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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, 1999
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)
1360 O'BRIEN DRIVE, MENLO PARK, CALIFORNIA 94025
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES) (ZIP CODE)
Registrant's telephone number, including area code: (650) 462-5900
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. [ X ]
The issuer's revenues for its most recent fiscal year were $115,327.
The aggregate market value of the voting stock held by non-affiliates
of the registrant on March 6, 1999, based upon the closing price of the Common
Stock on the American Stock Exchange for such date, was approximately
$38,357,000.
The number of outstanding shares of the registrant's Common Stock on
March 6, 2000 was 7,189,363.
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, 2000 and to be used in connection with the
Annual Meeting of Shareholders expected to be held June 7, 2000 are incorporated
by reference in Part III of this Form 10-KSB.
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DEPOMED, INC.
1999 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 ............................................................................................................. 11
Item 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER
MATTERS ............................................................................................. 11
Item 6. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS ............................................................................... 12
Item 7. FINANCIAL STATEMENTS ................................................................................ 19
Item 8. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE ................................................................................ 19
PART III ............................................................................................................ 20
Item 9. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT .................................................. 20
Item 10. EXECUTIVE COMPENSATION .............................................................................. 20
Item 11. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT ...................................... 20
Item 12. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS ...................................................... 20
Item 13. EXHIBITS AND REPORTS ON FORM 8-K .................................................................... 20
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The statements in this Annual Report on Form 10-KSB and other
statements made by DepoMed, Inc., a California corporation, 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 proprietary products utilizing certain off-patent and over-the-counter
("OTC") drugs in the DepoMed Systems.
In November 1999, we entered into an agreement to form a joint venture
with Elan Corporation, plc. The joint venture will develop a series of
undisclosed proprietary products using oral drug delivery technologies licensed
to the venture by both companies. 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 independently developed a potential
once-daily metformin product for Type II diabetes, 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 opportunities. We are currently seeking marketing partners
to commercialize 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.
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The increasing need to deliver medication to patients efficiently and
with fewer side effects has accelerated the pace of invention of new drug
delivery systems and the development and maturation of the drug delivery
industry. Today medication can be delivered to a patient through many different
delivery systems, including transdermal, injection, implant and oral methods.
However, these delivery methods continue to have certain limitations.
Transdermal patches are often inconvenient to apply, can be irritating to the
skin and the rate of release can be difficult to control. Injections are
uncomfortable for most patients. In most cases both injections and implants must
be administered in a hospital or physician's office and, accordingly, are
frequently not suitable for home use. Oral administration remains the preferred
method of administering medication. However, conventional oral drug
administration also has limitations. Because capsules and tablets have limited
effectiveness in providing controlled drug delivery, they frequently result in
drug release that is too rapid, causing incomplete absorption of the drug,
irritation to the GI tract and other side effects. In addition, they lack the
ability to provide localized therapy. The company believes that the need for
frequent dosing of many drugs administered by capsules and tablets also can
impede patient compliance with the prescribed regimen.
THE DEPOMED SYSTEMS
The DepoMed Systems are based on the company's proprietary oral drug
delivery technologies and are designed to include formulations of
drug-containing polymeric units that allow 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 individually
dosed or 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. We believe
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. We believe 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. We believe
that the DepoMed Systems may be able to make the oral delivery of some
of these drugs therapeutically effective.
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- - PROPRIETARY REFORMULATION OF GENERIC PRODUCTS. We believe that the
DepoMed Systems may offer the potential to produce improved
formulations of off-patent drugs. These proprietary formulations may be
differentiated from existing generic products by virtue of reduced
dosing requirements, improved efficacy, decreased toxicity or
additional indications.
THE GASTRIC RETENTION SYSTEM
The GR System consists of a proprietary formulation of 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.
We have demonstrated multihour gastric retention in humans who have
been given the GR System with food. In addition, we are 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. We believe 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. We believe 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, we believe 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. We believe 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.
We have developed a calcium supplement product which utilizes the GR
System. We are currently seeking a marketing partner to commercialize this
product. We believe 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 dissolution and subsequent absorption. However, conventional
calcium carbonate products pass through the stomach too quickly for a
significant amount of the calcium to dissolve.
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We believe 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 many 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-Registered Trademark- or Tagamet-Registered Trademark-,
which have a longer on-set of action. We believe 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. We believe 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. We believe that this mechanism will allow effective oral delivery of some
drugs that currently require administration by injection. In addition, we
believe 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 the bisphosphonates used in treatment of osteoporosis may benefit from the
RI System.
We have 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, including the formation of ulcers. The irritation properties of
aspirin are mostly local, not systemic in origin. Local damage begins and is
sustained by high local drug concentration against the mucosa, particularly when
aspirin is administered in a solid, crystalline state as from a rapidly
disintegrating 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.
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PRODUCT DEVELOPMENT INITIATIVES
The following table summarizes DepoMed's principal product development
initiatives:
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DEPOMED POTENTIAL EXPECTED
SYSTEM PROGRAM PARTNER INDICATIONS BENEFIT
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GR Metformin In-house Type II diabetes Less frequent dosing
GR Generic Compound (1) Elan Corporation, plc Confidential (2) Improved dosing
regimen & new
indication
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 absorption
deficiencies
RI Aspirin In-house Multiple, including pain Reduced
and cardiovascular gastrointestinal
therapy irritation
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(1) Undisclosed.
(2) The potential indication may not be disclosed pursuant to the terms of
the agreement between the company and Elan Corporation, plc. 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. In January 2000, we successfully completed Phase I human clinical
trials with Metformin GR-TM- and are preparing an Investigational New Drug
application ("IND") with the United States Food and Drug Administration (the
"FDA"). For the PRI compound, formulation work was initiated in March 1998. We
have completed internal development of the calcium supplement and aspirin
product and are seeking collaborative partners to manufacture and market these
products. Upon identification of the appropriate corporate partners, we expect
to initiate clinical trials to support marketing claims on these products.
COLLABORATIVE RELATIONSHIPS
ELAN CORPORATION, PLC. In November 1999, we signed a binding letter
agreement with Elan Corporation, plc, Elan Pharma International, Ltd. and Elan
International Services, Ltd. (together "Elan") to form a joint venture to
develop a series of undisclosed proprietary products using drug delivery
technologies and expertise of both companies. This joint venture, DepoMed
Development, Ltd. ("DDL"), a Bermuda limited liability company, is initially
owned 80.1% by DepoMed and 19.9% by Elan. DDL will subcontract research and
development efforts to DepoMed, Elan and others.
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. We successfully completed the first
phase of formulation development in March 1999 and the product is currently
under review at PRI. There can be no assurance, however, that the company will
be able to enter into an agreement with PRI on reasonable commercial terms, or
at all.
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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 GR System.
Pursuant to the agreement, BMS had an option to obtain an exclusive, worldwide
license to products incorporating the BMS compound utilizing the GR System. In
April 1999, BMS notified us that BMS would not exercise its option and the
agreement was terminated.
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 and Andrx Corporation, 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 DepoMed's, and in some cases with different sites of
delivery to the GI tract. We believe that we are 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). We believe that this combination of oral drug delivery
technologies differentiates us from other oral drug delivery companies and will
enable us 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 we. 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 four issued United States patents and three
United States patent applications are pending. Additionally, we are currently
preparing a series of patent applications representing our expanding technology
for filing in the United States. We have also 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, we cannot be certain
that others have not filed patent applications for technology covered by our
pending applications or that we were 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 our patent rights. 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.
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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 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. We 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. We 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.
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In the United States, the FDA rigorously regulates pharmaceutical
products, including any drugs using the DepoMed Systems. If a company fails to
comply with 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 often 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 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:
- 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 have
obtained product liability insurance for clinical trials currently underway.
Although, there can be no assurance that:
- we will be able to obtain product liability insurance for
future trials;
- we will be able to maintain product liability insurance on
acceptable terms;
- we 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, 1999, we had twenty-one full-time employees. None of
our employees is represented by a collective bargaining agreement, nor have we
experienced any work stoppage. We believe that our relations with our employees
are excellent.
