SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-K

 

(Mark one)

 

ý Annual Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934.

For the fiscal year ended: December 31, 2004

 

OR

 

o 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.

(Exact Name of Registrant as Specified in its Charter)

 

California

 

94-3229046

(State or other jurisdiction of incorporation or organization)

 

(I.R.S. Employer Identification No.)

 

 

 

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:

None

 

Securities registered pursuant to Section 12(g) of the Act:

 

Title of Each Class

Common Stock, no par value

 

Indicate by check mark whether the registrant (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  ý   No  o 

 

Indicate by check if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K 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-K or any amendment to this Form 10-K. o 

 

Indicate by check mark whether the registrant is an accelerated filer (as defined in Exchange Act Rule 12b-2). Yes  ý   No  o 

 

The aggregate market value of the voting stock held by non-affiliates of the registrant on June 30, 2004, based upon the closing price of the Common Stock on the Nasdaq National Market for such date, was approximately $124,052,000

 

The number of outstanding shares of the registrant’s Common Stock on March 4, 2005 was 39,727,190.

 

Documents Incorporated by Reference

 

Portions of the Proxy Statement to be filed with the Securities and Exchange Commission on or prior to April 30, 2005 and to be used in connection with the Annual Meeting of Shareholders expected to be held on or about May 26, 2005 are incorporated by reference in Part III of this Form 10-K.

 

 



 

DEPOMED, INC.

 

2004 FORM 10-K REPORT

 

TABLE OF CONTENTS

 

PART I

 

 

 

 

 

 

Item 1.

BUSINESS

 

 

Item 2.

PROPERTIES

 

 

Item 3.

LEGAL PROCEEDINGS

 

 

Item 4.

SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

 

 

 

 

PART II

 

 

 

 

 

 

Item 5.

MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED SHAREHOLDER MATTERS AND ISSUER REPURCHASE OF EQUITY SECURITIES

 

 

Item 6.

SELECTED FINANCIAL DATA

 

 

Item 7.

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

 

 

Item 7A.

QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

 

 

Item 8.

FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

 

 

Item 9.

CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE

 

 

Item 9A.

CONTROLS AND PROCEDURES

 

 

Item 9B.

OTHER INFORMATION

 

 

 

 

PART III

 

 

 

 

 

 

Item 10.

DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT

 

 

Item 11.

EXECUTIVE COMPENSATION

 

 

Item 12.

SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED SHAREHOLDER MATTERS

 

 

Item 13.

CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

 

 

Item 14.

PRINCIPAL ACCOUNTANT FEES AND SERVICES

 

 

 

 

PART IV

 

 

 

 

 

 

Item 15.

EXHIBITS AND REPORTS ON FORM 8-K

 

 

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Statements made in this Annual Report on Form 10-K 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. We have based these forward-looking statements on our current expectations and projections about future events. Our actual results could differ materially from those discussed in, or implied by, these forward-looking statements. Forward-looking statements are identified by words such as “believe,” “anticipate,” “expect,” “intend,” “plan,” “will,” “may” and other similar expressions. In addition, any statements that refer to expectations, projections or other characterizations of future events or circumstances are forward-looking statements. Forward-looking statements include, but are not necessarily limited to, those relating to:

 

  regulatory approval of Glumetza™ (Metformin GR™) and Proquin™ (Ciprofloxacin GR™)

 

  results and timing of our clinical trials, including the results of the Furosemide GR™ and Gabapentin GR™ trials and publication of those results;

 

  our ability to raise additional capital;

 

  our ability to obtain a marketing partner for Proquin or our other product candidates; and

 

  our plans to develop other product candidates.

 

Factors that could cause actual results or conditions to differ from those anticipated by these and other forward-looking statements include those more fully described in the “ADDITIONAL FACTORS THAT MAY AFFECT FUTURE RESULTS” section and elsewhere in this Annual Report on Form 10-K. We are not obligated to update or revise these forward-looking statements to reflect new events or circumstances.

 

PART I

 

Item 1.       Business

 

Company Overview

 

We are an emerging specialty pharmaceutical company engaged in the development of pharmaceutical products based on our proprietary oral drug delivery technologies. Our collaborative partner has received an approvable letter in response to a New Drug Application (NDA) submitted to the Food and Drug Administration (FDA) for one product we developed and we have submitted an NDA to the FDA for another proprietary product.  In addition, we have two products in Phase II clinical trials.  Our primary oral drug delivery system is our patented Gastric Retention System, or the GR™ System. The GR System is a tablet designed to be retained in the stomach for an extended period of time while it delivers the incorporated drug or drugs on a continuous, controlled-release basis. By incorporation into the GR System, some drugs currently taken two or three times a day may be administered only once a day. We also have a product containing two different drug compounds incorporated in the GR System in preclinical development. The principal patent on our GR System covers the controlled delivery of a broad range of drugs from a gastric retained polymer matrix tablet to maximize therapeutic benefits. Our intellectual property position includes nine issued patents and twelve patent applications pending in the United States.

 

In this Annual Report on Form 10-K, the “company,” “Depomed,” “we,” “us,” and “our,” refer to Depomed, Inc.

 

We are developing our own proprietary products and are also developing products utilizing our GR technology in collaboration with other pharmaceutical and biotechnology companies.  Regarding our collaborative programs, we apply our proprietary technology to the partner’s compound and from these collaborations we generally expect we will receive research and development funding, milestone payments, license fees and royalties. For our internal development programs, we apply our proprietary technology to existing drugs and typically fund development at least through Phase II clinical trials.  Upon the completion of Phase II clinical trials, we evaluate, on a case-by-case basis, the feasibility of retaining marketing or co-marketing

 

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rights to our product candidates in the United States, taking into account such factors as the marketing and sales efforts required for each of the product candidates, the potential collaborative partners and the proposed terms of any such collaboration. When we license marketing rights to a collaborative partner, we generally expect the partner to fund the completion of the clinical trials and to pay us license fees, milestones and royalties on sales of the product.

 

Glumetza™ (Metformin GR™ )

 

In April 2004, our collaborative partner, Biovail Laboratories, submitted an NDA for our internally developed once-daily metformin product for Type II diabetes, Metformin GR, also known as the 500mg strength version of Glumetza.  The FDA accepted the application for review in June 2004.  In February 2005, Biovail received an approvable letter from the FDA requiring certain additional steps be taken prior to approval of the drug.  The earliest that we expect to obtain FDA approval to market Metformin GR is in the second quarter of 2005, if at all.

 

In May 2002, we entered into an agreement with Biovail Laboratories granting Biovail an exclusive license in the United States and Canada to manufacture and market Metformin GR. The agreement provides for a $25.0 million milestone payment to us upon FDA approval and royalties on net sales of Metformin GR. Biovail has an option to reduce certain royalties for a one-time payment to us of $35.0 million.  In April 2004, we and Biovail amended the Metformin GR licensing agreement.  Under the amended agreement, we will receive royalties on sales of Biovail’s 1000 mg metformin HC1 tablet in the United States and Canada in exchange for allowing Biovail to use our clinical data for Metformin GR, our 500 mg metformin HC1 tablet, to support and accelerate regulatory submissions for Biovail’s 1000 mg tablet and to establish equivalence between the two dosage forms.  The NDA filed by Biovail was for approval of both Metformin GR and Biovail’s 1000 mg metformin HCl tablet under the brand name of Glumetza™.

 

In August 2004, we entered into an agreement granting LG Life Sciences, Ltd., a biopharmaceutical company based in Seoul, Korea, an exclusive license to distribute Glumetza (500mg) in the Republic of Korea.  The agreement provides for a $600,000 upfront license fee, $700,000 milestone fee upon approval in Korea and royalties on net sales of Glumetza (500mg).

 

Proquin™ (Ciprofloxacin GR™ )

 

In July 2004, we submitted an NDA to the FDA for Proquin, our internally developed once-daily formulation of the antibiotic drug ciprofloxacin, for urinary tract infections.  The FDA accepted the application for review in September 2004.  The earliest that we expect to obtain FDA approval to market Proquin is in the second quarter of 2005, if at all.   We are seeking potential marketing or co-marketing partners for Proquin.

 

Gabapentin GR™

 

We have developed Gabapentin GR, an extended release gabapentin product.  Gabapentin is marketed by Pfizer Inc. for adjunctive therapy for epileptic seizures and postherpetic pain under the label Neurontin®.  A Phase I clinical trial on Gabapentin GR was completed in the first quarter of 2002.  We initiated a Phase II clinical trial for Gabapentin GR in the first quarter of 2005 for post-herpetic neuralgia.

 

Furosemide GR™

 

In September 2004, we completed a Phase II clinical trial for Furosemide GR.  Furosemide is a widely prescribed diuretic marketed as an immediate release formulation and sold by Aventis as Lasix®, as well as by several other pharmaceutical companies as a generic.  The results of the Phase II trial in moderate to severe congestive heart failure patients met the primary endpoints, which indicated that patients in the Furosemide GR treatment group experienced excretion of urine and electrolytes comparable to that of the furosemide immediate release treatment group.  However, we are extending the Phase II clinical trial with some of the patients to

 

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evaluate the extent to which an improvement in the frequency and urgency of diuresis can be achieved with Furosemide GR in congestive heart failure patients.

 

Other Research and Development Activities

 

We are developing other product candidates expected to benefit from incorporation into our drug delivery system. For example, we are collaborating with AVI BioPharma, Inc. on a project for the delivery of large molecules, such as antisense compounds, from the GR System. We have also completed preclinical studies of a combination product comprising our Glumetza (500mg) once-daily formulation of metformin with a once-daily sulfonylurea for Type II diabetes. Under our agreement with Biovail, Biovail has an exclusive option to license this product from us. We expect that a Phase I clinical trial for this product will commence only if we enter into a development and licensing agreement with Biovail or another third party.

 

In June 2004, we gave notice of termination of our agreement with ActivBiotics, Inc.  Under the agreement we had conducted feasibility studies to develop an extended-release oral tablet to deliver ActivBiotics’ broad-spectrum antibiotic, Rifalazil, to the stomach and upper gastrointestinal tract.  In January 2004, we had completed the preclinical feasibility studies with a GR formulation of Rifalazil.

 

In January 2000, we and Elan Corporation, plc formed Depomed Development Ltd. (DDL), a Bermuda limited liability company and joint venture, to develop products using drug delivery technologies of both Elan and Depomed, Inc.   DDL was owned 80.1% by Depomed and 19.9% by Elan.  In August 2002, DDL discontinued all product development activity.  In September 2003, the joint venture partners amended or terminated the contracts governing the operation of DDL, which included the termination of Elan’s participation in the management of DDL.  In June 2004, we acquired Elan’s 19.9% interest in DDL for $50,000.

 

In addition to research and development conducted on our own behalf and through collaborations with pharmaceutical partners, our activities since inception (August 7, 1995) have included establishing our offices and research facilities, recruiting personnel, filing patent applications, developing a business strategy and raising capital. To date, we have received only limited revenue, all of which has been from these collaborative research and feasibility arrangements and feasibility studies.

 

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, ease of use and an improved side effect profile. We believe that drug delivery technologies can provide pharmaceutical companies with a means of developing new or improved products as well as extending existing patent franchises.

 

The increasing need to deliver medication to patients efficiently and with fewer side effects has accelerated the pace of invention of new drug delivery systems and the development and maturation of the drug delivery industry. 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 initially too rapid, causing incomplete absorption of the drug, irritation to the gastrointestinal tract and other side effects. In addition, they do not provide localized therapy. We believe that the need for frequent dosing of many drugs administered by capsules and tablets also can impede patient compliance with the prescribed regimen.

 

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The Gastric Retention System

 

The GR System is based on our proprietary oral drug delivery technologies and is designed to include formulations of drug-containing polymeric tablets that allow multi-hour delivery of an incorporated drug. Although our formulations are proprietary, the polymers utilized in the GR System are commonly used in the food and drug industries and are included in the list of inert substances approved by the FDA for use in oral pharmaceuticals. By using different formulations of the polymers, we believe that the GR System is able to provide continuous, controlled delivery of drugs of varying molecular complexity and solubility. With the use of different polymers and polymers of varying molecular weight, our GR tablet technology can deliver drugs by diffusion, tablet erosion, or from a bi-layer matrix. In addition, our technology allows for the delivery of more than one drug from a single tablet. If taken with a meal, these polymeric tablets 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 gastrointestinal transit. Following a meal, liquids and small particles flow continuously from the stomach into the intestine, leaving behind the larger undigested 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 in the stomach and/or upper small intestine. The drug-containing polymeric tablets of the GR System are formulated into easily swallowed shapes and are designed to swell upon ingestion. The tablets attain a size after ingestion sufficient to be retained in the stomach for multiple hours during the digestive process while delivering the drug content at a controlled rate. After drug delivery is complete, the polymeric tablet dissolves and becomes a watery gel, which is eliminated through the intestine.

 

The GR System is 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. We believe that the GR System can provide one or more of the following advantages over conventional methods of drug administration:

 

  Greater Patient and Caregiver Convenience.   We believe that the GR System 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 with 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.

 

  Enhanced Safety and Efficacy through Controlled Delivery.   We believe that the GR System 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 after which concentrations fall below therapeutic levels. Excessively high concentrations are a major cause of side effects and subtherapeutic concentrations are ineffective.

 

  Expansion of Types of Drugs Capable of Oral Delivery.   Some drugs, including certain proteins, peptides and oligonucleotides (antisense molecules), because of their large molecular size and susceptibility to degradation in the gastrointestinal 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 GR System may be able to make the oral delivery of some of these drugs therapeutically effective.

 

  Proprietary Reformulation of Generic Products.   We believe that the GR System 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.

 

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  More Efficient Gastrointestinal Drug Absorption.   We believe that the GR System can be used for improved oral administration of drugs that are 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 multi-hour flow of drugs to these regions of the gastrointestinal 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 gastrointestinal 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 gastrointestinal-dwelling microorganisms, such as H. pylori, the bacterium which is a cause of most peptic ulcers.

 

  Rational Drug Combinations.   We believe that the 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 appropriately incorporating different drugs into a GR System we believe that we can provide for the release of each incorporated drug continuously at a rate and duration (dose) appropriately adjusted for the specific biological half-lives of the drugs. We believe that future rational drug combination products using the GR System have the potential to simplify drug administration, increase patient compliance, and reduce medical costs. Our Glumetza/sulfonylurea product, currently in development, is an example of such a combination.

