-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, CzMEt8kdKgzxB8MI7Unt2dsm590mQYFLSL/tXnYLyiBysaZjngrrFxRMW0JA0BCh +tZQyGtplRSuWQun032qPg== 0000912057-00-015003.txt : 20000331 0000912057-00-015003.hdr.sgml : 20000331 ACCESSION NUMBER: 0000912057-00-015003 CONFORMED SUBMISSION TYPE: 10KSB40 PUBLIC DOCUMENT COUNT: 3 CONFORMED PERIOD OF REPORT: 19991231 FILED AS OF DATE: 20000330 FILER: COMPANY DATA: COMPANY CONFORMED NAME: DEPOMED INC CENTRAL INDEX KEY: 0001005201 STANDARD INDUSTRIAL CLASSIFICATION: SERVICES-COMMERCIAL PHYSICAL & BIOLOGICAL RESEARCH [8731] IRS NUMBER: 943229046 STATE OF INCORPORATION: CA FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10KSB40 SEC ACT: SEC FILE NUMBER: 001-13111 FILM NUMBER: 587281 BUSINESS ADDRESS: STREET 1: 366 LAKESIDE DRIVE CITY: FOSTER CITY STATE: CA ZIP: 94404-1167 BUSINESS PHONE: 6505130990 MAIL ADDRESS: STREET 1: 1170 B CHESS DRIVE CITY: FOSTER CITY STATE: CA ZIP: 94404 10KSB40 1 10KSB40 SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-KSB (MARK ONE) [X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934. FOR THE FISCAL YEAR ENDED: DECEMBER 31, 1999 OR [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934. FOR THE TRANSITION PERIOD FROM:_________________ TO________________ COMMISSION FILE NUMBER: 000-23267 DEPOMED, INC. (NAME OF SMALL BUSINESS ISSUER IN ITS CHARTER) CALIFORNIA 94-3229046 (STATE OR OTHER JURISDICTION OF (I.R.S. EMPLOYER IDENTIFICATION NO.) INCORPORATION OR ORGANIZATION) 1360 O'BRIEN DRIVE, MENLO PARK, CALIFORNIA 94025 (ADDRESS OF PRINCIPAL EXECUTIVE OFFICES) (ZIP CODE) Registrant's telephone number, including area code: (650) 462-5900 Securities registered pursuant to Section 12(b) of the Act:
TITLE OF EACH CLASS NAME OF EACH EXCHANGE ON WHICH REGISTERED ------------------- ----------------------------------------- Common Stock, no par value American Stock Exchange Common Stock Purchase Warrants, no par value American Stock Exchange
Securities registered pursuant to Section 12(g) of the Act: None Check whether the issuer (1) filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the past 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes X No --- --- Check if disclosure of delinquent filers pursuant to Item 405 of Regulation S-B is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-KSB or any amendment to this Form 10-KSB. [ X ] The issuer's revenues for its most recent fiscal year were $115,327. The aggregate market value of the voting stock held by non-affiliates of the registrant on March 6, 1999, based upon the closing price of the Common Stock on the American Stock Exchange for such date, was approximately $38,357,000. The number of outstanding shares of the registrant's Common Stock on March 6, 2000 was 7,189,363. DOCUMENTS INCORPORATED BY REFERENCE (1) Portions of the Proxy Statement to be filed with the Securities and Exchange Commission on or prior to April 30, 2000 and to be used in connection with the Annual Meeting of Shareholders expected to be held June 7, 2000 are incorporated by reference in Part III of this Form 10-KSB. DEPOMED, INC. 1999 FORM 10-KSB REPORT TABLE OF CONTENTS
PAGE ---- PART I .............................................................................................................. 1 Item 1. BUSINESS ............................................................................................ 1 Item 2. PROPERTIES .......................................................................................... 9 Item 3. LEGAL PROCEEDINGS ................................................................................... 9 Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS ................................................. 9 PART II ............................................................................................................. 11 Item 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS ............................................................................................. 11 Item 6. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS ............................................................................... 12 Item 7. FINANCIAL STATEMENTS ................................................................................ 19 Item 8. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE ................................................................................ 19 PART III ............................................................................................................ 20 Item 9. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT .................................................. 20 Item 10. EXECUTIVE COMPENSATION .............................................................................. 20 Item 11. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT ...................................... 20 Item 12. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS ...................................................... 20 Item 13. EXHIBITS AND REPORTS ON FORM 8-K .................................................................... 20