The success of the company is dependent in large part upon the
continued services of John W. Fara, our President and Chief Executive Officer
and other members of the company's executive management, and on our ability to
attract and retain key management and operating personnel. We maintain key man
life insurance on the life of Dr. Fara in the amount of $1,000,000. 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, we 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 will not be renewed
by our sublessor. In February 2000, we entered into a five-year non-cancelable
lease of approximately 21,000 square feet of laboratory and office facilities in
Menlo Park, California. It includes an option to renew for one additional term
of five years. We expect that this facility will accommodate our growth for at
least two years.
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, 1999.
9
<PAGE>
EXECUTIVE OFFICERS
The executive officers of the company and their ages as of December 31,
1999 are as follows:
<TABLE>
<CAPTION>
NAME AGE POSITION
---- --- --------
<S> <C> <C>
John W. Shell, Ph.D ........... 74 Founder, Chairman of the Board and Chief Scientific Officer
John W. Fara, Ph.D ............ 57 President, Chief Executive Officer and Director
Bret Berner, Ph.D ............. 47 Vice President, Product Development
John F. Hamilton .............. 55 Vice President, Finance and Chief Financial Officer
John N. Shell ................. 46 Vice President, Operations and Director
</TABLE>
John W. Shell, Ph.D., has served as Chairman of the Board of Directors
of the company since its inception in August 1995 and served as the company's
President and Chief Executive Officer from 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. In keeping with longstanding retirement plans, in March 2000, Dr. Shell
resigned as the company's Chairman and Chief Scientific Officer, effective April
1, 2000. Dr. Shell will continue to serve as a consultant and director of the
company. 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. In March 2000, he was elected Chairman of the Board of Directors of the
company to succeed Dr. Shell, effective April 1, 2000. From February 1990 to
June 1996 Dr. Fara 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 18
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.
10
<PAGE>
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER
MATTERS
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
the high and low closing prices of the company's Common Stock as reported by the
Nasdaq to November 8, 1998 and by the AMEX from November 9, 1998:
<TABLE>
<CAPTION>
1998 HIGH LOW
---- ---- ---
<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
1999
----
First Quarter ......... $ 12-1/4 $ 7-3/4
Second Quarter ........ $ 14-3/8 $2-13/16
Third Quarter ......... $3-15/16 $1-15/16
Fourth Quarter ........ $ 7-3/8 $ 2-1/2
</TABLE>
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 the high and low closing prices of
the Warrants, as reported by the Nasdaq to November 8, 1998 and by the AMEX
from November 9, 1998:
<TABLE>
<CAPTION>
1998 HIGH LOW
---- ---- ---
<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
1999
----
First Quarter ......... $ 7 $ 3-1/4
Second Quarter ........ $ 8-7/8 $ 3/4
Third Quarter ......... $ 2-1/4 $ 5/8
Fourth Quarter ........ $ 2-5/8 $ 5/8
</TABLE>
As of March 6, 2000, the numbers of holders of record of the Common
Stock and the Warrants were 33 and 9, respectively, and there were approximately
650 beneficial shareholders.
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.
11
<PAGE>
ITEM 6. MANAGEMENT'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"). To
date, we have received only limited revenue, all of which has been from these
collaborative research and feasibility arrangements. DepoMed has generated a
cumulative net loss of approximately $22,298,000 for the period from inception
through December 31, 1999. $12,015,000 of this loss is attributable to our share
of the loss in a joint venture as described below.
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 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 2000 and beyond, expenses can be expected to increase
from their 1999 levels.
12
<PAGE>
On November 30, 1999, we signed a legally binding letter agreement with
Elan Corporation, plc, Elan Pharma International, Ltd. and Elan International
Services, Ltd. (together "Elan") to form a joint venture to develop products
using drug delivery technologies and expertise of both companies. This joint
venture, DepoMed Development, Ltd. ("DDL"), a Bermuda limited liability company,
is initially owned 80.1% by DepoMed and 19.9% by Elan. DDL will subcontract
research and development efforts to DepoMed, Elan and others. Under the terms of
the agreement, DDL paid $15,000,000 to Elan for a license giving DDL
non-exclusive rights to use certain Elan drug delivery technologies. DepoMed
will also license certain drug delivery technologies to DDL on a non-exclusive
basis. As a legally binding agreement, the transaction was recorded in the
fourth quarter of 1999. All final documents, cash payments and stock issuances
were completed on January 21, 2000.
The agreement also provided for the following transactions:
- Elan purchased 717,286 shares of DepoMed's common stock at $7.00 per
share. The shares purchased are unregistered and have registration rights. The
proceeds may be used by DepoMed without restriction.
- Elan purchased 12,015 shares of DepoMed Series A convertible
exchangeable preferred stock (the "Series A Preferred Stock") at $1,000 per
share. The Series A Preferred Stock accrues a dividend of 7% per annum,
compounded semi-annually and payable in shares of our Series A Preferred Stock.
The Series A Preferred Stock is convertible at anytime after two years, at
Elan's option, into the Company's common stock at a price of $12.00 per share.
Additionally, Elan has an option to exchange 12,015 shares of Series A Preferred
Stock for a 30.1% interest in DDL, increasing Elan's ownership in DDL to 50%.
This exchange option is exercisable after two years from original issue date and
within six years of such date. The exchange right will terminate if the Series A
Preferred Stock is converted into the DepoMed's common stock unless this
conversion occurs as a result of a liquidation or certain transactions involving
a change of control of DepoMed. DepoMed used the proceeds of the Series A
Preferred Stock sale to purchase 6,000 shares of DDL common stock and 3,612
shares of DDL preferred stock to fund our share of DDL's initial capitalization.
- Elan purchased 2,388 shares of DDL preferred shares for $2,985,000, a
19.9% interest in DDL.
- DepoMed will fund 80.1% of the joint venture research and development
costs over the next two years. If Elan elects to exercise its exchange option on
the Series A Preferred Stock, it will also repay DepoMed 30.1% of joint venture
funding paid by DepoMed. Upon repayment by Elan, both DepoMed and Elan will have
shared evenly in funding the joint venture.
- Elan has made a loan facility available to DepoMed for up to
$8,010,000. The purpose of this facility is to support DepoMed's share of the
joint venture's research and development costs pursuant to a convertible
promissory note issued by DepoMed to Elan. The note has a six-year term and
bears interest of 9% per annum, compounded semi-annually, on any amounts
borrowed under the facility. Elan may convert all or any portion of the
outstanding principal amount and accrued and unpaid interest into DepoMed's
common stock at a conversion price of $10.00. As of March 30, 2000, there was no
amount outstanding related to the note.
While we own 80.1% of the outstanding common stock of DDL, Elan and its
subsidiaries have retained significant minority investor rights that are
considered "participating rights" as defined in the Emerging Issues Task Force
Consensus No. 96-16. Accordingly, we will not consolidate the financial
statements of DDL, but will instead account for our investment in DDL under the
equity method of accounting.
DepoMed Development, Ltd., for the quarter ended December 31, 1999,
recognized a net loss of $15,000,000 reflecting a charge to research and
development expense for a license fee paid to Elan for non-exclusive access to
certain Elan drug delivery technologies. We recorded 80.1% of the loss as our
share in the loss of the joint venture for the quarter ended December 31, 1999.
We had a zero basis in the DDL investment at December 31, 1999.
Final closing agreements were signed among DepoMed, Elan and DDL on
January 21, 2000.
13
<PAGE>
RESULTS OF OPERATIONS
YEARS ENDED DECEMBER 31, 1999 AND 1998
Revenues for the years ended December 31, 1999 and 1998 were
approximately $115,000 and $763,000, respectively. In 1999, these revenues
consisted entirely of amounts earned under the feasibility arrangement with PRI.