 

  Potential for Oral Delivery of Peptides, Proteins and Antisense Molecules.   Based on laboratory studies, we believe that the GR System can 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, antigen-laden vesicles or oligonucleotides such as antisense molecules, liposomes, and microspheres or nanoparticles. We are collaborating with AVI BioPharma, Inc. on a project to develop the GR System for the delivery of large antisense molecules.

 

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Product Development Initiatives

 

In addition to the products listed in the table below, from time to time we may enter into feasibility studies with collaborative partners that, if successful, may be followed by definitive agreements to advance development of the product. The following table summarizes our principal product development initiatives as of March 2005:

 

Program

 

Partner

 

Potential
Indications

 

Development
Status (1)

Glumetza (500mg)

 

Biovail

 

Type II diabetes

 

Approvable letter issued by the FDA

Proquin

 

In-house

 

Various bacterial infections

 

NDA under review by the FDA

Furosemide GR

 

In-house

 

Cardiovascular/ antihypertensive diuretic

 

Extension of Phase II clinical trial underway

Gabapentin GR

 

In-house

 

Post-herpetic neuralgia

 

Phase II clinical trial initiated
1Q-05

Glumetza (500mg) and sulfonylurea

 

In-house

 

Type II diabetes

 

Preclinical studies completed

Undisclosed NEUGENE® antisense compound

 

AVI BioPharma, Inc.

 

Confidential (2)

 

Preclinical studies underway

 


(1)    See the section below entitled “Government Regulation” for additional information regarding the phases of drug development.

 

(2)    The potential indication may not be disclosed pursuant to the terms of the agreement between Depomed and AVI BioPharma, Inc. See “Collaborative Relationships.”

 

Our estimated research and development expenditures for 2004, 2003 and 2002 are discussed in detail below under Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations.

 

Collaborative Relationships

 

Biovail Laboratories Incorporated.   In May 2002, we entered into an agreement granting Biovail an exclusive license in the United States and Canada to manufacture and market Metformin GR. Under the terms of the agreement, we are responsible for funding and completing the clinical development program and some related regulatory activities in support of Metformin GR. The agreement provides for a $25.0 million milestone payment to us upon FDA approval of the product and further provides for royalties on net sales of Metformin GR. Biovail has an option to reduce certain of the royalties for a one-time payment to us of $35.0 million.  In April 2004, we and Biovail amended the Metformin GR licensing agreement.  Under the amended agreement, we will receive royalties on sales of Biovail’s 1000 mg metformin HC1 tablet in the United States and Canada in exchange for allowing Biovail to use our clinical data for Metformin GR, our 500 mg metformin HC1 tablet, to support and accelerate regulatory submissions for Biovail’s 1000 mg tablet and to establish equivalence between the two dosage forms.  The NDA filed by Biovail was for approval of both Metformin GR and Biovail’s 1000 mg metformin HCl tablet under the brand name of Glumetza.  In February 2005, Biovail received an approvable letter from the FDA requiring certain additional steps be taken prior to approval of the drug.  The earliest that we expect to obtain FDA approval to market Glumetza is in the second quarter of 2005, if at all.

 

LG Life Sciences, Ltd.   In August 2004, we entered into a license and distribution agreement granting LG Life Sciences an exclusive license to Glumetza (500mg) in the Republic of Korea.  The agreement provides for a $600,000 upfront license fee, $700,000 milestone fee upon approval in Korea and royalties on net sales of Glumetza (500mg).  The upfront license fee will be amortized over a period of eight years, which represents the estimated length of time

 

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that we are obligated to provide assistance in development and manufacturing.  For the year ended December 31, 2004, we recognized $31,000 or 15% of our total revenue for the year.

 

ActivBiotics, Inc.   In October 2002, we signed an agreement with ActivBiotics, Inc. to conduct feasibility studies to develop an extended-release oral tablet to deliver ActivBiotics’ broad spectrum antibiotic, Rifalazil, to the stomach and upper gastrointestinal tract.  In January 2004, we completed the preclinical feasibility studies with a GR formulation of Rifalazil. In June 2004, we gave notice of termination of our agreement with ActivBiotics. For the years ended December 31, 2004, 2003 and 2002 revenues received for work performed for ActivBiotics were $28,000, $476,000 and $230,000, respectively or 14%, 48% and 14% of our total revenues, respectively.

 

AVI BioPharma, Inc.   In June 2000, we entered into a joint collaboration to investigate the feasibility of controlled oral delivery of AVI’s proprietary NEUGENE antisense agents. The purpose of the collaboration is to study the feasibility of oral drug formulations based on our GR System. We have developed candidate dosage forms incorporating one of AVI’s antisense agents and preclinical testing is underway. The indication for this product has not been disclosed. No revenues have been received under this agreement.

 

Other Collaborative Partner.   In June 2003, we signed an agreement with an undisclosed collaborative partner to conduct feasibility studies for the partner. We recognized revenue of approximately $144,000 and $408,000, or 71% and 42%, of our revenues in 2004 and 2003, respectively, which approximated the costs recognized under the agreement. We do not expect to perform additional product development services under this agreement.

 

Competition

 

Other companies that have oral drug delivery technologies competitive with the GR System include Bristol-Myers Squibb, IVAX Corporation, ALZA Corporation (a subsidiary of Johnson & Johnson), SkyePharma plc, Biovail Corporation, Flamel Technologies S.A., Ranbaxy Laboratories, Ltd., Kos Pharmaceuticals, Inc., XenoPort, Inc., Intec Pharma and Alpharma, Inc., all of which develop oral tablet products designed to release the incorporated drugs over time. Each of these companies has patented technologies with attributes different from ours, and in some cases with different sites of delivery to the gastrointestinal tract.

 

Bristol-Myers Squibb is currently marketing a sustained release formulation of metformin, Glucophage XR, with which Glumetza will compete. The limited license that Bristol-Myers Squibb obtained from us under our November 2002 settlement agreement extends to certain current and internally-developed future compounds, which may increase the likelihood that we will face competition from Bristol-Myers Squibb in the future on products in addition to Glumetza. IVAX Corporation, Par Pharmaceutical, Inc. and Alpharma, Inc. have received FDA approval for and are selling a controlled-release metformin product.  Flamel Technologies has a controlled-release metformin product in clinical trials.

 

Bayer Corporation is currently marketing a once-daily ciprofloxacin product for the treatment of urinary tract infections. There may be other companies developing products competitive with Glumetza and Proquin of which we are unaware.

 

To our knowledge, we are the only company currently developing a sustained release formulation of gabapentin for the United States market.

 

The competitive situation with respect to Gabapentin GR is complex and uncertain given the current regulatory and intellectual property status of gabapentin, which is currently marketed by Pfizer as Neurontin for adjunctive therapy for epileptic seizures and for postherpetic pain. Pfizer’s basic United States patents relating to Neurontin have expired, and at least seven companies are seeking or have received FDA approval for immediate release formulations of the drug. However, Pfizer has initiated several lawsuits against companies seeking to market formulations of gabapentin that compete with Neurontin, claiming that these formulations of gabapentin infringe Pfizer’s patents. In addition, Pfizer has developed a new product, Lyrica™ (pregabalin), which will be marketed as an improved version of Neurontin. It received FDA approval in December 2004.

 

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To our knowledge, we are the only company currently developing a sustained release formulation of furosemide for the United States market, but other companies have published research data indicating that products may be developed that are competitive with Furosemide GR.

 

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 to the GR System or products using the GR System, either generally or in particular market segments. These developments could make the GR System or products using the GR System noncompetitive or obsolete.

 

Most of our principal competitors have substantially greater financial, marketing, personnel and research and development resources than we do. 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 seek to protect our proprietary rights, by among other methods, filing patent applications in the United States and foreign jurisdictions to cover certain aspects of our technology. We currently hold nine issued United States patents and twelve United States patent applications are pending. In addition, we are preparing patent applications relating to our expanding technology for filing in the United States and abroad. We have also applied for patents in numerous foreign countries. Some of those countries have granted our applications and other applications are still pending. Our pending patent applications may lack priority over others’ applications or may not result in the issuance of patents. Even if issued, our patents may not be sufficiently broad to provide protection against competitors with similar technologies and may be challenged, invalidated or circumvented, which could limit our ability to stop competitors from marketing related products or may not provide us with competitive advantages against competing products.

 

We also rely on trade secrets and proprietary know-how, which are difficult to protect. We seek to protect such 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 or other intellectual property rights. We are not aware of any intellectual property claims against us. However, the pharmaceutical industry has experienced extensive litigation regarding patents and other intellectual property rights. For example, Pfizer has initiated several suits against companies seeking to market formulations of gabapentin that compete with Neurontin, claiming that these formulations of gabapentin infringe Pfizer’s patents. The results of this litigation could adversely impact our ability to commercialize Gabapentin GR. Also, we are aware that patents issued to third parties relating to sustained release drug formulations or particular pharmaceutical compounds could in the future be asserted against us, although we believe that we do not infringe any valid claim of any patents.  If claims concerning any of our products were to arise and it was determined that these products infringe a third party’s proprietary rights, we could be subject to substantial damages for past infringement or be forced to stop or delay our activities with respect to any infringing product, unless we can obtain a license or we may have to redesign our product so that it does not infringe upon others’ patent rights, which may not be possible or could require substantial funds or time.  Such a license may not be available on acceptable terms, or at all.  Even if we, our collaborators or our licensors were able to obtain a license, the rights may be nonexclusive, which would give our competitors access to the same intellectual property.  In addition, any public announcements related to litigation or interference proceedings initiated or threatened against us, even if such claims are without merit, could cause our stock price to decline.

 

From time to time, we may become aware of activities by third parties that may infringe our patents.  Infringement by others of our patents may reduce our market shares (if a related product is approved) and,

 

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consequently, our potential future revenues and adversely affect our patent rights if we do not take appropriate enforcement action.  We may need to engage in litigation in the future to enforce any patents issued or licensed to us or to determine the scope and validity of third-party proprietary rights. Our issued or licensed patents may not be held valid by a court of competent jurisdiction. Whether or not the outcome of litigation is favorable to us, defending a lawsuit takes significant time, may be expensive and may divert management attention from other business concerns. 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 our patent applications or other parties’ patent applications. Adverse determinations in litigation or interference proceedings could require us to seek licenses which may not be available on commercially reasonable terms, or at all, or subject us to significant liabilities to third parties.  If we need but cannot obtain a license, we may be prevented from marketing the affected product.

 

Manufacturing, Marketing and Sales

 

Although we have established internal manufacturing facilities to manufacture supplies for our Phase I and Phase II clinical trials, we do not have, and we do not intend to establish in the foreseeable future, internal commercial scale manufacturing capabilities. Rather, we intend to use the facilities of third parties to manufacture products for Phase III clinical trials and commercialization. Our dependence on third parties for the manufacture of products using the GR System may adversely affect our ability to deliver such products on a timely or competitive basis. Although Biovail has made arrangements for the third party manufacture of Glumetza, there may not be sufficient manufacturing capacity available to us when, if ever, we are ready to seek commercial sales of other products using the GR System. The manufacturing processes of our third party manufacturers may be found to violate the proprietary rights of others. If we are unable to contract for a sufficient supply of required products on acceptable terms, or if we encounter delays and difficulties in our relationships with manufacturers, the market introduction and commercial sales of our products will be delayed, and our revenue will suffer.

 

Applicable current Good Manufacturing Practices (cGMP) requirements and other rules and regulations prescribed by foreign regulatory authorities will apply to the manufacture of products using the GR System. We will depend on the manufacturers of products using the GR System to comply with cGMP and applicable foreign standards. Any failure by a manufacturer of products using the GR System to maintain cGMP or comply with applicable foreign standards could delay or prevent their initial or continued commercial sale.

 

In 2004, we announced our determination to evolve from a solely product development focused company to an integrated organization with sales and marketing of our own products.  While preliminary staffing for these activities will begin in 2005, we anticipate this process will continue over the next several years.

 

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 GR System and the manufacture and marketing of products using the GR System prior to the commercial use of those products. The regulatory process will take several years and require substantial funds. If products using the GR System do not receive the required regulatory approvals or if such approvals are delayed, our business would be materially adversely affected. There can be no assurance that the requisite regulatory approvals will be obtained without lengthy delays, if at all.

 

In the United States, the FDA rigorously regulates pharmaceutical products, including any drugs using the GR System. 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.

 

We generally must conduct preclinical testing on laboratory animals of new pharmaceutical products prior to commencement of clinical studies involving human beings. These studies evaluate the potential efficacy and

 

9



 

safety of the product. We then submit the results of these studies to the FDA as part of an Investigational New Drug application, 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, we conduct clinical trials with a small number of subjects to determine a drug’s early safety profile and its pharmacokinetic pattern.

 

  In Phase II, we conduct limited 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, we conduct 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 (NDA) for approval prior to commercialization. An NDA requires that our products are compliant with cGMP. Failure to achieve or maintain cGMP standards for products using the GR System would adversely impact their marketability. 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 GR System would have a material adverse effect on the company.

 

The FDA regulates not only prescription and over-the-counter drugs approved by NDAs, but also 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 we or our 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.

 

10



 

Product Liability

 

Our business involves exposure to potential product liability risks that are inherent in the production and manufacture of pharmaceutical products. We have obtained product liability insurance for clinical trials currently underway, but:

 

  we may not be able to obtain product liability insurance for future trials;

 

  we may not be able to maintain product liability insurance on acceptable terms;

 

  we may not be able to secure increased coverage as the commercialization of the GR System proceeds; or

 

  our insurance may not provide adequate protection against potential liabilities.

 

Our inability to obtain adequate insurance coverage at an acceptable cost could prevent or inhibit the commercialization of our products. Defending a lawsuit would be costly and significantly divert management’s attention from conducting our business. If third parties were to bring a successful product liability claim or series of claims against us for uninsured liabilities or in excess of insured liability limits, our business, financial condition and results of operations could be materially harmed.

 

Employees

 

As of December 31, 2004, we had 86 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 good.

 

Our success is dependent in large part upon the continued services of John W. Fara, Ph.D., our Chairman, President and Chief Executive Officer, and other members of our executive management team, and on our ability to attract and retain key management and operating personnel. We do not have agreements with Dr. Fara or any of our other executive officers that provide for their continued employment with us. Management, scientific and operating personnel are in high demand in our industry 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 could result in delays in the research, development and commercialization of our potential product candidates.

 

Additional Information

 

The address of our Internet website is http://www.depomedinc.com. We make available, free of charge through our website, our Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K and other periodic SEC reports, along with amendments to all of those reports, as soon as reasonably practicable after we file the reports with the SEC.