i The statements in this Annual Report on Form 10-KSB and other statements made by DepoMed, Inc., a California corporation, from time to time that are not historical are forward-looking statements which involve risks and uncertainties. Actual results, events or performance may differ materially from those anticipated in any forward-looking statements as a result of a variety of factors, including those set forth under "Factors That May Affect Future Results" and elsewhere in this Annual Report on Form 10-KSB. Readers are cautioned not to place undue reliance on these forward-looking statements which speak only as of the date hereof. The company undertakes no obligation to publicly release the result of any revisions to these forward-looking statements that may be made to reflect events or circumstances after the date hereof or to reflect the occurrence of unanticipated events. PART I ITEM 1. BUSINESS COMPANY OVERVIEW We are a development stage company engaged in the development of new and proprietary oral drug delivery technologies. We have developed two types of oral drug delivery systems, the Gastric Retention System (the "GR System") and the Reduced Irritation System (the "RI System" and together, the "DepoMed Systems"). The GR System is designed to be retained in the stomach for an extended period of time while it delivers the incorporated drug or drugs, and the RI System is designed to reduce the gastrointestinal irritation that is a side effect of many orally administered drugs. In addition, the DepoMed Systems are designed to provide continuous, controlled delivery of an incorporated drug. In this Annual Report on Form 10-KSB, the "company," "DepoMed," "we," "us," and "our," refer to DepoMed, Inc. We intend to develop products utilizing the DepoMed Systems in collaboration with pharmaceutical and biotechnology companies from which we expect to receive license fees, research and development funding, milestone payments and royalties. We also intend to develop either independently or jointly proprietary products utilizing certain off-patent and over-the-counter ("OTC") drugs in the DepoMed Systems. In November 1999, we entered into an agreement to form a joint venture with Elan Corporation, plc. The joint venture will develop a series of undisclosed proprietary products using oral drug delivery technologies licensed to the venture by both companies. In March 1998, we entered into a research agreement with R.W. Johnson Pharmaceutical Research Institute, a Johnson & Johnson unit ("PRI"), to develop a product incorporating a PRI proprietary compound into the GR System. We also have independently developed a potential once-daily metformin product for Type II diabetes, a reduced irritation aspirin and an enhanced absorption calcium supplement product. These products have been reformulated to incorporate advances in polymer technology and to address potential marketing opportunities. We are currently seeking marketing partners to commercialize these products. We are also developing certain other product candidates expected to benefit from incorporation into the DepoMed Systems. THE DRUG DELIVERY INDUSTRY Drug delivery companies apply proprietary technologies to create new pharmaceutical products utilizing drugs developed by others. These products are generally novel, cost-effective dosage forms that provide any of several benefits, including better control of drug concentration in the blood, improved safety and efficacy, improved patient compliance and ease of use. The company believes that drug delivery technologies can provide pharmaceutical companies with a means of developing new and/or improved products as well as of extending existing patent franchises. 1 The increasing need to deliver medication to patients efficiently and with fewer side effects has accelerated the pace of invention of new drug delivery systems and the development and maturation of the drug delivery industry. Today medication can be delivered to a patient through many different delivery systems, including transdermal, injection, implant and oral methods. However, these delivery methods continue to have certain limitations. Transdermal patches are often inconvenient to apply, can be irritating to the skin and the rate of release can be difficult to control. Injections are uncomfortable for most patients. In most cases both injections and implants must be administered in a hospital or physician's office and, accordingly, are frequently not suitable for home use. Oral administration remains the preferred method of administering medication. However, conventional oral drug administration also has limitations. Because capsules and tablets have limited effectiveness in providing controlled drug delivery, they frequently result in drug release that is too rapid, causing incomplete absorption of the drug, irritation to the GI tract and other side effects. In addition, they lack the ability to provide localized therapy. The company believes that the need for frequent dosing of many drugs administered by capsules and tablets also can impede patient compliance with the prescribed regimen. THE DEPOMED SYSTEMS The DepoMed Systems are based on the company's proprietary oral drug delivery technologies and are designed to include formulations of drug-containing polymeric units that allow multi-hour delivery of an incorporated drug. Although the company's formulations are proprietary, the polymers utilized in the DepoMed Systems are commonly used in the food and drug industries and are generally regarded as safe. The company has formulated these polymers into