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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, 1998
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)
94404
366 Lakeside Drive, Foster City, (Zip Code)
California
(Address of principal executive offices)
Registrant's telephone number, including area code: (650) 513-0990
Securities registered pursuant to Section 12(b) of the Act:
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Title of Each Class Name of Each Exchange on Which Registered
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Common Stock, no par value American Stock Exchange
Common Stock Purchase Warrants, no par value American Stock Exchange
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Securities registered pursuant to Section 12(g) of the Act:
None
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 $763,138.
The aggregate market value of the voting stock held by non-affiliates of the
registrant on February 26, 1999, based upon the closing price of the Common
Stock on the American Stock Exchange for such date, was approximately
$52,000,000.
The number of outstanding shares of the registrant's Common Stock on
February 28, 1999 was 6,472,778.
Documents Incorporated by Reference
(1) Portions of the Proxy Statement to be filed with the Securities and
Exchange Commission on or prior to April 30, 1999 and to be used in
connection with the Annual Meeting of Shareholders expected to be held
June 2, 1999 are incorporated by reference in Part III of this Form 10-
KSB.
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DEPOMED, INC.
1998 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................................................. 9
Item 3. LEGAL PROCEEDINGS.......................................... 9
Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS........ 9
PART II................................................................. 10
Item 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED
STOCKHOLDER MATTERS....................................... 10
Item 6. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS................................. 12
Item 7. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA................ 18
Item 8. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING
AND FINANCIAL DISCLOSURE.................................. 19
PART III................................................................ 19
Item 9. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT......... 19
Item 10. EXECUTIVE COMPENSATION..................................... 19
Item 11. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND
MANAGEMENT................................................ 19
Item 12. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS............. 19
Item 13. EXHIBITS AND REPORTS ON FORM 8-K........................... 19
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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
We are a development stage company engaged in the development of new and
proprietary oral drug delivery technologies. We have developed two types of
oral drug delivery systems, the Gastric Retention System (the "GR System") and
the Reduced Irritation System (the "RI System" and together, 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 irritation that is a
side effect of many orally administered drugs. In addition, the DepoMed
Systems are designed to provide continuous, controlled delivery of an
incorporated drug.
In this Annual Report on Form 10-KSB, the "company," "DepoMed," "we," "us,"
and "our," refer to DepoMed, Inc.
We intend to develop products utilizing the DepoMed Systems in collaboration
with pharmaceutical and biotechnology companies from which we expect to
receive license fees, research and development funding, milestone payments and
royalties. We also intend to develop either independently or jointly certain
off-patent and over-the-counter ("OTC") products utilizing the DepoMed
Systems.
In March 1998, we 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.
We also have 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. We have independently developed a reduced
irritation aspirin and an enhanced absorption calcium supplement product.
These products have been reformulated to incorporate advances in polymer
technology and to address potential marketing needs. We are currently seeking
marketing partners to commercialize both of these products. We are also
developing certain other product candidates expected to benefit from
incorporation into 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.
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
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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 multi-hour 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 as well as 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 multi-hour period. The company believes that the DepoMed Systems can
provide one or more of the following advantages over conventional methods of
drug administration:
. Enhanced 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 a
drug associated with toxicity, while maintaining levels of the 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 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.
. Expansion of 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 that
the DepoMed Systems may be able to make the oral delivery of some of
these drugs therapeutically effective.
. 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
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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 a drug-containing
polymer matrix which can be manufactured as tablets or multiple spherical
units. If taken with a meal, these polymeric tablets or units 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 or dissolved form or those consisting
of small particles tend to empty rapidly from the stomach and continue into
the small intestine and on into the large 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 and 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
regions, 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.
The company has developed a calcium supplement product which utilizes the GR
System. The company is currently seeking a marketing partner to commercialize
this product. 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.
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
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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 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 a drug/polymer matrix formed into
spheres or granules. The spheres are contained in an outer gelatin capsule;
the granules are compressed into a tablet. Each of these systems is designed
to rapidly disintegrate upon ingestion to deliver its multiple small,
particles. The particles are composed of an inert matrix of polymeric material
in which the active ingredient is homogeneously dispersed in its solid state.
The particles 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 particles 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 particles 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
has developed, 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 has developed an aspirin product that 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
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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
particles.
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 has undergone further testing by BMS.
For the PRI compound, formulation work was initiated in March 1998. The
company has completed internal development of the calcium supplement and
aspirin product and is seeking collaborative partners to manufacture and
market these products. Upon identification of the appropriate corporate
partners, the company expects to initiate clinical trials to support marketing
claims on these products.
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 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. BMS has conducted testing and
process scale-up and manufacturing methodologies have been transferred to BMS.
If such a 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 April 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.
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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. The study is ongoing. There can be no
assurance, however, that the 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, SkyePharma
plc, Biovail Corporation International, KOS Pharmaceuticals, Inc., Fuisz
Technologies Ltd. and Flamel Technologies 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 pharmaceutical products and drug delivery systems is intense.
We expect competition to increase. Competing technologies or products
developed in the future may prove superior either generally or in particular
market segments to the DepoMed Systems or products using the DepoMed Systems.
These developments would make the DepoMed Systems or products using them
noncompetitive or obsolete.
All of our principal competitors have substantially greater financial,
marketing, personnel and research and development resources than us. In
addition, many of our potential collaborative partners have devoted, and
continue to devote, significant resources to the development of their own drug
delivery systems and technologies.
Patents and Proprietary Rights
Our success will depend in part on our ability to obtain and maintain patent
protection for our technologies and to preserve our trade secrets. Our policy
is to file patent applications in the United States and foreign jurisdictions.
We currently hold two issued United States and two pending United States
patent applications. We have applied for patents in numerous foreign
countries. Some of those countries have granted our applications and other
applications are still pending. No assurance can be given that our patent
applications will be approved, or that any issued patents will provide
competitive advantages for the DepoMed Systems or our technologies.
With respect to already issued patents and any patents which may issue from
our applications, there can be no assurance that claims allowed will be
sufficient to protect our technologies. The United States maintains patent
applications in secrecy until a patent issues. As a result, the company cannot
be certain that others have not filed patent applications for technology
covered by our 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 our patent rights or permit the competitors to 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
. the rights granted under the patents issued to the company will provide
proprietary protection or commercial advantage to the company.
We also rely on trade secrets and proprietary know-how. We seek to protect
that information, in part, through entering into confidentiality agreements
with employees, consultants, collaborative partners and others
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before such persons or entities have access to our proprietary trade secrets
and know-how. These confidentiality agreements may not be effective in certain
cases, due to, among other things, the lack of an adequate remedy for breach
of an agreement or a finding that an agreement is unenforceable. In addition,
our trade secrets may otherwise become known or be independently developed by
competitors.
Our ability to develop our technologies and to make commercial sales of
products using our technologies also depends on not infringing others'
patents. We are not aware of any claim of patent infringement against us.
However, if claims concerning patents and proprietary technologies arise and
are determined adversely to the company, the claims could have a material
adverse effect on the company. Extensive litigation regarding patent and other
intellectual property rights is common in the pharmaceutical industry. We may
need to engage in litigation 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 our 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 diversion of our financial and
managerial resources to such litigation could have a material adverse effect
on the company. We may also be 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. These events
could have a material adverse effect on the company.
Manufacturing, Marketing and Sales
We do not have and do not intend to establish in the foreseeable future
internal manufacturing, marketing or sales capabilities. Rather, we intend to
use the facilities of our collaborative partners or those of contract
manufacturers to manufacture products using the DepoMed Systems. Our
dependence on third parties for the manufacture of products using the DepoMed
Systems may adversely affect our ability to develop and deliver such products
on a timely and competitive basis. There may not be sufficient manufacturing
capacity available to the company when, if ever, it is ready to seek
commercial sales of products using the DepoMed Systems. In addition, we expect
to rely on our collaborative partners or to develop distributor arrangements
to market and sell products using the DepoMed Systems. The company may not be
able to enter into manufacturing, marketing or sales agreements on reasonable
commercial terms, or at all, with third parties. Failure to do so would have a
material adverse effect on the company.