 

Item 2.       Properties

 

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. In May 2003, we renegotiated certain terms of our lease agreement including the lease term, which will now expire in April 2008 with an option to extend the lease for an additional five years. We also entered into a non-cancelable lease agreement to lease a 25,000 square foot facility adjacent to our existing facility in Menlo Park. This agreement also expires in April 2008 with an option to extend the lease for an additional five years. We expect that these facilities will accommodate our growth for the next one to two years.

 

Item 3.       Legal Proceedings

 

We are not a party to any material legal proceeding.

 

11



 

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, 2004.

 

Executive and Other Officers

 

Our executive and other officers of the company and their ages as of December 31, 2004 are as follows:

 

Name

 

Age

 

Position

Executive Officers

 

 

 

 

John W. Fara, Ph.D.

 

62

 

Chairman, President and Chief Executive Officer

Bret Berner, Ph.D.

 

52

 

Vice President, Product Development

John F. Hamilton

 

60

 

Vice President, Finance and Chief Financial Officer

John N. Shell

 

51

 

Vice President, Operations

Other Officers

 

 

 

 

Daniel M. Dye

 

57

 

Vice President, Quality Systems

Thadd M. Vargas

 

39

 

Vice President, Business Development

 

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 April 2000, he became Chairman of the Board of Directors of the company succeeding Dr. John W. Shell, the founder of the company. 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. Prior to 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. degree from the University of California, Los Angeles. He is also a member of the board of directors of AVI BioPharma, Inc. and Iomed, Inc., both of which are publicly held companies.

 

Bret Berner, Ph.D. has served as the company’s Vice President, Product Development since December 1998. Before joining the company, Dr. Berner served as Vice President of Development at Cygnus, Inc. for four years, where he was responsible for formulation, analytical chemistry, 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, has authored more than 70 publications and edited two books on controlled drug delivery. He received his B.A. degree from the University of Rochester and a Ph.D. degree from the University of California, Los Angeles.

 

John F. Hamilton has served as the company’s Vice President of 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. 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. degree from the University of Pennsylvania and an M.B.A. degree from the University of Chicago.

 

John N. Shell served as Director of Operations for the company from its inception in August 1995 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. Mr. Shell served as a director of the company from its inception until November 2003. 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. degree from the University of California, Berkeley.

 

Daniel M. Dye has served as the company’s Vice President of Quality Systems since December 2002 after serving as the company’s Director of Analytical Chemistry since 1998. Mr. Dye has held scientific management

 

12



 

positions in several pharmaceutical companies, most recently Scios, Inc., Centaur Pharmaceutical, Inc. and, for 17 years, ALZA Corporation. Mr. Dye holds a B.A. degree in Chemistry from San Jose State University and an M.S. degree in Biochemistry from the University of California at Davis.

 

Thadd M. Vargas has served as the company’s Vice President of Business Development since December 2002. Before joining the company, Mr. Vargas was Vice President of Finance at Worldres.com, Inc., Director of Finance at Kosan Biosciences, Inc. and Director of Business Development at Anergen, Inc. Prior to Anergen, Mr. Vargas was a member of Ernst & Young’s life sciences audit practice. Mr. Vargas holds a B.A. degree in Business Economics from the University of California at Santa Barbara.

 

PART II

 

Item 5.       Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities

 

Our common stock commenced trading on the Nasdaq SmallCap Market under the symbol “DPMD” on December 1, 1997. On November 9, 1998, our common stock ceased trading on the Nasdaq SmallCap Market and began trading on the American Stock Exchange (AMEX) under the symbol “DMI”. On December 17, 2003 our common stock ceased trading on the AMEX and began trading on the Nasdaq National Market (Nasdaq) under the symbol “DEPO”. The following table sets forth the high and low closing prices of our common stock as reported by the Nasdaq from December 17, 2003 to December 31, 2004 and as reported by the AMEX from January 1, 2003 to December 16, 2003.

 

 

 

2004

 

2003

 

 

 

High

 

Low

 

High

 

Low

 

First Quarter

 

$

7.83

 

$

6.25

 

$

3.05

 

$

2.00

 

Second Quarter

 

$

8.87

 

$

4.94

 

$

5.15

 

$

2.01

 

Third Quarter

 

$

5.43

 

$

3.87

 

$

7.88

 

$

4.83

 

Fourth Quarter

 

$

5.60

 

$

3.96

 

$

7.60

 

$

5.65

 

 

As of March 11, 2005, the number of holders of record of our common stock was 75. We believe that there are approximately 3,000 beneficial holders of our common stock.

 

We have never paid a cash dividend on our common stock and we do not anticipate paying any cash dividends in the foreseeable future. Further, our equipment financing credit facility precludes us from declaring or paying dividends on our common stock.

 

Information required by this item regarding our equity compensation plans is incorporated by reference into our definitive Proxy Statement to be filed pursuant to Regulation 14A under the Exchange Act in connection with our annual meeting of shareholders.

 

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Item 6.       Selected Financial Data

 

 

 

Year Ended December 31,

 

 

 

2004

 

2003

 

2002

 

2001
(Restated)

 

2000 (1)
(Restated)

 

Results of Operations

 

 

 

 

 

 

 

 

 

 

 

Revenue

 

$

202,569

 

$

981,990

 

$

1,661,186

 

$

3,673,326

 

$

1,776,218

 

Operating expenses

 

26,537,341

 

30,380,445

 

30,088,624

 

17,994,753

 

9,514,415

 

Loss from operations

 

(26,334,772

)

(29,398,455

)

(28,427,438

)

(14,321,427

)

(7,738,197

)

Equity in loss of joint venture (restated)(1)

 

 

(5,359

)

(2,435,667

)

(3,173,409

)

(14,202,627

 

Gain from Bristol-Myers Squibb legal settlement

 

 

 

18,000,000

 

 

 

Net loss before income taxes

 

(26,774,637

)

(30,015,098

)

(13,494,565

)

(17,600,039

)

(21,717,870

)

Provision for income taxes

 

(99,000

)

 

 

 

 

Net loss (restated)(1)(2)

 

$

(26,873,637

)

(30,015,098

)

(13,494,565

)

(17,600,039

)

(21,717,870

)

Basic and diluted net loss per share (restated)(1)(2)(3)

 

$

(0.78

)

$

(1.23

)

$

(0.92

)

$

(1.72

)

$

(2.96

)

Shares used in computing basic and diluted net loss per share

 

34,628,825

 

24,458,259

 

14,642,745

 

10,220,223

 

7,329,876

 

 

 

 

December 31,

 

 

 

2004

 

2003

 

2002

 

2001
(Restated)

 

2000 (1)
(Restated)

 

Balance Sheet Data

 

 

 

 

 

 

 

 

 

 

 

Cash, cash equivalents and securities available-for-sale

 

$

18,104,839

 

$

44,255,260

 

$

20,217,973

 

$

5,150,088

 

$

6,498,879

 

Total assets

 

22,868,583

 

47,692,649

 

23,179,277

 

8,746,846

 

8,732,538

 

Long-term obligations, less current portion

 

10,280,591

 

9,497,845

 

9,003,937

 

5,566,686

 

1,769,009

 

Series A preferred stock, (restated) (4)

 

12,015,000

 

12,015,000

 

12,015,000

 

12,015,000

 

12,015,000

 

Accumulated deficit

 

(119,984,625

)

(93,110,988

)

(63,095,890

)

(49,601,325

)

(32,001,286

)

Shareholders’ equity (net capital deficiency)

 

8,403,298

 

34,576,154

 

(6,413,866

)

(13,492,201

)

(7,428,835

)

 


(1)    Equity in net loss of joint venture has been restated to record $12,015,000, originally expensed in the year ended December 1999 to the year ended December 31, 2000.  The amounts represented Depomed’s share of DDL’s loss for the acquisition of a license to certain in-process technology.  Upon further analysis, management was no longer able to assert that all the rights and privileges were received by DDL prior to December 31, 1999.  Therefore, such amounts were amended to reflect the associated licenses expenses in the year ended December 31, 2000.

 

(2)    Net loss and net loss per share decreased in 2002 due to an $18.0 million payment we received in December 2002 from Bristol-Myers Squibb related to the settlement of the patent infringement lawsuit we filed against Bristol-Myers Squibb in January 2002. See Note 8 of the Notes to Consolidated Financial Statements.

 

(3)    The net loss per common share for 2001 and 2000 has been restated to eliminate the 7% dividend previously accrued on the Series A Preferred Stock.  As the dividends are only convertible into our common stock, the amounts previously recorded as dividend represented adjustments to the conversion price of the Series A Preferred Stock.  See Note 7 of the Notes to Consolidated Financial Statements, Series A Preferred Stock.

 

(4)    Shareholders’ equity for 2001 and 2000 has been restated to classify the Series A Preferred Stock outside of permanent equity. In September 2003, the joint venture agreements were amended and the exchange right associated with the Series A Preferred Stock was terminated and the Series A Preferred Stock was reclassified to permanent shareholders’ equity. See Note 7 of the Notes to Consolidated Financial Statements, Series A Preferred Stock.

 

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Item 7.       Management’s Discussion and Analysis of Financial Condition and Results of Operations

 

Overview

 

In 2004, we made substantial progress towards commercialization of our first products. Because of our development and regulatory activities during the year, we are now poised for FDA approvals of our two lead products:  Glumetza, our extended release metformin formulation for treatment of Type II diabetes and Proquin, our extended release formulation of the antibiotic ciprofloxacin.  In addition over the course of 2004, we advanced other products in our pipeline.

 

Highlights for the year include:

 

  Positive Phase III Proquin results

 

  Submission of New Drug Application and New Drug Submission seeking approval of Glumetza (500mg) in the US and Canada;

 

  Submission of New Drug Application seeking approval of Proquin in the US;

 

  Establishment of collaboration with LG Life Sciences to develop and market Glumetza (500mg) in Korea; and

 

  Reported preliminary Phase II results for Furosemide GR.

 

Recent developments in 2005 include:

 

  Sold 5,036,000 shares of our common stock in a registered direct public offering for $4.50 per share with net proceeds of approximately $21,075,000; and

 

  Received Approvable Letter from the FDA for Glumetza.

 

In 2004, we reported a net loss of $26.9 million or $0.78 per share, compared to a net loss of $30.0 million or $1.23 per share for the year ended December 31, 2003.  Cash and investment balances at December 31, 2004 were $18.1 million.

 

Revenues for the year ended December 31, 2004 totaled approximately $203,000 compared with $982,000 for the year ended December 31, 2003. Revenues from collaborative agreements decrease to $171,000 in 2004 from $982,000 in 2003 as a result of decreased development services provided for two collaborative partners. Revenue from licensing agreements increased to $31,000 due to an agreement signed in August 2004 with LG Life Sciences to market Glumetza (500mg) in the Republic of Korea.

 

Research and development expenses for the year ended December 31, 2004 were $21.4 million compared to $26.4 million for the year ended December 31, 2003. The decrease was primarily due to decreased external expenses such as clinical and manufacturing expenses for our Glumetza (500mg) and Proquin.

 

We have four products in clinical testing or submitted to the FDA for approval. The current status of each is described in Part I, Item 1.

 

Critical Accounting Policies and Estimates

 

A detailed discussion of our significant accounting policies can be found in Note 1 of the Notes to Consolidated Financial Statements, and the impact and risks associated with our accounting policies are discussed throughout this Annual Report on Form 10-K and in the footnotes to the consolidated financial statements. Critical accounting policies are those that require significant judgment and/or estimates by

 

15



 

management at the time that financial statements are prepared such that materially different results might have been reported if other assumptions had been made. We consider certain accounting policies related to revenue recognition and use of estimates to be critical policies. These estimates form the basis for making judgments about the carrying values of assets and liabilities. We base our estimates and judgments on historical experience and on various other assumptions that we believe to be reasonable under the circumstances. Actual results could differ materially from these estimates.

 

We believe the following policies to be the most critical to an understanding of our financial condition and results of operations because they require us to make estimates, assumptions and judgments about matters that are inherently uncertain.

 

Revenue Recognition

 

Revenue related to collaborative research agreements with corporate partners is recognized as the expenses are incurred for each contract. We are required to perform research activities as specified in each respective agreement on a best efforts basis, and we are reimbursed based on the costs associated with supplies, other outsourced activities and the hours worked by employees on each specific contract. Our business strategy includes performing additional development work for our partners, which we expect will include milestone payments and license fees. We will recognize nonrefundable milestone payments pursuant to collaborative agreements upon the achievement of specified milestones where no further obligation to perform exists under that provision of the arrangement. License fees are recognized over the period of continuing involvement of a specific contract or, if no continuing involvement exists, such license fees are recognized upon receipt.  Management has made assumptions relating to the period of continuing involvement, which are subject to change.  Changes in these estimates and assumptions could affect the amount of revenues from licenses recorded in any given period.

 

Accrued Liabilities

 

We record accrued liabilities for certain contract research activities, including clinical trials, preclinical studies and other external development activities. Some of the accrued liabilities are based on estimates because billings for these activities may not occur on a timely basis consistent with the performance of the services. If possible, we obtain information regarding the unbilled services directly from the service provider. However, we may be required to estimate these services based on information available to our product development staff. If we underestimate the research activity associated with a study at a given point in time, it would result in understated research and development expense in the period presented and overstated research and development expense in subsequent periods.

 

Stock-Based Compensation

 

The preparation of the financial statement footnotes requires us to estimate the fair value of stock options granted to employees.  While fair value may be readily determinable for awards of stock, market quotes are not available for long-term, nontransferable stock options because these instruments are not traded.  We currently use the Black-Scholes option-pricing model to estimate the fair value of employee stock options.  However, the Black-Scholes model was developed for use in estimating the fair value of traded options, which have no vesting restrictions and are fully transferable.  Option valuation models require the input of highly subjective assumptions, including but not limited to stock price volatility.  Because our stock options have characteristics significantly different from those of traded options and changes to the subjective impute assumptions can materially affect the fair value estimate, in management’s opinion, the existing models to not provide a reliable single measure of the fair value of our employee stock options.  We are currently evaluating our option valuation methodologies and assumptions in lights of evolving accounting standards related to employee stock options.

 

Change in Accounting Principle

 

In January 2003, the Financial Accounting Standards Board (FASB) issued Interpretation No. 46 (FIN 46), which requires a variable interest entity (VIE) to be consolidated by a company if that company absorbs a majority of the VIE’s expected losses, receives a majority of the entity’s expected residual returns, or both, as a

 

16



 

result of ownership, contractual or other financial interest in the VIE. Prior to the adoption of FIN 46, VIEs were generally consolidated only by companies owning a majority voting interest in the VIE.

