect events or circumstances after the
date hereof or to reflect the occurrence of unanticipated events.
PART I
ITEM 1. BUSINESS
COMPANY OVERVIEW
The Company is a development stage company engaged in the development of
new and proprietary oral drug delivery technologies. Utilizing these
technologies, the Company has developed two types of oral drug delivery systems:
the Gastric Retention System (the "GR System") and the Reduced Irritation System
(the "RI System" and collectively with the GR System, the "DepoMed Systems").
The GR System is designed to be retained in the stomach for an extended period
of time while it delivers the incorporated drug or drugs and the RI System is
designed to reduce the gastrointestinal ("GI") irritation that is a side effect
of many drugs. In addition, the DepoMed Systems are designed to provide
continuous, controlled delivery of an incorporated drug.
The Company intends to develop products utilizing the DepoMed Systems in
collaboration with pharmaceutical and biotechnology companies, from which the
Company expects to receive license fees, research and development funding,
milestone payments and royalties. The Company also intends to develop either
independently or jointly certain off-patent and over-the-counter ("OTC")
products utilizing the DepoMed Systems.
In March 1998, the Company entered into a research agreement with R.W.
Johnson Pharmaceutical Research Institute, a Johnson & Johnson unit ("PRI"), to
develop a product incorporating a PRI proprietary compound into the GR System.
The Company also has a joint research and development agreement with Bristol-
Myers Squibb Company ("BMS") to develop a product incorporating a BMS
proprietary compound into the GR System. The Company is independently
developing a reduced irritation aspirin product and an enhanced absorption
calcium supplement product and has identified certain other product candidates
expected to benefit from the DepoMed Systems.
THE DRUG DELIVERY INDUSTRY
Drug delivery companies apply proprietary technologies to create new
pharmaceutical products utilizing drugs developed by others. These products are
generally novel, cost-effective dosage forms that provide any of several
benefits, including better control of drug concentration in the blood, improved
safety and efficacy, improved patient compliance and ease of use. The Company
believes that drug delivery technologies can provide pharmaceutical companies
with a means of developing new and/or improved products as well as of extending
existing patent franchises.
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The increasing need to deliver medication to patients efficiently and with
fewer side effects has accelerated the pace of invention of new drug delivery
systems and the development and maturation of the drug delivery industry. Today
medication can be delivered to a patient through many different delivery
systems, including transdermal, injection, implant and oral methods. However,
these delivery methods continue to have certain limitations. Transdermal patches
are often inconvenient to apply, can be irritating to the skin and the rate of
release can be difficult to control. Injections are uncomfortable for most
patients. In most cases both injections and implants must be administered in a
hospital or physician's office and, accordingly, are frequently not suitable for
home use. Oral administration remains the preferred method of administering
medication. However, conventional oral drug administration also has limitations.
Because capsules and tablets have limited effectiveness in providing controlled
drug delivery, they frequently result in drug release that is too rapid, causing
incomplete absorption of the drug, irritation to the GI tract and other side
effects. In addition, they lack the ability to provide localized therapy. The
Company believes that the need for frequent dosing of many drugs administered by
capsules and tablets also can impede patient compliance with the prescribed
regimen.
THE DEPOMED SYSTEMS
The DepoMed Systems are based on the Company's proprietary oral drug
delivery technologies and are designed to include formulations of drug-
containing polymeric units that allow multihour delivery of an incorporated
drug. Although the Company's formulations are proprietary, the polymers utilized
in the DepoMed Systems are commonly used in the food and drug industries and are
generally regarded as safe. The Company has formulated these polymers into
tablets, cylinders and spheres that can be contained in gelatin capsules for
ease of administration. By using different formulations of the polymers, the
Company believes that the DepoMed Systems are able to provide continuous,
controlled delivery of drugs of varying molecular complexity and solubility.
The DepoMed Systems are designed to address certain limitations of drug
delivery and to provide for orally administered, conveniently dosed, cost-
effective drug therapy that provides continuous, controlled delivery of a drug
over a multihour period. The Company believes that the DepoMed Systems can
provide one or more of the following therapeutic advantages over conventional
methods of drug administration:
. Enhance Safety and Efficacy through Controlled Delivery. The Company believes
that the DepoMed Systems may improve the ratio of therapeutic effect to
toxicity by decreasing the initial peak concentrations of drug associated with
toxicity, while maintaining levels of a drug at therapeutic, subtoxic
concentrations for an extended period of time. Many drugs demonstrate optimal
efficacy when concentrations are maintained at therapeutic levels over an
extended period of time. When a drug is administered intermittently, the
therapeutic concentration is often exceeded for some period of time and then
the concentration rapidly drops below effective levels. Excessively high
concentrations are a major cause of side effects and subtherapeutic
concentrations are ineffective.
. Greater Patient and Caregiver Convenience. The Company believes that the
DepoMed Systems may offer once-daily or reduced frequency dosing for certain
drugs that are currently required to be administered several times daily. Such
less frequent dosing promotes compliance to dosing regimens. Patient
noncompliance with dosing regimens has been associated with increased costs of
medical therapies by prolonging treatment duration, increasing the likelihood
of secondary or tertiary disease manifestation and contributing to over-
utilization of medical personnel and facilities. By improving patient
compliance, providers and third-party payors may reduce unnecessary
expenditures and improve therapeutic outcomes.
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. Expand Types of Drugs Capable of Oral Delivery. Some drugs, including certain
proteins and peptides, because of their large molecular size and
susceptibility to degradation in the GI tract, must currently be administered
by injection or by continuous infusion, which is typically done in a hospital
or other clinical setting. The Company believes the DepoMed Systems may be
able to deliver some of these drugs orally.
. Proprietary Reformulation of Generic Products. The Company believes that the
DepoMed Systems may offer the potential to produce improved formulations of
off-patent drugs. These proprietary formulations may be differentiated from
existing generic products by virtue of reduced dosing requirements, improved
efficacy, decreased toxicity or additional indications.
THE GASTRIC RETENTION SYSTEM
The GR System consists of a proprietary formulation of drug-containing
polymeric units which, if taken with a meal, remain in the stomach for an
extended period of time to provide continuous, controlled delivery of an
incorporated drug. The GR System's design is based in part on principles of
human gastric emptying and GI transit. Following a meal, liquids and small
particles flow continuously from the stomach into the intestine leaving behind
the larger nondigested particles until the digestive process is complete. As a
result, drugs in liquid form or those consisting of small particles tend to
empty rapidly from the stomach and continue into the intestine, often before the
drug has time to act locally or to be absorbed, if the stomach and/or upper
small intestine are the sites of absorption. The drug-containing polymeric
tablets or units of the GR System are formulated into easily swallowed shapes
which are designed to swell upon ingestion. The tablets or units attain a size
after ingestion sufficient to be retained in the stomach for multiple hours
while delivering the drug content.
The Company has demonstrated multihour gastric retention in humans who have
been given the GR System with food. In addition, the Company is currently
developing an enhanced version of the GR System designed to be retained in the
stomach without the ingestion of food. This process is expected to allow for
treatment regimens unrelated to meal times, as well as for retention that is
more prolonged and with minimum patient-to-patient variation in retention time.
The Company believes that this feature will make medical treatment less
disruptive to a patient's normal schedule.
The expected advantages of the GR System over conventional oral drug
delivery systems include the following:
More Efficient GI Drug Absorption. The Company believes that the GR System
can be used for improved oral administration of drugs that are currently
inadequately absorbed when delivered as conventional tablets or capsules. Many
drugs are primarily absorbed in the stomach, duodenum or upper small intestine,
through which drugs administered in conventional oral dosage forms transit
quickly. In contrast, the GR System is designed to be retained in the stomach,
allowing for constant multihour flow of drugs to certain areas of the GI tract.
Accordingly, for such drugs, the Company believes that the GR System offers a
significantly enhanced opportunity for increased absorption. Unlike some
insoluble drug delivery systems, the polymer comprising the GR System dissolves
at the end of its useful life and is passed through the GI tract and eliminated.
Gastric Delivery for Local Therapy and Absorption. The Company believes
that the GR System can be used to deliver drugs which can efficiently eradicate
GI- dwelling microorganisms, such as H. pylori, the bacterium which is a cause
of ulcers.
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The Company is currently developing a calcium supplement product which
utilizes the GR System. Calcium supplements are generally indicated in the
treatment of osteoporosis. It is estimated that 20 million people in the
United States suffer from osteoporosis and that another 17 million people are
at risk. New medications for this debilitating condition are effective but
calcium supplementation is essential. In addition, it is estimated that 30
million people in the United States are under long-term treatment with
corticosteroids, such as prednisone, which can cause significant bone loss.
Accordingly, calcium supplementation is recommended as concomitant treatment
with these drugs. Current calcium supplement products are mostly in the form
of calcium carbonate, which is soluble only in an acidic medium and which
consequently must be retained in the stomach for an extended period of time
for efficient dissolution and subsequent absorption. However, conventional
calcium carbonate products pass through the stomach too quickly for a
significant amount of the calcium to dissolve. The Company believes that the
GR System will provide for the more efficient dissolution and absorption of an
orally administered calcium compound by keeping the product in the stomach for
an extended period of time.
The Company believes that a possible future application of the GR System is
the incorporation of a nonsystemic antacid into the GR System that would be
designed to provide sustained local action. Although currently used antacid
products are nonsystemic, their duration time is short. Accordingly,
individuals who need through-the-night protection from excess stomach acid must
resort to systemic antacids, such as Zantac(R) or Tagamet(R), which have a
longer on-set of action. The Company believes that the GR System may be designed
to provide continuous, controlled local delivery which is expected to allow for
a nonsystemic antacid product with more immediate and sustained action.
Rational Drug Combinations. The Company believes that a multi-
particulate GR System may allow for rational combinations of drugs with
different biological half-lives. Physicians frequently prescribe multiple drugs
for treatment of a single medical condition. Single product combinations have
not been considered feasible because the different biological half-lives of
these combination drugs would result in an overdosage of one drug and/or an
underdosage of the other. By incorporating different drugs into different
polymeric cylinders in the same capsule, the GR System is designed to release
each of its incorporated drugs continuously at a rate and duration (dose)
appropriately adjusted for the specific biological half-lives of the drugs.
The Company believes that future rational drug combination products using the
GR System have the potential to simplify drug administration, increase patient
compliance, and reduce medical costs.
Potential for Oral Delivery of Peptides and Proteins. Based on laboratory
studies conducted by the Company, the GR System is expected to protect drugs
from enzymes and acidity effects prior to their delivery in the stomach. This
feature coupled with gastric retention could allow for continuous delivery of
peptides and proteins (i.e., labile drugs) into the upper portion of the small
intestine, the most likely site of possible absorption for many such drugs. The
Company believes that this mechanism will allow effective oral delivery of some
drugs that currently require administration by injection. In addition, the
Company believes that the GR System can be formulated to provide for continuous,
controlled delivery of insoluble or particulate matter, including protein or
antigen-laden vesicles, such as liposomes, and microspheres or nanoparticles.
THE REDUCED IRRITATION SYSTEM
The RI System is designed to provide for significant reduction in local GI
irritation from the effects of certain drugs. Local tissue damage occurs when
solid crystals of a drug remain at any one site of the GI tract for long periods
of time. The RI System consists of an outer gelatin capsule, which is
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designed to rapidly disintegrate upon ingestion to deliver multiple small,
spherical pellets. The spherical pellets are composed of an inert matrix of
polymeric material in which the active ingredient is homogeneously dispersed in
its solid state. The spherical pellets persist for a period of time, but
ultimately dissolve and the polymer is eliminated.
The RI System is designed to reduce irritation through three distinct
mechanisms. First, the small spheres of the RI System are designed to deliver an
incorporated drug in solution state, in contrast to a solid or crystalline state
which may cause local GI irritation. Second, the dispersion of the spherical
pellets within the GI tract contributes further to the dilution of the local
drug effects. Third, controlled delivery contributes to the reduction of GI
irritation by delivering the incorporated drug over a longer period of time.
In addition to the reduced irritation aspirin that the Company is currently
developing, the Company believes that other GI irritating compounds such as
potassium chloride and erythromycin (a frequently used antibiotic) may benefit
from the RI System.