Applicable cGMP requirements and other rules and regulations prescribed by
foreign regulatory authorities will apply to the manufacture of products using
the DepoMed Systems. The company will depend on the manufacturers of products
using the DepoMed Systems to comply with cGMP and applicable foreign
standards. Any failure by a manufacturer of products using the DepoMed Systems
to maintain cGMP or comply with applicable foreign standards could delay or
prevent their commercial sale. This could have a material adverse effect on
the company.
Government Regulation
Numerous governmental authorities in the United States and other countries
regulate our research and development activities and those of our
collaborative partners. Governmental approval is required of all potential
pharmaceutical products using the DepoMed Systems and the manufacture and
marketing of products using the DepoMed Systems prior to the commercial use of
those products. The regulatory process will take several years and require
substantial funds. If products using the DepoMed Systems do not receive the
required regulatory approvals or if such approvals are delayed, the company's
business would be materially adversely affected. There can be no assurance
that the requisite regulatory approvals will be obtained without lengthy
delays, if at all.
In the United States, the United States Food and Drug Administration (the
"FDA") rigorously regulates pharmaceutical products, including any drugs using
the DepoMed Systems. If a company fails to comply with
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applicable requirements, the FDA or the courts may impose sanctions. These
sanctions may include 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. The FDA may withdraw
approved applications or refuse to approve pending new drug applications,
premarket approval applications, or supplements to approved applications.
The company generally must conduct preclinical testing on laboratory animals
of new pharmaceutical products prior to commencement of clinical studies
involving human beings. These studies evaluate the potential efficacy and
safety of the product. The company then submits the results of these studies
to the FDA as part of an Investigational New Drug application ("IND"), which
must become effective before beginning clinical testing in humans.
Typically, human clinical evaluation involves a time-consuming and costly
three-phase process:
. In Phase I, the company conducts clinical trials with a small number of
subjects to determine a drug's early safety profile and its
pharmacokinetic pattern.
. In Phase II, the company conducts clinical trials with groups of patients
afflicted with a specific disease in order to determine preliminary
efficacy, optimal dosages and further evidence of safety.
. In Phase III, the company conducts large-scale, multi-center, comparative
trials with patients afflicted with a target disease in order to provide
enough data to demonstrate the efficacy and safety required by the FDA
prior to commercialization.
The FDA closely monitors the progress of each phase of clinical testing. The
FDA may, at its discretion, re-evaluate, alter, suspend or terminate testing
based upon the data accumulated to that point and the FDA's assessment of the
risk/benefit ratio to patients.
The results of the preclinical and clinical testing are submitted to the FDA
in the form of a new drug application (an "NDA") for approval prior to
commercialization. In responding to an NDA, the FDA may grant marketing
approval, request additional information or deny the application. Failure to
receive approval for any products using the DepoMed Systems would have a
material adverse effect on the company.
Various FDA regulations apply to over-the-counter products that comply with
monographs issued by the FDA. These regulations include:
. current good manufacturing practices ("cGMP") requirements;
. general and specific over-the-counter labeling requirements (including
warning statements);
. advertising restrictions; and
. requirements regarding the safety and suitability of inactive
ingredients.
In addition, the FDA may inspect over-the-counter products and manufacturing
facilities. A failure to comply with applicable regulatory requirements may
lead to administrative or judicially imposed penalties. If an over-the-counter
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.
Foreign regulatory approval of a product must also be obtained prior to
marketing the product internationally. Foreign approval procedures vary from
country to country. The time required for approval may delay or prevent
marketing in certain countries. In certain instances the company or its
collaborative partners may seek approval to market and sell certain products
outside of the United States before submitting an application for United
States approval to the FDA. 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 these procedures and requirements are
time-consuming and expensive. Some EU countries require price approval as part
of the regulatory process. These constraints can cause 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 meaningfully indicate that another country will approve
the product.
8
<PAGE>
Product Liability
Our 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. We do not
currently have any product liability insurance. Although the company will
apply for product liability insurance when it deems it appropriate, there can
be no assurance that:
. the company will be able to obtain or maintain product liability
insurance on acceptable terms;
. the company will be able to secure increased coverage as the
commercialization of the DepoMed Systems proceeds; or
. any insurance will provide adequate protection against potential
liabilities.
Employees
As of December 31, 1998, the company had seventeen 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 excellent.
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
maintains key man life insurance on the lives of Drs. Shell and Fara in the
amount of $1,000,000 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
In March 1998, the company entered into a two-year non-cancelable sublease
of approximately 13,000 square feet of laboratory and office facilities in
Foster City, California. The sublease expires on March 31, 2000 and it
includes an option to renew for two additional terms of 12 and 10 months,
respectively, (at the discretion of the sublessor).
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, 1998.
Executive Officers
The executive officers of the company and their ages as of December 31, 1998
are as follows:
<TABLE>
<CAPTION>
Name Age Position
---- --- --------
<S> <C> <C>
John W. Shell, Ph.D..... 73 Founder, Chairman of the Board and Chief Scientific Officer
John W. Fara, Ph.D...... 56 President, Chief Executive Officer and Director
Bret Berner, Ph.D....... 46 Vice President, Product Development
John F. Hamilton........ 54 Vice President, Finance and Chief Financial Officer
John N. Shell........... 45 Vice President, Operations and Director
</TABLE>
9
<PAGE>
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 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.
Bret Berner, Ph.D. has served as the company's Vice President, Product
Development since December 1998. Before joining DepoMed, Dr. Berner served as
Vice President of Development at Cygnus, Inc. for four years, where he was
responsible for formulation, toxicology, project management, and new drug
delivery technology. From 1984 through 1994, Dr. Berner acted as the director
of basic pharmaceutics research at Ciba-Geigy. Prior to 1984, he also held the
position of staff scientist at The Procter & Gamble Company. Dr. Berner holds
11 patents and has authored more than 70 publications, including the
editorship of two books on controlled drug delivery. He received his B.A. in
neurosciences, cum laude, from the University of Rochester and his Ph.D. in
physical chemistry from the University of California, Los Angeles.
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 a M.B.A. from the University of
Chicago.
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.
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
10
<PAGE>
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
The company's Common Stock commenced trading on the Nasdaq SmallCap under
the symbol "DPMD" on December 1, 1997. On November 9, 1998 the company's
Common Stock ceased trading on the Nasdaq and began trading on the American
Stock Exchange ("AMEX") under the symbol "DMI". The following table sets
forth, for the periods indicated, the high and low closing prices of the
company's Common Stock as reported by the Nasdaq from December 1, 1997 to
November 8, 1998 and by the AMEX from November 9, 1998:
<CAPTION>
1997 High Low
---- -------- --------
<S> <C> <C>
Fourth Quarter (from December 1, 1997)................. $4 7/16 $2 1/2
<CAPTION>
1998
----
<S> <C> <C>
First Quarter.......................................... $ 14 1/4 $ 4
Second Quarter......................................... $ 12 1/4 $9 11/16
Third Quarter.......................................... $ 11 3/4 $ 8 1/8
Fourth Quarter......................................... $ 12 1/2 $ 6 3/4
The Warrants commenced trading under the symbol "DPMDW" on the Nasdaq
SmallCap on December 1, 1997. On November 9, 1998 the Warrants ceased trading
on the Nasdaq and began trading on the AMEX under the symbol "DMI/WS". The
following table sets forth, for the periods indicated, the high and low
closing prices of the Warrants as reported by the Nasdaq from December 1, 1997
to November 8, 1998 and by the AMEX from November 9, 1998:
<CAPTION>
1997 High Low
---- -------- --------
<S> <C> <C>
Fourth Quarter (from December 1, 1997)................. $ 2 3/16 $ 1/4
<CAPTION>
1998
----
<S> <C> <C>
First Quarter.......................................... $ 7 1/2 $ 1 1/2
Second Quarter......................................... $5 15/16 $ 4 1/2
Third Quarter.......................................... $ 5 3/4 $ 3
Fourth Quarter......................................... $ 4 $ 2 1/8
</TABLE>
As of February 28, 1999, the numbers of holders of record of the Common
Stock and the Warrants were 38 and 11, 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
In February 1998, the company sold 1,000,000 shares of its Common Stock to
accredited investors for $8.00 per share in a private placement exempt from
registration under Rule 506 of the regulations promulgated under the
Securities Act of 1933, as amended. Net of commissions paid to the placement
agent and other expenses related to the private placement, the company
received proceeds of approximately $7,500,000 from the private placement. The
company filed a Registration Statement on Form S-3 in November 1998 covering
resale of the shares sold in the private placement.