In 1998, these revenues consisted of amounts earned under the feasibility and
the research and development arrangements with PRI and Bristol-Myers Squibb
Company ("BMS"), respectively. Research and development payments from PRI
declined as a result of our having completed the first phase of formulation
development in March 1999, the product is currently under review at PRI.
Revenues from BMS ended in March 1998 as a result of our having completed our
research activities for BMS. In April 1999, we were notified by BMS that BMS
would not exercise its license and development option to use the DepoMed Gastric
Retention System for an undisclosed pharmaceutical product.
Research and development expense for the year ended December 31, 1999
was approximately $3,734,000 compared to approximately $2,062,000 during the
year ended December 31, 1998. The increase was primarily due to expenses for
clinical trials with DepoMed proprietary products which began in the third
quarter as well as the hiring of additional employees and related expenses,
increased laboratory supplies, and increased depreciation and amortization
expense of equipment and facilities improvements.
General and administrative expense for the year ended December 31, 1999
was approximately $1,872,000 compared to approximately $1,966,000 during the
year ended December 31, 1998. Increased salaries and the additional expense
incurred as a result of expanded investor relations activities were offset by
decreased legal and accounting fees realized as we reduced our reliance on
outside professionals for some reporting services. The cost of obtaining
directors and officers insurance also decreased from 1998 levels.
In October 1999, our sublessor notified us that our facility would not
be available for lease after March 31, 2000, the end of our sublease term. In
February 2000, we signed a five-year lease for a new facility located at 1360
O'Brien Drive in Menlo Park, California. As a result, building and occupancy
expense will increase approximately $90,000 per quarter and there will be
expenses for relocation to the new facility in the first quarter of 2000.
In the fourth quarter of 1999, we recognized 80.1%, or $12,015,000, of
the loss in our joint venture with Elan. Our joint venture, DDL, paid
$15,000,000 as a one-time license fee for non-exclusive access to certain Elan
drug delivery technologies. DDL will subcontract research and development
activities to DepoMed, Elan and others. Over the next two years, we expect our
share of DDL's losses will be approximately $8,000,000. Elan has made available
to us a convertible loan facility assisting us to fund our portion of the joint
venture research and development costs.
Net interest income was approximately $297,000 for the year ended
December 31, 1999 compared to approximately $486,000 during the year ended
December 31, 1998. The decrease was due to declining cash and investment
balances. Net interest income also includes immaterial gains realized on the
sale of some of our marketable securities.
LIQUIDITY AND CAPITAL RESOURCES
Cash used in operations in the year ended December 31, 1999 was
approximately $3,945,000 compared to approximately $2,522,000 for the year ended
December 31, 1998. During the year ended December 31, 1999, the change in cash
used was due primarily to the net loss offset by our share in the loss of a
joint venture. In 1998, the change in cash used in operations was due primarily
to the increase in net loss.
Cash provided by investing activities in the year ended December 31,
1999 totaled approximately $885,000 and consisted of a net decrease of
approximately $1,023,000 of marketable securities offset by purchases of
laboratory equipment, fixtures and office equipment. Cash used in investing
activities in the year ended December 31, 1998 totaled approximately $5,478,000
and consisted of purchases of marketable securities totaling $4,624,000 as well
as laboratory equipment, fixtures and office equipment. We expect that future
capital expenditures may
14
<PAGE>
include additional product development and quality control laboratory
equipment as we work towards implementation of current Good Manufacturing
Practices ("cGMP") in our laboratories. We also expect to spend approximately
$350,000 over the next three quarters of 2000 for leasehold improvements at
our new facility in Menlo Park, California.
Cash used in financing activities in the year ended December 31, 1999
was approximately $65,000 and consisted of payments on an equipment financing
credit facility established in 1998 and capital lease obligations totaling
approximately $175,000 offset against $106,000 in proceeds from the equipment
financing credit facility. (See Note 5 of Notes to Financial Statements). 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
1998, we financed $494,000 of equipment under the credit facility.
As of December 31, 1999, we had approximately $4,466,000 in cash, cash
equivalents and marketable securities, working capital of $8,845,000 and
accumulated losses of $22,298,000. In January 2000, we completed a private
placement with proceeds of approximately $5,000,000. (See Note 9 of Notes to
Financial Statements.) We expect to continue to incur operating losses over the
next several years. We anticipate that our existing capital resources will
permit us to meet our capital and operational requirements through the next
twelve to fifteen months. However, we base this expectation on our current
operating plan that 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 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 of our shareholders' equity positions. 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.
The inability to raise capital would have a material adverse effect on
the company.
15
<PAGE>
YEAR 2000
Year 2000 ("Y2K") exposure was the result of some computer programs
using two instead of four digits to represent the year. Computer programs may
have erroneously interpreted dates beyond the year 1999 causing system failures
or other computer errors, possibly leading to disruptions in operations.
In response to this potentiality, we developed and implemented a
program to eliminate Y2K exposures. Computer systems and applications were
reviewed for Y2K compliance, remedied as necessary and tested. Third-party
relationships were reviewed and monitored for Y2K compliance. We developed a
contingency plan to stockpile materials from any vendors that did not meet Y2K
compliance by year-end; however, we were sufficiently confident in our
preparation, and in our vendors', that we did not implement our contingency
plan. We have not experienced any system failures, errors or disruptions in our
operations due to Y2K and we do not expect any in the future.
As of December 31, 1999 we paid approximately $15,000 related to Y2K
compliance. The funds for compliance were part of our cash flow from operations
and capital expenditures.
NET OPERATING LOSSES
We have not generated any taxable income to date. At December 31, 1999,
the net operating losses available to offset future taxable income for federal
income tax purposes were approximately $9,300,000. Because we have 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 our
federal income tax liabilities.
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;
- dependence on 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 would need
to complete substantial additional research and development on a drug provided
by a collaborative partner. 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.
16
<PAGE>
Before we or others make commercial sales of products using the DepoMed
Systems, we or our collaborative partners would need to:
- 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 enter
into additional collaborative arrangements. The success of any such
collaborative arrangements requires that our collaborative partners:
- perform their obligations as expected; and
- devote sufficient resources to the development, clinical
testing and marketing of products developed under
collaborations.
Even when such arrangements are entered into, our 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, in April 1999, BMS informed the company of its decision not
to exercise its option under a 1996 agreement to license the DepoMed Gastric
Retention System for a product. Additionally, we are not currently conducting
research and development under the PRI feasibility agreement while we await a
PRI decision on whether or not to proceed. There can be no assurance that PRI
will support further development of its program based on our technology.
Further, we 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.
17
<PAGE>
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.
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 we desire access to inventions which are not our
property, we will have to obtain licenses to such inventions from these
institutions or companies. We 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. We expect 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. We expect this pressure to continue to increase. We
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.
18
<PAGE>
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.
ITEM 7. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The financial statements and supplementary data required by Item 7 are
set forth below on pages F-1 through F-19.
ITEM 8. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
Not applicable.
19
<PAGE>
PART III
ITEM 9. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The information required by this Item with respect to executive
officers is set forth in Part I of this report and the information with respect
to directors is incorporated by reference to the information set forth under the
caption "Election of Directors" in the proxy statement (the "Proxy Statement")
for the 2000 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.
20
<PAGE>
(a)3. EXHIBITS:
<TABLE>
<S> <C>
*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
*10.9 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
*10.12 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.
*****10.15 Securities Purchase Agreement dated January 21, 2000
between the company and Elan International Services,
Ltd.
*****10.16 Company Registration Rights Agreement dated January
21, 2000 between the company and Elan International
Services, Ltd.
*****10.17 Newco Registration Rights Agreement dated January 21,
2000 among the company, Newco and Elan International
Services, Ltd.
*****10.18 Funding Agreement dated January 21, 2000 among the
company, Elan Corporation, plc, Elan Pharma
International, Ltd. and Elan International Services,
Ltd.
*****10.19 Subscription, Joint Development Operating Agreement
dated January 21, 2000 among the company, Newco, Elan
Corporation, plc, Elan Pharma International, Ltd. and
Elan International Services, Ltd.