 

We adopted FIN 46 on July 1, 2003, and consolidated DDL, as of that date, as we determined that DDL was a VIE, as defined by FIN 46, and that we determined that we absorbed a majority of its expected losses. Accordingly, we were required to consolidate the assets and liabilities of DDL on July 1, 2003.  The adoption of FIN46 did not have a material impact on our financial position or results of operations. Also, as we had been responsible for 80% of DDL’s losses under the terms of our agreements with Elan, we had been recognizing 80% of DDL’s losses under the equity method of accounting prior to July 1, 2003. Since the inception of DDL through June 30, 2003, we had recognized approximately $19.8 million, or 80% of DDL’s expenses. Upon the adoption of FIN 46, we calculated what the impact would have been on our operations had we consolidated 100% of DDL’s expenses and recorded an offsetting “noncontrolling interest” equal to 20% of DDL’s expenses (the amounts funded by Elan under the arrangement) for the period from DDL’s inception through June 30, 2003, or $19.8 million, and determined that there was no cumulative catch-up charge to record upon the adoption of FIN 46.

 

Our results of operations include 100% of the operating results of DDL for the six months ended December 31, 2003. The noncontrolling interest for the period was not material, and it has been included as an offset to general and administrative expenses in the consolidated statement of operations. As DDL does not have any revenue, its accounts are reflected entirely in our consolidated operating expenses.  In September 2003, we modified our agreements with Elan that govern the terms of the joint venture and as a result of such modifications, we became responsible for 100% of the funding requirements of DDL. Accordingly, we did not allocate any portion of DDL’s results of operations to the noncontrolling interest.  In June 2004, DDL became our wholly owned subsidiary when we acquired Elan’s 19.9% interest in DDL.

 

RESULTS OF OPERATIONS

 

Years Ended December 31, 2004, 2003 and 2002

 

Revenues

 

Revenues for the years ended December 31, 2004, 2003 and 2002 were approximately $203,000, $982,000 and $1,661,000, respectively. In 2004, revenues consisted of $171,000 recognized under a collaboration with ActivBiotics and another collaborative partner.  We completed product development services for both partners and we do not expect to perform additional product development services for these partners under the respective agreements.  Other revenues in 2004 included $31,000 recorded under a licensing agreement signed with LG Life Sciences in August 2004.  In 2003, revenues consisted of $476,000 recognized under our collaboration with ActivBiotics and $506,000 from small collaborations with undisclosed partners.  In 2002, revenues consisted of $1,221,000 earned for development work performed for DDL and $441,000 recognized under the ActivBiotics collaboration and several small collaborations with undisclosed partners.

 

Research and Development Expense

 

Research and development expense for the year ended December 31, 2004 was approximately $21,359,000, compared to approximately $26,416,000 and $24,200,000 during the years ended December 31, 2003 and 2002, respectively. The decrease of $5,058,000 in 2004 was primarily due to a decrease of $8,408,000 in external research and development expenses, including activities to complete clinical trials and reports for Glumetza and Proquin in the fourth quarter of 2003, which were partially offset by $1,839,000 in expense related to the hiring of additional personnel to support the FDA filings and analytical testing of our product candidates.  The increase of $2,216,000 in 2003 was due primarily to $1,676,000 of expense related to the hiring of additional personnel to support the FDA filings and analytical testing for Glumetza and Proquin. Other increases were $405,000 in internal research and development as a result of our internal manufacturing and testing of clinical materials for our Phase I and II clinical trials. Rent expense also increased $219,000 due to the additional space we leased in May 2003. These increases were partially offset by decreased expense of $499,000 for external research and development expense, including manufacturing expense due to the completion in 2002 of

 

17



 

manufacturing of clinical trial supplies or drugs for our Glumetza and Proquin Phase III trials. We believe that our research and development expenses will remain relatively flat or increase moderately during 2005, compared to 2004, as we advance our other product candidates into later stage clinical development.

 

Our research and development expenses currently include costs for scientific personnel, supplies, equipment, outsourced clinical and other research activities, consultants, depreciation, facilities and utilities. The scope and magnitude of future research and development expenses cannot be predicted at this time for our product candidates in research and in development as it is not possible to determine the nature, timing and extent of clinical trials and studies, the FDA’s requirements for a particular drug and the requirements and level of participation, if any, by potential partners. As potential products proceed through the development process, each step is typically more extensive, and therefore more expensive, than the previous step. Success in development therefore results, generally, in increasing expenditures. Furthermore, our business strategy involves licensing certain of our drug candidates to collaborative partners. Depending upon when such collaborative arrangements are executed, the amount of costs incurred solely by us will be impacted.

 

Our largest cumulative research and development expense over the last three years has been related to the development of Glumetza and Proquin. In 2004, 2003 and 2002, Glumetza, accounted for approximately 10%, 35% and 40%, respectively, of our total research and development costs for that year. In 2004, 2003 and 2002, Proquin accounted for 50%, 45% and 15%, respectively, of our research and development cost for that year. In 2004, Gabapentin GR accounted for approximately 25% of our research and development expense.

 

Since Glumetza has been licensed to Biovail and submitted to the FDA for approval, we can be reasonably certain of our remaining development and regulatory responsibilities and the associated expenses. Therefore, we are able to estimate that, as of December 2004, the costs to complete our activities related to Glumetza will not exceed $500,000, including costs for regulatory management, analytical testing and support.  Based on the uncertainty of future events related to Proquin, such costs cannot be predicted at this time.

 

We have incurred research and development expenses of approximately $0.9 million in 2002 and none in 2003 and 2004, related to conducting research and development activities on behalf of our former joint venture, DDL. As of August 2002, DDL has terminated all product development activities and DDL will not perform any future product development. In June 2004, we acquired our partner’s 19.9% interest in DDL.  We will not incur any additional associated expenses and no additional associated revenues will be earned related to research services performed on behalf of DDL.

 

Our research and development activities can be divided into preclinical stage programs, which include analytical testing, process development, pilot-scale production and preclinical testing, and later stage programs, which include clinical testing, regulatory affairs and manufacturing clinical supplies. The costs associated with these programs approximate the following:

 

 

 

2004

 

2003

 

2002

 

Preclinical programs

 

$

666,000

 

$

2,356,000

 

$

2,109,000

 

Later stage programs

 

20,693,000

 

24,060,000

 

22,091,000

 

 

 

$

21,359,000

 

$

26,416,000

 

$

24,200,000

 

 

Our research and development activities can be divided into those related to our internal projects and those related to collaboration arrangements. The costs related to internal projects versus collaboration arrangements approximate the following:

 

 

 

2004

 

2003

 

2002

 

Internal projects

 

$

19,339,000

 

$

15,922,000

 

$

8,807,000

 

Collaborative arrangements funded by partners

 

153,000

 

1,020,000

 

713,000

 

Collaborative arrangements not funded by partners

 

1,867,000

 

9,474,000

 

14,680,000

 

 

 

$

21,359,000

 

$

26,416,000

 

$

24,200,000

 

 

18



 

The following table summarizes our principal product development initiatives and the related stages of development for each product in development. The information in the column labeled “Estimated Completion Date of Current Phase” contains forward-looking statements regarding timing of completion of product development phases. The actual timing of completion of those phases could differ materially from the estimates provided in the table. For a discussion of the risks and uncertainties associated with the timing of completing a product development phase, see “Additional Factors that May Affect Future Results” and elsewhere in this Form 10-K. In addition to the products listed below, from time to time we may enter into feasibility studies with collaborative partners that, if successful, may be followed by definitive agreements to advance development of the product.

 

Program

 

Partner

 

Potential
Indications

 

Development
Status

 

Estimated
Completion Date
of Current Phase

Glumetza (500mg)

 

Biovail

 

Type II diabetes

 

Approvable letter issued by the FDA

 

Unknown

Proquin

 

In-house

 

Various bacterial infections

 

NDA under review by the FDA

 

Unknown

Furosemide GR

 

In-house

 

Cardiovascular/ antihypertensive

 

Extension of Phase II clinical trial underway

 

Expected to be completed in the 1st quarter of 2005

Gabapentin GR

 

In-house

 

Post herpetic neuralgia

 

Phase II clinical trial initiated in the 1st quarter of 2005

 

Expected to be completed in the 3rd quarter of 2005

Glumetza (500mg) and sulfonylurea

 

In-house

 

Type II diabetes

 

Preclinical studies completed

 

 

Undisclosed NEUGENE® antisense compound

 

AVI BioPharma, Inc.

 

Confidential (1)

 

Preclinical studies underway

 

Unknown

 


(1)    The potential indication may not be disclosed pursuant to the terms of the agreement between the company and AVI BioPharma, Inc. See “Collaborative Relationships.”

 

We expect that the pharmaceutical products that we develop internally will take, on average, from four to eight years to research, develop and obtain FDA approval in the United States. We generally must conduct preclinical testing on laboratory animals of new pharmaceutical products prior to commencement of clinical studies involving human beings. These studies evaluate the potential efficacy and safety of the product. We then submit the results of these studies to the FDA as part of an Investigational New Drug Application (or IND) which, if successful, allows the opportunity for clinical study of the potential new medicine.

 

Typically, human clinical evaluation involves a time-consuming and costly three-phase process:

 

  In Phase I, we conduct clinical trials with a small number of subjects to determine a drug’s early safety profile and its blood concentration profile over time. A Phase I trial for our average potential product may take 6 to 12 months to plan and complete.

 

  In Phase II, we conduct limited clinical trials with groups of patients afflicted with a specific disease in order to determine preliminary efficacy, optimal dosages and further evidence of safety. A Phase II trial for our average potential product may take 9 to 18 months to plan and complete.

 

  In Phase III, we conduct 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

 

19



 

to commercialization of the product. A Phase III trial for our average potential product may take 1 to 3 years to plan and complete.

 

The most significant costs associated with clinical development are the Phase III trials as they tend to be the longest and largest studies conducted during the drug development process. We currently have two products that have completed Phase III.

 

The successful development of pharmaceutical products is highly uncertain. 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. Various statutes and regulations also govern or influence the manufacturing, safety, labeling, storage and record keeping for each product. The lengthy process of seeking FDA approvals, and the subsequent compliance with applicable statutes and regulation, require the expenditure of substantial resources.

 

General and Administrative Expense

 

General and administrative expense for the year ended December 31, 2004 was approximately $5,179,000, compared to approximately $3,964,000 and $5,888,000 for the years ended December 31, 2003 and 2002, respectively. The increase of $1,215,000 in 2004 compared to 2003 was due to $795,000 in legal and accounting expense, $444,000 in increased salaries and $179,000 in consulting expense.  Legal, accounting and consulting expense increases resulted primarily from increased costs related to our compliance with the Sarbanes-Oxley Act of 2002.  Salary expense increased due to increased salaries and the hiring of additional employees, including our director of corporate communications. The decrease in 2003 compared to 2002 was due to a decrease of $2,717,000 in legal expense resulting from the settlement of our lawsuit with Bristol-Myers Squibb in November 2002. The decrease in 2003 was partially offset by an increase of $334,000 related to increased salaries and the hiring of a Vice President of Business Development in December 2002, a newly created position at that time. Other increases in 2003 included $193,000 for increased insurance rates and $125,000 in listing fees related to our move to the Nasdaq National Market from the American Stock Exchange in December 2003 In 2005, we expect general and administrative expense will increase over 2004 levels as we begin building our sales and marketing capabilities to promote our product candidates.  We anticipate this process will evolve over the next several years.

 

Consolidated Subsidiary

 

Prior to the adoption of FIN 46 on July 1, 2003, our equity in the loss of DDL was based on 100% of DDL’s losses (since we owned 100% of the DDL voting common stock), less the amounts funded by Elan. For the period from inception to June 30, 2003, we recognized approximately 80.1% of DDL’s loss, or approximately $19,817,000 as equity in the loss of the joint venture in our statement of operations. For the year ended December 31, 2002, we recognized approximately $2,436,000 of DDL’s net loss. In 2003, we recognized approximately $5,000 of DDL’s net loss prior to the adoption of FIN 46 on July 1, 2003.  In June 2004, we acquired the remaining 19.9% interest in DDL for $50,000.  For the year ended December 31, 2004, we consolidated 100% of DDL expenses, or approximately $6,000, included in general and administrative expenses in the consolidated statement of operations.  We expect to consolidate general and administrative expense of approximately $10,000 annually. DDL does not have any fixed assets, liabilities or employees and will not perform any further product development.

 

For the year ended December 31, 2004, DDL recognized general and administrative expense and net loss of $6,000. For the year ended December 31, 2003, DDL recognized a loss of $16,000, in general and administrative expense. For the year ended December 31, 2002, DDL recognized a loss of $3,041,000, which included $3,027,000 in research and development expense and $14,000 in general and administrative expense. In August 2002, all research and development work for DDL ceased.  We expect DDL will recognize annual general and administrative expense of approximately $10,000 related to legal fees.

 

For the period from inception (January 7, 2000) to December 31, 2004, DDL recognized a net loss of approximately $24,756,000. This net loss includes a $15,000,000 payment by DDL to Elan for the acquisition of

 

20



 

in-process research and development rights related to certain Elan drug delivery technologies. To date, DDL has not recognized any revenue.

 

Elan made available to us a convertible loan facility to assist us in funding our portion of DDL’s losses up to a principal maximum of $8,010,000. The funding term of the loan expired in September 2002. See “Contractual Obligations” below for additional information on this loan facility.

 

Interest Expense and Interest Income

 

Interest expense was approximately $929,000 for the year ended December 31, 2004 compared to interest expense of approximately $910,000 and $733,000 for the years ended December 31, 2003 and 2002, respectively. In 2004 and 2003, interest expense increased year over year due to compounding of accrued interest on the Elan convertible loan facility. In 2003, the increase was also due to $2.4 million in final loan draws which increased the Elan loan balance in the fourth quarter of 2002.

 

For the year ended December 31, 2004, interest and other income increased to $489,000 from $299,000 and $101,000 in the years ended December 31, 2003 and 2002, respectively. In 2004, the increase was due to our increased investment balances as a result of our public offering in the fourth quarter of 2003.  In 2003, the increase was due to our increased investment balances as a result of our April 2003 private placement and our public offering in the fourth quarter of 2003 which was partially offset by decreasing average interest rates earned in 2003 compared to 2002. Net interest income also includes insignificant losses and gains realized on the sale of certain of our marketable securities prior to the maturities of such instruments.