The Company is currently developing an aspirin product which utilizes the
RI System and is designed to reduce the GI irritation which is common when
aspirin is administered in conventional tablet or capsule form. Aspirin usage
has been expanding with important new medical indications, including the
prevention and treatment of cardiovascular disease. Aspirin is widely recognized
for its ability to cause damage to the GI tract and local irritation of the
stomach and intestine, which often relates to GI discomfort and a patient's
intolerance to this drug. The irritation properties of aspirin are mostly local,
not systemic in origin. Local damage begins and is sustained by high local drug
concentration against the mucosa, particularly when aspirin is administered in a
solid, crystalline state as from a rapidly dissolving tablet. These crystals in
contact with the mucosa provide a stagnant pool of saturated drug solution
against the cell walls, resulting in damage from both cellular mechanisms and
from back diffusion of acid into the mucosal cells and into the submucosal
capillaries, causing tissue necrosis and bleeding. To minimize local damage, the
RI System is designed to deliver its drug in solution, in a controlled manner
from a dispersion of polymeric units.
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PRODUCT DEVELOPMENT INITIATIVES
The following table summarizes the Company's principal product development
initiatives:
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DEPOMED
POTENTIAL EXPECTED
SYSTEM PROGRAM PARTNER INDICATIONS BENEFIT
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GR BMS Proprietary Bristol-Myers Squibb Confidential(2) Less frequent dosing
Compound Company(1)
GR PRI Proprietary R.W. Johnson Confidential (4) Less frequent dosing
Compound Pharmaceutical
Research Institute (3)
GR Calcium Supplement In-house Osteoporosis, Improved calcium
other calcium absorption
deficiencies
RI Aspirin In-house Multiple, Reduced
including pain and gastrointestinal
cardiovascular irritation
therapy
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(1) The Company entered into an option agreement relating to this compound with
BMS in July 1996. See "Collaborative Relationships."
(2) The potential indication may not be disclosed pursuant to the terms of the
agreement between the Company and BMS. See "Collaborative Relationships."
(3) The Company entered into a feasibility agreement relating to this compound
with PRI in March 1998.
(4) The potential indication may not be disclosed pursuant to the terms of the
agreement between the Company and PRI. See "Collaborative Relationships."
The products listed in the above table are in various stages of
development. For the BMS compound, an early stage pharmacokinetic trial was
conducted in humans in January 1997, and the product is now undergoing further
clinical testing. For the PRI compound, formulation work was initiated in March
1998. The calcium supplement and aspirin products are in pre-clinical
development by the Company. As no clinical trials will be required for the
initial commercialization of the calcium supplement product, that product will
be available for manufacturing, marketing and sale upon completion of
development. The Company expects to initiate a clinical trial for its reduced
irritation aspirin product during the second half of 1998.
COLLABORATIVE RELATIONSHIPS
Bristol-Myers Squibb Company. In July 1996, the Company and BMS entered
into a joint research agreement to develop a product incorporating a BMS
proprietary compound into the GR
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System. Pursuant to the agreement, BMS has an option to obtain an exclusive,
worldwide license to products incorporating the BMS compound utilizing the GR
System. Based on a pharmacokinetic study in humans that was conducted in January
1997, a dosage level (drug release rate and duration) for the product has been
selected. Further clinical testing is now in progress, while process scale-up
and manufacturing methodologies are being finalized. If such license is entered
into, the Company will receive a royalty on net sales of the products as well as
certain milestone payments. The option expires in February 1999. There can be no
assurance, however, that BMS will exercise the option or that, if it does, any
resulting product will be approved by the FDA or, if approved, will be
successfully commercialized.
R.W. Johnson Pharmaceutical Research Institute. In March 1998, the Company
and PRI entered into a feasibility study involving the use of the GR System to
deliver a pharmaceutical product. There can be no assurance, however, that
such feasibility study will be concluded successfully, and even if successfully
concluded, that the Company will be able to enter into an agreement with PRI on
reasonable commercial terms or at all.
COMPETITION
Other companies that have oral drug delivery technologies competitive with
the DepoMed Systems include ALZA Corporation, Elan Corporation plc, JAGO Pharma
AG, KOS Pharmaceuticals, Inc., and Flamel Aromatic SA, all of which have oral
tablet products designed to release the incorporated drugs over time. Each of
these companies has a patented technology with attributes different from those
of the Company's, and in some cases with different sites of delivery to the GI
tract. The Company believes that it is the only drug delivery company that is
currently developing products for oral drug delivery systems both for enhanced
retention in the stomach of an orally administered tablet (the GR System) and
the safer oral administration of otherwise locally irritating drugs (the RI
System). The Company believes that this combination of oral drug delivery
technologies differentiates the Company from other oral drug delivery companies
and will enable the Company to interest pharmaceutical companies in
incorporating their proprietary drugs into the DepoMed Systems and also to
differentiate any OTC and/or off-patent drugs that utilize the DepoMed Systems
from those of other drug delivery companies.
Competition in the areas of pharmaceutical products and drug delivery
systems is intense and is expected to become more so in the future. Competing
technologies may prove superior, either generally or in particular market
segments, in terms of factors such as cost, consumer satisfaction or drug
delivery profile. The Company's principal competitors in the business of
developing and applying drug delivery systems all have substantially greater
financial, technological, marketing, personnel and research and development
resources than the Company. In addition, the Company may face competition from
pharmaceutical and biotechnology companies that may develop or acquire drug
delivery technologies. Many of the Company's potential collaborative partners
have devoted and are continuing to devote significant resources in the
development of their own drug delivery systems and technologies. Products
incorporating the Company's technologies will compete both with products
employing advanced drug delivery systems and with products in conventional
dosage forms. New drugs or future developments in alternate drug delivery
technologies may provide therapeutic or cost advantages over any potential
products which utilize the DepoMed Systems. There can be no assurance that
developments by others will not render any potential products utilizing the
DepoMed Systems noncompetitive or obsolete. In addition, the Company's
competitive success will depend heavily on entering into collaborative
relationships on reasonable commercial terms, commercial development of
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products incorporating the DepoMed Systems, regulatory approvals, protection of
intellectual property and market acceptance of such products.
PATENTS AND PROPRIETARY RIGHTS
The Company's success will depend in part on its ability to obtain and
maintain patent protection for its technologies and to preserve its trade
secrets. It is the policy of the Company to file patent applications in the
United States and foreign jurisdictions. The Company currently holds two issued
United States and three pending United States patent applications, and has
applied for patents in numerous foreign countries, some of which have been
granted and others of which are still pending. No assurance can be given that
the Company's patent applications will be approved or that any issued patents
will provide competitive advantages for the DepoMed Systems or the Company's
technologies or will not be challenged or circumvented by competitors. With
respect to already issued patents and any patents which may issue from the
Company's applications, there can be no assurance that claims allowed will be
sufficient to protect the Company's technologies. Patent applications in the
United States are maintained in secrecy until a patent issues, and the Company
cannot be certain that others have not filed patent applications for technology
covered by the Company's pending applications or that the Company was the first
to file patent applications for such technology. Competitors may have filed
applications for, or may have received patents and may obtain additional patents
and proprietary rights relating to, compounds or processes that may block the
Company's patent rights or compete without infringing the patent rights of the
Company. In addition, there can be no assurance that any patents issued to the
Company will not be challenged, invalidated or circumvented, or that the rights
granted thereunder will provide proprietary protection or commercial advantage
to the Company.
The Company also relies on trade secrets and proprietary know-how which it
seeks to protect, in part, through confidentiality agreements with employees,
consultants, collaborative partners and others. There can be no assurance that
these agreements will not be breached, that the Company will have adequate
remedies for any such breach or that the Company's trade secrets will not
otherwise become known or be independently developed by competitors. Although
potential collaborative partners and the Company's research partners and
consultants are not given access to proprietary trade secrets and know-how of
the Company until they have entered into confidentiality agreements with the
Company, these agreements may be breached by them or may otherwise be of
limited effectiveness or enforceability.
The ability to develop the Company's technologies and to commercialize
products using such technologies will depend on not infringing the patents of
others. Although the Company is not aware of any claim of patent infringement
against it, claims concerning patents and proprietary technologies determined
adversely to the Company could have a material adverse effect on the Company. In
addition, litigation may also be necessary to enforce any patents issued or
licensed to the Company or to determine the scope and validity of third-party
proprietary rights. There can be no assurance that the Company's issued or
licensed patents would be held valid by a court of competent jurisdiction.
Whether or not the outcome of litigation is favorable to the Company, the cost
of such litigation and the diversion of the Company's resources during such
litigation could have a material adverse effect on the Company.
The pharmaceutical industry has experienced extensive litigation regarding
patent and other intellectual property rights. Accordingly, the Company could
incur substantial costs in defending itself in suits that may be brought against
the Company claiming infringement of the patent rights of others or in asserting
the Company's patent rights in a suit against another party. The Company may
also be
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required to participate in interference proceedings declared by the United
States Patent and Trademark Office for the purpose of determining the priority
of inventions in connection with the patent applications of the Company or other
parties. Adverse determinations in litigation or interference proceedings could
require the Company to seek licenses (which may not be available on commercially
reasonable terms) or subject the Company to significant liabilities to third
parties, and could therefore have a material adverse effect on the Company.
MANUFACTURING, MARKETING AND SALES
The Company intends to develop products utilizing the DepoMed Systems for
its collaborators and, in some cases, retain rights to manufacture commercial
quantities of such products. The manufacture and incorporation of drugs into
hydrophilic (readily absorbing moisture), polymer matrix pellets used in the
DepoMed Systems is accomplished by using a variety of standard techniques. These
include direct compression, compression using high speed rotary tablet press or,
alternatively, by an extrusion/spheronization process, which results in very
small spherical bodies. The Company does not have any internal manufacturing,
marketing or sales resources. Although the Company intends to acquire pilot
manufacturing equipment, the Company does not intend to acquire or establish its
own dedicated manufacturing facilities for the foreseeable future. Rather, the
Company's manufacturing strategy will be to utilize the facilities of its
collaborative partners, or to develop manufacturing relationships with
established contract manufacturers to make products utilizing the DepoMed
Systems. In addition, the Company does not intend to establish an internal sales
and marketing capability, but will seek to rely on its collaborative partners or
distributor arrangements to market and sell the products utilizing the DepoMed
Systems. In April 1997, the Company and Oakmont Pharmaceuticals, Inc.
("Oakmont") signed a letter of intent to enter into an agreement pursuant to
which Oakmont would manufacture the Company's reduced irritation aspirin and
enhanced absorption calcium supplement products and have rights to distribute
and sell these products in territories to be determined. The letter of intent
expired without a definitive agreement having been reached. There can be no
assurance that the Company will be able to enter into manufacturing, marketing
or sales agreements on reasonable commercial terms, or at all, with third
parties. Failure to do so could have a material adverse effect on the Company.
Manufacturers of products utilizing the DepoMed Systems will be subject to
applicable current good manufacturing practices ("cGMP") requirements prescribed
by the United States Food and Drug Administration ("FDA") or other rules and
regulations prescribed by foreign regulatory authorities. There can be no
assurance that the Company will be able to enter into manufacturing agreements
either domestically or abroad with companies whose facilities and procedures
comply with cGMP or applicable foreign standards. Should such agreements be
entered into, the Company will be dependent on such manufacturers for
continued compliance with cGMP and applicable foreign standards. Failure by a
manufacturer of products utilizing the DepoMed Systems to maintain cGMP or
applicable foreign standards could result in significant time delays or the
inability of the Company to commercialize the DepoMed Systems and could have a
material adverse effect on the Company. At the present time, due to ongoing
consolidation in the chemical and pharmaceutical industries, the Company
believes there is a worldwide excess of manufacturing capacity available to
the Company. As a result, the Company believes that it will be able to enter
into agreements with suppliers and manufacturers on reasonable commercial
terms. However, there can be no assurance that there will be manufacturing
capacity available to the Company at the time the Company is ready to
commercialize products utilizing the DepoMed Systems. There also can be no
assurance that any products utilizing the DepoMed Systems can be manufactured
at a cost or in quantities required to make them commercially viable. The
Company's inability to contract on acceptable terms and with qualified
suppliers for the manufacture of any products or delays or
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difficulties in its relationships with manufacturers, would have a material
adverse effect on the Company.
Contract manufacturers must adhere to cGMP regulations strictly enforced by
the FDA on an ongoing basis through its facilities inspection program. Contract
manufacturing facilities must generally pass a pre-approval plant inspection
before the FDA will approve a New Drug Application (an "NDA"). Certain
material manufacturing changes that occur after such approval are also subject
to FDA review and clearance or approval. There can be no assurance that the
FDA or other regulatory agencies will approve the process or facilities by
which any of the products utilizing the DepoMed Systems may be manufactured.