tablets as well as cylinders and spheres that can be individually dosed or contained in gelatin capsules for ease of administration. By using different formulations of the polymers, the company believes that the DepoMed Systems are able to provide continuous, controlled delivery of drugs of varying molecular complexity and solubility. The DepoMed Systems are designed to address certain limitations of drug delivery and to provide for orally administered, conveniently dosed, cost-effective drug therapy that provides continuous, controlled delivery of a drug over a multi-hour period. The company believes that the DepoMed Systems can provide one or more of the following advantages over conventional methods of drug administration: - - ENHANCED SAFETY AND EFFICACY THROUGH CONTROLLED DELIVERY. We believe that the DepoMed Systems may improve the ratio of therapeutic effect to toxicity by decreasing the initial peak concentrations of a drug associated with toxicity, while maintaining levels of the drug at therapeutic, subtoxic concentrations for an extended period of time. Many drugs demonstrate optimal efficacy when concentrations are maintained at therapeutic levels over an extended period of time. When a drug is administered intermittently, the therapeutic concentration is often exceeded for some period of time and then the concentration drops below effective levels. Excessively high concentrations are a major cause of side effects and subtherapeutic concentrations are ineffective. - - GREATER PATIENT AND CAREGIVER CONVENIENCE. We believe that the DepoMed Systems may offer once-daily or reduced frequency dosing for certain drugs that are currently required to be administered several times daily. Such less frequent dosing promotes compliance to dosing regimens. Patient noncompliance with dosing regimens has been associated with increased costs of medical therapies by prolonging treatment duration, increasing the likelihood of secondary or tertiary disease manifestation and contributing to over-utilization of medical personnel and facilities. By improving patient compliance, providers and third-party payors may reduce unnecessary expenditures and improve therapeutic outcomes. - - EXPANSION OF TYPES OF DRUGS CAPABLE OF ORAL DELIVERY. Some drugs, including certain proteins and peptides, because of their large molecular size and susceptibility to degradation in the GI tract, must currently be administered by injection or by continuous infusion, which is typically done in a hospital or other clinical setting. We believe that the DepoMed Systems may be able to make the oral delivery of some of these drugs therapeutically effective. 2 - - PROPRIETARY REFORMULATION OF GENERIC PRODUCTS. We believe that the DepoMed Systems may offer the potential to produce improved formulations of off-patent drugs. These proprietary formulations may be differentiated from existing generic products by virtue of reduced dosing requirements, improved efficacy, decreased toxicity or additional indications. THE GASTRIC RETENTION SYSTEM The GR System consists of a proprietary formulation of a drug-containing polymer matrix which can be manufactured as tablets or multiple spherical units. If taken with a meal, these polymeric tablets or units remain in the stomach for an extended period of time to provide continuous, controlled delivery of an incorporated drug. The GR System's design is based in part on principles of human gastric emptying and GI transit. Following a meal, liquids and small particles flow continuously from the stomach into the intestine, leaving behind the larger nondigested particles until the digestive process is complete. As a result, drugs in liquid or dissolved form or those consisting of small particles tend to empty rapidly from the stomach and continue into the small intestine and on into the large intestine, often before the drug has time to act locally or to be absorbed, if the stomach and/or upper small intestine are the sites of absorption. The drug-containing polymeric tablets or units of the GR System are formulated into easily swallowed shapes and are designed to swell upon ingestion. The tablets or units attain a size after ingestion sufficient to be retained in the stomach for multiple hours while delivering the drug content. We have demonstrated multihour gastric retention in humans who have been given the GR System with food. In addition, we are currently developing an enhanced version of the GR System designed to be retained in the stomach without the ingestion of food. This process is expected to allow for treatment regimens unrelated to meal times, as well as for retention that is more prolonged and with minimum patient-to-patient variation in retention time. We believe that this feature will make medical treatment less disruptive to a patient's normal schedule. The expected advantages of the GR System over conventional oral drug delivery systems include the following: MORE EFFICIENT GI DRUG ABSORPTION. We believe that the GR System can be used for improved oral administration of drugs that are currently inadequately absorbed when delivered as conventional tablets or capsules. Many drugs are primarily absorbed in the stomach, duodenum or upper small intestine regions, through which drugs administered in conventional oral dosage forms transit quickly. In