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.
11
<PAGE>
From the effective date of the Registration Statement to December 31, 1998,
the company incurred approximately $586,000 in underwriting discounts and
commissions, approximately $281,000 of expenses paid to or for the
underwriters, and approximately $1,097,000 in other related expenses. The net
proceeds of the offering, after deducting the foregoing expenses, were
approximately $5,356,000. 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, 1998, the company has used
approximately $2,841,000 of the proceeds to fund ongoing operations.
Item 6. Managements's Discussion and Analysis of Financial Condition and
Results of Operations
Forward-Looking Information
Statements made in this "Management's Discussion and Analysis of Financial
Condition and Results of Operations" and elsewhere in this Annual Report on
Form 10-KSB that are not statements of historical fact are forward-looking
statements within the meaning of Section 27A of the Securities Act of 1933, as
amended (the "Securities Act"), and Section 21E of the Securities Exchange Act
of 1934, as amended (the "Exchange Act"). A number of risks and uncertainties,
including those discussed under the caption "FACTORS THAT MAY AFFECT FUTURE
RESULTS" below and elsewhere in this Annual Report on Form 10-KSB could affect
such forward-looking statements and could cause actual results to differ
materially from the statements made. The company expressly disclaims any
obligation or undertaking to release publicly any updates or revisions to any
forward-looking statements contained herein to reflect any changes in the
company's expectations with regard thereto or any change in events, conditions
or circumstances on which any such statements are based.
Overview
General
We are a development stage company engaged in the development of new and
proprietary oral drug delivery technologies. We have developed two types of
oral drug delivery systems, the Gastric Retention System (the "GR System") and
the Reduced Irritation System (the "RI System" and together, 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 irritation that is a
side effect of many orally administered drugs. In addition, the DepoMed
Systems are designed to provide continuous, controlled delivery of an
incorporated drug.
In this "Management's Discussion and Analysis of Financial Condition and
Results of Operations", the "company," "DepoMed," "we," "us," and "our," refer
to DepoMed, Inc.
Since the company's inception in August 1995, we have devoted substantially
all our efforts to research and development conducted on our own behalf and
through collaborations with pharmaceutical partners in connection with the
DepoMed Systems. Our primary activities since inception (August 7, 1995) have
been, in addition to research and development, establishing our offices and
research facilities, recruiting personnel, filing patent applications,
developing a business strategy and raising capital. We have also been involved
in revenue generating research and development projects for clients including
R. W. Johnson Pharmaceutical Research Institute ("PRI") and Bristol-Myers
Squibb ("BMS"). To date, we have received only limited revenue, all of which
has been from collaborative research and feasibility arrangements. At the
inception of the company, in 1995, we 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 subsequent years. DepoMed has generated a
cumulative net loss of approximately $5,090,000 for the period from inception
through December 31, 1998.
We intend to continue investing in the further development of our drug
delivery technologies and the DepoMed Systems. We also intend to internally
develop and find partners to commercialize products based on generic and over-
the-counter compounds, such as a reduced irritation aspirin product and an
enhanced absorption
12
<PAGE>
calcium supplement product. Depending upon a variety of factors, including
collaborative arrangements, available personnel and financial resources, we
will conduct or fund clinical trials on such products and will undertake the
associated regulatory activities. We will need to make additional capital
investments in laboratories and related facilities. As additional personnel
are hired in 1999 and beyond, expenses can be expected to increase from their
1998 levels.
Results of Operations
Years Ended December 31, 1998 and 1997
Revenues for the years ended December 31, 1998 and 1997 were approximately
$763,000 and $605,000, respectively. In 1998, these revenues consisted of
amounts earned under the research and development arrangement with BMS, and
feasibility arrangement with PRI. In 1997, revenues consisted entirely of
amounts earned under the research and development arrangement with BMS.
Research and development payments from BMS declined as a result of the
completion of our activities for BMS in March 1998, while payments from PRI
subsequently increased due to expanded product development activities
beginning in the third quarter of 1998. The feasibility study with PRI is
ongoing and additional product development revenues are expected in 1999. We
do not anticipate additional research and development revenues from the BMS
arrangement as we have completed our activities for BMS.
Research and development expenses for the year ended December 31, 1998 were
approximately $2,062,000 compared to approximately $853,000 during the year
ended December 31, 1997. The increase was due to the hiring of additional
employees and related expenses, and increased laboratory supplies. Research
and development allocation of occupancy expense also increased due to the
company's sublease of larger facilities in March 1998.
General and administrative expenses for the year ended December 31, 1998
were approximately $1,966,000 compared to approximately $960,000 during the
year ended December 31, 1997. The increase was due to the additional expense
incurred as a result of becoming a public company, including the costs of
Directors and Officers insurance and expanded investor relations activities,
the increased occupancy expense of our newly subleased facility and the hiring
of additional employees.
Net interest income was approximately $486,000 for the year ended December
31, 1998 compared to a net interest expense of approximately $28,000 during
the year ended December 31, 1997. The increase was due to increased interest
income earned on funds raised in our initial public offering in November 1997
and a private placement in February 1998. It also includes immaterial gains
realized on the sale of securities.
The company granted options to purchase approximately 80,000 shares of
common stock in December 1998 that were not reserved for under the 1995 Stock
Option Plan (the "Plan"). The Board of Directors authorized an increase in the
number of shares reserved under the Plan by 200,000; however, these shares are
not duly authorized and available for grant until the shareholders approve the
increase at the Annual Meeting of Shareholders in June 1999. For accounting
purposes, the company must recognize compensation expense for the difference
between the fair market value on the date of grant (measurement date) and the
exercise price. The stock options granted have exercise prices of $7.63 and
$7.75, which represent the fair market value of the company's common stock on
the respective dates of grant. However, as the options granted will not be
authorized for grant until the shareholders have approved the increase in the
number of shares authorized under the Plan, the measurement date will not be
established until such approval is obtained. The company will be required to
recognize as compensation expense the difference between the exercise price
and the fair market value of the underlying common stock at that time. If the
stock price is significantly higher on this date compared to the exercise
price, the company's results could be materially impacted in the second
quarter of 1999.
Liquidity and Capital Resources
Cash used in operations in the year ended December 31, 1998 was
approximately $2,522,000 compared to approximately $1,129,000 for the year
ended December 31, 1997. During the year ended December 31, 1998 the
13
<PAGE>
change in cash used in operations was due primarily to the increase in the net
loss. During the year ended December 31, 1997, the change was also primarily
due to the net loss. Operating losses in the fourth quarter of 1998 included a
payment of $85,000 made in October 1998 related to a settlement of a
contingent liability. See Note 5 of the Notes to Financial Statements.
Cash used in investing activities in the year ended December 31, 1998
totaled approximately $5,478,000 and consisted of purchases of approximately
$4,624,000 of short-term investments as well as purchases of laboratory
equipment, fixtures and office equipment. Net cash used in investing
activities in the year ended December 31, 1997 totaled approximately $60,000
and consisted of purchases of laboratory equipment, fixtures and office
equipment. We expect that future capital expenditures may include additional
product development and quality control laboratory equipment.
Cash provided by financing activities in the year ended December 31, 1998
was approximately $7,929,000, which primarily consisted of the proceeds
received in February 1998 from a private placement of 1,000,000 shares of
common stock at a price of $8.00 per share, with net proceeds of approximately
$7,500,000. Also in the fourth quarter, we established a $600,000 credit
facility to finance our equipment purchases through July 1999. As of December
31, 1998, we financed approximately $494,000 of equipment under that credit
facility. Cash provided by financing activities in the year ended December 31,
1997 was approximately $5,307,000 which consisted primarily of the net
proceeds from our initial public offering of $5,356,000.
We anticipate that our existing capital resources will permit us to meet our
capital and operational requirements through at least the end of 1999.