The Company's dependence on third parties for the manufacture of products
utilizing the DepoMed Systems may adversely affect the Company's ability to
develop and deliver such products on a timely and competitive basis.
GOVERNMENT REGULATION
The Company is subject to regulation under various federal laws regarding
pharmaceutical products and also various federal and state laws regarding, among
other things, occupational safety, environmental protection, hazardous substance
control and product advertising and promotion. In connection with its research
and development activities, the Company is subject to federal, state and local
laws, rules, regulations and policies governing the use, generation,
manufacture, storage, air emission, effluent discharge, handling and disposal of
certain materials and wastes. The Company believes that it has complied with
these laws and regulations in all material respects and it has not been required
to take any action to correct any material noncompliance.
In the United States, pharmaceutical products, including any drugs
utilizing the DepoMed Systems, are subject to rigorous regulation by the FDA. If
a company fails to comply with applicable requirements, it may be subject to
administrative or judicially imposed sanctions such as civil penalties, criminal
prosecution of the company or its officers and employees, injunctions, product
seizure or detention, product recalls, total or partial suspension of
production, FDA withdrawal of approved applications or FDA refusal to approve
pending new drug applications, premarket approval applications, or supplements
to approved applications.
Prior to commencement of clinical studies involving human beings,
preclinical testing of new pharmaceutical products is generally conducted on
animals in the laboratory to evaluate the potential efficacy and the safety of
the product. The results of these studies are submitted to the FDA as a part of
an Investigational New Drug application ("IND"), which must become effective
before clinical testing in humans can begin. Typically, clinical evaluation
involves a time consuming and costly three-phase process. In Phase I, clinical
trials are conducted with a small number of subjects to determine the early
safety profile and the pharmacokinetic pattern of a drug. In Phase II, clinical
trials are conducted with groups of patients afflicted with a specific disease
in order to determine preliminary efficacy, optimal dosages and expanded
evidence of safety. In Phase III, large-scale, multi-center, comparative trials
are conducted with patients afflicted with a target disease in order to provide
enough data to demonstrate the efficacy and safety required by the FDA. The FDA
closely monitors the progress of each of the three phases of clinical testing
and may, at its discretion, re-evaluate, alter, suspend or terminate the testing
based upon the data which have been accumulated to that point and its assessment
of the risk/benefit ratio to the patient.
The results of the preclinical and clinical testing on drugs are submitted
to the FDA in the form of an NDA for approval prior to commencement of
commercial sales. In
10
<PAGE>
responding to an NDA, the FDA may grant marketing approval, request additional
information or deny the application if the FDA determines that the application
does not satisfy its regulatory approval criteria. There can be no assurance
that approvals will be granted on a timely basis, if at all. Failure to receive
approval for any products utilizing the DepoMed Systems could have a material
adverse effect on the Company.
OTC products that comply with monographs issued by the FDA are subject to
various FDA regulations such as cGMP requirements, general and specific OTC
labeling requirements (including warning statements), the restriction against
advertising for conditions other than those stated in product labeling, and the
requirement that in addition to approved active ingredients OTC drugs contain
only safe and suitable inactive ingredients. OTC products and manufacturing
facilities are subject to FDA inspection, and failure to comply with applicable
regulatory requirements may lead to administrative or judicially imposed
penalties. If an OTC product differs from the terms of a monograph, it will, in
most cases, require FDA approval of an NDA for the product to be marketed.
Even if required FDA approval has been obtained with respect to a product,
foreign regulatory approval of a product must also be obtained prior to
marketing the product internationally. Foreign approval procedures vary from
country to country and the time required for approval may delay or prevent
marketing. In certain instances the Company or its collaborative partners may
seek approval to market and sell certain of its products outside of the U.S.
before submitting an application for U.S. approval to the FDA. The regulatory
procedures for approval of new pharmaceutical products vary significantly among
foreign countries. The clinical testing requirements and the time required to
obtain foreign regulatory approvals may differ from that required for FDA
approval. Although there is now a centralized European Union ("EU") approval
mechanism in place, each EU country may nonetheless impose its own procedures
and requirements, many of which are time consuming and expensive, and some EU
countries require price approval as part of the regulatory process. Thus, there
can be substantial delays in obtaining required approval from both the FDA and
foreign regulatory authorities after the relevant applications are filed, and
approval in any single country may not be a meaningful indication that the
product will thereafter be approved in another country.
The Company is also subject to regulation under various federal and state
laws regarding, among other things, occupational safety, environmental
protection, hazardous substance control and product advertising and promotion.
In connection with its research and development activities and its
manufacturing, the Company is subject to federal, state and local laws, rules,
regulations and policies governing the use, generation, manufacture, storage,
air emission, effluent discharge, handling and disposal of certain materials and
wastes.
PRODUCT LIABILITY
The Company's business involves exposure to potential product liability
risks that are inherent in the production and manufacture of pharmaceutical
products. Any such claims could have a material adverse effect on the Company.
The Company does not currently have any product liability insurance. Although
the Company has applied for product liability insurance, there can be no
assurance that it will be able to obtain or maintain such insurance on
acceptable terms, that the Company will be able to secure increased coverage as
the commercialization of the DepoMed Systems proceeds or that any insurance will
provide adequate protection against potential liabilities.
11
<PAGE>
EMPLOYEES
As of December 31, 1997, the Company had eight full-time employees. None of
the Company's employees is represented by a collective bargaining agreement, nor
has the Company experienced any work stoppage. The Company believes that its
relations with its employees are good. The success of the Company is dependent
in large part upon the continued services of John W. Shell and John W. Fara, its
Chairman and Chief Scientific Officer and President and Chief Executive Officer,
respectively, and other members of the Company's executive management, and on
the Company's ability to attract and retain key management and operating
personnel. The Company has obtained key man life insurance on the lives of Drs.
Shell and Fara in the amount of $2,000,000 each. Management, scientific
and operating personnel are in high demand and are often subject to competing
offers. The loss of the services of one or more members of
management or key employees or the inability to hire additional personnel as
needed may have a material adverse effect on the Company.
ITEM 2. PROPERTIES
The Company leases approximately 3,300 square feet in Foster City,
California, under a non-cancelable lease which expires on February 28, 1999. In
March 1998, the Company entered into a two year sublease, which includes an
option to renew for two additional terms of 12 and 10 months, respectively,
(at the discretion of the sublessor) to lease approximately 13,000 square feet
in Foster City for its executive offices, laboratory, testing and pilot
manufacturing facilities. The Company intends to relocate to the larger facility
and sublease its current facility in April 1998.
ITEM 3. LEGAL PROCEEDINGS
Not Applicable.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted to a vote of security holders during the fourth
quarter of the fiscal year ended December 31, 1997.
EXECUTIVE OFFICERS
The executive officers of the Company and their ages as of December 31,
1997 are as follows:
<TABLE>
<CAPTION>
NAME Age POSITION
---- --- --------
<S> <C> <C>
John W. Shell, Ph.D..................... 72 Founder, Chairman of the Board and Chief Scientific Officer
John W. Fara, Ph.D...................... 55 President, Chief Executive Officer and Director
John N. Shell........................... 44 Vice President, Operations and Director
John F. Hamilton........................ 53 Vice President, Finance and Chief Financial Officer
</TABLE>
John W. Shell, Ph.D., has served as Chairman of the Board of Directors of
the Company since its inception in August 1995 and served as the Company's
President and Chief Executive Officer from
12
<PAGE>
May 1995 to December 1996, when he became the Company's Chief Scientific
Officer. Dr. Shell founded DepoMed Systems, Inc. ("DSI") in 1991, and served as
its Chairman and Chief Executive Officer until its merger with M6
Pharmaceuticals, Inc. ("M6") in 1994, and served as President of the DepoMed
Division of M6 from March 1994 until May 1995. Prior to founding DSI, from 1987
until 1990 he was Vice President for Research at Johnson & Johnson's IOLAB
division. His experience also includes eight years as a Senior Research
Scientist at The Upjohn Company, six years as Director of Research for Allergan
Pharmaceuticals and fifteen years with ALZA Corporation ("ALZA") dating from
its founding in 1968. Dr. Shell served as Vice President of ALZA
Pharmaceuticals, and later as Vice President of Business Development for
ALZA. Dr. Shell received B.A., B.S. and Ph.D. degrees from the University of
Colorado.
John W. Fara, Ph.D., has served as a director of the Company since November
1995 and as its President and Chief Executive Officer since December 1996. From
February 1990 to June 1996 he was President and Chief Executive Officer of
Anergen, Inc., a biotechnology company. Prior to February 1990 he was President
of Prototek, Inc., a biotechnology company ("Prototek"). Prior to his tenure at
Prototek, he was Director of Biomedical Research and then Vice President of
Business Development during ten years with ALZA. Dr. Fara received a B.S. from
the University of Wisconsin and a Ph.D. from University of California, Los
Angeles.
John N. Shell has served as a director of the Company since its inception
in August 1995 and Director of Operations for the Company until December 1996,
when he was named Vice President, Operations. From May 1994 to August 1995, Mr.
Shell served in a similar capacity at the DepoMed Division of M6. Prior to
1994, Mr. Shell served as Materials Manager for Ebara International Corporation,
a multi-national semiconductor equipment manufacturer, and as Materials Manager
for ILC Technology, an electro-optics and electronics manufacturer. Mr. Shell
received his B.A. from the University of California, Berkeley.
John F. Hamilton has served as the Company's Vice President, Finance and
Chief Financial Officer since January 1997. Prior to joining the Company, Mr.
Hamilton was Vice President and Chief Financial Officer of Glyko, Inc. and Glyko
Biomedical Ltd., a carbohydrate instrument and reagents company from May 1992 to
September 1996. Previously he was President and Chief Financial Officer of
Protos Corporation, a drug design subsidiary of Chiron Corporation, from June
1988 to May 1992 and held various positions with Chiron Corporation, including
Treasurer, from September 1987 to May 1992. Mr. Hamilton received a B.A. from
the University of Pennsylvania and an M.B.A. from the University of Chicago.
13
<PAGE>
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
In November 1997, the Company issued units (the "Units") consisting of one
share of Common Stock (the "Common Stock") and one Common Stock Purchase
Warrant (the "Warrants"). On December 1, 1997, the Common Stock and Warrants
commenced trading separately, and on December 8, 1997, the Units ceased
trading.
The Units were quoted on the Nasdaq SmallCap Market ("Nasdaq SmallCap")
tier of the Nasdaq Stock Market ("Nasdaq") under the symbol "DPMDU". The Units
commenced trading on the Nasdaq SmallCap on November 5, 1997. The following
table sets forth, for the period indicated, the high and low closing prices for
the Units as reported on the Nasdaq:
<TABLE>
<CAPTION>
1997 High Low
------------------------------------------
<S> <C> <C>
Fourth Quarter (from November 5, 1997 to December 8, 1997) $6-15/16 $4
</TABLE>
The Company's Common Stock is quoted on the Nasdaq SmallCap under the
symbol "DPMD". The Company's Common Stock commenced trading on the Nasdaq
SmallCap on December 1, 1997. The following table sets forth, for the period
indicated, the high and low closing prices for the Company's Common Stock as
reported by the Nasdaq:
<TABLE>
<CAPTION>
1997 High Low
--------------------------------------
<S> <C> <C>
Fourth Quarter (from December 1, 1997)............................ $4-7/16 $2-1/2
</TABLE>
The Warrants are quoted on the Nasdaq SmallCap under the symbol "DPMDW".
The Warrants commenced trading on the Nasdaq SmallCap on December 1, 1997. The
following table sets forth, for the period indicated, the high and low closing
prices of the Warrants as reported by the Nasdaq:
<TABLE>
<CAPTION>
1997 High Low
--------------------------------------
<S> <C> <C>
Fourth Quarter (from December 1, 1997)............................ $2-3/16 $1/4
</TABLE>
As of January 31, 1998, the numbers of holders of record of the Common Stock
and the Warrants were 55 and 10, respectively.
The Company has never paid a cash dividend on its Common Stock and does not
anticipate paying any cash dividends for the foreseeable future.
RECENT SALES OF UNREGISTERED SECURITIES
During the past three years, the Company has issued the securities set
forth below which were not registered under the Securities Act of 1933, as
amended (the "Securities Act").
14
<PAGE>
In March 1994, DSI, a company founded and principally owned by Dr. John W.