 

Income Taxes

 

Income tax expense for the year ended December 31, 2004 was $99,000 and none in prior periods.  The tax was paid to the Republic of Korea on a license fee we received from LG Life Sciences, Ltd., a Korean company.  All revenue received from LG Life Sciences will require income tax payment to the Republic of Korea.

 

We have not generated any federal or state taxable income to date. At December 31, 2004, the net operating losses available to offset future taxable income for federal income tax purposes were approximately $106.0 million. 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 2024 if not utilized and federal research and development tax credits of approximately $1.1 million which expire at various dates beginning in 2011 through 2024.  Our net operating loss carryforwards for state income tax purposes were approximately $62.0 million which expire at various dates beginning in 2005 through 2014 and state research and development tax credits of approximately $1.2 million which have no expiration date.  As a result of the annual limitation, anticipated and future losses or changes in ownership of the company, all or a portion of these carryforwards may expire before becoming available to reduce our federal and state income tax liabilities.

 

Gain from Bristol-Myers Legal Settlement

 

In January 2002, we filed a complaint against Bristol-Myers Squibb in the United States District Court for the Northern District of California for infringement of our U.S. Patent No. 6,340,475.

 

In November 2002, we signed a definitive settlement agreement and release with Bristol-Myers Squibb related to the litigation. Under the terms of the agreement, Bristol-Myers Squibb made a one-time payment of $18.0 million to us. We and Bristol-Myers Squibb released all claims in the lawsuit against each other and granted each other a limited non-exclusive royalty free license. The license that Bristol-Myers Squibb obtained from us extends to certain current and future compounds that Bristol-Myers may develop internally.

 

Series A Preferred Stock and Dividends

 

In January 2000, we issued 12,015 shares of Series A Preferred Stock at a price of $1,000 per share to fund our 80.1% share of the initial capitalization of DDL. The Series A Preferred Stock accrues a dividend of 7% per annum, compounded semi-annually and payable in shares of Series A Preferred Stock. The Series A Preferred Stock and dividends are convertible at anytime into our common stock. The original conversion price of the Series A Preferred Stock was $12.00. However, as a result of our March 2002 and October 2003 financing, the

 

21



 

conversion price has been adjusted to $9.51 per share. In December 2004, we entered into an agreement with the Series A Preferred stockholder to resolve a misunderstanding between us and the stockholder relating primarily to prior adjustments to the conversion price of the Series A Preferred Stock (the December 2004 Agreement).  Pursuant to the December 2004 Agreement, among other matters, we agreed to adjust the conversion price to $7.50 per share.  We and the stockholder also agreed to binding interpretations of certain other terms related to the Series A conversion price.

 

Prior to December 2004, the amounts calculated as Series A Preferred stock dividends were accounted for as an adjustment to the conversion price following EITF Issue No. 98-5, Accounting for Convertible Securities with Beneficial Conversion Features or Contingently Adjustable Conversion Ratios (Issue No. 98-5). As a result of the December 2004 Agreement, we determined that a significant modification of the preferred stock agreement had occurred, and, therefore, a new commitment date was established for the Series A Preferred Stock.  Further, we determined that the fair value of the modified preferred stock was below the carrying value of such securities as of the date of the modification, therefore, no deemed dividend resulted from this modification.  Also, we determined that although a new commitment date had been established, this change did not result in a beneficial conversion feature subject to recognition pursuant to Emerging Issues Task Force Issue No. 00-27, Application of Issue No. 98-5 to Certain Convertible Instruments.

 

In conjunction with the Series A Preferred stockholder agreement, we issued a warrant to the Series A Preferred stockholder.  The warrant is exercisable for shares of our common stock during the period between January 2006 and January 2009.  The exercise price of the warrant initially will be equal to the Series A Preferred Stock conversion in effect as of January 20, 2006. The exercise price of the warrant will decrease by approximately 4.8% per year during the exercise period, such that the number of shares of our common stock issuable upon exercise of the warrant will increase by approximately 5.1% per year.  The exercise of the warrant will be satisfied only by surrender of outstanding shares of Series A Preferred Stock.

 

Stock-Based Compensation Expense

 

In December 2002, our Board of Directors authorized an increase in the number of shares authorized for issuance under our 1995 Stock Option Plan (the Plan) by 1,306,811 shares. On May 29, 2003, at the 2003 Annual Meeting of Shareholders, our shareholders approved the increase to the Plan. In December 2002 and March 2003, we granted options to purchase approximately 585,000 shares of common stock out of the 1,306,811 share increase of common stock at exercise prices of $1.71 and $2.70, respectively, which represented the fair market values of our common stock on the respective dates of grant. However, as the options were not deemed authorized for grant until the shareholders approved the increase in the number of shares authorized under the Plan, the applicable measurement date for accounting purposes was on the date such approval was obtained. Since the fair market value of the underlying common stock on May 29, 2003 was $3.50, which was greater than the exercise prices of the stock options granted, we were required to record the difference of approximately $1,015,000 as deferred stock-based compensation expense to be recognized ratably over the vesting period of the related stock options. In the year ended December 31, 2004, we recognized approximately $251,000 in stock-based compensation expense related to the stock options. We expect to recognize approximately $62,000 in stock-based compensation expense related to these stock options per quarter through the second quarter of 2007.

 

In December 2003, our Board of Directors approved a stock option which was subject to the optionee’s acceptance of employment which occurred in February 2004.  Since the fair market value of the underlying common stock was greater on the date of the optionee’s employment than on the grant date, we were required to record the difference of approximately $32,000 as deferred stock-based compensation expense to be recognized ratably over the vesting period of the related stock option.  In the year ended December 31, 2004, we recognized approximately $7,000 in stock-based compensation related to this stock option.  We expect to recognize approximately $2,000 per quarter through the first quarter of 2008 related to this stock option.

 

In July 2003, our Board of Directors approved an amendment to all stock options granted to non-employee members of our Board of Directors. In the case of the death of a non-employee director, the amendment provides for the director’s beneficiary to exercise the director’s stock options at anytime over the remaining life of the

 

22



 

stock option. A non-cash compensation expense related to the amended stock options will be recognized if and when a director’s beneficiary benefits from this modified provision. The maximum stock-based compensation expense would be $369,000 if all non-employee directors benefit from this provision with respect to outstanding options. To date, no expense has been recognized related to these options.

 

Common Stock Equivalents

 

Common stock equivalent shares from outstanding stock options, warrants and other convertible securities and loans for the three years ended December 31 are shown below:

 

 

 

2004

 

2003

 

2002

 

 

 

Common
Equivalent
Shares

 

Weighted-
Average
Exercise
Price

 

Common
Equivalent
Shares

 

Weighted-
Average
Exercise
Price

 

Common
Equivalent
Shares

 

Weighted-
Average
Exercise
Price

 

Stock options

 

4,346,620

 

$

5.01

 

3,820,898

 

$

4.16

 

3,299,690

 

$

3.78

 

Warrants

 

2,942,404

 

$

2.89

 

3,211,283

 

$

3.09

 

1,818,629

 

$

4.56

 

Convertible preferred shares and accrued dividends

 

2,251,822

 

 

1,478,690

 

 

1,380,373

 

 

Convertible promissory note and accrued interest

 

1,338,620

 

 

1,037,709

 

 

950,244

 

 

Biovail Conditional Option

 

 

 

 

 

821,959

 

$

5.13

 

Biovail Purchaser’s Option

 

3,901,961

 

$

8.21

 

3,871,467

 

$

6.73

 

210,835

 

$

5.43

 

 

 

14,781,427

 

 

 

13,420,047

 

 

 

8,481,730

 

 

 

 

Related Party Transactions

 

Elan Corporation, plc

 

In January 2000, DDL was formed to develop a series of undisclosed proprietary products using drug delivery technologies and expertise of both companies. DDL was owned 80.1% by Depomed and 19.9% by Elan until June 2004 when we acquired Elan’s 19.9% interest. (See Note 3 of the Notes to Consolidated Financial Statements, Collaborative Arrangements and Contracts, Elan Corporation, plc).

 

AVI BioPharma, Inc.

 

In June 2000, we entered into a joint collaboration to investigate the feasibility of controlled oral delivery of AVI’s proprietary NEUGENE® antisense agents. Our Chairman, President and Chief Executive Officer, John W. Fara, is currently serving as a director of AVI BioPharma, Inc. No revenues have been received under this agreement.

 

LIQUIDITY AND CAPITAL RESOURCES

 

As of December 31, 2004, we had approximately $18,105,000 in cash, cash equivalents and marketable securities, working capital of $15,073,000 and accumulated net losses of $119,985,000.  In January 2005, we sold 5,036,000 shares of our common stock in a registered direct public offering for $4.50 per share with net proceeds of approximately $21,075,000.  We expect to continue to incur operating losses for at least the next two years.

 

Operating Activities

 

Cash used in operations in the year ended December 31, 2004 was approximately $23,315,000, compared to approximately $33,148,000 and $4,437,000 for the years ended December 31, 2003 and 2002, respectively. In 2004, the change in cash used in operations was due primarily to the net loss and partially offset by adjustments for non-cash items and an increase in deferred revenue from the LG Life Sciences license agreement signed in August 2004.  In 2003, the change in cash used in operations was due primarily to the net loss and decreases in accounts payable due to decreased clinical trial activity by the end of 2003. In 2002, the change in cash used in

 

23



 

operations was due primarily to our net loss partially offset by our share of the loss of the joint venture (a non-cash charge in operating activities) and increases in accounts payable due to increased clinical trials activity.

 

Investing Activities

 

Cash provided by investing activities in the year ended December 31, 2004 totaled approximately $4,132,000 and consisted primarily of a net decrease in marketable securities of $6,758,000 and was partially offset by $2,626,000 in purchases of capital equipment and leasehold improvements, including approximately $1,936,000 to build out the additional space we leased in May 2003.  Cash used in investing activities in the year ended December 31, 2003 totaled approximately $16,718,000 and consisted primarily of a net increase in marketable securities of $15,589,000 and $1,123,000 of purchases of lab equipment, furniture, computers and leasehold improvements. Marketable securities were increased in 2003 after the completion of our public offering in the fourth quarter. Cash used in investing activities in the year ended December 31, 2002 totaled approximately $12,437,000 and consisted of an increase in marketable securities of $8,691,000 and approximately $3,282,000 related to the investment in our joint venture and $464,000 related to purchases of lab equipment, furniture and computers. Marketable securities were increased in 2002 after we received the $18,000,000 payment from Bristol-Myers related to the settlement of our patent infringement lawsuit in November 2002.  We expect future capital expenditures will include additional product development and quality control laboratory equipment to maintain current Good Manufacturing Practices (cGMP) in our laboratories.

 

Financing Activities

 

Cash provided by financing activities for the year ended December 31, 2004 was $91,000 and consisted primarily of $419,000 of proceeds from exercises of stock options and warrants partially offset by $328,000 in payments on equipment loans and capital leases.  Cash provided by financing activities for the year ended December 31, 2003 was $58,377,000 and consisted primarily of net proceeds of $18,668,000 received in April 2003 from a private placement of common stock and net proceeds of $38,227,000 received from our public offering of common stock in the fourth quarter. (See Note 7 of the Notes to Consolidated Financial Statements, Redeemable Preferred Stock and Shareholders’ Equity, Private Placements and Public Offering) Proceeds received were partially offset by $441,000 in payments on equipment loans and capital leases. Cash provided by financing activities for the year ended December 31, 2002 was $23,257,000 and consisted primarily of net proceeds of $8,078,000 received in March 2002 and $12,263,000 received in July 2002 in private placements of common stock. Proceeds of $3,282,000 were received on the convertible loan facility provided by Elan to fund our share of DDL’s expenses (See Note 5 of the Notes to Consolidated Financial Statements, Commitments and Contingencies). Proceeds received were partially offset by $563,000 in payments on the equipment loans and capital lease obligations.

 

Contractual Obligations and Capital Resources

 

As of December 31, 2004 and 2003, there was $10,281,000 and $9,412,000, respectively, outstanding related to the convertible loan facility provided by Elan. The outstanding amounts include accrued interest of $2,484,000 and $1,615,000 at December 31, 2004 and 2003, respectively. The funding term of the loan expired on September 30, 2002. The loan and accrued interest are payable in January 2006 in cash or shares of our common stock at the rate of $7.68 per share, with the form of payment at Elan’s option.

 

Through December 31, 2004, we have invested approximately $7,317,000 in equipment, furniture and leasehold improvements, of which approximately $1,947,000 was financed through long-term debt equipment financing arrangements. As of December 31, 2002, there were no further borrowings available under the financing arrangements. If we do not obtain additional credit arrangements, we will need to spend our own resources for future equipment purchases.

 

24



 

As of December 31, 2004, our aggregate contractual obligations are as follows:

 

 

 

 

 

Payments due by period

 

Contractual Obligations

 

Total

 

Less than
1 year

 

1 to 3
years

 

3 to 5
years

 

More than
5 years

 

Operating leases

 

$

3,304,572

 

$

1,000,078

 

$

1,970,536

 

$

333,958

 

$

 

Capital leases

 

33,159

 

33,159

 

 

 

 

Long-term debt

 

88,652

 

88,652

 

 

 

 

Elan convertible loan and accrued interest

 

11,283,300

 

 

11,283,300

 

 

 

 

 

$

14,709,683

 

$

1,121,889

 

$

13,253,836

 

$

333,958

 

$

 

 

We anticipate that our existing capital resources, including the proceeds from our January 2005 financing and exclusive of potential payments from licensing partners, will permit us to meet our capital and operational requirements through at least January 2006.  However, we base this expectation on our current operating plan, which may change as a result of many factors.  Our cash needs may also vary materially from our current expectations because of numerous factors, including:

 

                  results of research and development efforts;

                  financial terms of definitive license agreements or other commercial agreements we enter into, if any;

                  relationships with collaborative partners;

                  changes in the focus and direction of our research and development programs;

                  technological advances;

                  results of clinical testing, requirements of the FDA and comparable foreign regulatory agencies; and

                  acquisitions or investment in complimentary businesses, products or technologies.

 

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 GR System.

 

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 sources of capital.  To the extent that our capital resources are insufficient to meet our future capital requirements, we will have to raise additional funds through the sale of our equity securities or from development and licensing arrangements to continue our development programs.  We may not be able to raise such additional capital on favorable terms, or at all.  If we raise additional capital by selling our 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 we may have to:

 

                  delay, postpone or terminate clinical trials;

                  curtail other operations significantly; and/or

                  obtain funds through entering into collaboration agreements on unattractive terms.