However, we base this expectation on our current operating plan which may
change as a result of many factors. Accordingly, we could require additional
funding sooner than anticipated. Our cash needs may also vary materially from
our current expectations because of numerous factors, including:
. results of research and development;
. relationships with current and potential collaborative partners;
. changes in the focus and direction of our research and development
programs;
. technological advances; and
. results of clinical testing, requirements of the FDA and comparable
foreign regulatory agencies.
We will need substantial funds of our own or from third parties to:
. conduct research and development programs;
. conduct preclinical and clinical testing; and
. manufacture (or have manufactured) and market (or have marketed)
potential products using the DepoMed Systems.
Our existing capital resources may not be sufficient to fund our operations
until such time as we may be able to generate sufficient revenues to support
our operations. We have limited credit facilities and no other committed
source of capital. To the extent that our capital resources are insufficient
to meet our future capital requirements, we will have to raise additional
funds to continue our development programs. We may not be able to raise such
additional capital on favorable terms, or at all. If the company raises
additional capital by selling its equity or convertible debt securities, the
issuance of such securities could result in dilution to our shareholders. If
adequate funds are not available the company may have to:
. curtail operations significantly; or
. obtain funds through entering into collaboration agreements on
unattractive terms.
14
<PAGE>
The 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,
1998, the net operating losses available to offset future taxable income for
federal income tax purposes were approximately $3,900,000. Because the company
has experienced ownership changes, future utilization of carryforwards may be
limited in any fiscal year pursuant to Internal Revenue Code regulations. The
carryforwards expire at various dates beginning in 2010 through 2018 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.
Year 2000
Year 2000 ("Y2K") exposure is the result of computer programs using two
instead of four digits to represent the year. These computer programs may
erroneously interpret dates beyond the year 1999, which could cause system
failures or other computer errors, leading to disruptions in operations.
We have developed a three-phase program to limit or eliminate Y2K exposures.
Phase I is to identify those systems, applications and third-party
relationships from which we have exposure to Y2K disruptions in operations.
Phase II is the development and implementation of action plans to achieve Y2K
compliance in all areas prior to the end of 1999. Also included in Phase II is
the development of contingency plans which would be implemented should Y2K
compliance not be achieved in order to minimize disruptions in operations.
Phase III is the final testing or equivalent certification of testing of each
major area of exposure to ensure compliance. We intend to complete all phases
before the end of 1999.
We have identified three major areas determined to be critical for
successful Y2K compliance: Area 1, which includes financial, research and
development and administrative informational systems applications reliant on
system software; Area 2, which includes research, development and quality
applications reliant on computer programs embedded in microprocessors; and
Area 3, which includes third-party relationships which may be affected by Area
1 and 2 exposures which exist in other companies.
We have completed Phase I of our Y2K program with respect to all three of
the major areas. We believe that we rely on systems, applications and third-
party relationships which, if not Y2K compliant prior to the end of 1999,
could have a material adverse impact on our operations.
We have developed and implemented action plans toward the completion of
Phase II of Y2K compliance in all three Areas. With respect to Area 1 and Area
2, we have reviewed all internal software and hardware to determine our Y2K
exposure. With respect to Area 3, we have evaluated our reliance on third
parties in order to determine whether their Y2K compliance will affect our
operations. We have confirmed the Y2K compliance of some of our suppliers and
we continue to monitor the progress toward compliance of those suppliers who
currently are not. Because we have not yet completed Phase II contingency
planning, we can not describe what action we would take in any of the areas
should Y2K compliance not be achievable in time. We expect to complete Y2K
contingency planning by June 30, 1999 at which time we expect to be able to
identify our most reasonably likely worst case Y2K scenario.
Costs related to replacement or remediation and testing of our Area 1 and
Area 2 computer information systems are estimated at $30,000, as determined by
an independent consultant. We expect to complete Phase III of our Y2K
compliance program in Area 1 and Area 2 by June 30, 1999. The funds for
compliance will be part of our cash flow from operations and capital
expenditures. We expect Phase III, in Area 3, to be completed before the end
of 1999.
15
<PAGE>
FACTORS THAT MAY AFFECT FUTURE RESULTS
Early Stage of Development; Limited Revenues
We are at an early stage of development. Accordingly, our business is
subject to all of the business risks associated with a new enterprise,
including:
. uncertainties regarding product development;
. lack of collaborative partnering relationships;
. lack of revenue and uncertainty regarding future revenues;
. limited financial and personnel resources; and
. lack of established credit facilities.
As we expand our research and development efforts, we anticipate that we
will continue to incur substantial operating losses for at least the next
several years. Therefore, we expect our cumulative losses to increase. To
date, we have had no revenues from product sales and only minimal revenues
from our collaborative research and development arrangements and feasibility
studies. Our success will depend on commercial sales of products that generate
significant revenues for us. We cannot predict whether we will be able to
achieve commercial sales of any revenue-generating products.
No Assurance of Successful Product Development
Our research and development programs are at an early stage. In order for us
to incorporate a pharmaceutical product into a DepoMed System, we need to
complete substantial additional research and development on the collaborative
partner's drug. Even if we are successful, the collaborative partner's drug
incorporated in the DepoMed System:
. may not be offered for commercial sale; or
. may prove to have undesirable or unintended side effects that prevent or
limit its commercial use.
Before we or others make commercial sales of products using the DepoMed
Systems, we or our collaborative partners must:
. conduct clinical tests showing that these products are safe and
effective; and
. obtain regulatory approval.
This process involves substantial financial investment. Successful
commercial sales of any of these products require:
. market acceptance;
. cost-effective commercial scale production; and
. reimbursement under private or governmental health plans.
We will have to curtail, redirect or eliminate our product development
programs if we or our collaborative partners find that:
. the DepoMed Systems prove to have unintended or undesirable side effects;
or
. products which appear promising in preclinical studies do not demonstrate
efficacy in larger scale clinical trials.
These events could have a material adverse effect on the company.
Dependence on and Need for Collaborative Partners
We have generated all of our revenues through collaborative arrangements
with pharmaceutical and biotechnology companies. Our strategy to continue the
research, development, clinical testing, manufacturing and commercial sale of
products using the DepoMed Systems requires that we maintain our current
collaborative
16
<PAGE>
arrangements and enter into additional collaborative arrangements. The success
of collaborative arrangements requires that the company's present and future
collaborative partners:
. perform their obligations as expected; and
. devote sufficient resources to the development, clinical testing and
marketing of products developed under collaborations.
The company's collaborative partners may not continue to:
. fund their particular projects;
. perform their agreed-to obligations; or
. choose to develop and make commercial sales of products using the DepoMed
Systems.
For example, Bristol-Myers Squibb Company ("BMS") holds an option to license
the DepoMed Gastric Retention System for a product. The option expires in
April 1999. BMS has no obligation to exercise its option and may choose not to
exercise its option. A decision by BMS to exercise the license option will
result in a milestone payment to the company. A decision by BMS not to license
the technology could have a material adverse affect on the company.
Further, the company may not be able to enter into future collaborative
arrangements on acceptable terms. The following events could have a material
adverse effect on the company:
. any parallel development by a collaborative partner of competitive
technologies or products;
. arrangements with collaborative partners that limit or preclude the
company from developing products or technologies;
. premature termination of an agreement; or
. failure by a collaborative partner to devote sufficient resources to the
development; and commercial sales of products using the DepoMed Systems.
Collaborative agreements are generally complex and may contain provisions
which give rise to disputes regarding the relative rights and obligations of
the parties. Any such dispute could delay collaborative research, development
or commercialization of potential products, or could lead to lengthy,
expensive litigation or arbitration.
Fluctuations in Operating Results
The following factors will affect our quarterly operating results and may
result in a material adverse effect on the company:
. variations in revenues obtained from collaborative agreements, including
milestone payments, royalties, license fees and other contract revenues;
. success or failure of the company in entering into further collaborative
relationships;
. decisions by collaborative partners to proceed or not to proceed with
subsequent phases of the relationship or program;
. the timing of any future product introductions by us or our collaborative
partners;
. market acceptance of the DepoMed Systems;
. regulatory actions;
. adoption of new technologies;
. the introduction of new products by our competitors;
. manufacturing costs and capabilities;
. changes in government funding; and
. third-party reimbursement policies.
17
<PAGE>
Relationships of Advisors with other Entities
Two groups (the Policy Advisory Board and Development Advisory Board) advise
the company on business and scientific issues and future opportunities.