Shell, was merged into M6. In August 1995, pursuant to a settlement agreement
between DSI and Dr. Shell, on the one hand, and M6, on the other hand, M6
transferred all of the intellectual property and other technology assets
attributable to DSI to the Company, and the Company assumed certain liabilities
related thereto. In September 1995, the Company issued 2,066,667 shares of its
Common Stock to Dr. Shell and other prior shareholders of DSI in cancellation of
the M6 stock received in the merger. The shares were issued under section 4(2)
of the Securities Act.
In September 1995, the Company also issued 1,196,491 shares of Common Stock
to CSO Ventures LLC ("CSO") in consideration of the prior agreement of CSO to
lend the Company $100,000 to finance the litigation against M6 and to assist the
Company in its initial financing. The shares were issued under section 4(2) of
the Securities Act.
In November 1995, the Company sold 2,447,368 shares of Series A Preferred
Stock to certain accredited investors. The shares were issued under section
4(2) of the Securities Act.
In the first quarter of 1997, the Company sold 278,500 shares of Series B
Preferred Stock to eight accredited investors. The shares were issued under
section 4(2) of the Securities Act.
USE OF PROCEEDS FROM REGISTERED SECURITIES
On November 4, 1997, a Registration Statement on Form SB-2 (No. 333-25445)
was declared effective by the Securities and Exchange Commission pursuant to
which 1,200,000 Units were offered and sold for the account of the Company at
a price of $6.10 per Unit, generating $7,320,000 in gross proceeds to the
Company. The initial public offering was managed by National Securities
Corporation.
From the effective date of the Registration Statement to December 31, 1997,
the Company incurred approximately $586,000 in underwriting discounts and
commissions, approximately $231,000 of expenses paid to or for the
underwriters, and approximately $667,000 in other related expenses. The net
proceeds of the offering, after deducting the foregoing expenses, were
approximately $5,836,000. Approximately $1,650,000 of the proceeds of the
initial public offering were used to repay indebtedness of the Company,
including repayment of indebtedness of approximately $308,000 to certain
related parties. In addition, upon consummation of the initial public
offering, the Company paid Dr. John W. Fara, the Company's Chief Executive
Officer, an incentive bonus of $100,000.
From the effective date of the Registration Statement to December 31, 1997,
the Company has used approximately $319,000 to fund ongoing operations.
15
<PAGE>
ITEM 6. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
The statements in "Management's Discussion and Analysis of Financial
Condition and Results of Operations" that are not historical are forward-looking
statements which involve risks and uncertainties. Actual results, events or
performance may differ materially from those anticipated in these forward-
looking statements as a result of a variety of factors, including those set
forth under "Factors That May Affect Future Results" and elsewhere in this
Annual Report on Form 10-KSB. Readers are cautioned not to place undue reliance
on these forward-looking statements, which speak only as of the date hereof.
The Company undertakes no obligation to publicly release the result of any
revisions to these forward-looking statements that may be needed to reflect
events or circumstances after the date hereof or to reflect the occurrence of
unanticipated events.
OVERVIEW
GENERAL
Since its inception in August 1995, the Company has devoted substantially
all its efforts to research and development conducted on its own behalf and
through collaborations with pharmaceutical partners in connection with the
DepoMed Systems. The Company's primary activities since inception (August 7,
1995) have been, in addition to research and development, establishing its
offices and research facilities, recruiting personnel, filing patent
applications, developing a business strategy and raising capital. To date, the
Company has received only limited revenue, all of which has been from
collaborative research and feasibility arrangements. At its inception in 1995,
the Company acquired $298,154 of in-process research and development technology.
This amount was recognized as operating expense in 1995. There was no such
expense in 1996. The Company has generated a cumulative net loss of $2,309,893
for the period from its inception through December 31, 1997.
The Company intends to continue investing in the further development of its
drug delivery technologies and the DepoMed Systems. The Company also intends to
develop generic compounds, such as a reduced irritation aspirin product and an
enhanced absorption calcium supplement product, internally. Depending upon a
variety of factors, including collaborative arrangements, available personnel
and financial resources, the Company will conduct or fund clinical trials on
such products and will undertake the associated regulatory activities. The
Company will need to make additional capital investments in laboratories and
related facilities, including acquisition of laboratory and pilot scale
manufacturing equipment. As additional personnel are hired in 1998 and beyond,
expenses can be expected to increase from their 1997 levels.
RESULTS OF OPERATIONS
Years Ended December 31, 1997 and 1996
Revenues for the years ended December 31, 1997 and 1996 were $604,876 and
$317,971, respectively, and consisted entirely in 1997 and primarily in 1996 of
amounts earned under the research and development arrangement with BMS. The
Company anticipates that research and development payments from BMS will decline
in 1998 as a result of the Company having completed most of the technology
transfer to BMS for the GR System. The Company expects to receive research and
development revenues in connection with the feasibility agreement with PRI
entered into in March 1998. If other, similar
16
<PAGE>
research agreements are concluded, the Company will receive research and
development revenues associated with them.
Research and development expenses for the year ended December 31, 1997 were
approximately $853,000, compared to approximately $390,000 during the year ended
December 31, 1996. The increase was due to the hiring of additional employees
and related expenses, and increased laboratory supplies. The Company entered
into a sublease for additional space in the first quarter of 1998, part of
which will be allocated to research and development. The Company plans to
hire additional laboratory personnel and, accordingly, anticipates that research
and development salaries, benefits, supplies and related expenses will increase
in 1998.
General and administrative expenses for the year ended December 31, 1997
were approximately $960,000, compared to approximately $394,000 during the year
ended December 31, 1996. The increase was due to the hiring of additional
employees, and related expenses and deferred compensation expense associated
with stock option grants. Further, as the result of becoming a public company
in 1997, the Company incurred for the first time such associated expenses as
directors' and officers' insurance, key person life insurance, and investor
relations. The Company entered into a sublease for additional space in the
first quarter of 1998, which will result in higher occupancy expense. The
Company plans to hire additional administrative personnel and accordingly
anticipates that salaries, benefits and related expenses will increase in
1998.
LIQUIDITY AND CAPITAL RESOURCES
Historically, the Company has financed operations principally from the sale
of equity securities. Proceeds raised from the sale of equity securities
include net proceeds of approximately $5,356,000 from the Company's initial
public offering in November 1997 and approximately $961,000 in aggregate net
proceeds from sales of preferred stock in 1995 and 1996. Approximately
$1,650,000 of the proceeds from the initial public offering were used to repay
indebtedness.
Cash used in operations in the year ended December 31, 1997 was
approximately $1,129,000 compared to approximately $391,000 for the year ended
December 31, 1996. During the year ended December 31, 1997 the increased net
loss, increases in accounts receivable and decreases in accrued compensation
more than offset increases in accounts payable and the effect of the
amortization of deferred compensation and decreases in accrued compensation.
Initial public offering costs of approximately $1,964,000 were offset against
gross proceeds. During the year ended December 31, 1996 increases in accrued
compensation and accounts payable were offset by the net loss and an increase in
accounts receivable.
Cash used in investing activities in the year ended December 31, 1997
totaled approximately $60,000 and consisted of purchases of laboratory
equipment, furniture and office equipment. Net cash provided by investing
activities in the year ended December 31, 1996 totaled approximately $51,000
and consisted of sales of short term investments offset by purchases of
laboratory equipment.
In February 1998 the Company completed a private placement of 1,000,000
shares of Common Stock at a price of $8.00 per share. The gross proceeds were
$8,000,000 and, after deductions of fees and expenses, the net proceeds were
approximately $7,500,000. See Note 9 of Notes to the Financial Statements.
The Company anticipates that its existing capital resources will enable it
to meet its capital and operational requirements through the end of 1999. Cash
needs of the Company may vary materially
17
<PAGE>
from those now planned because of results of research and development,
relationships with possible collaborative partners, changes in the focus and
direction of the Company's research and development programs, competitive and
technological advances, results of clinical testing, requirements of the FDA and
comparable foreign regulatory processes and other factors. The Company will
require substantial funds of its own or from third parties to conduct research
and development, preclinical and clinical testing, and to manufacture (or have
manufactured) and market (or have marketed) the products utilizing the DepoMed
Systems. The Company's existing capital resources may not be sufficient to fund
the Company's operations through commercialization of products yielding
sufficient revenues to support the Company's operations. The Company has no
credit facility or other committed sources of capital. To the extent capital
resources are insufficient to meet future capital requirements, the Company may
have to raise additional funds to continue the development of its technologies.
There can be no assurance that such funds will be available on favorable terms,
or at all. To the extent that additional capital is raised through the sale of
equity or convertible debt securities, the issuance of such securities could
result in dilution to the Company's shareholders. If adequate funds are not
available, the Company may be required to curtail operations significantly or to
obtain funds through entering into collaboration agreements on unattractive
terms. The Company's inability to raise capital would have a material adverse
effect on the Company.
NET OPERATING LOSSES
The Company has not generated any taxable income to date. At December 31,
1997, the net operating losses available to offset future taxable income for
federal income tax purposes were approximately $1,900,000. Because the Company
has experienced ownership changes, future utilization of carry forwards may be
limited in any fiscal year pursuant to Internal Revenue Code regulations. The
carryforwards expire at various dates beginning in 2010 through 2012 if not
utilized. As a result of the annual limitation, anticipated and future losses,
all or a portion of these carryforwards may expire before becoming available to
reduce the Company's federal income tax liabilities.
FACTORS THAT MAY AFFECT FUTURE RESULTS
EARLY STAGE OF DEVELOPMENT; WORKING CAPITAL DEFICIT; LIMITED REVENUES; LIMITED
OPERATING HISTORY
The Company is at an early stage of development and is subject to all the
business risks associated with a new enterprise, including constraints on the
Company's financial and personnel resources, lack of established credit
facilities and collaborative partnering relationships, and uncertainties
regarding product development and future revenues. At December 31, 1997, the
Company had an accumulated deficit of $2,309,893. The Company anticipates that
it will continue to incur substantial additional operating losses for at least
the next several years and expects cumulative losses to increase as the
Company's research and development efforts expand. The Company has had only
minimal revenues to date from collaborative research and development
arrangements and feasibility studies, and no revenues from product sales. There
can be no assurance as to when or whether it will be able to develop significant
sources of revenue or that its operations will become
18
<PAGE>
profitable, even if it is able to commercialize any products. The Company has
only a limited history of operations, consisting primarily of development of its
products and sponsorship of research.
NO ASSURANCE OF SUCCESSFUL PRODUCT DEVELOPMENT
The Company's research and development programs are at an early stage of
development. Substantial additional research and development will be necessary
in order for the Company to develop the DepoMed Systems, and there can be no
assurance that the DepoMed Systems will be developed or that products utilizing
the DepoMed Systems will be commercialized by the Company or third parties in a
timely manner or at all. In addition to further research and development
related to the DepoMed Systems, products utilizing the DepoMed Systems will
require clinical testing, regulatory approval and substantial additional
investment prior to commercialization. There can be no assurance that products
utilizing the DepoMed Systems will be successfully developed, prove to be safe
and efficacious in clinical trials, meet applicable regulatory standards, be
capable of being produced in commercial quantities at acceptable costs, be
eligible for third-party reimbursement from governmental or private insurers, be
successfully marketed or achieve market acceptance. Further, the DepoMed
Systems may prove to have undesirable or unintended side effects that may
prevent or limit their commercial use. The Company or its collaborative
partners may find that products that appeared promising in preclinical studies
do not demonstrate efficacy in larger-scale clinical trials and/or that such
products will not receive regulatory approvals. Accordingly, any product
development program undertaken by the Company may be curtailed, redirected or
eliminated at any time which could have a material adverse effect on the
Company.
NEED FOR SUBSTANTIAL ADDITIONAL FUNDS
The Company anticipates that its existing capital resources will enable it
to meet its capital and operational requirements through the end of 1999.
However, this expectation is based on the Company's current operating plan which
can change as a result of many factors and the Company could require additional
funding sooner than anticipated. The Company's cash needs may also vary
materially from those now planned because of results of research and
development, relationships with possible collaborative partners, changes in the
focus and direction of the Company's research and development programs,
competitive and technological advances, results of clinical testing,
requirements of the FDA and comparable foreign regulatory agencies and other
factors. The Company will require substantial funds of its own or from third
parties to conduct research and development, preclinical and clinical testing,
and to manufacture (or have manufactured) and market (or have marketed) the
products utilizing the DepoMed Systems. The Company's existing capital
resources are not expected to be sufficient to fund the Company's operations
through commercialization of products yielding sufficient revenues to support
the Company's operations. The Company has no credit facility or other committed
sources of capital. To the extent capital resources are insufficient to meet
future capital requirements, the Company will have to raise additional funds to
continue the development of the DepoMed Systems. There can be no assurance that
such funds will be available on favorable terms, or at all. To the extent that
additional capital is raised through the sale of equity or convertible debt
securities, the issuance of such securities could result in dilution to the
Company's shareholders. If adequate funds are not available, the Company may be
required to curtail operations significantly or to obtain funds through entering
into collaboration agreements on unattractive terms. The Company's inability to
raise capital would have a material adverse effect on the Company.