*****10.20 Convertible Promissory Note dated January 21, 2000
issued by the company to Elan International Services,
Ltd.
*****10.21 Company License Agreement dated January 21, 2000 among
the company, Newco and Elan Corporation, plc.
*****10.22 Elan License Agreement dated January 21, 2000 among
the company, Newco, Elan Corporation, plc and Elan
Pharma International, Ltd.
*****10.23 Certificate of Determination of Rights and Preferences
of Series A Preferred Stock filed with the State of
California on January 14, 2000
23.1 Consent of Ernst & Young LLP, Independent Auditors
24.1 Power of Attorney (see page 22)
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
***** Incorporated by reference to the company's Form 8-K filed on February
18, 2000
+ Confidential treatment granted.
(b) REPORTS ON FORM 8-K:
None
21
<PAGE>
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the issuer, a corporation organized and existing under the
laws of the State of California, has duly caused this report to be signed on its
behalf by the undersigned thereunto duly authorized, in the City of Foster City,
State of California, on the 30th day of March, 2000.
DEPOMED, INC.
By /S/ John W. Fara, Ph.D.
---------------------------------------
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.
<TABLE>
<CAPTION>
SIGNATURE
---------
<S> <C> <C>
/s/ John W. Shell, Ph.D. Chairman of the March 30, 2000
- ----------------------------------------- Board of Directors
JOHN W. SHELL, PH.D. and Chief Scientific Officer
/s/ John W. Fara, Ph.D. President, Chief March 30, 2000
- ----------------------------------------- Executive Officer
JOHN W. FARA, PH.D. and Director
(Principal Executive Officer)
/s/ John N. Shell Vice President, March 30, 2000
- ----------------------------------------- Operations and Director
JOHN N. SHELL
/s/ John F. Hamilton Vice President, March 30, 2000
- ----------------------------------------- Finance and Chief
JOHN F. HAMILTON Financial Officer
(Principal Financial Officer)
/s/ G. Steven Burrill Director March 30, 2000
- -----------------------------------------
G. STEVEN BURRILL
/s/ W. Leigh Thompson, Ph.D. Director March 30, 2000
- -----------------------------------------
W. LEIGH THOMPSON, PH.D.
</TABLE>
22
<PAGE>
DEPOMED, INC.
(A DEVELOPMENT STAGE COMPANY)
INDEX TO FINANCIAL STATEMENTS
<TABLE>
<CAPTION>
FINANCIAL STATEMENTS
<S> <C>
Report of Ernst & Young LLP, Independent Auditors ................................................................. F-2
Balance Sheet ..................................................................................................... F-3
Statements of Operations .......................................................................................... F-4
Statement of Shareholders' Equity ................................................................................. F-5
Statements of Cash Flows .......................................................................................... F-7
Notes to Financial Statements ..................................................................................... F-8
</TABLE>
<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, 1999, and the related statements of
operations, shareholders' equity, and cash flows for the years ended December
31, 1999 and 1998 and for the period from inception (August 7, 1995) to December
31, 1999. 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 auditing standards generally accepted
in the United States. 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, 1999, and the results of its operations and its
cash flows for the years ended December 31, 1999 and 1998 and for the period
from inception (August 7, 1995) to December 31, 1999, in conformity with
accounting principles generally accepted in the United States.
/s/ ERNST & YOUNG LLP
Palo Alto, California
February 25, 2000
F-2
<PAGE>
DEPOMED, INC.
(A DEVELOPMENT STAGE COMPANY)
BALANCE SHEET
DECEMBER 31, 1999
<TABLE>
<S> <C>
ASSETS
Current assets:
Cash and cash equivalents .................................... $ 934,317
Marketable securities ........................................ 3,532,065
Receivable for capital stock ................................. 17,015,000
Prepaid and other current assets ............................. 169,385
------------
Total current assets ................................. 21,650,767
Property and equipment, net ........................................ 779,631
Other assets ....................................................... 4,467
------------
$ 22,434,865
------------
------------
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Accounts payable ............................................. $ 219,675
Accrued compensation ......................................... 275,047
Other accrued liabilities .................................... 131,889
Payable to joint venture ..................................... 12,015,000
Capital lease obligation, current portion .................... 41,131
Long-term debt, current portion .............................. 123,042
------------
Total current liabilities ............................ 12,805,784
Capital lease obligation, non-current portion ...................... 53,952
Long-term debt, non-current portion ................................ 356,649
Commitments
Shareholders' equity:
Preferred stock, no par value; 5,000,000 shares
authorized; no shares issued and outstanding .............. -
Common stock, no par value, 25,000,000 shares
authorized; 6,475,077 shares issued and outstanding ....... 14,797,072
Capital stock issuable ....................................... 17,015,000
Deferred compensation ........................................ (282,184)
Deficit accumulated during the development stage ............. (22,298,416)
Accumulated other comprehensive loss ......................... (12,992)
------------
Total shareholders' equity ........................... 9,218,480
------------
$ 22,434,865
------------
------------
</TABLE>
See accompanying notes.
F-3
<PAGE>
DEPOMED, INC.
(A DEVELOPMENT STAGE COMPANY)
STATEMENTS OF OPERATIONS
<TABLE>
<CAPTION>
PERIOD FROM
YEAR ENDED DECEMBER 31, INCEPTION
---------------------------------- (AUGUST 7, 1995) TO
1999 1998 DECEMBER 31, 1999
------------ ----------- -------------------
<S> <C> <C> <C>
Product development revenue ................. $ 115,327 $ 763,138 $ 1,801,312
Operating expenses:
Research and development .............. 3,734,196 2,061,983 7,178,615
General and administrative ............ 1,871,596 1,966,458 5,346,946
Purchase of in-process
research and development ........... - - 298,154
------------ ----------- ------------
Total operating expenses .................... 5,605,792 4,028,441 12,823,715
------------ ----------- ------------
Loss from operations ........................ (5,490,465) (3,265,303) (11,022,403)
Other income (expenses):
Equity in loss of joint venture ....... (12,015,000) - (12,015,000)
Interest income, net .................. 296,665 485,580 738,987
------------ ----------- ------------
Total other income (expenses) ............... (11,718,335) 485,580 (11,276,013)
------------ ----------- ------------
Net loss .................................... $(17,208,800) $(2,779,723) $(22,298,416)
------------ ----------- ------------
------------ ----------- ------------
Basic and diluted net loss per share ........ $ (2.66) $ (0.44)
------------ -----------
------------ -----------
Shares used in computing basic
and diluted net loss per share .......... 6,474,538 6,318,233
------------ -----------
------------ -----------
</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, 1999
<TABLE>
<CAPTION>
Convertible
Preferred Stock Common Stock Capital
----------------------------- ------------------------ Stock
Shares Amount Shares Amount Issuable
-------------- ------------- ---------- ------------ -----------
<S> <C> <C> <C> <C> <C>
Balances at inception
(August 7, 1995) ............ - $ - - $ - $ -
Issuance of common stock
to founders on August 7,
1995 in exchange for
shares held by them in M6 ... - - 2,066,666 - -
Pharmaceuticals, Inc.
Issuance of common stock
for cash to investors
at approximately
$0.0009 per share on
November 15, 1995 ........... - - 1,196,491 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 - - -
Comprehensive loss .............. - - - - -
-------------- ------------- ---------- ------------ -----------
Balances at
December 31, 1995 ........... 2,447,368 682,759 3,263,157 1,000 -
Issuance of common stock
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 -
Deferred compensation
related to grants of
certain stock options ....... - - - 275,000 -
Comprehensive loss .............. - - - - -
-------------- ------------- ---------- ------------ -----------
Balances at
December 31, 1996 ........... 2,447,368 682,759 3,354,823 284,250 -
Issuance of Series B
convertible preferred
stock to investors for
cash at $1.00 per share ..... 278,500 278,500 - - -
Conversion of
preferred stock to
common stock on
November 5, 1997
at a ratio of one share
of common for three
shares of preferred ......... (2,725,868) (961,259) 908,615 961,259 -
Issuance of common stock
and warrants for $6.10
per unit on November 5,
1997 in connection
with the initial public
offering, net of issuance
costs of $1,963,889 ......... - - 1,200,000 5,356,111 -
</TABLE>
<TABLE>
<CAPTION>
Deficit Total
Accumulated Accumulated Shareholders'
During Other Equity (Net
Deferred Development Comprehensive Capital
Compensation Stage Income (Loss) Deficiency)
------------- ------------- --------------- --------------
<S> <C> <C> <C> <C>
Balances at inception
(August 7, 1995) ............ $ - $ - $ - $ -
Issuance of common stock
to founders on August 7,
1995 in exchange for
shares held by them in M6 ... - - - -
Pharmaceuticals, Inc.