contrast, the GR System is designed to be retained in the stomach, allowing for constant multihour flow of drugs to certain areas of the GI tract. Accordingly, for such drugs, we believe that the GR System offers a significantly enhanced opportunity for increased absorption. Unlike some insoluble drug delivery systems, the polymer comprising the GR System dissolves at the end of its useful life and is passed through the GI tract and eliminated. GASTRIC DELIVERY FOR LOCAL THERAPY AND ABSORPTION. We believe that the GR System can be used to deliver drugs which can efficiently eradicate GI-dwelling microorganisms, such as H. PYLORI, the bacterium which is a cause of ulcers. We have developed a calcium supplement product which utilizes the GR System. We are currently seeking a marketing partner to commercialize this product. We believe that the GR System will provide for the more efficient dissolution and absorption of an orally administered calcium compound by keeping the product in the stomach for an extended period of time. Calcium supplements are generally indicated in the treatment of osteoporosis. It is estimated that 20 million people in the United States suffer from osteoporosis and that another 17 million people are at risk. New medications for this debilitating condition are effective but calcium supplementation is essential. In addition, it is estimated that 30 million people in the United States are under long-term treatment with corticosteroids, such as prednisone, which can cause significant bone loss. Accordingly, calcium supplementation is recommended as concomitant treatment with these drugs. Current calcium supplement products are mostly in the form of calcium carbonate, which is soluble only in an acidic medium and which consequently must be retained in the stomach for an extended period of time for efficient dissolution and subsequent absorption. However, conventional calcium carbonate products pass through the stomach too quickly for a significant amount of the calcium to dissolve. 3 We believe that a possible future application of the GR System is the incorporation of a nonsystemic antacid into the GR System that would be designed to provide sustained local action. Although many currently used antacid products are nonsystemic, their duration time is short. Accordingly, individuals who need through-the-night protection from excess stomach acid must resort to systemic antacids, such as Zantac-Registered Trademark- or Tagamet-Registered Trademark-, which have a longer on-set of action. We believe that the GR System may be designed to provide continuous, controlled local delivery which is expected to allow for a nonsystemic antacid product with more immediate and sustained action. RATIONAL DRUG COMBINATIONS. We believe that a multi-particulate GR System may allow for rational combinations of drugs with different biological half-lives. Physicians frequently prescribe multiple drugs for treatment of a single medical condition. Single product combinations have not been considered feasible because the different biological half-lives of these combination drugs would result in an overdosage of one drug and/or an underdosage of the other. By incorporating different drugs into different polymeric cylinders in the same capsule, the GR System is designed to release each of its incorporated drugs continuously at a rate and duration (dose) appropriately adjusted for the specific biological half-lives of the drugs. The company believes that future rational drug combination products using the GR System have the potential to simplify drug administration, increase patient compliance, and reduce medical costs. POTENTIAL FOR ORAL DELIVERY OF PEPTIDES AND PROTEINS. Based on laboratory studies conducted by the company, the GR System is expected to protect drugs from enzymes and acidity effects prior to their delivery in the stomach. This feature coupled with gastric retention could allow for continuous delivery of peptides and proteins (i.e., labile drugs) into the upper portion of the small intestine, the most likely site of possible absorption for many such drugs. We believe that this mechanism will allow effective oral delivery of some drugs that currently require administration by injection. In addition, we believe that the GR System can be formulated to provide for continuous, controlled delivery of insoluble or particulate matter, including protein or antigen-laden vesicles, such as liposomes, and microspheres or nanoparticles. THE REDUCED IRRITATION SYSTEM The RI System is designed to provide for significant reduction in local GI irritation from the effects of certain drugs. Local tissue damage occurs when solid crystals of a drug remain at any one site of the GI tract for long periods of time. The RI System consists of a drug/polymer matrix formed into spheres or granules. The spheres are contained in an outer gelatin capsule; the granules are compressed into a tablet. Each of these systems is designed to rapidly disintegrate upon ingestion to deliver its multiple small, particles. The particles are composed of an inert matrix of polymeric material in which the active ingredient is homogeneously dispersed in its solid state. The particles persist for a period of time, but ultimately dissolve and the polymer is eliminated. The RI System is designed to reduce