Certain members of our Policy Advisory Board and Development Advisory Board
work full-time for academic or research institutions. Others act as
consultants to other 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 their own intellectual property
or that of their institutions or other companies. Further, invention
assignment agreements signed 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.
If the company desires access to inventions which are not its property, the
company will have to obtain licenses to such inventions from these
institutions or companies. The company may not be able to obtain these
licenses on commercially reasonable terms.
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 our business, particularly to the extent that
the company develops the DepoMed Systems for use in prescription drug
applications.
Certain foreign governments regulate pricing or profitability of
prescription pharmaceuticals sold in their countries. There have been a number
of federal and state proposals to implement similar government control in the
United States, particularly with respect to Medicare payments. The company
expects that these proposals will continue to be advanced. In addition,
downward pressure on pharmaceutical pricing in the United States has increased
due to an enhanced emphasis on managed care. The company expects this pressure
to continue to increase. 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. However, the
announcement of such proposals or efforts could have a material adverse effect
on the company's ability to raise capital. Further, the adoption of such
proposals or efforts would have a material adverse effect on the company and
any prospective collaborative partners.
Sales of products using the DepoMed Systems in domestic and foreign markets
will depend in part on the availability of reimbursement from third-party
payors, such as government health administration authorities and private
health insurers. 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. Accordingly, products using the DepoMed Systems may not be eligible
for third-party reimbursement at price levels sufficient for us or our
collaborative partners to realize appropriate returns on our investments 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 process accurately. We have
developed a three-phase program to limit or eliminate Y2K exposures. See
Management's Discussion and Analysis of Financial Condition and Results of
Operations, "Year 2000".
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-16.
18
<PAGE>
Item 8. Changes in and Disagreements with Accountants on Accounting and
Financial Disclosure
Not applicable.
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 1999 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 Exchange Act 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.
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.
19
<PAGE>
(a)3. 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
**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
*10.7 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
***+10.13 Joint Research Agreement dated February 20, 1998 between the company
and R.W. Johnson Pharmaceutical Research Institute
****10.14 Sublease dated February 18, 1998 between the company and Cell
Genesys, Inc.
23.1 Consent of Ernst & Young LLP, Independent Auditors
24.1 Power of Attorney (see page 21)
27.1 Financial Data Schedule
</TABLE>
- --------
* Incorporated by reference to the company's registration statement on Form
SB-2 (File No. 333-25445)
** Incorporated by reference to Exhibit 99.1 of the company's registration
statement on Form S-8 (File No. 333-66923)
*** Incorporated by reference to Exhibit 10.1 of the company's quarterly
report on Form 10-QSB filed on May 17, 1998
**** Incorporated by reference to Exhibit 10.2 of the company's quarterly
report on Form 10-QSB filed on May 17, 1998
+ Confidential treatment granted.
(b) Reports on Form 8-K:
The company filed a report on Form 8-K on November 11, 1998, related to a
change in the listing of the company's common stock and warrants from the
Nasdaq Small Cap to the American Stock Exchange, effective November 9, 1998.
20
<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 22nd day of March, 1999.
Depomed, Inc.
/s/ John W. Fara, Ph.D.
By: _________________________________
John W. Fara, Ph.D.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.
Signature Title Date
/s/ John W. Shell, Ph.D. Chairman of the March 22, 1999
- ------------------------------------- Board of Directors
John W. Shell, Ph.D. and Chief
Scientific Officer
/s/ John W. Fara, Ph.D. President, Chief March 22, 1999
- ------------------------------------- Executive Officer
John W. Fara, Ph.D. and Director
(Principal
Executive Officer)
/s/ John N. Shell Vice President, March 22, 1999
- ------------------------------------- Operations and
John N. Shell Director
/s/ John F. Hamilton Vice President, March 22, 1999
- ------------------------------------- Finance and Chief
John F. Hamilton Financial Officer
(Principal
Financial Officer)
21
<PAGE>
Signature Title Date
/s/ G. Steven Burrill Director March 22, 1999
- -------------------------------------
G. Steven Burrill
/s/ W. Leigh Thompson, Ph.D. Director March 22, 1999
- -------------------------------------
W. Leigh Thompson, Ph.D.
22
<PAGE>
DEPOMED, INC.
(A Development Stage Company)
INDEX TO FINANCIAL STATEMENTS
FINANCIAL STATEMENTS
<TABLE>
<S> <C>
Report of Ernst & Young LLP, Independent Auditors........................... F-2
Balance Sheet............................................................... F-3
Statements of Operations.................................................... F-4
Statement of Shareholders' Equity........................................... 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 and Shareholders
DepoMed, Inc.
We have audited the accompanying balance sheet of DepoMed, Inc. (a
development stage company) as of December 31, 1998, and the related statements
of operations, shareholders' equity, and cash flows for the years ended
December 31, 1998 and 1997 and for the period from inception (August 7, 1995)
to December 31, 1998. 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, 1998, and the results of its
operations and its cash flows for the years ended December 31, 1998 and 1997
and for the period from inception (August 7, 1995) to December 31, 1998, in
conformity with generally accepted accounting principles.
/s/ Ernst & Young LLP
Palo Alto, California
February 12, 1999
F-2
<PAGE>
DEPOMED, INC.
(A Development Stage Company)
BALANCE SHEET
<TABLE>
<CAPTION>
December 31,
1998
------------
<S> <C>
ASSETS
Current assets:
Cash and cash equivalents....................................... $ 4,058,716
Short-term investments.......................................... 2,603,398
Accounts receivable............................................. 306,148
Prepaid and other current assets................................ 187,024
-----------
Total current assets.......................................... 7,155,286
Property and equipment, net..................................... 1,008,171
Long-term investments........................................... 2,027,320
Other assets.................................................... 88,027
-----------
$10,278,804
===========
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Accounts payable................................................ $ 216,636
Accrued compensation............................................ 170,995
Other accrued liabilities....................................... 40,791
Capital lease obligation, current portion....................... 55,153
Long-term debt, current portion................................. 107,212
-----------
Total current liabilities..................................... 590,787
Capital lease obligation, non-current portion................... 95,083
Long-term debt, non-current portion............................. 386,921
Commitments
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;
6,463,438 shares issued and outstanding........................ 14,792,074
Deferred compensation........................................... (510,332)
Deficit accumulated during the development stage................ (5,089,616)
Accumulated other comprehensive income.......................... 13,887
-----------
Total shareholders' equity.................................... 9,206,013
-----------
$10,278,804
===========
</TABLE>
See accompanying notes.
F-3
<PAGE>
DEPOMED, INC.
(A Development Stage Company)
STATEMENTS OF OPERATIONS
<TABLE>
<CAPTION>
Period From
Inception
(August 7,
Year Ended December 31, 1995) to
------------------------ December 31,
1998 1997 1998
----------- ----------- ------------
<S> <C> <C> <C>
Product development revenue............ $ 763,138 $ 604,876 $ 1,685,985
Operating expenses:
Research and development............. 2,061,983 853,124 3,444,419
General and administrative........... 1,966,458 960,059 3,475,350
Purchase of in-process research and
development......................... -- -- 298,154
----------- ----------- -----------
Total operating expenses............ 4,028,441 1,813,183 7,217,923
Loss from operations................... (3,265,303) (1,208,307) (5,531,938)
Interest income (expense), net......... 485,580 (28,145) 442,322
----------- ----------- -----------
Net loss............................ $(2,779,723) $(1,236,452) $(5,089,616)
=========== =========== ===========
Basic and diluted net loss per share... $ (0.44) $ (0.34)
=========== ===========
Shares used in computing basic and
diluted net loss per share............ 6,318,233 3,664,242
=========== ===========
</TABLE>
See accompanying notes.
F-4
<PAGE>
DEPOMED, INC.