 

The inability to raise capital would have a material adverse effect on our company.

 

Recently Issued Accounting Standards

 

In June 2004, the Financial Accounting Standards Board (FASB) issued Emerging Issues Task Force Issue No. 03-1, The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments (EITF 03-1). EITF 03-1 includes new guidance for evaluating and recording impairment losses on debt and equity investments, as well as new disclosure requirements for investments that are deemed to be temporarily

 

25



 

impaired. In September 2004, the EITF delayed the effective date for the measurement and recognition guidance. The Company is in the process of evaluating the effect of adopting EITF 03-1.

 

In December 2004, the FASB issued Statement No. 123R, “Share-Based Payment” (FAS 123R), which is a revision of FASB Statement No. 123, “Accounting for Stock-Based Compensation” (FAS 123). FAS 123R supersedes APB Opinion No. 25, “Accounting for Stock Issued to Employees”, and amends FAS No. 95, Statement of Cash Flows.  Generally, the approach in FAS 123R is similar to the approach described in FAS 123. FAS 123R requires all share-based payments to employees, including grants of employee stock options, to be recognized in the statement of operations based on their fair values. Pro forma disclosure is not longer an alternative.  FAS 123R must be adopted by us no later than July 1, 2005.  Early adoption will be permitted in periods in which financial statements have not yet been issued.  We expect to adopt FAS 123R on July 1, 2005.

 

FAS 123R permits public companies to adopt its requirement using one of two methods:  1)  A “modified prospective” method in which compensation cost is recognized beginning with the effective date (a) based on the requirements of FAS 123R for all share-based payments granted after the effective date and (b) based on the requirements of FAS 123R for all awards granted to employees prior to the effective date of FAS 123R that remain unvested on the effective date; or 2) A “modified retrospective” method which includes the requirements of the modified prospective method described above, but also permits entities to restate based on the amounts previously recognized under Statement 123 for purposes of pro forma disclosures either (a) all prior periods presented or (b) prior interim periods of the year of adoption.  We plan to adopt FAS 123R using the modified prospective method.

 

As permitted by FAS 123, we currently account for share-based payments to employees using APB Opinion No. 25’s intrinsic value method and, as such, recognizes no compensation cost for employee stock options where the exercise price equals the fair market value of the underlying common shares on the measurement date.  Accordingly, the adoption of FAS 123R’s fair value method will have a significant impact on our result of operations, although it will have no impact on our overall financial position. The impact of adoption of FAS 123R cannot be predicted at this time because it will depend on levels of share-based payments granted in the future.  However, had we adopted FAS 123R in prior periods, the impact of that standard would have approximated the impact of FAS 123 as described in the disclosure of pro forma net loss and loss per share in Note 2, to our consolidated financial statements.  FAS 123R also requires the benefits of tax deductions in excess of recognized compensation cost to be reported as a financing cash flow, rather than as an operating cash flow as required under current literature.  This requirement will reduce net operating cash flows and increase net financing cash flows in periods after adoption.  We cannot estimate what those amounts will be in the future (because they depend on, among other things, when employees exercise stock options, and whether we will be in a taxable position).  There is no tax impact related to the prior periods since we are in a net loss position.

 

ADDITIONAL FACTORS THAT MAY AFFECT FUTURE RESULTS

 

In addition to other information in this report, the following factors should be considered carefully in evaluating the company. We believe the following risks, along with the risks described elsewhere in this Form 10-K, are the material risks we face at the present time. If any of the risks or uncertainties described in this Form 10-K actually occurs, our business, results of operations or financial condition could be materially adversely affected. The risks and uncertainties described in this Form 10-K are not the only ones facing the company. Additional risks and uncertainties of which we are unaware or currently deem immaterial may also become important factors that may harm our business.

 

We are at an early stage of development and are expecting operating losses in the future.

 

To date, we have had no revenues from product sales and only minimal revenues from our collaborative research and development arrangements and feasibility studies.  For the years ended December 31, 2002, 2003 and 2004, we had total revenues of $1.7 million in 2002 and $1.0 million in 2003 and $203,000 in 2004. For the

 

26



 

years ended December 31, 2002, 2003 and 2004, we incurred losses of $13.5 million in 2002 and $30.0 million in 2003 and $26.9 million in 2004. As we continue our research and development efforts, preclinical testing and clinical trial activities, we anticipate that we will continue to incur substantial operating losses for at least the next two years. Therefore, we expect our cumulative losses to increase.  These losses, among other things, have had, and we expect that they will continue to have, an adverse impact on our total assets, shareholders’ equity and working capital.

 

We depend heavily on the successful development and commercialization of our lead product candidates, Glumetza (500mg) and Proquin, each of which is still subject to approval by the FDA, and our other product candidates, which are in early stages of development, and on our core technology platform, the GR System.

 

To date, we have not commercialized any products.  Two of our product candidates, Glumetza (500mg) and Proquin, each have an NDA filed with the FDA.  Our other product candidates are in earlier stages of clinical or preclinical development.  We anticipate that in the near term our ability to generate revenues will depend principally on the successful commercialization of Glumetza and Proquin.  If we fail to obtain regulatory approval for, or successfully commercialize, Glumetza (500mg) or Proquin, our ability to raise financing and our business, financial condition and results of operations will be materially and adversely affected.  Also, our various product candidates use the GR System.  If it is discovered that the GR System could have adverse effects or other characteristics that indicate it is unlikely to be effective as a delivery system for drugs or therapeutics, our product development efforts and our business would be significantly harmed.

 

We will receive future payments from Biovail related to Glumetza only if Glumetza is approved by the FDA.

 

In May 2002, we entered into an exclusive license agreement with Biovail to manufacture and market Glumetza in the United States and Canada.  We were responsible for completing the clinical development of Glumetza.  Biovail will not reimburse us for any of our expenses incurred in connection with the development of Glumetza.  In February 2005, Biovail received an approvable letter from the FDA requiring certain additional steps be taken prior to approval of the drug. Only if we receive FDA approval of Glumetza will Biovail be required to make a $25.0 million milestone payment to us.  We will not receive any other payments from Biovail unless the FDA approves Glumetza for marketing in the United States, which we do not expect to occur prior to the first half of 2005, if at all.  Biovail can sublicense its rights to Glumetza, and has indicated that it plans to do so, in which event we would depend on the sublicensee to commercialize Glumetza.

 

Our quarterly operating results may fluctuate and affect our stock price.

 

The following factors will affect our quarterly operating results and may result in a material adverse effect on our stock price:

 

                  our success or failure in entering into further collaborative relationships;

•     variations in revenues obtained from collaborative agreements, including milestone payments, royalties, license fees and other contract revenues;

                  decisions by collaborative partners to proceed or not to proceed with subsequent phases of the collaboration or program;

                  the timing of any future product introductions by us or our collaborative partners;

                  market acceptance of the GR System;

                  regulatory actions;

                  adoption of new technologies;

                  developments concerning proprietary rights, including patents, infringement allegations and litigation matters;

                  the introduction of new products by our competitors;

                  manufacturing costs and difficulties;

                  results of clinical trials for our products;

 

27



 

                  changes in government funding;

                  third-party reimbursement policies; and

                  the status of our compliance with the provision of the Sarbanes-Oxley Act of 2002.

 

Our collaborative arrangements may give rise to disputes over commercial terms, contract interpretation and ownership of our intellectual property and may adversely affect the commercial success of our products.

 

We currently have a collaboration agreement with Biovail to develop Glumetza. In addition, we have entered into other collaborative arrangements, some of which have been based on less definitive agreements, such as memoranda of understanding, material transfer agreements, options or feasibility agreements and we may not execute definitive agreements formalizing these arrangements. Collaborative relationships are generally complex and may give rise to disputes regarding the relative rights, obligations and revenues of the parties, including the ownership of intellectual property and associated rights and obligations, especially when the applicable provisions have not been fully negotiated. Such disputes can delay collaborative research, development or commercialization of potential products, or can lead to lengthy, expensive litigation or arbitration. The terms of collaborative arrangements may also limit or preclude us from developing products or technologies developed pursuant to such collaborations. Additionally, the collaborators under these arrangements might breach the terms of their respective agreements or fail to prevent infringement of the licensed patents by third parties.  Moreover, negotiating collaborative arrangements often takes considerably longer to conclude than the parties initially anticipate, which could cause us to agree to less favorable agreement terms that delay or defer recovery of our development costs and reduce the funding available to support key programs.

 

We may not be able to enter into future collaborative arrangements on acceptable terms, which would harm our ability to commercialize our products. Further, even if we do enter into collaboration arrangements, it is possible that our collaborative partners may not choose to develop and commercialize products using the GR System technologies. Other factors relating to collaborations that may adversely affect the commercial success of our products include:

 

                  any parallel development by a collaborative partner of competitive technologies or products;

                  arrangements with collaborative partners that limit or preclude us from developing products or technologies;

                  premature termination of a collaboration agreement; or

      failure by a collaborative partner to devote sufficient resources to the development and commercial sales of products using the GR System.

 

Generally, our collaborative arrangements do not restrict our collaborative partners from competing with us or restrict their ability to market or sell competitive products. Our current and any future collaborative partners may pursue existing or other development-stage products or alternative technologies in preference to those being developed in collaboration with us. Our collaborative partners may also terminate their collaborative relationships with us or otherwise decide not to proceed with development and commercialization of our products.

 

It is difficult to develop a successful product. If we do not develop a successful product we may not be able to raise additional funds.

 

The drug development process is costly, time-consuming and subject to unpredictable delays and failures. Before we or others make commercial sales of products using the GR System, we, our current and any future collaborative partners will need to:

 

                  conduct preclinical and clinical tests showing that these products are safe and effective; and

                  obtain regulatory approval from the FDA and foreign regulatory authorities.

 

We will have to curtail, redirect or eliminate our product development programs if we or our collaborative partners find that:

 

                  the GR System has unintended or undesirable side effects; or

 

28



 

•     products that appear promising in preclinical or early-stage clinical studies do not demonstrate efficacy in later-stage, larger scale clinical trials.

 

Even if our products obtain regulatory approval, successful commercialization would require:

 

                  market acceptance;

                  cost-effective commercial scale production; and

                  reimbursement under private or governmental health plans.

 

Any material delay or failure in the governmental approval process and/or the commercialization of our potential products, particularly Glumetza or Proquin XR, would adversely impact our financial position and liquidity and would make it difficult for us to raise financing on favorable terms, if at all.

 

If we do not achieve our projected development goals in the timeframes we announce and expect, the commercialization of our product candidates may be delayed and our business will be harmed.

 

For planning purposes, we estimate the timing of the accomplishment of various scientific, clinical, regulatory and other product development goals.  These milestones may include the commencement or completion of scientific studies and clinical trials and the submission of regulatory filings.  From time to time, we may publicly announce the expected timing of some of these milestones.  All of these milestones are based on a variety of assumptions.  The actual timing of these milestones can vary considerably from our estimates depending on numerous factors, some of which are beyond our control, including:

 

                  our ability to obtain adequate funding;

      the rate of progress, costs and results of our clinical trial and research and development activities, including the extent of scheduling conflicts with participating clinicians and clinical institutions and our ability to identify and enroll patients who meet clinical trial eligibility criteria;

                  our receipt of approvals by the FDA and other regulatory agencies and the timing thereof;

                  other actions by regulators;

      our ability to access sufficient, reliable and affordable supplies of components used in the manufacture of our product candidates, including insulin and materials for our GR System; and

                  the costs of ramping up and maintaining manufacturing operations, as necessary;

 

If we fail to achieve our announced milestones in the timeframes we announce and expect, our business and results of operations may be harmed and the price of our stock may decline.

 

If we are unable to obtain or maintain regulatory approval, we will be limited in our ability to commercialize our products, and our business will be harmed.

 

Our collaborative partner, Biovail, submitted the NDA to the FDA for Glumetza in April 2004.  The FDA accepted the NDA for review in June 2004.  Because the NDA submitted by Biovail for the Glumetza 500 mg tablet (Metformin GR) also seeks approval for Biovail’s 1000 mg metformin tablet, which has a different extended release technology, any issues that may arise in the FDA review process with respect to the Biovail tablet could delay approval of the 500mg Glumetza tablet.  In February 2005, Biovail received an approvable letter from the FDA requiring certain additional steps be taken prior to approval of the drug.  The earliest that we expect to be able to obtain FDA approval to market Glumetza is in the second quarter of 2005, if at all.

 

In July 2004, we filed an NDA to the FDA for our internally developed once-daily formulation of the antibiotic drug ciprofloxacin for uncomplicated urinary tract infection, called Proquin.  The FDA accepted the NDA for review in September 2004.  The earliest that we expect to be able to obtain FDA approval to market Proquin is in the second quarter of 2005, if at all.

 

We believe that the application submitted to the FDA for Proquin will be reviewed as a full, stand-alone NDA under Section 505(b)(1) of the Federal Food, Drug and Cosmetic Act, or FDC Act.  There is the possibility, however, that to the extent that any such application refers to information in the scientific literature, the FDA will deem it to be what is known as a “505(b)(2) NDA,” named after the section of the FDC Act that permits it to be

 

29



 

filed.  Section 505(b)(2) of the FDC Act permits the filing of an NDA for which at least some of the information required for product approval comes from studies not conducted by or for the applicant and for which the applicant has not obtained a right of reference.  If the FDA deems that an application is a 505(b)(2) NDA, we will be required to identify the listed drug.  The listed drug is the drug for which the FDA has made a finding of safety and effectiveness on which the applicant relies to seek approval of its product.  In addition to identifying the listed drug, we will be required to certify in the application as to whether or not its product may infringe any relevant patents on the listed drug.  In addition, a 505(b)(2) NDA would be subject to any market exclusivity of the listed drug.  If the FDA determines that an application is a 505(b)(2) NDA, and the application is approved, these additional requirements may result in a delay of the effective date of the application approval of the application.

 

The regulatory process is expensive and time consuming. Even after investing significant time and expenditures on clinical trials, we may not obtain regulatory approval of our products. Data obtained from clinical trials are susceptible to varying interpretations that could delay, limit or prevent regulatory approval. Significant clinical trial delays would impair our ability to commercialize our products and could allow our competitors to bring products to market before we do. In addition, changes in regulatory policy for product approval during the period of product development and regulatory agency review of each submitted new application may cause delays or rejections. Even if we receive regulatory approval, this approval may entail limitations on the indicated uses for which we can market a product.