irritation through three distinct mechanisms. First, the small particles of the RI System are designed to deliver an incorporated drug in solution state, in contrast to a solid or crystalline state which may cause local GI irritation. Second, the dispersion of the particles within the GI tract contributes further to the dilution of the local drug effects. Third, controlled delivery contributes to the reduction of GI irritation by delivering the incorporated drug over a longer period of time. In addition to the reduced irritation aspirin that the company has developed, the company believes that other GI irritating compounds such as potassium chloride and the bisphosphonates used in treatment of osteoporosis may benefit from the RI System. We have developed an aspirin product that utilizes the RI System and is designed to reduce the GI irritation which is common when aspirin is administered in conventional tablet or capsule form. Aspirin usage has been expanding with important new medical indications, including the prevention and treatment of cardiovascular disease. Aspirin is widely recognized for its ability to cause damage to the GI tract and local irritation of the stomach and intestine, including the formation of ulcers. The irritation properties of aspirin are mostly local, not systemic in origin. Local damage begins and is sustained by high local drug concentration against the mucosa, particularly when aspirin is administered in a solid, crystalline state as from a rapidly disintegrating tablet. These crystals in contact with the mucosa provide a stagnant pool of saturated drug solution against the cell walls, resulting in damage from both cellular mechanisms and from back diffusion of acid into the mucosal cells and into the submucosal capillaries, causing tissue necrosis and bleeding. To minimize local damage, the RI System is designed to deliver its drug in solution, in a controlled manner from a dispersion of polymeric particles. 4 PRODUCT DEVELOPMENT INITIATIVES The following table summarizes DepoMed's principal product development initiatives:
DEPOMED POTENTIAL EXPECTED SYSTEM PROGRAM PARTNER INDICATIONS BENEFIT ------ ------- ------- ----------- ------- GR Metformin In-house Type II diabetes Less frequent dosing GR Generic Compound (1) Elan Corporation, plc Confidential (2) Improved dosing regimen & new indication GR PRI Proprietary R.W. Johnson Confidential (4) Less frequent dosing Compound Pharmaceutical Research Institute (3) GR Calcium Supplement In-house Osteoporosis, Improved calcium other calcium absorption absorption deficiencies RI Aspirin In-house Multiple, including pain Reduced and cardiovascular gastrointestinal therapy irritation
- ---------------- (1) Undisclosed. (2) The potential indication may not be disclosed pursuant to the terms of the agreement between the company and Elan Corporation, plc. See "Collaborative Relationships." (3) The company entered into a feasibility agreement relating to this compound with PRI in March 1998. (4) The potential indication may not be disclosed pursuant to the terms of the agreement between the company and PRI. See "Collaborative Relationships." The products listed in the above table are in various stages of development. In January 2000, we successfully completed Phase I human clinical trials with Metformin GR-TM- and are preparing an Investigational New Drug application ("IND") with the United States Food and Drug Administration (the "FDA"). For the PRI compound, formulation work was initiated in March 1998. We have completed internal development of the calcium supplement and aspirin product and are seeking collaborative partners to manufacture and market these products. Upon identification of the appropriate corporate partners, we expect to initiate clinical trials to support marketing claims on these products. COLLABORATIVE RELATIONSHIPS ELAN CORPORATION, PLC. In November 1999, we signed a binding letter agreement with Elan Corporation, plc, Elan Pharma International, Ltd. and Elan International Services, Ltd. (together "Elan") to form a joint venture to develop a series of undisclosed proprietary products using drug delivery technologies and expertise of both companies. This joint venture, DepoMed Development, Ltd. ("DDL"), a Bermuda limited liability company, is initially owned 80.1% by DepoMed and 19.9% by Elan. DDL will subcontract research and development efforts to DepoMed, Elan and others. R.W. JOHNSON PHARMACEUTICAL RESEARCH INSTITUTE. In March 1998, the company and PRI entered into a feasibility study involving the use of the GR System to deliver a pharmaceutical product. We successfully completed the first phase of formulation development in March 1999 and the product is currently under review at PRI. There can be no assurance, however, that the company will be able to enter into an agreement with PRI on reasonable commercial terms, or at all. 5 BRISTOL-MYERS SQUIBB COMPANY. In July 1996, the company and Bristol-Myers Squibb Company ("BMS") entered into a joint research agreement to develop a product incorporating a BMS proprietary compound into the GR System. Pursuant to the agreement, BMS had an option to obtain an exclusive, worldwide license to products incorporating the BMS compound utilizing the GR System. In April 1999, BMS notified us that BMS would not exercise its