19
<PAGE>
DEPENDENCE ON AND NEED FOR COLLABORATIVE PARTNERS
The Company's strategy for the research, development, clinical testing,
manufacturing and commercialization of products utilizing the DepoMed Systems
requires entering into collaborative arrangements with pharmaceutical and/or
biotechnology companies. The Company has received substantially all of its
revenues since inception from its collaborative partners and intends to enter
into additional collaborative arrangements to fund the continued development of
the DepoMed Systems, commercialize potential products utilizing the DepoMed
Systems and assist in obtaining regulatory approval. Although the Company has
entered into a joint research agreement with BMS and a feasibility study with
PRI, there can be no assurance that either BMS or PRI will choose to continue to
fund these projects or enter into arrangements to commercialize products
utilizing the DepoMed Systems or, if they do, that any products utilizing the
DepoMed Systems will be successfully developed or commercialized. For example,
in May 1996, the Company and GalaGen Inc. ("GalaGen") entered into a
feasibility study involving the use of the GR System to deliver oral
immunoglobulin products developed by GalaGen. Although the study demonstrated
the effectiveness of the GR System in protecting GalaGen's incorporated
product while the GR System was in simulated gastric fluid, GalaGen has not
chosen to enter into a product development agreement with the Company.
Further, there can be no assurance that any of the Company's present or future
collaborative partners will perform their obligations as expected or will
devote sufficient resources to the development, clinical testing or marketing
of the Company's potential products developed under the collaborations or that
the Company will be able to negotiate future collaborative arrangements on
acceptable terms, if at all, or that such collaborations will be successful.
Any parallel development by a collaborative partner of alternative
technologies or products, preclusion of the Company from entering into
competitive arrangements, failure to obtain timely regulatory approvals,
premature termination of an agreement, or failure by a collaborative partner
to devote sufficient resources to the development and commercialization of
products utilizing the DepoMed Systems could have a material adverse effect on
the Company.
The Company's agreements with its collaborative partners are likely to be
complex. There may be provisions within such agreements which give rise to
disputes regarding the rights and obligations of the parties. These and other
possible disagreements could lead to delays in collaborative research,
development or commercialization of potential products, or could require or
result in litigation or arbitration, which would be time-consuming and
expensive, and could have a material adverse effect on the Company.
FLUCTUATIONS IN OPERATING RESULTS
The Company's quarterly operating results will depend upon variations in
revenues recognized under existing and possible future collaborative agreements,
including milestones, royalties, license fees and other contract revenues, and
the timing of any future product introductions by the Company and its
collaborative partners. The Company's quarterly operating results may also
fluctuate significantly depending on other factors, including the introduction
of new products by the Company's competitors, regulatory actions, market
acceptance of the DepoMed Systems, adoption of new technologies, manufacturing
costs and capabilities, changes in government funding, and third-party
reimbursement policies.
RELATIONSHIPS OF ADVISORS WITH OTHER ENTITIES
The Company has two groups of advisors (the Policy Advisory Board and
Development Advisory Board) that advise the Company on business and scientific
issues and on future opportunities. As compensation for these services, the
Company has granted the advisors options to purchase shares of Common Stock and,
in certain cases, pays them consulting fees. Certain members of the Company's
Policy Advisory Board and Development Advisory Board are employed on a full-time
basis by academic or research institutions. In some cases, members of the Policy
Advisory Board and Development Advisory Board also act as consultants to other
20
<PAGE>
companies. In addition, except for work performed specifically for and at the
direction of the Company, any inventions or processes discovered by such persons
will be the intellectual property of their institutions or other companies. If
the Company desires access to inventions which are not its property, it will be
necessary for the Company to obtain licenses to such inventions from these
institutions or companies. In addition, invention assignment agreements executed
by such persons in connection with their relationships with the Company may be
subject to the rights of their primary employers or other third parties with
whom they have consulting relationships.
HEALTHCARE REFORM; UNCERTAIN AVAILABILITY OF HEALTHCARE REIMBURSEMENT
The healthcare industry is changing rapidly as the public, government,
medical professionals, third-party payors and the pharmaceutical industry
examine ways to contain or reduce the cost of health care. Changes in the
healthcare industry could impact the Company's business, particularly to the
extent that the Company develops the DepoMed Systems for use in prescription
drug applications. In certain foreign markets pricing or profitability of
prescription pharmaceuticals is subject to government control. In the United
States, there have been, and the Company expects that there will continue to be,
a number of federal and state proposals to implement similar government control
or cost containment, particular with respect to Medicare payments. In addition,
emphasis on managed care in the United States has increased and is expected to
continue to increase the pressure on pharmaceutical pricing. While the Company
cannot predict whether any such legislative or regulatory proposals will be
adopted or the effect such proposals or managed care efforts may have on its
business, the announcement of such proposals or efforts could have a material
adverse effect on the Company's ability to raise capital, and the adoption of
such proposals or efforts could have a material adverse effect on the Company.
Further, to the extent that such proposals or efforts have a material adverse
effect on pharmaceutical and biotechnology companies or other healthcare
providers that are prospective collaborative partners for the Company, the
Company's ability to establish collaborations may be adversely affected. In
addition, in both domestic and foreign markets, sales of products utilizing the
DepoMed Systems will depend in part on the availability of reimbursement from
third-party payors such as government health administration authorities, private
health insurers and other organizations. Third-party payors are increasingly
challenging the price and cost-effectiveness of prescription pharmaceutical
products. Significant uncertainty exists as to the reimbursement status of
newly approved healthcare products. There can be no assurance that products
utilizing the DepoMed Systems will be considered cost effective or that adequate
third-party reimbursement will be available to the Company's collaborators to
maintain price levels sufficient to realize an appropriate return on the
Company's investment in the DepoMed Systems.
YEAR 2000
As the year 2000 approaches, an issue impacting all companies has emerged
regarding how existing application software programs and operating systems can
accommodate this date value. In brief, many existing application software
products in the marketplace were designed to accommodate only a two digit date
position which represents the year (e.g., "95" is stored on the system and
represents the year 1995). As a result, the year 1999 (i.e., "99") could be
the maximum date value systems will be able to accurately process. Management
is in the process of working with its software consultants to assure that the
Company is prepared for the year 2000. Management does not anticipate that the
Company will incur significant operating expenses or be required to invest
heavily in computer system improvements to be year 2000 compliant.
ITEM 7. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The financial statements and supplementary data required by Item 7 are set
forth below on pages F-1 through F-19.
ITEM 8. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
Not applicable.
21
<PAGE>
PART III
ITEM 9. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The information required by this Item with respect to executive officers is
set forth in Part I of this report and the information with respect to directors
is incorporated by reference to the information set forth under the caption
"Election of Directors" in the proxy statement (the "Proxy Statement") for the
1998 annual meeting of shareholders.
The section entitled "Compliance Under Section 16(a) of the Securities
Exchange Act of 1934" appearing in the Proxy Statement sets forth the
information concerning compliance by officers, directors and 10% shareholders
of the Company with Section 16 of the Securities Exchange Act of 1934, as
amended, and is incorporated herein by reference.
ITEM 10. EXECUTIVE COMPENSATION
The information required by this Item is incorporated herein by reference
to the information set forth under the caption "Executive Compensation" in the
Proxy Statement.
ITEM 11. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information required by this Item is incorporated herein by reference
to the information set forth under the caption "Security Ownership of Certain
Beneficial Owners and Management" in the Proxy Statement.
ITEM 12. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information required by this Item is incorporated herein by reference
to the information set forth under the caption "Certain Relationships and
Related Transactions" in the Proxy Statement.
22
<PAGE>
ITEM 13. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
(a)1. FINANCIAL STATEMENTS.
Included in Part II of this report.
(a)2. FINANCIAL STATEMENT SCHEDULES.
All schedules have been omitted because the required information is not
present or because the information required is included in the financial
statements, including the notes thereto.
(a)3. EXHIBITS:
<TABLE>
<CAPTION>
<C> <S>
*3.1 Third Amended and Restated Articles of Incorporation
*3.2 Form of Amended and Restated Articles of Incorporation
*3.3 Bylaws
*3.4 Certificate of Amendment to the Third Amended and Restated Articles of Incorporation
*4.1 Specimen Common Stock Certificate
*4.2 Specimen Warrant Certificate (filed as Exhibit A to the Form of Warrant Agreement)
*4.3 Form of Representative's Warrant Agreement including form of Representative's Warrant
*4.4 Form of Warrant Agreement
*4.5 Form of Lock-up Agreement
*10.1 1995 Stock Option Plan, as amended
*+10.2 Agreement dated July 11, 1996 between the Company and Bristol-Myers Squibb Company
*+10.3 Feasibility Agreement dated May 13, 1996 between the Company and GalaGen Inc.
*10.4 Agreement dated March 18, 1997 between the Company and CSO Ventures LLC
*10.5 Lease Agreement between the Company and 1170 Chess Drive Limited Partnership dated
September 2, 1992
*10.6 First Amendment to lease agreement dated January 1, 1996 between the Company and SKW II
Real Estate Partnership
*10.7 Employment Agreement between DepoMed, Inc. and John W. Shell
*10.8 Employment Agreement between DepoMed, Inc. and John W. Fara
*10.9 Agreement re: Settlement of Lawsuit, Conveyance of Assets and Assumption of Liabilities
dated August 28, 1995 by and among DepoMed Systems, Inc., Dr. John W. Shell and M6
Pharmaceuticals, Inc.
*10.10 Form of Indemnification Agreement between the Company and its directors and executive
officers
*10.11 Letter Agreement dated October 25, 1996 between the Company and John W. Fara
*10.12 Form of Agreement between the Company and Burrill & Company
24.1 Power of Attorney (see page 25)
27.1 Financial Data Schedule
</TABLE>
_____________
* Incorporated by reference to the Company's registration statement on
Form SB-2 (File No. 333-25445)
+ Confidential treatment granted.
23
<PAGE>
(b) REPORTS ON FORM 8-K:
None.
24
<PAGE>
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the issuer, a corporation organized and existing under the
laws of the State of California, has duly caused this report to be signed on its
behalf by the undersigned thereunto duly authorized, in the City of Foster City,
State of California, on the 30th day of March, 1998.
DEPOMED, INC.
By /s/ John W. Fara
_______________________________________
John W. Fara
President and Chief Executive Officer
POWERS OF ATTORNEY
KNOW ALL PERSONS BY THESE PRESENTS, each person whose signature appears
below constitutes and appoints John W. Fara, John W. Shell and John F. Hamilton
his true and lawful attorneys-in-fact and agents, each acting alone, with full
power of substitution and resubstitution, for him and in his name, place and
stead, in any and all capacities, to sign any or all amendments to the Annual
Report on Form 10-KSB, and to file the same, with all exhibits thereto, and all
documents in connection therewith, with the Securities and Exchange Commission,
granting unto said attorneys-in-fact and agents, full power and authority to do
and perform each and every act and thing requisite and necessary to be done in
and about the premises, as fully to all intents and purposes as he might or
could do in person, hereby ratifying and confirming all that said attorneys-in-
fact and agents, each acting alone, or his substitute or substitutes, may
lawfully do or cause to be done by virtue hereof.
Pursuant to the requirements of the Securities Exchange Act of 1934, this
Annual Report on Form 10-KSB has been signed by the following persons in the
capacities and on the dates indicated.
<TABLE>
<CAPTION>
<S> <C> <C>
Chairman of the
/s/ John W. Shell, Ph.D. Board of Directors
- --------------------------------------------- and Chief March 30, 1998
John W. Shell, Ph.D. Scientific Officer
President, Chief
/s/ John W. Fara, Ph.D. Executive Officer
- --------------------------------------------- and Director March 30, 1998
John W. Fara, Ph.D. (Principal
Executive Officer)
/s/ John N. Shell Vice President,
- --------------------------------------------- Operations and March 30, 1998
John N. Shell Director
Vice President,
/s/ John F. Hamilton Finance and Chief
- --------------------------------------------- Financial Officer March 30, 1998
John F. Hamilton (Principal
Financial Officer)
</TABLE>
25
<PAGE>
<TABLE>
<CAPTION>
<S> <C> <C>
/s/ G. Steven Burrill
- --------------------------------------------- Director March 30, 1998
G. Steven Burrill
/s/ Judson A. Cooper
- --------------------------------------------- Director March 30, 1998
Judson A. Cooper
/s/ Joshua Schein, Ph.D.