 

Further, once regulatory approval is obtained, a marketed product and its manufacturer are subject to continual review. The discovery of previously unknown problems with a product or manufacturer may result in restrictions on the product, manufacturer or manufacturing facility, including withdrawal of the product from the market. Manufacturers of approved products are also subject to ongoing regulation, including compliance with FDA regulations governing current Good Manufacturing Practices (cGMP). Failure to comply with manufacturing regulations can result in, among other things, warning letters, fines, injunctions, civil penalties, recall or seizure of products, total or partial suspension of production, refusal of the government to renew marketing applications and criminal prosecution.

 

Pharmaceutical marketing is subject to substantial regulation in the United States.

 

Even if we obtain approval to market our products in the United States, our marketing activities will be subject to numerous federal and state laws governing the marketing and promotion of pharmaceutical products.  The FDA regulates post-approval promotional labeling and advertising to ensure that they conform with statutory and regulatory requirements.  In addition to FDA restrictions, the marketing of prescription drugs is subject to laws and regulations prohibiting fraud and abuse under government healthcare programs.  For example, the federal healthcare program antikickback statute prohibits giving things of value to induce the prescribing or purchase of products that are reimbursed by federal healthcare programs, such as Medicare and Medicaid.  In addition, federal false claims laws prohibit any person from knowingly presenting, or causing to be presented, a false claim for payment to the federal government.  Under this law, the federal government in recent years has brought claims against drug manufacturers alleging that certain marketing activities caused false claims for prescription drugs to be submitted to federal programs.  Many states have similar statutes or regulations, which apply to items and services reimbursed under Medicaid and other state programs, or, in some states, regardless of the payor.  If we, or our collaborative partners, fail to comply with applicable FDA regulations or other laws or regulations relating to the marketing of our products, we could be subject to criminal prosecution, civil penalties, seizure of products, injunction, exclusion of our products from reimbursement under government programs, as well as other regulatory actions against our product candidates, our collaborative partners or us.

 

The approval process outside the United States is uncertain and may limit our ability to develop, manufacture and sell our products internationally.

 

To market any of our products outside of the United States, we and our collaborative partners are subject to numerous and varying foreign regulatory requirements, implemented by foreign health authorities, governing the design and conduct of human clinical trials and marketing approval for drug products. The approval procedure varies among countries and can involve additional testing, and the time required to obtain approval may differ from that required to obtain FDA approval. The foreign regulatory approval process includes all of the risks

 

30



 

associated with obtaining FDA approval set forth above, and approval by the FDA does not ensure approval by the health authorities of any other country, nor does the approval by foreign health authorities ensure approval by the FDA.

 

If we are unable to obtain acceptable prices or adequate reimbursement for our products from third-party payors, we will be unable to generate significant revenues.

 

In both domestic and foreign markets, sales of our product candidates will depend in part on the availability of adequate reimbursement from third-party payors such as:

 

                  government health administration authorities;

                  private health insurers;

                  health maintenance organizations;

                  pharmacy benefit management companies; and

                  other healthcare-related organizations.

 

If reimbursement is not available for our product candidates, demand for these products may be limited. Further, any delay in receiving approval for reimbursement from third-party payors would have an adverse effect on our revenues. Third-party payors are increasingly challenging the price and cost-effectiveness of medical products and services. Significant uncertainty exists as to the reimbursement status of newly approved healthcare products, including pharmaceuticals. Our product candidates may not be considered cost effective, and adequate third-party reimbursement may be unavailable to enable us to maintain price levels sufficient to realize an acceptable return on our investment.

 

Federal and state governments in the United States and foreign governments continue to propose and pass new legislation designed to contain or reduce the cost of healthcare. Existing regulations affecting pricing may also change before any of our product candidates are approved for marketing. Cost control initiatives could decrease the price that we receive for any product we may develop in the future.

 

Increased costs associated with corporate governance compliance may significantly impact our results of operations.

 

Changing laws, regulations and standards relating to corporate governance, public disclosure and compliance practices, including the Sarbanes-Oxley Act of 2002, new SEC regulations and Nasdaq National Market rules, are creating uncertainty for companies such as ours in understanding and complying with these laws, regulations and standards.  As a result of this uncertainty and other factors, devoting the necessary resources to comply with evolving corporate governance and public disclosure standards may result in increased general and administrative expenses and a diversion of management time and attention to compliance activities.  We also expect these developments to increase our legal compliance and financial reporting costs.  In addition, these developments may make it more difficult and more expensive for us to obtain director and officer liability insurance, and we may be required to accept reduced coverage or incur substantially higher costs to obtain coverage.  Moreover, we may not be able to comply with these new rules and regulations on a timely basis.

 

These developments could make it more difficult for us to attract and retain qualified members of our board of directors, or qualified executive officers.  We are presently evaluating and monitoring regulatory developments and cannot estimate the timing or magnitude of additional costs we may incur as a result.  To the extent these costs are significant, our general and administrative expenses are likely to increase.

 

Business interruptions could limit our ability to operate our business.

 

Our operations are vulnerable to damage or interruption from computer viruses, human error, natural disasters, telecommunications failures, intentional acts of vandalism and similar events. In particular, our corporate headquarters are located in the San Francisco Bay area, which is known for seismic activity. We have not established a formal disaster recovery plan, and our back-up operations and our business interruption insurance may not be adequate to compensate us for losses that occur. A significant business interruption could result in losses or damages incurred by us and require us to cease or curtail our operations.

 

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Item 7A.           Quantitative and Qualitative Disclosures about Market Risk

 

Interest Rate Sensitivity

 

Our operating results have not been sensitive to changes in the general level of U.S. interest rates, particularly because most of our cash equivalents and marketable securities are invested in short-term debt instruments. If market interest rates were to change immediately and uniformly by 10% from levels at December 31, 2004, the fair value of our cash equivalents and marketable securities would not change by a significant amount.

 

Foreign Currency Fluctuations

 

We have not had any significant transactions in foreign currencies, nor did we have any balances that were due or payable in foreign currencies at December 31, 2004. Therefore, a hypothetical 10% change in foreign currency rates would not have an impact on our financial position and results of operations. We do not hedge any of our foreign currency exposure.

 

Item 8.                    Financial Statements and Supplementary Data

 

The financial statements and supplementary data required by Item 8 are set forth below on pages F-1 through F-32.

 

Item 9.                    Changes in and Disagreements with Accountants on Accounting and Financial Disclosure

 

None.

 

Item 9A.            Controls and Procedures

 

Conclusion Regarding the Effectiveness of Disclosure Controls and Procedures

 

At the end of the period covered by this report, we carried out an evaluation, under the supervision and with the participation of our management, including our principal executive officer and principal financial officer, of the effectiveness of the design and operation of our disclosure controls and procedures, as such term is defined under Rule 13a-15(e) promulgated under the Securities Exchange Act of 1934, as amended (the Exchange Act). Based on this evaluation, our principal executive officer and our principal financial officer concluded that our disclosure controls and procedures were effective as of December 31, 2004 to ensure that information required to be disclosed by us in this Annual Report on Form 10-K was recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission's rules and Form 10-K.

 

Management’s Report on Internal Control Over Financial Reporting

 

Our management is responsible for establishing and maintaining adequate internal control over financial reporting, as such term is defined in Exchange Act Rules 13a-15(f). Under the supervision and with the participation of our management, including our principal executive officer and principal financial officer, we conducted an evaluation of the effectiveness of our internal control over financial reporting based on the framework in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based on our evaluation under the framework in Internal Control - Integrated Framework, our management concluded that our internal control over financial reporting was effective as of December 31, 2004.

 

Our management’s assessment of the effectiveness of our internal control over financial reporting as of December 31, 2004 has been audited by Ernst & Young LLP, an independent registered public accounting firm, as stated in their report which is included herein.

 

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Report of Independent Registered Public Accounting Firm

 

The Board of Directors and Shareholders

Depomed, Inc.

 

We have audited management’s assessment, included above in the accompanying Management Report on Internal Control Over Financial Reporting, that Depomed, Inc. maintained effective internal control over financial reporting as of December 31, 2004, based on criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (the COSO criteria). Depomed’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting. Our responsibility is to express an opinion on management’s assessment and an opinion on the effectiveness of the company’s internal control over financial reporting based on our audit.

 

We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, evaluating management’s assessment, testing and evaluating the design and operating effectiveness of internal control, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.

 

A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.

 

Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements.  Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

 

In our opinion, management’s assessment that Depomed, Inc. maintained effective internal control over financial reporting as of December 31, 2004, is fairly stated, in all material respects, based on the COSO criteria.  Also, in our opinion, Depomed, Inc. maintained, in all material respects, effective internal control over financial reporting as of December 31, 2004, based on the COSO criteria.

 

We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheets of Depomed, Inc. (a development stage company) as of December 31, 2004 and 2003, and the related consolidated statements of operations, redeemable preferred stock and shareholders’ equity (net capital deficiency), and cash flows for each of the three years in the period ended December 31, 2004 and for the period from inception (August 7, 1995) to December 31, 2004 of Depomed, Inc. and our report dated March 15, 2005 expressed an unqualified opinion thereon.

 

 

 

/s/Ernst & Young LLP

 

 

 

Palo Alto, California

 

March 15, 2005

 

 

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Item 9B.            Other Information

 

None.

 

PART III

 

Item 10.             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, code of ethics, audit committee and audit committee financial experts of the company is incorporated by reference to the information set forth under the caption “Election of Directors” in the company’s Proxy Statement for the 2005 Annual Meeting of Shareholders.

 

The section entitled “Compliance Under Section 16(a) of the Securities Exchange Act of 1934” appearing in the Proxy Statement for the 2005 Annual Meeting of Shareholders sets forth the information concerning compliance by officers, directors and 10% shareholders of the company with Section 16 of the Exchange Act of 1934 and is incorporated herein by reference.

 

Item 11.             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 for the 2005 Annual Meeting of Shareholders.

 

Item 12.             Security Ownership of Certain Beneficial Owners and Management and Related Shareholder Matters

 

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 and Related Shareholder Matters” in the Proxy Statement for the 2005 Annual Meeting of Shareholders.

 

Item 13.             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 for the 2005 Annual Meeting of Shareholders.

 

Item 14.             Principal Accountant Fees and Services

 

The information required by this Item is incorporated herein by reference to the information set forth under the caption “Principal Accountant Fees and Services” in the Proxy Statement for the 2005 Annual Meeting of Shareholders.

 

PART IV

 

Item 15.              Exhibits, Financial Statement Schedules, and Reports on Form 8-K

 

(a) 1.   Financial Statements

Report of Independent Registered Public Accounting Firm

 

Consolidated Balance Sheets

 

Consolidated Statements of Operations

 

Consolidated Statement of Redeemable Preferred Stock and Shareholders' Equity (Net Capital Deficiency)

 

Consolidated Statements of Cash Flows

 

Notes to Consolidated Financial Statements

 

 

34



 

(a) 2.   Financial Statement Schedules

All schedules have been omitted because the required information is not present or because the information required is included in the financial statements, including the notes thereto.

 

(a) 3.   Exhibits:

 

3.1(1)

 

Amended and Restated Articles of Incorporation

3.2(11)

 

Certificate of Amendment to Amended and Restated Articles of Incorporation

3.3(2)

 

Certificate of Determination of Rights and Preferences of Series A Preferred Stock filed with the State of California on January 14, 2000

3.4(1)

 

Bylaws, as amended

4.1(1)

 

Specimen Common Stock Certificate

4.1(2)

 

Company Registration Rights Agreement dated January 21, 2000 between the company and Elan International Services, Ltd.

4.2(2)

 

Newco Registration Rights Agreement dated January 21, 2000 among the company Newco and Elan International Services, Ltd.

4.3(2)

 

Convertible Promissory Note dated January 21, 2000 issued by the company to Elan International Services, Ltd.

4.4(3)

 

Form of Subscription Agreement dated as of November 2, 2000

4.5(3)

 

Form of Class A Warrant dated as of November 2, 2000

4.6(3)

 

Form of Class B Warrant dated as of November 2, 2000

4.7(4)

 

Form of Subscription Agreement dated as of May 2, 2001

4.8(4)

 

Supplement to Form of Subscription Agreement dated as of May 29, 2001

4.9(4)

 

Form of Warrant dated as of June 13, 2001

4.10(6)

 

Form of Subscription Agreement dated as of March 14, 2002

4.11(6)

 

Placement Agent Warrant dated as of March 14, 2002

4.12(12)

 

Form of Warrant dated as of April 21, 2003

10.1(8)

 

1995 Stock Option Plan, as amended

10.2(1)

 

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.

10.3(1)

 

Form of Indemnification Agreement between the company and its directors and executive officers

+10.4(2)

 

Securities Purchase Agreement dated January 21, 2000 between the company and Elan International Services, Ltd.

+10.5(2)

 

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.

+10.6(2)

 

Company License Agreement dated January 21, 2000 among the company, Newco and Elan Corporation, plc.

10.7(5)

 

Loan agreement dated March 29, 2001 between the company and GATX Ventures, Inc.

+10.8(11)

 

Waiver and Termination Agreement dated November 8, 2002 among the company, Elan Corporation, plc, Elan Pharma International, Ltd. and Elan International Services, Ltd.

+10.9(7)

 

Amended License and Development Agreement, dated as of April 27, 2004, between the company and Biovail Laboratories Incorporated

+10.10(9)

 

Stock Purchase Agreement, dated as of May 28, 2002, between the company and Biovail Laboratories Incorporated

 

35



 

10.11(10)

 

Settlement and Release Agreement, dated as of November 22, 2002, between the company and Bristol-Myers Squibb Company

10.12(12)

 

Depomed, Inc. Securities Purchase Agreement, dated as of April 21, 2003

10.13(13)

 

Lease extension agreement dated April 30, 2003 between the company and Menlo Business Park LLC

10.14(13)

 

Lease agreement dated April 30, 2003 between the company and Menlo Park Business Park LLC

10.15(14)

 

Termination Agreement, dated as of September 16, 2003 among the company, Elan Corporation, plc, Elan Pharma International Limited, Ltd. and Depomed Development, Ltd.

10.16(14)

 

Exclusive License Agreement, dated as of September 18, 2003, between the company and Depomed Development, Ltd.

10.17(15)

 

2004 Equity Incentive Plan

10.18(15)

 

2004 Employee Stock Purchase Plan

10.19(16)

 

Agreement, dated as of December 10, 2004, between the company and Kings Road Investments, Ltd.