option and the agreement was terminated. COMPETITION Other companies that have oral drug delivery technologies competitive with the DepoMed Systems include ALZA Corporation, Elan Corporation plc, SkyePharma plc, Biovail Corporation International and Andrx Corporation, all of which have oral tablet products designed to release the incorporated drugs over time. Each of these companies has a patented technology with attributes different from those of DepoMed's, and in some cases with different sites of delivery to the GI tract. We believe that we are the only drug delivery company that is currently developing products for oral drug delivery systems both for enhanced retention in the stomach of an orally administered tablet (the GR System) and the safer oral administration of otherwise locally irritating drugs (the RI System). We believe that this combination of oral drug delivery technologies differentiates us from other oral drug delivery companies and will enable us to interest pharmaceutical companies in incorporating their proprietary drugs into the DepoMed Systems and also to differentiate any OTC and/or off-patent drugs that utilize the DepoMed Systems from those of other drug delivery companies. Competition in pharmaceutical products and drug delivery systems is intense. We expect competition to increase. Competing technologies or products developed in the future may prove superior either generally or in particular market segments to the DepoMed Systems or products using the DepoMed Systems. These developments would make the DepoMed Systems or products using them noncompetitive or obsolete. All of our principal competitors have substantially greater financial, marketing, personnel and research and development resources than we. In addition, many of our potential collaborative partners have devoted, and continue to devote, significant resources to the development of their own drug delivery systems and technologies. PATENTS AND PROPRIETARY RIGHTS Our success will depend in part on our ability to obtain and maintain patent protection for our technologies and to preserve our trade secrets. Our policy is to file patent applications in the United States and foreign jurisdictions. We currently hold four issued United States patents and three United States patent applications are pending. Additionally, we are currently preparing a series of patent applications representing our expanding technology for filing in the United States. We have also applied for patents in numerous foreign countries. Some of those countries have granted our applications and other applications are still pending. No assurance can be given that our patent applications will be approved, or that any issued patents will provide competitive advantages for the DepoMed Systems or our technologies. With respect to already issued patents and any patents which may issue from our applications, there can be no assurance that claims allowed will be sufficient to protect our technologies. The United States maintains patent applications in secrecy until a patent issues. As a result, we cannot be certain that others have not filed patent applications for technology covered by our pending applications or that we were the first to file patent applications for such technology. Competitors may have filed applications for, or may have received patents and may obtain additional patents and proprietary rights relating to, compounds or processes that may block our patent rights or permit the competitors to compete without infringing our patent rights. In addition, there can be no assurance that: - any patents issued to the company will not be challenged, invalidated or circumvented; or - the rights granted under the patents issued to the company will provide proprietary protection or commercial advantage to the company. 6 We also rely on trade secrets and proprietary know-how. We seek to protect that information, in part, through entering into confidentiality agreements with employees, consultants, collaborative partners and others before such persons or entities have access to our proprietary trade secrets and know-how. These confidentiality agreements may not be effective in certain cases, due to, among other things, the lack of an adequate remedy for breach of an agreement or a finding that an agreement is unenforceable. In addition, our trade secrets may otherwise become known or be independently developed by competitors. Our ability to develop our technologies and to make commercial sales of products using our technologies also depends on not infringing others' patents. We are not aware of any claim of patent infringement against us. However, if claims concerning patents and proprietary technologies arise and are determined adversely to the company, the claims could have a material adverse effect on the company. Extensive litigation regarding patent and other intellectual property rights is common in the pharmaceutical industry. We may need to engage in litigation to enforce any patents issued or licensed to the company or to determine the scope and validity of third-party proprietary rights. There can be no assurance that our issued or licensed patents would be held valid by a court of competent jurisdiction. Whether or not the outcome of litigation is favorable to the company, the diversion of our