- --------------------------------------------- Director March 30, 1998
Joshua Schein, Ph.D.
/s/ W. Leigh Thompson, Ph.D.
- --------------------------------------------- Director March 30, 1998
W. Leigh Thompson, Ph.D.
</TABLE>
26
<PAGE>
DepoMed, Inc.
(a development stage company)
INDEX TO FINANCIAL STATEMENTS
<TABLE>
<CAPTION>
FINANCIAL STATEMENTS
<S> <C>
Report of Ernst & Young LLP, Independent Auditors.................... F-2
Balance Sheet........................................................ F-3
Statements of Operations............................................. F-4
Statement of Shareholders' Equity (Net Capital Deficiency)........... F-5
Statements of Cash Flows............................................. F-6
Notes to Financial Statements........................................ F-7
</TABLE>
F-1
<PAGE>
REPORT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS
The Board of Directors
DepoMed, Inc.
We have audited the accompanying balance sheet of DepoMed, Inc. (a development
stage company) as of December 31, 1997, and the related statements of
operations, shareholders' equity (net capital deficiency), and cash flows for
the years ended December 31, 1997 and 1996 and for the period from inception
(August 7, 1995) to December 31, 1997. These financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the financial position of DepoMed, Inc. (a development
stage company) at December 31, 1997, and the results of its operations and its
cash flows for the years ended December 31, 1997 and 1996 and for the period
from inception (August 7, 1995) to December 31, 1997, in conformity with
generally accepted accounting principles.
/S/ ERNST & YOUNG LLP
Palo Alto, California
February 27, 1998
F-2
<PAGE>
DEPOMED, INC.
(a development stage company)
BALANCE SHEET
<TABLE>
<CAPTION>
December 31,
1997
-------------
<S> <C>
ASSETS
Current assets:
Cash and cash equivalents $ 4,129,545
Accounts receivable 144,887
Other current assets 100,679
-----------
Total current assets 4,375,111
Property and equipment, net 199,818
Other assets 10,415
-----------
$ 4,585,344
===========
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 279,256
Accrued compensation 35,547
Capital lease obligation, current portion 29,655
Other current liabilities 74,086
-----------
Total current liabilities 418,544
Capital lease obligation, non-current portion 33,737
Shareholders' equity:
Preferred stock, no par value; 5,000,000 shares
authorized, none issued and outstanding
Common stock, no par value, 25,000,000 shares
authorized; 5,463,438 shares issued and outstanding 6,843,670
Deferred compensation (400,714)
Deficit accumulated during the development stage (2,309,893)
-----------
Total shareholders' equity 4,133,063
-----------
$ 4,585,344
===========
</TABLE>
See accompanying notes.
F-3
<PAGE>
DEPOMED, INC.
(a development stage company)
STATEMENTS OF OPERATIONS
<TABLE>
<CAPTION>
INCEPTION
(AUGUST 7,
YEAR ENDED DECEMBER 31, 1995) TO
----------------------------------- DECEMBER 31,
1997 1996 1997
-----------------------------------------------------
<S> <C> <C> <C>
Product development revenue $ 604,876 $ 317,971 $ 922,847
Operating expenses:
Research and development 853,124 390,496 1,382,436
General and administrative 960,059 393,676 1,508,892
Purchase of in-process research and
development -- -- 298,154
----------- ---------- -----------
Total operating expenses 1,813,183 784,172 3,189,482
Loss from operations (1,208,307) (466,201) (2,266,635)
Interest expense, net 28,145 6,572 43,258
----------- ---------- -----------
Net loss $(1,236,452) $ (472,773) $(2,309,893)
=========== ========== ===========
Basic and diluted net loss per share (pro
forma in 1996) $ (0.34) $ (0.12)
=========== ==========
Shares used in computing basic and
diluted net loss per share (pro forma in
1996) 3,664,242 4,101,536
=========== ==========
</TABLE>
See accompanying notes.
F-4
<PAGE>
DEPOMED, INC.
(a development stage company)
STATEMENT OF SHAREHOLDERS' EQUITY (NET CAPITAL DEFICIENCY)
From inception (August 7, 1995) to December 31, 1997
<TABLE>
<CAPTION>
CONVERTIBLE PREFERRED
STOCK COMMON STOCK
----------------------------------------------
SHARES AMOUNT SHARES
----------------------------------------------
<S> <C> <C> <C>
Balances at inception (August 7, 1995) -- $ -- --
Issuance of common shares to founders on August 7,
1995 in exchange for shares held by them in M6
Pharmaceuticals, Inc. -- -- 2,066,666
Issuance of common shares for cash to investors at
approximately $0.0009 per share on November 15, 1995 -- -- 1,196,491
Issuance of Series A convertible preferred stock for
cash to investors at approximately $0.31 per share on
November 15, 1995, net of issuance costs of $67,241 2,447,368 682,759 --
Net loss -- -- --
---------- -------- ---------
Balances at December 31, 1995 2,447,368 682,759 3,263,157
Issuance of common shares for cash at various dates at
$0.09 per share to employees and the Company's
counsel pursuant to stock option agreements -- -- 91,666
Deferred compensation related to grants of certain
stock options -- -- --
Net loss -- -- --
---------- -------- ---------
Balances at December 31, 1996 2,447,368 682,759 3,354,823
Issuance of Series B convertible preferred stock to
investors for cash at $1.00 per share 278,500 278,500 --
Conversion of preferred stock to common stock on
November 5, 1997 at a ratio of one share of common
for three shares of preferred (2,725,868) (961,259) 908,615
Issuance of common stock for $6.10 per unit on
November 5, 1997 in connection with initial public
offering (net of issuance costs of $1,963,889) -- -- 1,200,000
Deferred compensation related to grants of certain
stock options -- -- --
Amortization of deferred compensation -- -- --
Net loss -- -- --
---------- -------- ---------
Balances at December 31, 1997 -- $ -- 5,463,438
========== ========= =========
</TABLE>
<TABLE>
<CAPTION>
DEFICIT TOTAL
ACCUMULATED SHAREHOLDERS'
COMMON STOCK DURING EQUITY (NET
-------------- DEFERRED DEVELOPMENT CAPITAL
AMOUNT COMPENSATION STAGE DEFICIENCY)
------------------------------------------------------------
<S> <C> <C> <C> <C>
Balances at inception (August 7, 1995) $ -- $ -- $ -- $ --
Issuance of common shares to founders on August 7,
1995 in exchange for shares held by them in M6
Pharmaceuticals, Inc. -- -- -- --
Issuance of common shares for cash to investors at
approximately $0.0009 per share on November 15, 1995 1,000 -- -- 1,000
Issuance of Series A convertible preferred stock for
cash to investors at approximately $0.31 per share on
November 15, 1995, net of issuance costs of $67,241 -- -- -- 682,579
Net loss -- -- (600,668) (600,668)
---------- --------- ----------- -----------
Balances at December 31, 1995 1,000 -- (600,668) 83,091
Issuance of common shares for cash at various dates at
$0.09 per share to employees and the Company's
counsel pursuant to stock option agreements 8,250 -- -- 8,250
Deferred compensation related to grants of certain
stock options 275,000 (275,000) -- --
Net loss -- -- (472,773) (472,773)
---------- --------- ----------- -----------
Balances at December 31, 1996 284,250 (275,000) (1,073,441) (381,432)
Issuance of Series B convertible preferred stock to
investors for cash at $1.00 per share -- -- -- 278,500
Conversion of preferred stock to common stock on
November 5, 1997 at a ratio of one share of common -- -- -- --
for three shares of preferred 961,259 -- -- --
Issuance of common stock for $6.10 per unit on
November 5, 1997 in connection with initial public
offering (net of issuance costs of $1,963,889) 5,356,111 -- -- 5,356,111
Deferred compensation related to grants of certain
stock options 242,050 (242,050) -- --
Amortization of deferred compensation -- 116,336 -- 116,336
Net loss -- -- (1,236,452) (1,236,452)
---------- --------- ----------- -----------
Balances at December 31, 1997 $6,843,670 $(400,714) $(2,309,893) $ 4,133,063
========== ========= =========== ===========
</TABLE>
F-5
<PAGE>
DEPOMED, INC.
(a development stage company)
STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
INCEPTION
(AUGUST 7, 1995)
YEAR ENDED DECEMBER 31 TO DECEMBER 31,
----------------------------------------------------
1997 1996 1997
----------------------------------------------------
<S> <C> <C> <C>
OPERATING ACTIVITIES
Net loss $(1,236,452) $(472,773) $(2,309,893)
Adjustments to reconcile net loss to net cash used
in operating activities:
Depreciation and amortization 56,904 32,878 102,016
Accrued interest expense on shareholder notes -- 10,688 13,618
Amortization of deferred compensation expense 116,336 -- 116,336
Purchase of in-process research and development -- -- 298,154
Changes in assets and liabilities:
Accounts receivable (23,989) (120,898) (144,887)
Other current assets (69,142) (22,393) (100,679)
Other assets 4,336 (4,675) (10,415)
Accounts payable 227,510 39,746 279,256
Accrued compensation (255,827) 161,615 (31,929)
Other current liabilities 51,322 (15,504) 74,086
----------- --------- -----------
Net cash used in operating activities (1,129,002) (391,316) (1,714,337)
----------- --------- -----------
INVESTING ACTIVITIES
Expenditures for property and equipment (59,656) (28,708) (138,009)
Purchases of short-term investments -- -- (79,582)
Sales of short-term investments -- 79,582 79,582
----------- --------- -----------
Net cash (used in) provided by investing activities (59,656) 50,874 (138,009)
----------- --------- -----------
FINANCING ACTIVITIES
Payments on capital lease obligations (32,972) (45,013) (100,491)
Proceeds from issuance of notes 1,000,000 50,000 1,050,000
Payments of notes (1,000,000) -- (1,000,000)
Payment of shareholder loans (294,238) -- (294,238)
Proceeds on issuance of common stock 5,356,111 8,250 5,365,361
Proceeds on issuance of preferred stock 278,500 -- 961,259
----------- --------- -----------
Net cash provided by financing activities 5,307,401 13,237 5,981,891
----------- --------- -----------
Net increase (decrease) in cash and cash equivalents 4,118,743 (327,205) 4,129,545
Cash and cash equivalents at beginning of year 10,802 338,007 --
----------- --------- -----------
Cash and cash equivalents at end of year $ 4,129,545 $ 10,802 $ 4,129,545
=========== ========= ===========
SUPPLEMENTAL SCHEDULE OF NONCASH FINANCING AND
INVESTING ACTIVITIES
Acquisition of property and equipment under capital
leases $ 41,927 $ 56,393 $ 163,883
=========== ========= ===========
Assumption of net liabilities of M6 Pharmaceuticals
at inception (August 7, 1995) $ -- $ -- $ 298,154
=========== ========= ===========
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION
Cash paid during the period for interest $ 109,623 $ 5,695 $ 121,811
=========== ========= ===========
</TABLE>
See accompanying notes.
F-6
<PAGE>
DEPOMED, INC.
(A DEVELOPMENT STAGE COMPANY)
NOTES TO FINANCIAL STATEMENTS
1. ORGANIZATION AND BASIS OF PRESENTATION
ORGANIZATION
DepoMed, Inc. (the "Company"), a development stage company, was incorporated in
the State of California on August 7, 1995. The Company is engaged in the
research and development of oral drug delivery systems. The Company's primary
activities since incorporation have been establishing its offices and research
facilities, recruiting personnel, conducting research and development,
performing business and strategic planning and raising capital.
In March 1994, DepoMed Systems, Inc. ("DSI"), a company founded and principally
owned by Dr. John W. Shell, the founder of the Company, was merged into M6
Pharmaceuticals, Inc. ("M6"). In August 1995, pursuant to a settlement
agreement (the "1995 Settlement Agreement") among M6, DSI and Dr. Shell, M6
transferred all of the assets related to the research, development, marketing,
production and sale of oral drug delivery systems and technology developed by or
under the direction of Dr. Shell to the Company, and the Company assumed certain
net liabilities totaling $298,154 related thereto. Such amount has been
reflected in the statement of operations as a charge for the purchase of in-
process research and development.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
CASH AND CASH EQUIVALENTS
The Company considers all highly liquid investments purchased with an original
maturity from the date of purchase of three months or less to be cash
equivalents. All liquid investments are classified as cash equivalents and
consist of commercial paper with maturities less than three months. The Company
places its cash and cash equivalents with a high quality, U.S. financial
institution and, to date, has not experienced losses on any of its balances.