Issuance of common stock
for cash to investors
at approximately
$0.0009 per share on
November 15, 1995 ........... - - - 1,000
Issuance of Series A
convertible
preferred stock
for cash to
investors
at approximately
$0.31 per share on
November 15, 1995
net of issuance
costs of $67,241............. - - - 682,759
Comprehensive loss .............. - (600,668) - (600,668)
------------- ------------- --------------- --------------
Balances at
December 31, 1995 ........... - (600,668) - 83,091
Issuance of common stock
for cash at various
dates at $0.09 per share
to employees and
the Company's counsel
pursuant to stock option
agreements .................. - - - 8,250
Deferred compensation
related to grants of
certain stock options ....... (275,000) - - -
Comprehensive loss .............. - (472,773) - (472,773)
------------- ------------- --------------- --------------
Balances at
December 31, 1996 ........... (275,000) (1,073,441) - (381,432)
Issuance of Series B
convertible preferred
stock to investors for
cash at $1.00 per share ..... - - - 278,500
Conversion of
preferred stock to
common stock on
November 5, 1997
at a ratio of one share
of common for three
shares of preferred ......... - - - -
Issuance of common stock
and warrants for $6.10
per unit on November 5,
1997 in connection
with the initial public
offering, net of issuance
costs of $1,963,889 ......... - - - 5,356,111
</TABLE>
See accompanying notes.
F-5
<PAGE>
DEPOMED, INC.
(A DEVELOPMENT STAGE COMPANY)
STATEMENT OF SHAREHOLDERS' EQUITY
PERIOD FROM INCEPTION (AUGUST 7, 1995) TO DECEMBER 31, 1999 (CONTINUED)
<TABLE>
<CAPTION>
Convertible
Preferred Stock Common Stock Capital
Stock
Shares Amount Shares Amount Issuable
------------- ---------------- --------------- --------------- ------------
<S> <C> <C> <C> <C> <C>
Deferred compensation
related to grants of
certain stock options .............. - - - 242,050 -
Amortization of
deferred compensation .............. - - - - -
Comprehensive loss ..................... - - - - -
------------- ---------------- --------------- --------------- ------------
Balances at
December 31, 1997 .................. - - 5,463,438 6,843,670 -
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 -
Deferred compensation
related to grants of
certain stock options .............. - - - 430,200 -
Amortization of
deferred compensation .............. - - - - -
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 -
Comprehensive loss:
Net loss ........................... - - - - -
Unrealized gains on
available-for-sale securities .... - - - - -
Comprehensive loss .....................
------------- ---------------- --------------- --------------- ------------
Balances at
December 31, 1998 .................. - - 6,463,438 14,792,074 -
Issuance of common
shares for cash on
February 16, 1999 for
$3.00 per share to a
consultant pursuantto a
stock option agreement ............. - - 1,666 4,998 -
Net exercise of common stock
warrants at $7.63 per share
in January and April 1999 .......... - - 9,973 - -
Common stock issuable to
Elan Corporation for $7.00
per share with proceeds of
$5,000,000 ......................... - - - - 5,000,000
Series A preferred stock issuable
to Elan Corporation for
$1,000 per share with
proceeds of $12,015,000 ............ - - - - 12,015,000
Amortization of deferred
compensation ....................... - - - - -
Comprehensive loss:
Net loss ........................... - - - - -
Unrealized losses on ............... - - - - -
available-for-sale securities
Comprehensive loss .....................
------------- ---------------- --------------- --------------- ------------
Balances at
December 31, 1999 .................. - $ - 6,475,077 $ 14,797,072 $ 17,015,000
------------- ---------------- --------------- --------------- ------------
------------- ---------------- --------------- --------------- ------------
</TABLE>
<TABLE>
<CAPTION>
Deficit Total
Accumulated Accumulated Shareholders'
During Other Equity (Net
Deferred Development Comprehensive Capital
Compensation Stage Income (Loss) Deficiency)
----------------- --------------- ---------------- --------------
<S> <C> <C> <C> <C>
Deferred compensation
related to grants of
certain stock options .............. (242,050) - - -
Amortization of
deferred compensation .............. 116,336 - - 116,336
Comprehensive loss ..................... - (1,236,452) - (1,236,452)
Balances at
December 31, 1997 .................. (400,714) (2,309,893) - 4,133,063
Issuance of common stock
to investors for $8.00 per
share on February 23, 1998,
net of issuance costs
of $507,846 ........................ - - - 7,492,154
Deferred compensation
related to grants of
certain stock options .............. (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
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)
----------------- --------------- ---------------- --------------
Balances at
December 31, 1998 .................. (510,332) (5,089,616) 13,887 9,206,013
Issuance of common
shares for cash on
February 16, 1999 for
$3.00 per share to a
consultant pursuantto a
stock option agreement ............. - - - 4,998
Net exercise of common stock
warrants at $7.63 per share
in January and April 1999 .......... - - - -
Common stock issuable to
Elan Corporation for $7.00
per share with proceeds of
$5,000,000 ......................... - - - 5,000,000
Series A preferred stock issuable
to Elan Corporation for
$1,000 per share with
proceeds of $12,015,000 ............ - - - 12,015,000
Amortization of deferred
compensation ....................... 228,148 - - 228,148
Comprehensive loss:
Net loss ........................... - (17,208,800) - (17,208,800)
Unrealized losses on ............... - - (26,879) (26,879)
--------------
available-for-sale securities
Comprehensive loss ..................... (17,235,679)
----------------- --------------- ---------------- --------------
Balances at
December 31, 1999 .................. $ (282,184) $(22,298,416) $ (12,992) $ 9,218,480
================= =============== ================ ==============
</TABLE>
See accompanying notes.
F-6
<PAGE>
DEPOMED, INC.