23.1

 

Consent of Independent Registered Public Accounting Firm

24.1

 

Power of Attorney (See Page 37)

31.1

 

Certification pursuant to Rule 13a-14(a) under the Securities Exchange Act of 1934 of John W. Fara, Ph.D.

31.2

 

Certification pursuant to Rule 13a-14(a) under the Securities Exchange Act of John F. Hamilton

32.1

 

Certification pursuant to 18 U.S.C. Section 1350 of John W. Fara, Ph.D.

32.2

 

Certification pursuant to 18 U.S.C. Section 1350 of John F. Hamilton

 


  (1)       Incorporated by reference to the company’s registration statement on Form SB-2 (File No. 333-25445)

  (2)       Incorporated by reference to the company’s Form 8-K filed on February 18, 2000

  (3)       Incorporated by reference to the company’s registration statement on Form S-3 (File No. 333-53486) filed on January 10, 2001

  (4)       Incorporated by reference to the company’s registration statement on Form S-3 (File No. 333-66688) filed on August 3, 2001

  (5)       Incorporated by reference to the company’s Form 10-Q filed on November 14, 2001

  (6)       Incorporated by reference to the company’s registration statement on Form S-3 (File No. 333-86542) filed on April 18, 2002

  (7)       Incorporated by reference to the company’s Form 8-K filed on May 4, 2004

  (8)       Incorporated by reference to the company’s registration statement on Form S-8 (File No. 333-101796) filed on December 12, 2002

  (9)       Incorporated by reference to the company’s Form 8-K/A dated May 28, 2002 and filed on December 23, 2002

(10)       Incorporated by reference to the company’s Form 8-K/A dated November 22, 2002 and filed on December 23, 2002

(11)       Incorporated by reference to the company’s Form 10-K filed on March 31, 2003

(12)       Incorporated by reference to the company’s Form 8-K filed on April 25, 2003

(13)       Incorporated by reference to the company’s Form 10-Q filed on August 14, 2003

(14)       Incorporated by reference to the company’s Form 10-Q filed on November 14, 2003

(15)       Incorporated by reference to the company’s Form S-8 filed on June 21, 2004

(16)       Incorporated by reference to the company’s Form 8-K filed on December 14, 2004

    +        Confidential treatment granted

 

36



 

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 Menlo Park, State of California, on the 16th day of March, 2005.

 

 

DEPOMED, INC.

 

 

 

 

 

By

/s/ JOHN W. FARA, Ph.D.

 

 

 

John W. Fara, Ph.D.

 

 

Chairman, President and Chief Executive Officer

 

POWER OF ATTORNEY

 

KNOW ALL PERSONS BY THESE PRESENTS, that each person whose signature appears below hereby constitutes and appoints John W. Fara and John F. Hamilton, and each of them acting individually, as his true and lawful attorneys-in-fact and agents, each with full power of substitution, for him in any and all capacities, to sign any and all amendments to this report on Form 10-K and to file the same, with exhibits thereto and other documents in connection therewith, with the Securities and Exchange Commission, granting unto said attorneys-in-fact and agents, with full power of each to act alone, full power and authority to do and perform each and every act and thing requisite and necessary to be done in connection therewith, as fully for all intents and purposes as he might or could do in person, hereby ratifying and confirming all that said attorneys-in-fact and agents, or his or their 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-K has been signed by the following persons in the capacities and on the dates indicated.

 

Signature

 

 

 

 

 

 

 

 

 

/s/ JOHN W. FARA, Ph.D.

 

Chairman, President and Chief Executive
Officer (Principal Executive Officer)

 

March 16, 2005

John W. Fara, Ph.D.

 

 

 

 

 

 

/s/ JOHN F. HAMILTON

 

Vice President, Finance and Chief
Financial Officer (Principal Financial Officer)

 

March 16, 2005

John F. Hamilton

 

 

 

 

 

 

/s/ G. STEVEN BURRILL

 

Director

 

March 16, 2005

G. Steven Burrill

 

 

 

 

 

 

 

 

 

/s/ GERALD T. PROEHL

 

Director

 

March 16, 2005

Gerald T. Proehl

 

 

 

 

 

 

 

 

 

/s/ JOHN W. SHELL, Ph.D.

 

Director

 

March 16, 2005

John W. Shell, Ph.D.

 

 

 

 

 

 

 

 

 

/s/ CRAIG R. SMITH, M.D.

 

Director

 

March 16, 2005

Craig R. Smith, M.D.

 

 

 

 

 

 

 

 

 

/s/ PETER D. STAPLE

 

Director

 

March 16, 2005

Peter D. Staple

 

 

 

 

 

 

 

 

 

/s/ JULIAN N. STERN

 

Director and Secretary

 

March 16, 2005

Julian N. Stern

 

 

 

 

 

37



 

DEPOMED, INC.

(A Development Stage Company)

INDEX TO CONSOLIDATED FINANCIAL STATEMENTS

 

DEPOMED, INC. CONSOLIDATED FINANCIAL STATEMENTS

 

Report of Independent Registered Public Accounting Firm

 

Consolidated Balance Sheets

 

Consolidated Statements of Operations

 

Consolidated Statement of Redeemable Preferred Stock and Shareholders’ Equity (Net Capital Deficiency)

 

Consolidated Statements of Cash Flows

 

Notes to Consolidated Financial Statements

 

 

F-1



 

Report of Independent Registered Public Accounting Firm

 

We have audited the accompanying consolidated balance sheets of Depomed, Inc. (a development stage company) as of December 31, 2004 and 2003, and the related consolidated statements of operations, redeemable preferred stock and shareholders’ equity (net capital deficiency), and cash flows for each of the three years in the period ended December 31, 2004 and for the period from inception (August 7, 1995) to December 31, 2004. 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 the standards of the Public Company Accounting Oversight Board (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 consolidated financial position of Depomed, Inc. (a development stage company) at December 31, 2004 and 2003, and the consolidated results of its operations and its cash flows for each of the three years in the period ended December 31, 2004 and for the period from inception (August 7, 1995) to December 31, 2004, in conformity with U.S. generally accepted accounting principles.

 

As described in Note 2 of the consolidated financial statements, in 2003 the Company changed its method of accounting for variable interest entities. As described in Note 1 of the consolidated financial statements, the Company has restated its statement of redeemable preferred stock and shareholders’ equity for each of the three years in the period ended December 31, 2001.

 

We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the effectiveness of Depomed, Inc.’s internal control over financial reporting as of December 31, 2004, based on criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission and our report dated March 15, 2005 expressed an unqualified opinion thereon.

 

 

 

 

/s/ Ernst & Young LLP

 

Palo Alto, California

 

 

March 15, 2005

 

 

 

F-2



 

DEPOMED, INC.

(A Development Stage Company)

CONSOLIDATED BALANCE SHEETS

 

 

 

December 31,

 

 

 

2004

 

2003

 

ASSETS

 

 

 

 

 

Current assets:

 

 

 

 

 

Cash and cash equivalents

 

$

953,295

 

$

20,044,698

 

Marketable securities

 

17,151,544

 

24,210,562

 

Accounts receivable

 

 

278,452

 

Prepaid and other current assets

 

442,349

 

692,191

 

Total current assets

 

18,547,188

 

45,225,903

 

Property and equipment, net

 

3,941,127

 

2,140,610

 

Other assets

 

380,268

 

326,136

 

 

 

$

22,868,583

 

$

47,692,649

 

LIABILITIES AND SHAREHOLDERS’ EQUITY

 

 

 

 

 

Current liabilities:

 

 

 

 

 

Accounts payable

 

$

1,733,474

 

$

2,024,221

 

Accrued compensation

 

910,723

 

809,509

 

Other accrued liabilities

 

556,084

 

468,981

 

Capital lease obligation, current portion

 

32,412

 

26,384

 

Long-term debt, current portion

 

73,008

 

289,555

 

Deferred revenue, current portion

 

75,000

 

 

Other current liabilities

 

93,073

 

 

Total current liabilities

 

3,473,774

 

3,618,650

 

Capital lease obligation, non-current portion

 

 

12,808

 

Long-term debt, non-current portion

 

 

73,012

 

Promissory note from related party, non-current portion

 

10,280,591

 

9,412,025

 

Deferred revenue, non-current portion

 

493,750

 

 

Other long-term liabilities

 

217,170

 

 

Commitments

 

 

 

 

 

Shareholders’ equity:

 

 

 

 

 

Preferred stock, no par value; 5,000,000 shares authorized; Series A convertible preferred stock; 25,000 shares designated, 15,821 and 12,015 shares issued and outstanding at December 31, 2004 and 2003, respectively, with an aggregate liquidation preference of $16,888,665

 

12,015,000

 

12,015,000

 

Common stock, no par value, 100,000,000 shares authorized; 34,691,190 and 34,569,212 shares issued and outstanding at December 31, 2004 and 2003, respectively

 

117,070,946

 

116,540,841

 

Deferred compensation

 

(621,980

)

(863,872

)

Deficit accumulated during the development stage

 

(119,984,625

)

(93,110,988

)

Accumulated other comprehensive (loss)

 

(76,043

)

(4,827

)

Total shareholders’ equity

 

8,403,298

 

34,576,154

 

 

 

$

22,868,583

 

$

47,692,649

 

 

See accompanying notes.

 

F-3



 

DEPOMED, INC.

(A Development Stage Company)

CONSOLIDATED STATEMENTS OF OPERATIONS

 

 

 



Year Ended December 31,

 

Period From
Inception
(August 7, 1995) to
December 31, 2004

 

 

 

2004

 

2003

 

2002

 

 

Revenue:

 

 

 

 

 

 

 

 

 

Collaborative agreements

 

$

171,319

 

$

981,990

 

$

440,659

 

$

4,964,332

 

Contract revenue from joint venture

 

 

 

1,220,527

 

5,101,019

 

License revenue

 

31,250

 

 

 

31,250

 

Total revenue

 

202,569

 

981,990

 

1,661,186

 

10,096,601

 

Operating expenses:

 

 

 

 

 

 

 

 

 

Research and development

 

21,358,802

 

26,416,425

 

24,200,321

 

101,363,069

 

General and administrative

 

5,178,539

 

3,964,020

 

5,888,303

 

25,678,070

 

Purchase of in-process research and development

 

 

 

 

298,154

 

Total operating expenses

 

26,537,341

 

30,380,445

 

30,088,624

 

127,339,293

 

Loss from operations

 

(26,334,772

)

(29,398,455

)

(28,427,438

)

(117,242,692

)

Other income (expenses):

 

 

 

 

 

 

 

 

 

Equity in loss of joint venture

 

 

(5,359

)

(2,435,667

)

(19,817,062

)

Gain from Bristol-Myers legal settlement

 

 

 

18,000,000

 

18,000,000

 

Interest and other income

 

489,013

 

299,140

 

101,106

 

2,394,776

 

Interest expense

 

(928,878

)

(910,424

)

(732,566

)

(3,220,647

)

Total other income (expenses)

 

(439,865

)

(616,643

)

14,932,873

 

(2,642,933

)

Net loss before income taxes

 

(26,774,637

)

(30,015,098

)

(13,494,565

)

(119,885,625

)

Provision for income taxes

 

(99,000

)

 

 

(99,000

)

Net loss

 

$

(26,873,637

)

$

(30,015,098

)

$

(13,494,565

)

$

(119,984,625

)

Basic and diluted net loss per share

 

$

(0.78

)

$

(1.23

)

$

(0.92

)

 

 

Shares used in computing basic and diluted net loss per share

 

34,628,825

 

24,458,259

 

14,642,745

 

 

 

 

See accompanying notes.

 

F-4



 

DEPOMED, INC.

(A Development Stage Company)

CONSOLIDATED STATEMENTS OF REDEEMABLE PREFERRED STOCK

AND SHAREHOLDERS’ EQUITY (NET CAPITAL DEFICIENCY)

Period from Inception (August 7, 1995) to December 31,2004

(Restated)

 

 

 

Convertible
Exchangeable
Preferred Stock

 

Preferred Stock

 

Common Stock

 

Deferred
Stock-Based

 

Deficit
Accumulated
During
Development

 

Accumulated
Other
Comprehensive
Income

 

Shareholders’
Equity
(Net
Capital

 

 

 

Shares

 

Amount

 

Shares

 

Amount

 

Shares

 

Amount

 

Compensation

 

Stage

 

(Loss)

 

Deficiency)

 

Balances at inception (Aug. 7, 1995)

 

 

$

 

 

$

 

 

$

 

$

 

$

 

$

 

$

 

Issuance of common stock to founders on Aug. 7, 1995 in exchange for shares held by them in M6 Pharmaceuticals

 

 

 

 

 

 

 

2,066,666

 

 

 

 

 

 

Issuance of common stock for cash to investors at approx. $0.0009 per share on Nov. 15, 1995

 

 

 

 

 

 

 

1,196,491

 

1,000

 

 

 

 

1,000

 

Issuance of Series A convertible preferred stock for cash to investors at approx. $0.31 per share on Nov. 15, 1995, net of issuance costs of $67,241

 

 

 

 

 

2,447,368

 

682,759

 

 

 

 

 

 

682,759

 

Comprehensive loss and net loss

 

 

 

 

 

 

 

 

 

 

(600,668

)

 

(600,668

)

Balances at Dec. 31, 1995

 

 

 

2,447,368

 

682,759

 

3,263,157

 

1,000

 

 

(600,668

)

 

83,091

 

Issuance of common stock for cash at various dates at $0.09 per share to employees and pursuant to stock option agreements.

 

 

 

 

 

 

 

91,666

 

8,250

 

 

 

 

8,250

 

Deferred stock-based compensation related to grants of certain stock options

 

 

 

 

 

 

 

 

275,000

 

(275,000

)

 

 

 

Comprehensive loss and net loss

 

 

 

 

 

 

 

 

 

 

(472,773

)

 

(472,773

)

Balances at Dec. 31, 1996

 

 

 

2,447,368

 

682,759

 

3,354,823

 

284,250

 

(275,000

)

(1,073,441

)

 

(381,432

)

Issuance of Series B convertible preferred stock for cash at $1.00 per share

 

 

 

 

 

278,500

 

278,500

 

 

 

 

 

 

278,500

 

Conversion of preferred stock to common stock on Nov. 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 Nov. 5, 1997 in connection with the initial public offering, net of issuance costs of $1,963,889

 

 

 

 

 

 

 

1,200,000

 

5,356,111

 

 

 

 

5,356,111

 

Deferred stock-based compensation related to grants of certain stock options

 

 

 

 

 

 

 

 

242,050

 

(242,050

)

 

 

 

Amortization of deferred stock-based compensation