The Company records cash and cash equivalents at cost, which approximates the
fair value.
DEPRECIATION AND AMORTIZATION
Property and equipment are stated at cost, less accumulated depreciation and
amortization. Depreciation is provided using the straight-line method over the
estimated useful lives of the respective assets, generally three to five years.
Leasehold improvements are amortized over the lesser of the lease term or the
estimated useful lives of the related assets, generally four years.
F-7
<PAGE>
DEPOMED, INC.
(A DEVELOPMENT STAGE COMPANY)
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
USE OF ESTIMATES
The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions that
affect the amounts reported in the financial statements and accompanying notes.
Actual results could differ from those estimates.
STOCK-BASED COMPENSATION
The Company accounts for stock options granted to employees using the intrinsic-
value method and thus recognizes no compensation expense for options granted
with exercise prices equal to the fair value of the Company's common stock on
the date of the grant.
NET LOSS PER SHARE
Effective December 31, 1997, the Company adopted Statement of Financial
Accounting Standards No. 128 "Earnings Per Share" ("SFAS 128"). SFAS 128
requires the presentation of basic earnings (loss) per share and diluted
earnings per share, if more dilutive, for all periods presented.
In accordance with SFAS 128, basic net loss per share has been computed using
the weighted average number of shares of common stock outstanding during the
period. The Company also adopted the provisions of Securities and Exchange
Commission Staff Bulletin No. 98, which resulted in the removal of certain
shares which had been included in the calculation in the periods prior to the
Company's initial public offering. Diluted net loss per share has not been
presented as, given the Company's net loss position, the result would be anti-
dilutive.
Pro forma net loss per share as presented in the statement of operations for
1996 has been computed as described above and also gives effect to the
conversion of the convertible preferred stock that automatically converted
into shares of common stock upon completion of the Company's initial public
offering (using the as-if converted method) from the original date of
issuance.
F-8
<PAGE>
DEPOMED, INC.
(A DEVELOPMENT STAGE COMPANY)
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
NET LOSS PER SHARE (CONTINUED)
A reconciliation of the shares used in the calculation of basic and diluted and
pro forma net loss per share follows:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
1997 1996
-------------------------------
<S> <C> <C>
Net loss $(1,236,452) $ (472,773)
=========== ==========
Weighted average shares of common
stock outstanding 3,664,242 3,285,747
=========== ==========
Basic and diluted net loss per share $ (0.34) $ (0.14)
=========== ==========
Pro forma:
Weighted average shares of common
stock outstanding 3,664,242 3,285,747
Adjustment to reflect the effect of
assumed conversion of preferred
stock to common stock as of date of
issuance 775,292 815,789
----------- ----------
Shares used in calculating pro forma
net loss per share 4,439,534 4,101,536
=========== ==========
Pro forma net loss per share $ (0.28) $ (0.12)
=========== ==========
</TABLE>
REVENUE RECOGNITION
Product development revenue relates to the reimbursement of costs incurred for
research and development and the achievement of milestones as specified in the
related agreement and are recorded as earned.
F-9
<PAGE>
DEPOMED, INC.
(A DEVELOPMENT STAGE COMPANY)
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
EFFECT OF NEW ACCOUNTING STANDARDS
In June 1997, the Financial Accounting Standards Board issued Statement No. 130,
"Reporting Comprehensive Income" ("FAS 130"), and Statement No. 131,
"Disclosures about Segments of an Enterprise and Related Information" ("FAS
131"). The Company is required to adopt these Statements in 1998. FAS 130
establishes new standards for reporting and displaying comprehensive income and
its components. FAS 131 requires disclosure of certain information regarding
operating segments, products and services, geographic areas of operation and
major customers. Adoption of these Statements is expected to have no material
impact on the Company's financial position, results of operations or cash flows.
3. RESEARCH ARRANGEMENTS
BRISTOL-MYERS SQUIBB COMPANY
In July 1996, the Company and Bristol-Myers Squibb Company ("BMS") entered into
a joint research agreement to develop a product incorporating a BMS proprietary
compound into the DepoMed Gastric Retention System ("GR System"). Pursuant to
the agreement, the Company achieved all the specified milestones and recorded
approximately $198,000 in product development revenues in 1996, the entire fee
specified in the agreement. The amounts receivable under the agreement totaled
$57,778 as of December 31, 1996.
Also in 1997 and 1996, the Company performed contract research services for BMS
under an arrangement whereby BMS reimbursed specific research costs relating to
the same product. Revenue recognized in accordance with this arrangement
amounted to $604,876 and $110,000, and the amounts receivable under the
arrangement totaled $144,887 and $63,120 as of December 31, 1997 and 1996,
respectively.
Pursuant to the agreement, BMS has an option to obtain an exclusive, worldwide
license to products incorporating the BMS compound utilizing the GR System. If
such license is entered into, the Company will receive a royalty on net sales of
the products as well as certain milestone payments. The option expires in
February 1999.
F-10
<PAGE>
DEPOMED, INC.
(A DEVELOPMENT STAGE COMPANY)
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
3. RESEARCH ARRANGEMENTS (CONTINUED)
OAKMONT PHARMACEUTICALS, INC.
In April 1997, the Company and Oakmont signed a letter of intent to enter into
an agreement pursuant to which Oakmont will manufacture the Company's reduced
irritation aspirin and enhanced absorption calcium supplement products and have
rights to distribute and sell these products in territories to be determined.
The letter of intent also provided for the Company and Oakmont each to offer
rights to future products to the other party. The letter of intent expired
without a definitive agreement having been reached.
GALAGEN, INC.
In May 1996, the Company and GalaGen Inc. ("GalaGen") entered into a feasibility
study involving the use of the GR System to deliver oral immunoglobulin products
developed by GalaGen. Although the study demonstrated the effectiveness of the
GR System in protecting GalaGen's incorporated product while the GR System was
in simulated gastric fluid, GalaGen has not chosen to enter into a product
development agreement with the Company relating to the product.
4. PROPERTY AND EQUIPMENT
Property and equipment consists of the following:
<TABLE>
<CAPTION>
DECEMBER 31,
1997
-----------
<S> <C>
Furniture and office equipment $ 61,890
Laboratory equipment 209,240
Leasehold improvements 30,704
---------
301,834
Less accumulated depreciation and
amortization (102,016)
---------
$ 199,818
=========
</TABLE>
Property and equipment includes assets under capitalized leases of $163,883 at
December 31, 1997. Accumulated amortization related to assets under capital
leases totaled $37,605 at December 31, 1997.
F-11
<PAGE>
DEPOMED, INC.
(A DEVELOPMENT STAGE COMPANY)
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
5. COMMITMENTS AND CONTINGENCIES
LEASES
The Company leases its facilities under a noncancelable operating lease. The
facilities lease expires in February 1999 and includes an option to renew the
lease for an additional five years. In 1997, the Company entered into capital
leases with two lessors to finance capital expenditures. Future minimum lease
payments under the operating leases and capital leases at December 31, 1997,
together with the present value of the minimum lease payments, are as follows:
<TABLE>
<CAPTION>
OPERATING CAPITAL
LEASES LEASES
------- --------
<S> <C> <C>
Year ending December 31,
1998 $41,893 $ 36,958
1999 7,813 30,108
2000 -- 9,060
------- --------
Total minimum payments required $49,706 76,126
=======
Less amount representing
interest (12,734)
--------
Present value of future
lease payments 63,392
Less current portion (29,655)
--------
Noncurrent portion $ 33,737
========
</TABLE>
Rent expense for the years ended December 31, 1997 and 1996 and for the period
from inception to December 31, 1997 was approximately $48,486, $36,960 and
$101,286, respectively.
CONTINGENT LIABILITY
The Company has received a claim of approximately $250,000 from CSO Ventures
LLC ("CSO"), a related party, involving the payment of certain fees. The
Company's management, after reviewing available information relating to the
claim and consulting with the Company's legal counsel, believes that the claim
is without merit. In the event of an unanticipated adverse final determination
with respect to this matter, the Company's results of operations for the
period in which such determination occurs would be adversely affected by the
amount of such determination.
F-12
<PAGE>
DEPOMED, INC.
(A DEVELOPMENT STAGE COMPANY)
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
6. RELATED PARTY TRANSACTIONS
CSO VENTURES LLC
In September 1995, the Company issued 1,196,491 shares of common stock to CSO in
consideration of the prior agreement of CSO to lend the Company $100,000 to
finance the litigation against M6 and to assist the Company in its initial
financing. In September 1995, the Company also entered into a consulting
agreement with CSO, pursuant to which CSO provided financial advisory services
to the Company for an annual fee of $120,000. The consulting agreement
terminated in September 1996. In March 1997, the Company entered into a
consulting agreement with CSO which provides for business development,
operations and financial advisory services to be performed by CSO for an annual
fee of $120,000. The agreement has a term of one year and is renewed
automatically unless terminated by either party with 60 days written notice. Two
members of CSO are also directors of the Company. Through December 31, 1997 and
1996, the Company has paid $90,000 and $120,000, respectively, in fees to CSO
under these arrangements.
PROMISSORY NOTE TO THE CHAIRMAN OF THE BOARD
DSI entered into a promissory note with the Company's founder, a shareholder and
the Chairman of the Board of Directors, in each of December 1992 and 1993 in the
aggregate principal amount of $100,667. These notes were among the liabilities
assumed by the Company pursuant to the 1995 Settlement Agreement. In November
1996, the Company entered into a promissory note with the same individual in the
aggregate principal amount of $50,000. All the notes bore interest at 6% per
annum on the outstanding principal balance. The aggregate principal balance of
all outstanding notes including the related interest due the Chairman was
$171,488 as of December 31, 1996. The notes were repaid in November 1997.
PROMISSORY NOTE TO SHAREHOLDER
In July 1993, DSI signed two promissory notes with a shareholder who is also the
secretary to the Board of Directors. These notes were among the liabilities
assumed by the Company pursuant to the 1995 Settlement Agreement. The principal
of the notes aggregated $100,000 and bore interest at 6.5% per annum. The
aggregate principal balance of all outstanding notes including the related
interest due the shareholder was $122,750, as of December 31, 1996. The notes
were repaid in November 1997.
F-13
<PAGE>
DEPOMED, INC.
(A DEVELOPMENT STAGE COMPANY)
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
6. RELATED PARTY TRANSACTIONS (CONTINUED)
CONSULTING AGREEMENT
In September 1997, the Company entered into a one year consulting agreement with
Burrill & Co. to provide advisory services. The principal of Burrill & Co. is a
director of the Company. The agreement requires that the Company pay a monthly
retainer of $10,000 as well as additional fees related to Burrill & Co.'s
involvement in partnering arrangements. In 1997, the Company paid a total of
$40,396 in connection with this agreement. The Company may terminate the
arrangement at any time with sixty days notice.
7. SHAREHOLDERS' EQUITY
INITIAL PUBLIC OFFERING
The Company completed its initial public offering of common stock and common
stock purchase warrants on November 5, 1997. The offering consisted of
1,200,000 units ("Units"), each unit consisting of one share of common stock,
no par value, and a redeemable warrant to purchase one share of common stock
at an exercise price of $7.625 per share. The Warrants may be exercised at any
time beginning November 5, 1998 until November 4, 2002. The Company offered
these units to the public at a price of $6.10 per unit. Upon the completion of
the initial public offering, all of the convertible preferred shares
outstanding as of the closing date were automatically converted into 908,615
shares of common stock. The shares and warrants comprising the units were
detached and began trading separately on December 1, 1997.
In connection with a bridge financing, which was funded and repaid in 1997, the
Company issued to the bridge financing investors warrants to purchase 81,254
shares exercisable at $6.00 per share and 2,084 shares exercisable at $7.625 per
share. The bridge warrants may be exercised at any time beginning April 7, 1998
until April 7, 2002. The value of the warrants was deemed to be insignificant,
therefore, the Company did not record any value for these warrants.
1995 STOCK OPTION PLAN
The Company's 1995 Stock Option Plan (the "Plan") was adopted by the Board of
Directors and approved by the shareholders in September 1995, and has
subsequently been amended. As of December 31, 1997, a total of 1,000,000 shares
of common stock have been reserved for issuance under the Plan. The Plan
provides for the granting to employees of the Company, including officers and
employee directors, of incentive stock options, and for the granting of
nonstatutory stock options to employees and consultants of the Company.