(A DEVELOPMENT STAGE COMPANY)
STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
PERIOD FROM
INCEPTION
YEAR ENDED DECEMBER 31, (AUGUST 7, 1995)
----------------------------- TO
1999 1998 DECEMBER 31, 1999
------------ ----------- -----------------
<S> <C> <C> <C>
OPERATING ACTIVITIES
Net loss ....................................................................... $(17,208,800) $(2,779,723) $(22,298,416)
Adjustments to reconcile net loss to net cash used in operating activities:
Equity in loss of joint venture ............................................ 12,015,000 - 12,015,000
Depreciation and amortization .............................................. 415,343 196,967 714,326
Accrued interest expense on shareholder notes .............................. - - 13,618
Amortization of deferred compensation ...................................... 228,148 320,582 665,066
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 .................................................... 306,148 (161,261) -
Other current assets ................................................... 17,639 (86,345) (169,385)
Other assets ........................................................... 83,465 (77,675) (4,625)
Accounts payable and other accrued liabilities ......................... 94,137 (21,829) 351,564
Accrued compensation ................................................... 104,052 135,448 207,571
Other current liabilities .............................................. - (74,086) -
------------ ----------- ------------
Net cash used in operating activities .......................... (3,944,868) (2,521,872) (8,181,077)
------------ ----------- ------------
INVESTING ACTIVITIES
Expenditures for property and equipment ........................................ (138,232) (853,600) (1,129,841)
Purchases of marketable securities ............................................. (2,264,082) (4,624,175) (6,967,839)
Maturities of marketable securities ............................................ 3,287,380 - 3,366,962
------------ ----------- ------------
Net cash provided by (used in) investing activities ............ 885,066 (5,477,775) (4,730,718)
------------ ----------- ------------
FINANCING ACTIVITIES
Payments on capital lease obligations .......................................... (55,153) (57,469) (213,113)
Proceeds from equipment loan ................................................... 105,734 494,133 599,867
Payments of equipment loan ..................................................... (120,176) - (120,176)
Proceeds from issuance of notes ................................................ - - 1,050,000
Payments of notes .............................................................. - - (1,000,000)
Payment of shareholder loans ................................................... - - (294,238)
Proceeds on issuance of common stock ........................................... 4,998 7,492,154 13,823,772
------------ ----------- ------------
Net cash (used in) provided by financing activities ............ (64,597) 7,928,818 13,846,112
------------ ----------- ------------
Net increase (decrease) in cash and cash equivalents ........................... (3,124,399) (70,829) 934,317
Cash and cash equivalents at beginning of period ............................... 4,058,716 4,129,545 -
------------ ----------- ------------
Cash and cash equivalents at end of period ..................................... $ 934,317 $ 4,058,716 $ 934,317
------------ ----------- ------------
------------ ----------- ------------
SUPPLEMENTAL SCHEDULE OF NONCASH FINANCING AND INVESTING ACTIVITIES
Payable to joint venture ....................................................... $ 12,015,000 $ - $ 12,015,000
------------ ----------- ------------
------------ ----------- ------------
Acquisition of property and equipment under capital leases ..................... $ - $ 144,313 $ 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 ....................................... $ 75,616 $ 21,437 $ 218,864
------------ ----------- ------------
------------ ----------- ------------
</TABLE>
See accompanying notes
F-7
<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.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
CASH, CASH EQUIVALENTS AND MARKETABLE SECURITIES
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 marketable securities 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 marketable securities range
from 1-24 months. All marketable securities are classified as
available-for-sale. These securities are carried at market value with unrealized
gains and losses included in accumulated other comprehensive income (loss) in
shareholders' equity.
Securities classified as available-for-sale as of December 31, 1999 are
summarized below. Estimated fair value is based on quoted market prices for
these investments.
<TABLE>
<CAPTION>
GROSS
AMORTIZED UNREALIZED ESTIMATED
COST LOSSES FAIR VALUE
---------- -------- ----------
<S> <C> <C> <C>
U.S. corporate securities:
Total included in cash and cash equivalents.... $ 498,264 $ - $ 498,264
Total included in short-term investments....... 3,545,057 (12,992) 3,532,065
---------- -------- ----------
Total available-for-sale.......................... $4,043,321 $(12,992) $4,030,329
---------- -------- ----------
---------- -------- ----------
</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-8
<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 accounting
principles generally accepted in the United States 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 grants of stock options and common stock
purchase rights to its employees according to the intrinsic value method and,
thus, recognizes no stock-based compensation expense for options granted with
exercise prices equal to or greater than fair value of the Company's common
stock on the date of grant. The Company records deferred stock-based
compensation when the deemed fair value of the Company's common stock for
financial accounting purposes exceeds the exercise price of the stock options or
purchase rights on the date of grant. Any such deferred stock-based compensation
is amortized over the vesting period of the individual options. Pro forma net
loss information using the fair value method accounting for grants of stock
options to employees is included in Note 7.
Options granted to non-employees are accounted for at fair value using
the Black-Scholes option valuation model and may be subject to periodic
re-valuation over their vesting terms. The resulting stock-based compensation
expense is recorded over the service period in which the non-employee provides
services to the Company.
NET LOSS PER SHARE
Net loss per share is computed using the weighted-average number of
shares of common stock outstanding. Common stock equivalent shares from
outstanding stock options and warrants are not included as their effect is
antidilutive. Stock options to purchase 1,327,383 shares of common stock at a
weighted-average purchase price of $4.29 and warrants to purchase 1,479,979
shares of common stock at a weighted-average purchase price of $7.54 were
outstanding as of December 31, 1999. These shares were not included in the
computation of diluted earnings per share as they would have had an antidilutive
effect on net loss per share.
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
Comprehensive income (loss) is comprised of net loss and other
comprehensive income (loss). Other comprehensive income (loss) 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 shareholders'
equity, to be included in accumulated other comprehensive loss. Comprehensive
loss for the years ended December 31, 1999 and 1998 has been reflected in the
Statement of Shareholders' Equity.
F-9
<PAGE>
DEPOMED, INC.
(A DEVELOPMENT STAGE COMPANY)
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
RECENT ACCOUNTING STANDARDS
In June 1998, the Financial Accounting Standards Board issued Statement
of Financial Accounting Standards No. 133, "Accounting for Derivative
Instruments and Hedging Activities" ("SFAS 133"). SFAS 133 provides a
comprehensive and consistent standard for the recognition and measurement of
derivatives and hedging activities. In July 1999, the Financial Accounting
Standards Board announced the delay of the effective date of SFAS 133 for one
year, to the first quarter of 2001. To date, the Company has not engaged in
derivative or hedging activities.
In March 1998, the AICPA issued Statement of Position 98-1, "Accounting
for the Costs of Computer Software Developed or Obtained for Internal Use" ("SOP
98-1"). SOP 98-1 requires that entities capitalize certain costs related to
internal use software once certain criteria have been met. The Company adopted
the provisions of SOP 98-1 on January 1, 1999. The Company has not incurred any
costs related to internal use software as of December 31, 1999.
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 in 1998.
There were no revenues recorded under the arrangement in 1999.
Pursuant to the agreement, BMS had an option to obtain an exclusive,
worldwide license to products incorporating the BMS compound utilizing the GR
System. In April 1999, the Company was notified by BMS that BMS would not
exercise its license and development option to use the Company's GR System for
the undisclosed pharmaceutical product.
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 $115,327 and $682,858 during
1999 and 1998, respectively, in accordance with the agreement. There was no
amount receivable at December 31, 1999 under this feasibility agreement.
In the first quarter of 1999, the Company successfully completed the
first phase of formulation development under the PRI feasibility agreement. The
product is currently under review at PRI.
F-10
<PAGE>
DEPOMED, INC.
(A DEVELOPMENT STAGE COMPANY)
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
3. RESEARCH ARRANGEMENTS (CONTINUED)
ELAN CORPORATION, PLC
On November 30, 1999, the Company signed a legally binding letter
agreement (the "Agreement") with Elan Corporation, plc, Elan Pharma
International, Ltd. and Elan International Services, Ltd. (together "Elan") to
form a joint venture to develop products using drug delivery technologies and
expertise of both companies. This joint venture, DepoMed Development, Ltd.
("DDL"), a Bermuda limited liability company, is initially owned 80.1% by the
Company and 19.9% by Elan. DDL will subcontract research and development efforts
to the Company, Elan and others. Under the terms of the Agreement, DDL was to
pay $15,000,000 to Elan for a license providing DDL non-exclusive rights to use
certain Elan drug delivery technologies. The Company also licensed certain drug
delivery technologies to DDL on a non-exclusive basis. Since the agreement was a
legally binding agreement as of the date of the execution of such agreement, the
Company recorded the transaction in the fourth quarter of 1999, except for
actual cash payments and stock issuances. Such amounts were recorded as
receivables or payables, as appropriate.
The Agreement also provides for the following transactions:
- Elan will purchase 717,286 shares of the Company's common stock at
$7.00 per share. The shares purchased will be unregistered and have registration
rights. The proceeds may be used by the Company without restriction.
- Elan will purchase 12,015 shares of DepoMed Series A convertible
exchangeable preferred stock (the "Series A Preferred Stock") at $1,000 per
share. The Series A Preferred Stock accrues a dividend of 7% per annum,
compounded semi-annually and payable in shares of the Series A Preferred Stock.
The Series A Preferred Stock is convertible at anytime after two years, at
Elan's option, into the Company's common stock at a price of $12.00 per share.