(A Development Stage Company)
STATEMENT OF SHAREHOLDERS' EQUITY
Period from inception (August 7, 1995) to December 31, 1998
<TABLE>
<CAPTION>
Deficit Total
Convertible Accumulated Accumulated Shareholders'
Preferred Stock Common Stock During Other Equity (Net
-------------------- --------------------- Deferred Development Comprehensive Capital
Shares Amount Shares Amount Compensation Stage Income Deficiency)
---------- -------- --------- ----------- ------------ ----------- ------------- -------------
<S> <C> <C> <C> <C> <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. -- -- 2,066,666 -- -- -- -- --
Issuance of common
shares for cash to
investors at
approximately $0.0009
per share on November
15, 1995............. -- -- 1,196,491 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.............. 2,447,368 682,759 -- -- -- -- -- 682,759
Net loss.............. -- -- -- -- -- (600,668) -- (600,668)
---------- -------- --------- ----------- --------- ----------- ------- ----------
Balances at December
31, 1995............. 2,447,368 682,759 3,263,157 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.... -- -- 91,666 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............. 2,447,368 682,759 3,354,823 284,250 (275,000) (1,073,441) -- (381,432)
Issuance of Series B
convertible preferred
stock to investors
for cash at $1.00 per
share................ 278,500 278,500 -- -- -- -- -- 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) 908,615 961,259 -- -- -- --
Issuance of common
stock and warrants
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 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............. -- -- 5,463,438 6,843,670 (400,714) (2,309,893) -- 4,133,063
Comprehensive loss
Net loss............. -- -- -- -- -- (2,779,723) -- (2,779,723)
Unrealized gains on
available-for-sale
securities.......... -- -- -- -- -- -- 13,887 13,887
----------
Comprehensive loss.... (2,765,836)
Issuance of common
stock to investors
for $8.00 per share
on February 23, 1998,
net of issuance costs
of $507,846.......... -- -- 1,000,000 7,492,154 -- -- -- 7,492,154
Deferred compensation
related to grants of
certain stock
options.............. -- -- -- 430,200 (430,200) -- -- --
Amortization of
deferred
compensation......... -- -- -- -- 320,582 -- -- 320,582
Issuance of common
stock options to a
consultant for
services with an
exercise price of
$11.25 per share on
June 18, 1998........ -- -- -- 26,050 -- -- -- 26,050
---------- -------- --------- ----------- --------- ----------- ------- ----------
Balances at December
31, 1998............. -- $ -- 6,463,438 $14,792,074 $(510,332) $(5,089,616) $13,887 $9,206,013
========== ======== ========= =========== ========= =========== ======= ==========
</TABLE>
See accompanying notes.
F-5
<PAGE>
DEPOMED, INC.
(A Development Stage Company)
STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
Period From
Inception
(August 7,
Year Ended December 31, 1995) to
------------------------ December
1998 1997 31, 1998
----------- ----------- -----------
<S> <C> <C> <C>
Operating Activities
Net loss............................... $(2,779,723) $(1,236,452) $(5,089,616)
Adjustments to reconcile net loss to
net cash used in operating activities:
Depreciation and amortization........ 196,967 56,904 298,983
Accrued interest expense on
shareholder notes................... -- -- 13,618
Amortization of deferred
compensation........................ 320,582 116,336 436,918
Value of stock options issued for
services............................ 26,050 -- 26,050
Purchase of in-process research and
development......................... -- -- 298,154
Changes in assets and liabilities:
Accounts receivable................ (161,261) (23,989) (306,148)
Other current assets............... (86,345) (69,142) (187,024)
Other assets....................... (77,675) 4,336 (88,090)
Accounts payable and other accrued
liabilities....................... (21,829) 227,510 257,427
Accrued compensation............... 135,448 (255,827) 103,519
Other current liabilities.......... (74,086) 51,322 --
----------- ----------- -----------
Net cash used in operating
activities...................... (2,521,872) (1,129,002) (4,236,209)
----------- ----------- -----------
Investing Activities
Expenditures for property and
equipment............................. (853,600) (59,656) (991,609)
Purchases of investments............... (4,624,175) -- (4,703,757)
Maturities of investments.............. -- -- 79,582
----------- ----------- -----------
Net cash used in investing
activities...................... (5,477,775) (59,656) (5,615,784)
----------- ----------- -----------
Financing Activities
Payments on capital lease obligations.. (57,469) (32,972) (157,960)
Proceeds from equipment loan........... 494,133 -- 494,133
Proceeds from issuance of notes........ -- 1,000,000 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... 7,492,154 5,634,611 13,818,774
----------- ----------- -----------
Net cash provided by financing
activities...................... 7,928,818 5,307,401 13,910,709
----------- ----------- -----------
Net increase (decrease) in cash and
cash equivalents...................... (70,829) 4,118,743 4,058,716
Cash and cash equivalents at beginning
of period............................. 4,129,545 10,802 --
----------- ----------- -----------
Cash and cash equivalents at end of
period................................ $ 4,058,716 $ 4,129,545 $ 4,058,716
=========== =========== ===========
Supplemental Schedule of Noncash
Financing and Investing Activities
Acquisition of property and equipment
under capital leases.................. $ 144,313 $ 41,927 $ 308,196
=========== =========== ===========
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.............................. $ 21,437 $ 109,623 $ 143,248
=========== =========== ===========
</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 in 1991 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, Cash Equivalents and Investments
The Company considers all highly liquid investments with an original
maturity (at date of purchase) of three months or less to be cash equivalents.
Cash and cash equivalents consist of cash on deposit with banks, money market
instruments and commercial paper. The Company places its cash, cash
equivalents and investments with high quality, U.S. financial institutions
and, to date, has not experienced losses on any of its balances. The Company
records cash and cash equivalents at amortized cost, which approximates the
fair value. The remaining contractual period until maturity of short-term and
long-term investments range from 1-12 months and 13- 24 months, respectively.
All short- and long-term investments are classified as available-for-sale.
These securities are carried at market value with unrealized gains and losses
included in accumulated other comprehensive income in shareholders' equity.
Securities classified as available-for-sale as of December 31, 1998 are
summarized below. Estimated fair value is based on quoted market prices for
these investments.
<TABLE>
<CAPTION>
Gross
Amortized Unrealized Estimated
Cost Gains Fair Value
---------- ---------- ----------
<S> <C> <C> <C>
U.S. corporate securities
Total included in cash and cash
equivalents.......................... $3,888,612 $ -- $3,888,612
Total included in short-term
investments.......................... 2,600,283 3,115 2,603,398
Total included in long-term
investments.......................... 2,016,548 10,772 2,027,320
---------- ------- ----------
Total available-for-sale................ $8,505,443 $13,887 $8,519,320
========== ======= ==========
</TABLE>
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 two 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 in accordance
with Accounting Principles Board No. 25, "Accounting for Stock Issued to
Employees", ("APB 25"), and has adopted the "disclosure only" alternative
described in Statement of Financial Accounting Standards No. 123.
Net Loss Per Share, Historical and Pro Forma
Basic and Diluted Net Loss Per Share (Historical)
In 1997, the Financial Accounting Standards Board issued Statement No. 128,
"Earnings Per Share" ("SFAS 128"). SFAS 128 replaced the calculation of
primary and fully diluted earnings per share with basic and diluted earnings
per share. Unlike primary earnings per share, basic earnings per share
excludes any dilutive effects of options, warrants and convertible securities.
Diluted earnings per share is very similar to the previously reported fully
diluted earnings per share. All net loss per share amounts for all periods
have been restated to conform to the FAS 128 requirements. Except as noted
below, net loss per share is computed using the weighted-average number of
shares of common stock outstanding. Common stock equivalent shares from
convertible preferred stock and from stock options and warrants are not
included as their effect is antidilutive.
Pro forma
Pro forma net loss per share has been computed as described above and also
gives effect to the conversion of convertible preferred shares not included
above that were automatically converted upon completion of the Company's
November 5, 1997 initial public offering, using the as-if-converted method
from the original date of issuance.
The following table sets forth the computation of basic and diluted loss per
share, on an historical and pro forma basis.
<TABLE>
<CAPTION>
Year Ended
December
31, 1997
-----------
<S> <C>
Numerator:
Net loss........................................................ $(1,236,452)
===========
Denominator:
Denominator for computing basic and diluted net loss per share
Historical...................................................... 3,664,242
Adjustments to reflect the effect of the assumed conversion of
convertible preferred stock from the original date of
issuance....................................................... 775,292
-----------
Denominator for computing basic and diluted net loss per share
Pro forma....................................................... 4,439,534
===========
Basic and diluted net loss per share -- Historical................ $ (0.34)
===========
Basic and diluted net loss per share -- Pro forma................. $ (0.28)
===========
</TABLE>
F-8
<PAGE>
DEPOMED, INC.