F-14
<PAGE>
DEPOMED, INC.
(A DEVELOPMENT STAGE COMPANY)
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
7. SHAREHOLDERS' EQUITY (CONTINUED)
1995 STOCK OPTION PLAN (CONTINUED)
The exercise price of all stock options granted under the Plan must be at least
100% of the fair value of the common stock of the Company on the grant date. The
term of an incentive stock option may not exceed 10 years from the date of
grant. An option shall be exercisable on or after each vesting date in
accordance with the terms set forth in the option agreement; provided, however,
that the right to exercise an option generally vests at the rate of at least 25%
per year over four years from the grant date.
STOCK-BASED COMPENSATION
During 1996, the Company adopted Financial Accounting Standards Board Statement
No. 123 ("SFAS 123"). In accordance with SFAS 123, the Company applies APB 25 in
accounting for option grants to employees under the Plan and, accordingly, does
not recognize compensation expense for options granted to employees at fair
value, but does recognize compensation expense for options granted at prices
below fair value. The valuation related to stock options granted to non-
employees in 1996 was immaterial and, therefore, no value was recorded in the
financial statements in 1996. The Company used the minimum value method to
determine the fair value of stock options at the grant date issued in 1996,
and in 1997, up to the date of the initial public offering. The weighted
average assumptions used for 1996 were as follows; risk free rate of 6.4%,
expected dividend yield of zero, weighted-average expected option life of 4
years. The weighted average assumptions for 1997 are as follows (options
granted subsequent to the initial public offering have been valued using the
Black-Scholes option pricing model with the expected volatility .70); risk-
free interest rate of and 6.2%, expected dividend yield of zero, and a
weighted-average expected option life of 4 years. The weighted-average
estimated fair value of employee stock options granted during 1997 and 1996
was $1.92 and $0.51 per share for shares granted at fair value and $2.15 and
$3.51 per share for shares granted below fair value, respectively.
The option valuation models used in 1997, were developed for using in estimating
the fair value of traded options which have no vesting restrictions and are
fully transferable. In addition, option valuation models require the input of
highly subjective assumptions including the expected stock price volatility.
Because the Company's employee stock options have characteristics significantly
different from those of traded options, and because changes in the subjective
input assumptions can materially affect the fair value estimate, in management's
opinion, the existing models do not necessarily provide a reliable single
measure of the fair value of its employee stock options.
F-15
<PAGE>
DEPOMED, INC.
(A DEVELOPMENT STAGE COMPANY)
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
7. SHAREHOLDERS' EQUITY (CONTINUED)
STOCK-BASED COMPENSATION (CONTINUED)
For purposes of pro forma disclosures, the estimated fair value of the options
is amortized to expense over the option's vesting period. The Company's pro
forma information follows:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
--------------------------
1997 1996
--------------------------
<S> <C> <C>
Net loss - as reported $(1,236,452) $(472,773)
Net loss - pro forma $(1,275,943) $(548,811)
Net loss per share - as reported $(0.34) $(0.12)
Net loss per share pro forma $(0.35) $(0.13)
</TABLE>
A summary of the Company's stock option activity and related information for the
period from inception (August 7, 1995) to December 31, 1997 follows:
<TABLE>
<CAPTION>
OUTSTANDING OPTIONS
------------------------
WEIGHTED
SHARES AVERAGE
AVAILABLE NUMBER EXERCISE
FOR GRANT OF SHARES PRICE
----------------------------------
<S> <C> <C> <C>
Shares authorized 250,000 -- --
Options granted (120,000) 120,000 $0.09
-------- -------
Balance at December 31, 1995 130,000 120,000 $0.09
Shares authorized -- -- --
Options granted at fair value (3,334) 3,334 $0.09
Options granted below fair value (83,333) 83,333 $0.90
Options exercised -- (91,667) $0.09
-------- -------
Balance at December 31, 1996 43,333 115,000 $0.68
Shares authorized 750,000 -- --
Options granted at fair value (369,166) 369,166 $4.12
Options granted below fair value (153,333) 153,333 $3.00
Options exercised -- -- --
-------- -------
Balance at December 31, 1997 270,834 637,499 $3.23
======== =======
</TABLE>
F-16
<PAGE>
DEPOMED, INC.
(A DEVELOPMENT STAGE COMPANY)
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
7. SHAREHOLDERS' EQUITY (CONTINUED)
STOCK-BASED COMPENSATION (CONTINUED)
Exercisable options at December 31, 1997, totaled 76,628.
Exercise prices for options outstanding as of December 31, 1997 ranged from
$0.09 to $6.00. The following table summarizes information about options
outstanding at December 31, 1997:
<TABLE>
<CAPTION>
OUTSTANDING OPTIONS EXERCISABLE OPTIONS
----------------------------------- ----------------------------
WEIGHTED- WEIGHTED-
AVERAGE REMAINING AVERAGE-
EXERCISE NUMBER EXERCISE CONTRACTUAL NUMBER EXERCISE
PRICES OF OPTIONS PRICE LIFE OF OPTIONS PRICE
- ----------------------------------------------- ------------------------------
(In years)
<S> <C> <C> <C> <C> <C>
$0.09 31,667 $0.09 7.85 16,988 $0.09
0.90 83,333 0.90 8.82 24,640 0.90
3.00 153,333 3.00 9.15 -- --
3.75 297,499 3.75 9.95 -- --
5.25-6.00 71,667 5.64 9.48 35,000 6.00
------- ------
637,499 76,628
======= ======
</TABLE>
For options granted through November 5, 1997, the Company recognized an
aggregate of $517,050 as deferred compensation for the excess of the deemed
fair value for financial statement presentation purposes of the Common Stock
issuable on exercise of such options over the exercise price. The deferred
compensation expense is being recognized over the vesting period of options.
F-17
<PAGE>
DEPOMED, INC.
(A DEVELOPMENT STAGE COMPANY)
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
8. INCOME TAXES
As of December 31, 1997, the Company had federal and state net operating loss
carryforwards of approximately $1,900,000 and $1,100,000, respectively. The
primary difference between the accumulated deficit and the net operating loss
carryforwards relates to the deferred compensation which was paid in 1997. The
net operating loss carryforwards will expire at various dates beginning on 2010
through 2012 if not utilized.
Utilization of the net operating losses and credits may be subject to an annual
limitation due to the ownership change limitations provided by the Internal
Revenue Code of 1986. The annual limitations may result in the expiration of net
operating losses before utilization.
Deferred income taxes reflect the net tax effects of temporary differences
between the carrying amounts of assets and liabilities for financial reporting
and the amount used for income tax purposes. Significant components of the
Company's deferred tax assets are as follows:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-----------------------
1997 1996
-----------------------
<S> <C>
Net operating loss carryforward $ 700,000 $ 380,000
Other 100,000 120,000
---------- ---------
Total deferred tax assets 800,000 500,000
Valuation allowance for deferred tax
assets (800,000) (500,000)
---------- ---------
Total $ -- $ --
========== =========
</TABLE>
The change in the valuation allowance in 1997 was $300,000.
9. SUBSEQUENT EVENTS
PRIVATE PLACEMENT
In February 1998, the Company completed a private placement of 1,000,000 shares
common stock for $8,000,000, with net proceeds of approximately $7,500,000. The
Company is obligated to file a registration statement on Form S-3 no later than
November 6, 1998.
F-18
<PAGE>
9. SUBSEQUENT EVENTS (CONTINUED)
RESEARCH AGREEMENT
In March 1998, the Company entered into a research agreement with the R. W.
Johnson Pharmaceutical Research Institute ("PRI"), a Johnson & Johnson unit, to
study the feasibility of an orally administered, controlled release
pharmaceutical product using the Company's Gastric Retention System. The Company
will be paid for actual costs incurred, as incurred, at the fees stipulated in
the agreement. The agreement may be terminated by PRI at any time upon 30 days
written notice to the Company.
FACILITIES LEASE
In March 1998, the Company entered into a two-year sublease, which includes an
option to renew, subject to approval by the Company and the sublessor, for two
additional terms of twelve and ten months, respectively. Future payments under
the lease for 1998, 1999 and 2000 total $207,900, $277,200 and $69,300,
respectively.
FINANCIAL CONSULTING AGREEMENT
In February 1998, the Company entered into a letter of engagement with a three-
year term with a financial advisor. As consideration for services to be
rendered under this arrangement, the Company has granted the financial advisor
options to purchase 40,000 shares of common stock at an exercise price of
$4.0625 per share and 20,000 at an exercise price $9.625 per share. One third
of the options vest on each of the three anniversary dates during the term of
the agreement. The value of these options will be recorded in the quarter
ended March 31, 1998.
F-19
<PAGE>
INDEX TO EXHIBITS
<TABLE>
<C> <S>
*3.1 Third Amended and Restated Articles of Incorporation
*3.2 Form of Amended and Restated Articles of Incorporation
*3.3 Bylaws
*3.4 Certificate of Amendment to the Third Amended and Restated Articles of Incorporation
*4.1 Specimen Common Stock Certificate
*4.2 Specimen Warrant Certificate (filed as Exhibit A to the Form of Warrant Agreement)
*4.3 Form of Representative's Warrant Agreement including form of Representative's Warrant
*4.4 Form of Warrant Agreement
*4.5 Form of Lock-up Agreement
*10.1 1995 Stock Option Plan, as amended
*+10.2 Agreement dated July 11, 1996 between the Company and Bristol-Myers Squibb Company
*+10.3 Feasibility Agreement dated May 13, 1996 between the Company and GalaGen Inc.
*10.4 Agreement dated March 18, 1997 between the Company and CSO Ventures LLC
*10.5 Lease Agreement between the Company and 1170 Chess Drive Limited Partnership dated
September 2, 1992
*10.6 First Amendment to lease agreement dated January 1, 1996 between the Company and SKW II
Real Estate Partnership
*10.7 Employment Agreement between DepoMed, Inc. and John W. Shell
*10.8 Employment Agreement between DepoMed, Inc. and John W. Fara
*10.9 Agreement re: Settlement of Lawsuit, Conveyance of Assets and Assumption of Liabilities
dated August 28, 1995 by and among DepoMed Systems, Inc., Dr. John W. Shell and M6
Pharmaceuticals, Inc.
*10.10 Form of Indemnification Agreement between the Company and its directors and executive
officers
*10.11 Letter Agreement dated October 25, 1996 between the Company and John W. Fara
*10.12 Form of Agreement between the Company and Burrill & Company
24.1 Power of Attorney (see page 25)
27.1 Financial Data Schedule
</TABLE>
_____________
* Incorporated by reference to the Company's registration statement on
Form SB-2 (File No. 333-25445)
+ Confidential treatment granted.
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<S> <C> <C>
<PERIOD-TYPE> 12-MOS 12-MOS
<FISCAL-YEAR-END> DEC-31-1997 DEC-31-1996
<PERIOD-START> JAN-01-1997 JAN-01-1996
<PERIOD-END> DEC-31-1997 DEC-31-1996
<CASH> 4,129,545 0
<SECURITIES> 0 0
<RECEIVABLES> 144,887 0
<ALLOWANCES> 0 0
<INVENTORY> 0 0
<CURRENT-ASSETS> 4,375,111 0
<PP&E> 301,834 0
<DEPRECIATION> 102,016 0
<TOTAL-ASSETS> 4,585,344 0
<CURRENT-LIABILITIES> 418,544 0
<BONDS> 0 0
0 0
0 0
<COMMON> 6,843,670 0
<OTHER-SE> (2,710,607) 0
<TOTAL-LIABILITY-AND-EQUITY> 4,585,344 0
<SALES> 0 0
<TOTAL-REVENUES> 604,876 317,971
<CGS> 0 0
<TOTAL-COSTS> 1,813,183 784,172
<OTHER-EXPENSES> 0 0
<LOSS-PROVISION> 0 0
<INTEREST-EXPENSE> 28,145 6,572
<INCOME-PRETAX> (1,236,452) (472,773)
<INCOME-TAX> 0 0
<INCOME-CONTINUING> (1,236,452) (472,773)
<DISCONTINUED> 0 0
<EXTRAORDINARY> 0 0
<CHANGES> 0 0
<NET-INCOME> (1,236,452) (472,773)
<EPS-PRIMARY> (0.34) (0.12)
<EPS-DILUTED> (0.34) (0.12)
</TABLE>