Additionally, Elan has the right to exchange 12,015 shares of Series A Preferred
Stock for a 30.1% interest in DDL, increasing Elan's ownership in DDL to 50%.
This exchange option is exercisable after two years from original issue date and
within six years of such date. The exchange right will terminate if the Series A
Preferred Stock is converted into the DepoMed's common stock unless this
conversion occurs as a result of a liquidation or upon the occurrence of certain
transactions involving a change of control of the Company. DepoMed will use the
proceeds of the Series A Preferred Stock sale to purchase 6,000 shares of DDL
common stock and 3,612 shares of DDL preferred stock, both classes of stock
purchased at $1,250 per share, to fund the Company's share of DDL's initial
capitalization.
- Elan will purchase 2,388 shares of DDL preferred shares, a 19.9%
interest in DDL.
- DepoMed will fund 80.1% of the joint venture research and development
costs over the next two years. If Elan elects to exercise its exchange option on
the Series A Preferred Stock, it will also repay DepoMed 30.1% of joint venture
funding paid by DepoMed. Upon repayment by Elan, both DepoMed and Elan will have
shared evenly in funding the joint venture.
- Elan will also make a loan facility available to DepoMed for up to
$8,010,000. The purpose of this loan is to support DepoMed's share of the joint
venture's research and development costs pursuant to a convertible promissory
note issued by the Company to Elan. The note has a six-year term and will bear
interest at 9% per annum, compounded semi-annually, on any amounts borrowed
under the facility. The note and accrued interest will be convertible at Elan's
option. Elan may convert all or any portion of the outstanding principal amount
and accrued and unpaid interest into DepoMed's common stock at a conversion
price of $10.00 per share.
F-11
<PAGE>
DEPOMED, INC.
(A DEVELOPMENT STAGE COMPANY)
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
3. RESEARCH ARRANGEMENTS (CONTINUED)
ELAN CORPORATION, PLC (CONTINUED)
While the Company owns 80.1% of the outstanding common stock of DDL,
Elan and its subsidiaries have retained significant minority investor rights
that are considered "participating rights" as defined in the Emerging Issues
Task Force Consensus No. 96-16. Accordingly, DepoMed will not consolidate the
financial statements of DDL, but will instead account for its investment in DDL
under the equity method of accounting.
For the quarter ended December 31, 1999, DDL recognized a net loss of
$15,000,000, reflecting a charge to research and development expense for a
license fee paid to Elan for non-exclusive access to certain Elan drug delivery
technologies. The Company recorded 80.1% of the loss as equity in loss of the
joint venture for the quarter ended December 31, 1999. The Company had a zero
basis in its DDL investment at December 31, 1999.
Final closing agreements were signed among the Company, Elan and DDL on
January 21, 2000.
4. PROPERTY AND EQUIPMENT
At December 31, 1999, property and equipment consists of the following:
<TABLE>
<CAPTION>
<S> <C>
Furniture and office equipment ................... $ 264,486
Laboratory equipment ............................. 913,643
Leasehold improvements ........................... 219,464
-----------
1,397,593
Less accumulated depreciation and amortization ... (617,962)
-----------
$ 779,631
-----------
-----------
</TABLE>
Property and equipment includes assets under capitalized leases of
$186,240 at December 31, 1999. Accumulated amortization related to assets under
capital leases totaled $74,246 at December 31, 1999.
5. COMMITMENTS AND CONTINGENCIES
CONVERTIBLE PROMISSORY NOTE
On November 30, 1999, the Company signed a binding letter agreement to
issue a convertible promissory note to Elan Corporation, plc, for $8,010,000 to
fund research and development of a joint venture, DDL. As of December 31, 1999
there was no amount outstanding related to the note. (See Note 3, Research
Arrangements, Elan Corporation, plc)
LONG-TERM DEBT
The Company entered into a $600,000 equipment financing credit facility
("Credit Facility") with a third party in 1998. The Credit Facility allowed the
Company to incur loans up to $600,000 through 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. In June 1999, the Company
financed additional equipment of approximately $106,000 under the agreement, at
an annual percentage rate of 13.5%. Equal payments of approximately $2,500 are
due monthly through May 2003 with a balloon payment of approximately $10,500 due
June 2003. The financed equipment serves as collateral for the loan.
F-12
<PAGE>
DEPOMED, INC.
(A DEVELOPMENT STAGE COMPANY)
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
5. COMMITMENTS AND CONTINGENCIES (CONTINUED)
LEASES
The Company leases its facilities under a noncancelable operating
sublease that expires in March 2000. In October 1999, the Company was notified
by its sublessor that its facility would not be available for lease after the
current lease term. In February 2000, the Company leased new facilities in Menlo
Park, California, and expects to move its operations and offices by April 2000.
The new facility is leased under a non-cancelable agreement that expires in
March 2005, with an option to extend the lease term for an additional five
years.
Future minimum payments under the operating leases, including the new
facility lease, capital leases and long-term debt at December 31, 1999, 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,
2000 ................................ $ 516,661 $ 51,190 $175,816
2001 ................................ 595,410 42,130 175,816
2002 ................................ 613,272 14,187 213,212
2003 ................................ 657,379 4,545 23,748
2004 ................................ 650,620 - -
Thereafter .......................... 136,373 - -
----------- --------- --------
$ 3,169,715 112,052 588,592
-----------
-----------
Less amount representing interest ......... (16,969) (108,901)
--------- ---------
Present value of future lease payments .... 95,083 479,691
Less current portion ...................... (41,131) (123,042)
--------- ---------
Non-current portion ....................... $ 53,952 $ 356,649
--------- ---------
--------- ---------
</TABLE>
Rent expense for the years ended December 31, 1999 and 1998 and for the
period from inception to December 31, 1999 was approximately $350,000, $282,000
and $734,000, respectively.
FINANCIAL CONSULTING AGREEMENT
In 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.
F-13
<PAGE>
DEPOMED, INC.
(A DEVELOPMENT STAGE COMPANY)
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
6. RELATED PARTY TRANSACTIONS
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, 1999 and 1998, the Company paid a
total of $62,699 and $103,042, 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, 1999, 1,479,979 shares of common stock were reserved
for issuance of outstanding warrants.
F-14
<PAGE>
DEPOMED, INC.
(A DEVELOPMENT STAGE COMPANY)
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
7. SHAREHOLDERS' EQUITY (CONTINUED)
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. In June 1999, at the Company's Annual Meeting of
Shareholders, the stockholders approved an increase to the Plan of 800,000
shares. As of December 31, 1999, a total of 1,800,000 shares of common stock
have been reserved for issuance under the Plan. The Plan provides for the
granting to employees of the Company, including officers and employee directors,
of incentive stock options, and for the granting of nonstatutory stock options
to employees and consultants of the Company.
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 vesting
period of the option.
F-15
<PAGE>
DEPOMED, INC.
(A DEVELOPMENT STAGE COMPANY)
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
7. SHAREHOLDERS' EQUITY (CONTINUED)
1995 STOCK OPTION PLAN (CONTINUED)
A summary of the Company's stock option activity and related
information for the period from inception (August 7, 1995) to December 31, 1999
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
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 forfeited .................... 7,500 (7,500) $3.75
-------- --------- -----
Balance at December 31, 1998 ................. 121,836 986,498 $4.85
Shares authorized ............................ 600,000 - -
Options granted at fair value ........ (363,551) 363,551 $2.93
Options exercised .................... - (1,666) $3.00
Options forfeited .................... 21,000 (21,000) $7.29
-------- --------- -----
Balance at December 31, 1999 ................. 379,285 1,327,383 $4.29
-------- ---------
-------- ---------
</TABLE>
* On December 9, 1998 the Board of Directors approved an increase of
200,000 shares to the plan which was approved by the stockholders at
the Annual Meeting of Shareholders on June 2, 1999.
F-16
<PAGE>
DEPOMED, INC.