financial and managerial resources to such litigation could have a material adverse effect on the company. We may also be required to participate in interference proceedings declared by the United States Patent and Trademark Office for the purpose of determining the priority of inventions in connection with the patent applications of the company or other parties. Adverse determinations in litigation or interference proceedings could require the company to seek licenses (which may not be available on commercially reasonable terms) or subject the company to significant liabilities to third parties. These events could have a material adverse effect on the company. MANUFACTURING, MARKETING AND SALES We do not have and do not intend to establish in the foreseeable future internal manufacturing, marketing or sales capabilities. Rather, we intend to use the facilities of our collaborative partners or those of contract manufacturers to manufacture products using the DepoMed Systems. Our dependence on third parties for the manufacture of products using the DepoMed Systems may adversely affect our ability to develop and deliver such products on a timely and competitive basis. There may not be sufficient manufacturing capacity available to the company when, if ever, it is ready to seek commercial sales of products using the DepoMed Systems. In addition, we expect to rely on our collaborative partners or to develop distributor arrangements to market and sell products using the DepoMed Systems. We may not be able to enter into manufacturing, marketing or sales agreements on reasonable commercial terms, or at all, with third parties. Failure to do so would have a material adverse effect on the company. Applicable cGMP requirements and other rules and regulations prescribed by foreign regulatory authorities will apply to the manufacture of products using the DepoMed Systems. We will depend on the manufacturers of products using the DepoMed Systems to comply with cGMP and applicable foreign standards. Any failure by a manufacturer of products using the DepoMed Systems to maintain cGMP or comply with applicable foreign standards could delay or prevent their commercial sale. This could have a material adverse effect on the company. GOVERNMENT REGULATION Numerous governmental authorities in the United States and other countries regulate our research and development activities and those of our collaborative partners. Governmental approval is required of all potential pharmaceutical products using the DepoMed Systems and the manufacture and marketing of products using the DepoMed Systems prior to the commercial use of those products. The regulatory process will take several years and require substantial funds. If products using the DepoMed Systems do not receive the required regulatory approvals or if such approvals are delayed, the company's business would be materially adversely affected. There can be no assurance that the requisite regulatory approvals will be obtained without lengthy delays, if at all. 7 In the United States, the FDA rigorously regulates pharmaceutical products, including any drugs using the DepoMed Systems. If a company fails to comply with applicable requirements, the FDA or the courts may impose sanctions. These sanctions may include civil penalties, criminal prosecution of the company or its officers and employees, injunctions, product seizure or detention, product recalls, total or partial suspension of production. The FDA may withdraw approved applications or refuse to approve pending new drug applications, premarket approval applications, or supplements to approved applications. The company often must conduct preclinical testing on laboratory animals of new pharmaceutical products prior to commencement of clinical studies involving human beings. These studies evaluate the potential efficacy and safety of the product. The company then submits the results of these studies to the FDA as part of an IND, which must become effective before beginning clinical testing in humans. Typically, human clinical evaluation involves a time-consuming and costly three-phase process: - In Phase I, the company conducts clinical trials with a small number of subjects to determine a drug's early safety profile and its pharmacokinetic pattern. - In Phase II, the company conducts clinical trials with groups of patients afflicted with a specific disease in order to determine preliminary efficacy, optimal dosages and further evidence of safety. - In Phase III, the company conducts large-scale, multi-center, comparative trials with patients afflicted with a target disease in order to provide enough data to demonstrate the efficacy and safety required by the FDA prior to commercialization. The FDA closely monitors the progress of each phase of clinical testing. The FDA may, at its discretion, re-evaluate, alter, suspend or terminate testing based upon the data accumulated to that point and the FDA's assessment of the risk/benefit ratio to patients. The results of the preclinical and clinical testing are submitted to the FDA in the form of a new drug application (an "NDA") for approval prior to commercialization. In responding to an NDA, the FDA may grant marketing approval, request additional information or deny the application. Failure to receive approval for any products