(A Development Stage Company)
NOTES TO FINANCIAL STATEMENTS--(Continued)
2. Summary of Significant Accounting Policies (Continued)
Revenue Recognition
Revenue related to collaborative research agreements with corporate partners
is recognized as the expenses are incurred for each contract. The Company is
required to perform research activities as specified in each respective
agreement on a best efforts basis, and the Company is reimbursed based on the
costs associated with supplies and the hours worked by employees on each
specific contract. Nonrefundable milestone payments are recognized pursuant to
collaborative agreements upon the achievement of specified milestones where no
further obligation to perform exists under that provision of the arrangement.
Comprehensive Income
The Company adopted Statement of Financial Accounting Standards ("SFAS")
130, "Reporting Comprehensive Income," at December 31, 1998. Under SFAS 130,
the Company is required to display comprehensive income and its components as
part of the Company's full set of financial statements. The measurement and
presentation of net loss did not change. Comprehensive income is comprised of
net loss and other comprehensive income. Other comprehensive income includes
certain changes in equity of the Company that are excluded from net loss.
Specifically, SFAS 130 requires unrealized holding gains and losses on the
Company's available-for-sale securities, which were reported separately in
stockholders' equity, to be included in accumulated other comprehensive
income. Comprehensive loss for the year ended December 31, 1998 has been
reflected in the Statement of Shareholders' Equity.
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.
Also in 1996 and continuing through 1998, the Company performed contract
research services for BMS under an arrangement whereby BMS reimbursed specific
research costs relating to the same product referred to above. Revenue
recognized in accordance with this arrangement amounted to $80,280 and
$604,876 in 1998 and 1997, respectively. There was no amount receivable under
the arrangement as of December 31, 1998.
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 April 1999.
R. W. Johnson Pharmaceutical Research Institute
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 GR System. The Company is paid for
actual costs, 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. The Company recognized revenues of $682,858 during 1998 in
accordance with the agreement. The amount receivable at December 31, 1998
under this feasibility agreement totaled $306,148.
F-9
<PAGE>
DEPOMED, INC.
(A Development Stage Company)
NOTES TO FINANCIAL STATEMENTS--(Continued)
4. Property and Equipment
Property and equipment consists of the following:
<TABLE>
<CAPTION>
December 31,
1998
------------
<S> <C>
Furniture and office equipment............................... $ 232,020
Laboratory equipment......................................... 809,420
Leasehold improvements....................................... 218,787
----------
1,260,227
Less accumulated depreciation and amortization............... (252,056)
----------
$1,008,171
==========
</TABLE>
Property and equipment includes assets under capitalized leases of $308,196
at December 31, 1998. Accumulated amortization related to assets under capital
leases totaled $97,929 at December 31, 1998.
5. Commitments and Contingencies
Long-Term Debt
In October 1998, the Company entered into a $600,000 equipment financing
credit facility ("Credit Facility") with a third party. The Credit Facility
allows the Company to incur loans up to $600,000 until July 1999. At December
1998, the Company had utilized approximately $494,000 of the Credit Facility,
at an annual percentage rate of 12.2%. Equal payments of principal and
interest of approximately $12,000 are due monthly through November 2002 with a
balloon payment of approximately $49,000 due December 2002. The financed
equipment serves as collateral for the loan.
Leases
The Company leases its facilities under a noncancelable operating sublease.
The facilities lease expires in March 2000 and includes an option to renew the
lease, subject to the approval by the Company and the sublessor, for two
additional terms of twelve and ten months, respectively. In 1998, the Company
entered into capital leases with one existing and three new lessors to finance
capital expenditures.
Future minimum payments under the operating leases, capital leases and long-
term debt at December 31, 1998, together with the present value of those
minimum payments, are as follows:
<TABLE>
<CAPTION>
Operating Capital Long-term
Leases Leases Debt
--------- -------- ---------
<S> <C> <C> <C>
Year ending December 31,
1999..................................... $349,452 $ 72,238 $ 156,212
2000..................................... 87,363 51,190 144,196
2001..................................... -- 42,130 144,196
2002..................................... -- 14,187 181,593
2003..................................... -- 4,544 --
-------- -------- ---------
$436,815 184,289 626,197
========
Less amount representing interest.......... (34,053) (132,064)
-------- ---------
Present value of future lease payments..... 150,236 494,133
Less current portion....................... (55,153) (107,212)
-------- ---------
Non-current portion........................ $ 95,083 $ 386,921
======== =========
</TABLE>
Rent expense for the years ended December 31, 1998 and 1997 and for the period
from inception to December 31, 1998 was approximately $282,000, $48,000 and
$384,000, respectively.
F-10
<PAGE>
DEPOMED, INC.
(A Development Stage Company)
NOTES TO FINANCIAL STATEMENTS--(Continued)
5. Commitments and Contingencies (Continued)
Contingent Liability
During the year, the Company 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 negotiated a settlement of $85,000 as full
payment of the CSO claim. The agreement and mutual release was signed by CSO
and the Company in October 1998.
Financial Consulting Agreement
In February 1998, the Company entered into a three-year agreement 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 shares of common stock at an exercise price $9.625 per share. The
options were fully vested as of the date of grant. The fair value of these
options is $430,200, as determined using the Black-Scholes Estimation Pricing
Model. The value of these options will be amortized ratably over the three-
year term of the consulting agreement.
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 provided for business development,
operations and financial advisory services to be performed by CSO for an
annual fee of $120,000. The agreement terminated in March 1998. Two members of
CSO were also directors of the Company until June 1998. During the years ended
December 31, 1998 and 1997, the Company paid $15,000 and $90,000,
respectively, in fees to CSO under the March 1997 arrangement.
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 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 notes were repaid in November 1997.
F-11
<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 required 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 September 1998, the Company
amended the agreement with Burrill & Co., whereby the Company is required to
pay a monthly retainer of $5,000 per month and other fees related to
partnering arrangements. Through December 31, 1998 and 1997, the Company paid
a total of $103,042 and $40,396, respectively, 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
the initial public offering, the Company issued warrants to purchase 117,917
Units (the "Representative's Warrants"). The Representative's Warrants are
exercisable at a price of $7.625 per Unit for a period of four years
commencing one year after the date of the initial public offering. The
warrants issuable upon exercise of the Representative's Warrants are
exercisable at $7.625 per warrant for a period of four years, commencing one
year from the date of the initial public offering.
In connection with a bridge financing, which was funded and repaid in
November 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 immaterial, therefore, the Company did not record any value
for these warrants.
As of December 31, 1998, 1,519,172 shares of common stock were reserved for
issuance of outstanding warrants.
Private Placement
On February 6, 1998, the Company completed a private placement of 1,000,000
shares of common stock for $8.00 per share, with net proceeds of approximately
$7,500,000.
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, 1998, a total of 1,000,000
shares of common stock have been reserved for issuance under the Plan. In
December 1998, the Board of Directors approved an increase to the Plan of
200,000 shares, subject to approval by the stockholders at the Company's
Annual Meeting of Shareholders in June 1999. 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-12
<PAGE>
DEPOMED, INC.
(A Development Stage Company)
NOTES TO FINANCIAL STATEMENTS--(Continued)
7. Shareholders' Equity (Continued)
1995 Stock Option Plan (Continued)
Generally, the exercise price of all incentive stock options and non-
qualified stock options granted under the Plan must be at least 100% and 85%,
respectively, 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. The right
to exercise an option generally vests at the rate of at least 25% at the end
of the first year and then ratably in monthly installments over the remaining
years of the option.
A summary of the Company's stock option activity and related information for
the period from inception (August 7, 1995) to December 31, 1998 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..................... -- (91,666) $ 0.09
-------- ----------
Balance at December 31, 1996............ 43,333 115,001 $ 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............ 270,834 637,500 $ 3.23
Shares authorized..................... 200,000* -- --
Options granted at fair value......... (296,498) 296,498 $ 8.10
Options granted below fair value...... (60,000) 60,000 $ 5.92
Options exercised..................... -- -- --
Options forfeited..................... 7,500 (7,500) $ 3.75
-------- ----------
Balance at December 31, 1998............ 121,836 986,498 $ 4.85
======== ==========
</TABLE>
* On December 9,1998 the Board of Directors approved an increase
of 200,000 shares to the plan subject to shareholders' approval
at the Annual Meeting of Shareholders on June 2, 1999.