(A DEVELOPMENT STAGE COMPANY)
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
7. SHAREHOLDERS' EQUITY (CONTINUED)
1995 STOCK OPTION PLAN (CONTINUED)
Exercisable options at December 31, 1999, totaled 567,973. Exercise
prices for options outstanding as of December 31, 1999 ranged from $0.09 to
$11.25. The following table summarizes information about options outstanding at
December 31, 1999:
<TABLE>
<CAPTION>
OUTSTANDING OPTIONS EXERCISABLE OPTIONS
--------------------------------------------- ----------------------
WEIGHTED- REMAINING WEIGHTED-
AVERAGE CONTRACTUAL AVERAGE
EXERCISE NUMBER EXERCISE LIFE NUMBER EXERCISE
PRICES OF OPTIONS PRICE (IN YEARS) OF OPTIONS PRICE
--------- ----------- ---------- ------------ ---------- ---------
<S> <C> <C> <C> <C> <C>
$0.09-0.90 114,999 $ 0.68 6.49 97,637 $ 0.64
$2.88-4.19 836,217 $ 3.27 8.47 291,902 $ 3.52
$5.25-6.10 71,667 $ 5.69 7.44 61,666 $ 5.76
$7.63-7.75 232,500 $ 7.64 8.93 72,895 $ 7.66
$9.50-9.88 66,000 $ 9.67 8.26 38,394 $ 9.65
$10.25-11.25 6,000 $ 11.08 8.38 5,479 $11.16
--------- -------
1,327,383 567,973
--------- -------
--------- -------
</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 Option Valuation Model. The weighted-average assumptions used
for 1999 and 1998 were as follows:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
------------------------
1999 1998
------ ------
<S> <C> <C>
Risk free interest rate 4.81% 4.75%
Expected dividend yield 0 0
Expected option life in years 4 4
Expected stock price volatility .80 .80
</TABLE>
The weighted-average estimated fair value of employee stock options was
$1.83 and $4.92 for stock options granted in 1999 and 1998, respectively.
The option valuation models used in 1999 and 1998, were developed for
using in estimating the fair value of traded options which have no vesting
restrictions and are fully transferable. In addition, option valuation models
require the input of highly subjective assumptions including the expected stock
price volatility. Because the Company's employee stock options have
characteristics significantly different from those of traded options, and
because changes in the subjective input assumptions can materially affect the
fair value estimate, in management's opinion, the existing models do not
necessarily provide a reliable single measure of the fair value of its employee
stock options.
F-17
<PAGE>
DEPOMED, INC.
(A DEVELOPMENT STAGE COMPANY)
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
7. SHAREHOLDERS' EQUITY (CONTINUED)
STOCK-BASED COMPENSATION (CONTINUED)
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,
----------------------------------
1999 1998
------------- ------------
<S> <C> <C>
Net loss-as reported ................................. $(17,208,800) $(2,779,723)
Net loss-pro forma ................................... $(17,827,568) $(3,067,834)
Net loss per share-as reported ....................... $ (2.66) $ (0.44)
Net loss per share-pro forma ......................... $ (2.75) $ (0.49)
</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 reporting
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 totaled $430,000.
There was no deferred compensation recorded in 1999. Compensation expense
relating to the amortization of deferred compensation recorded in the 1999 and
1998 statements of operations was $228,000 and $321,000, 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, 1999, the Company had federal and state net
operating loss carryforwards of approximately $9,300,000 each. The Company also
had federal and California research and development tax credit carryforwards of
approximately $200,000 each. The net operating loss and credit carryforwards
will expire at various dates beginning on 2003 through 2019 if not utilized.
Utilization of the net operating loss and credit carryforwards may be
subject to a substantial annual limitation due to the ownership change
limitations provided by the Internal Revenue Code of 1986 and similar state
provisions. The annual limitation may result in the expiration of net operating
losses and credits before utilization.
F-18
<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 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,
---------------------------------
1999 1998
----------- -----------
<S> <C> <C>
Net operating loss carryforwards ................... $ 3,700,000 $ 1,500,000
Research credit carryforwards ...................... 400,000 100,000
Technology license ................................. 4,800,000 -
----------- -----------
Total deferred tax assets .......................... 8,900,000 1,600,000
Valuation allowance for deferred tax assets ........ (8,900,000) (1,600,000)
----------- -----------
Total .............................................. $ - $ -
----------- -----------
----------- -----------
</TABLE>
Due to the Company's lack of earnings history, the net deferred tax assets have
been fully offset by a valuation allowance. The valuation allowance increased by
$800,000 during the year ended December 31, 1998.
9. SUBSEQUENT EVENTS
SALE OF SECURITIES
On January 21, 2000, 717,286 shares of common stock and 12,015 shares of Series
A convertible exchangeable preferred stock were issued to Elan Corporation, plc
for consideration of $5,000,000 and $12,015,000, respectively. (See Note 3,
Research Arrangements, Elan Corporation, plc)
FACILITIES LEASE
In February 2000, the Company entered into a five-year lease for a new
facility, beginning March 2000, which includes an option to renew for one
additional five-year term. (See Note 5, Commitments and Contingencies, Leases)
F-19
<PAGE>
INDEX TO EXHIBITS
<TABLE>
<S> <C>
*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
*10.9 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
*10.12 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.
*****10.15 Securities Purchase Agreement dated January 21, 2000
between the company and Elan International Services,
Ltd.
*****10.16 Company Registration Rights Agreement dated January
21, 2000 between the company and Elan International
Services, Ltd.
*****10.17 Newco Registration Rights Agreement dated January 21,
2000 among the company, Newco and Elan International
Services, Ltd.
*****10.18 Funding Agreement dated January 21, 2000 among the
company, Elan Corporation, plc, Elan Pharma
International, Ltd. and Elan International Services,
Ltd.
*****10.19 Subscription, Joint Development Operating Agreement
dated January 21, 2000 among the company, Newco, Elan
Corporation, plc, Elan Pharma International, Ltd. and
Elan International Services, Ltd.
*****10.20 Convertible Promissory Note dated January 21, 2000
issued by the company to Elan International Services,
Ltd.
*****10.21 Company License Agreement dated January 21, 2000 among
the company, Newco and Elan Corporation, plc.
*****10.22 Elan License Agreement dated January 21, 2000 among
the company, Newco, Elan Corporation, plc and Elan
Pharma International, Ltd.
*****10.23 Certificate of Determination of Rights and Preferences
of Series A Preferred Stock filed with the State of
California on January 14, 2000
23.1 Consent of Ernst & Young LLP, Independent Auditors
24.1 Power of Attorney (see page 22)
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
***** Incorporated by reference to the company's Form 8-K filed on February
18, 2000
+ 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 25, 2000, with respect
to the financial statements of DepoMed, Inc. included in this Annual Report
(Form 10-KSB) for the year ended December 31, 1999.
/s/ ERNST & YOUNG LLP
Palo Alto, California
March 29, 2000
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<S> <C>
<PERIOD-TYPE> 12-MOS
<FISCAL-YEAR-END> DEC-31-1999
<PERIOD-START> JAN-01-1999
<PERIOD-END> DEC-31-1999
<CASH> 934,317
<SECURITIES> 3,532,065
<RECEIVABLES> 0
<ALLOWANCES> 0
<INVENTORY> 0
<CURRENT-ASSETS> 21,650,767
<PP&E> 1,397,593
<DEPRECIATION> 617,962
<TOTAL-ASSETS> 22,434,865
<CURRENT-LIABILITIES> 12,805,784
<BONDS> 0
0
0
<COMMON> 14,797,072
<OTHER-SE> 0
<TOTAL-LIABILITY-AND-EQUITY> 22,434,865
<SALES> 0
<TOTAL-REVENUES> 115,327
<CGS> 0
<TOTAL-COSTS> 5,605,792
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 75,616
<INCOME-PRETAX> (17,208,800)
<INCOME-TAX> 0
<INCOME-CONTINUING> (17,208,800)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (17,208,800)
<EPS-BASIC> (2.66)
<EPS-DILUTED> (2.66)
</TABLE>