The company granted options to purchase approximately 80,000 shares of
common stock in December 1998 that were not reserved for under the 1995 Stock
Option Plan (the "Plan"). The Board of Directors authorized an increase in the
number of shares reserved under the Plan by 200,000; however, these shares are
not duly authorized and available for grant until the shareholders approve the
increase at the Annual Meeting of Shareholders in June 1999. For accounting
purposes, the company must recognize compensation expense for the difference
between the fair market value on the date of grant (measurement date) and the
exercise price. The
F-13
<PAGE>
DEPOMED, INC.
(A Development Stage Company)
NOTES TO FINANCIAL STATEMENTS--(Continued)
7.Shareholders' Equity (Continued)
1995 Stock Option Plan (Continued)
stock options granted have exercise prices of $7.63 and $7.75, which represent
the fair market value of the company's common stock on the respective dates of
grant. However, as the options granted will not be authorized for grant until
the shareholders have approved the increase in the number of shares authorized
under the Plan, the measurement date will not be established until such
approval is obtained. The company will be required to recognize as
compensation expense the difference between the exercise price and the fair
market value of the underlying common stock at that time. If the stock price
is significantly higher on this date compared to the exercise price, the
company's results could be materially impacted in the second quarter of 1999.
Exercisable options at December 31, 1998, totaled 331,551. Exercise prices
for options outstanding as of December 31, 1998 ranged from $0.09 to $11.25.
The following table summarizes information about options outstanding at
December 31, 1998:
<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>
$0.09-0.90 114,999 $ 0.68 7.51 72,150 $ 0.60
$3.00-4.06 483,332 $ 3.54 8.69 182,735 $ 3.53
$5.25-6.10 71,667 $ 5.69 8.45 51,666 $ 5.85
$7.63-7.75 236,500 $ 7.64 9.96 -- --
$9.50-9.69 64,000 $ 9.67 9.25 20,000 $ 9.63
$10.25-11.25 16,000 $10.56 9.19 5,000 $11.25
------- -------
986,498 331,551
======= =======
</TABLE>
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. Options granted subsequent to the Company's initial public offering
were valued using the Black-Scholes Estimation Option Pricing Model. The
weighted-average assumptions used for 1998 and 1997 were as follows:
<TABLE>
<CAPTION>
Year Ended December 31,
-----------------------
1998 1997
------------ -----------
<S> <C> <C>
Risk free interest rate......................... 4.75% 6.2%
Expected dividend yield......................... 0 0
Expected option life in years................... 4 4
Expected stock price volatility................. .80 .70
</TABLE>
The weighted-average estimated fair value of employee stock option granted
at fair value was $4.92 and $1.92 for stock options granted in 1998 and 1997,
respectively. There were no employee stock options granted below fair value in
1998. The weighted-average estimated fair value of employee stock options
granted below fair value in 1997 was $2.15.
F-14
<PAGE>
DEPOMED, INC.
(A Development Stage Company)
NOTES TO FINANCIAL STATEMENTS--(Continued)
7. Shareholders' Equity (Continued)
Stock-Based Compensation (Continued)
The option valuation models used in 1998 and 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.
For pro forma purposes, the estimated fair value of the options is amortized
to expense over the option's vesting period. If the Company had elected to
recognize compensation expense based on the fair value of the options granted
on the date of grant as prescribed by SFAS 123, net loss and net loss per
share would have increased as reflected in the pro forma amounts shown in the
table below:
<TABLE>
<CAPTION>
Year Ended December 31,
------------------------
1998 1997
----------- -----------
<S> <C> <C>
Net loss--as reported........................... $(2,779,723) $(1,236,452)
Net loss--pro forma............................. $(3,067,834) $(1,275,943)
Net loss per share--as reported................. $ (0.44) $ (0.34)
Net loss per share--pro forma................... $ (0.49) $ (0.35)
</TABLE>
Deferred Compensation
For options granted through the initial public offering date, 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 the options.
Total deferred compensation recorded during 1998 and 1997 totaled $430,000
and $242,000, respectively. Compensation expense relating to the amortization
of deferred compensation recorded in the 1998 and 1997 income statements was
$321,000 and $116,000, respectively. Further, the Company recognized expense
of $26,000 in 1998 relating to the value of stock options granted to a
consultant in exchange for services.
8. Income Taxes
As of December 31, 1998, the Company had federal and state net operating
loss carryforwards of approximately $3,900,000 each. The Company also had
federal research and development tax credit carryforwards of approximately
$100,000. The net operating loss carryforwards will expire at various dates
beginning on 2010 through 2018 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 and similar state provisions. The annual
limitations may result in the expiration of net operating losses before
utilization.
F-15
<PAGE>
DEPOMED, INC.
(A Development Stage Company)
NOTES TO FINANCIAL STATEMENTS--(Continued)
8. Income Taxes (Continued)
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,
----------------------
1998 1997
----------- ---------
<S> <C> <C>
Net operating loss carryforward.................... $1 ,500,000 $ 700,000
Other.............................................. 100,000 100,000
----------- ---------
Total deferred tax assets.......................... 1,600,000 800,000
Valuation allowance for deferred tax assets........ (1,600,000) (800,000)
----------- ---------
Total............................................ $ -- $ --
=========== =========
</TABLE>
The net valuation allowance increased by $300,000 during the year ended
December 31, 1997.
F-16
<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
**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
*10.7 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
***+10.13 Joint Research Agreement dated February 20, 1998 between the company
and R.W. Johnson Pharmaceutical Research Institute
****10.14 Sublease dated February 18, 1998 between the company and R.W.
Johnson Pharmaceutical Research Institute
23.1 Consent of Ernst & Young LLP, Independent Auditors
24.1 Power of Attorney (see page 21)
27.1 Financial Data Schedule
</TABLE>
- --------
* Incorporated by reference to the Company's registration statement on Form
SB-2 (File No. 333-25445)
** Incorporated by reference to Exhibit 99.1 of the company's registration
statement on Form S-8 (File No. 333-66923)
*** Incorporated by reference to Exhibit 10.1 of the company's quarterly
report on Form 10-QSB filed on May 17, 1998
**** Incorporated by reference to Exhibit 10.2 of the company's quarterly
report on Form 10-QSB filed on May 17, 1998
+ Confidential treatment granted.
<PAGE>
Exhibit 23.1
CONSENT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS
We consent to the incorporation by reference in the Registration Statement
on Form S-3 (No. 333-66843) and the related Prospectus and in the Registration
Statement on Form S-8 (No. 333-66923) pertaining to the 1995 Stock Option
Plan, as amended, of DepoMed, Inc. of our report dated February 12, 1999, with
respect to the financial statements of DepoMed, Inc. included in its Annual
Report (Form 10-KSB) for the year ended December 31, 1998.
/s/ ERNST & YOUNG LLP
Palo Alto, California
March 22, 1999
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<S> <C>
<PERIOD-TYPE> 12-MOS
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-START> JAN-01-1998
<PERIOD-END> DEC-31-1998
<CASH> 4,058,716
<SECURITIES> 2,603,398
<RECEIVABLES> 306,148
<ALLOWANCES> 0
<INVENTORY> 0
<CURRENT-ASSETS> 187,024
<PP&E> 1,260,228
<DEPRECIATION> 252,057
<TOTAL-ASSETS> 10,278,804
<CURRENT-LIABILITIES> 590,787
<BONDS> 0
0
0
<COMMON> 14,792,072
<OTHER-SE> 0
<TOTAL-LIABILITY-AND-EQUITY> 10,278,804
<SALES> 0
<TOTAL-REVENUES> 763,138
<CGS> 2,061,983
<TOTAL-COSTS> 4,028,441
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 21,437
<INCOME-PRETAX> (2,779,723)
<INCOME-TAX> 0
<INCOME-CONTINUING> (2,779,723)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (2,779,723)
<EPS-PRIMARY> (0.44)
<EPS-DILUTED> (0.44)
</TABLE>