using the DepoMed Systems would have a material adverse effect on the company. Various FDA regulations apply to over-the-counter products that comply with monographs issued by the FDA. These regulations include: - cGMP requirements; - general and specific over-the-counter labeling requirements (including warning statements); - advertising restrictions; and - requirements regarding the safety and suitability of inactive ingredients. In addition, the FDA may inspect over-the-counter products and manufacturing facilities. A failure to comply with applicable regulatory requirements may lead to administrative or judicially imposed penalties. If an over-the-counter product differs from the terms of a monograph, it will, in most cases, require FDA approval of an NDA for the product to be marketed. Foreign regulatory approval of a product must also be obtained prior to marketing the product internationally. Foreign approval procedures vary from country to country. The time required for approval may delay or prevent marketing in certain countries. In certain instances the company or its collaborative partners may seek approval to market and sell certain products outside of the United States before submitting an application for United States approval to the FDA. The clinical testing requirements and the time required to obtain foreign regulatory approvals may differ from that required for FDA approval. Although there is now a centralized European Union ("EU") approval mechanism in place, each EU country may nonetheless impose its own procedures and requirements. Many of these procedures and requirements are time-consuming and expensive. Some EU countries require price approval as part of the regulatory process. These constraints can cause substantial delays in obtaining required approval from both the FDA and foreign regulatory authorities after the relevant applications are filed, and approval in any single country may not meaningfully indicate that another country will approve the product. 8 PRODUCT LIABILITY Our business involves exposure to potential product liability risks that are inherent in the production and manufacture of pharmaceutical products. Any such claims could have a material adverse effect on the company. We have obtained product liability insurance for clinical trials currently underway. Although, there can be no assurance that: - we will be able to obtain product liability insurance for future trials; - we will be able to maintain product liability insurance on acceptable terms; - we will be able to secure increased coverage as the commercialization of the DepoMed Systems proceeds; or - any insurance will provide adequate protection against potential liabilities. EMPLOYEES As of December 31, 1999, we had twenty-one full-time employees. None of our employees is represented by a collective bargaining agreement, nor have we experienced any work stoppage. We believe that our relations with our employees are excellent. The success of the company is dependent in large part upon the continued services of John W. Fara, our President and Chief Executive Officer and other members of the company's executive management, and on our ability to attract and retain key management and operating personnel. We maintain key man life insurance on the life of Dr. Fara in the amount of $1,000,000. Management, scientific and operating personnel are in high demand and are often subject to competing offers. The loss of the services of one or more members of management or key employees or the inability to hire additional personnel as needed may have a material adverse effect on the company. ITEM 2. PROPERTIES In March 1998, we entered into a two-year non-cancelable sublease of approximately 13,000 square feet of laboratory and office facilities in Foster City, California. The sublease expires on March 31, 2000 and will not be renewed by our sublessor. In February 2000, we entered into a five-year non-cancelable lease of approximately 21,000 square feet of laboratory and office facilities in Menlo Park, California. It includes an option to renew for one additional term of five years. We expect that this facility will accommodate our growth for at least two years. ITEM 3. LEGAL PROCEEDINGS Not applicable. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS No matters were submitted to a vote of security holders during the fourth quarter of the fiscal year ended December 31, 1999. 9 EXECUTIVE OFFICERS The executive officers of the company and their ages as of December 31, 1999 are as follows:
NAME AGE POSITION ---- --- -------- John W. Shell, Ph.D ........... 74 Founder, Chairman of the Board and Chief Scientific Officer John W. Fara, Ph.D ............ 57 President, Chief Executive Officer and Director Bret Berner, Ph.D ............. 47 Vice President, Product Development John F. Hamilton .............. 55 Vice President, Finance and Chief Financial Officer John N. Shell ................. 46 Vice President, Operations and Director
John W. Shell, Ph.D., has served as Chairman of the Board of Directors of the company since its inception in August 1995 and served as the company's President and Chief Executive Officer from May 1995 to December 1996, when he became the company's Chief Scientific Officer. Dr. Shell founded DepoMed Systems, Inc. ("DSI") in 1991, and served as its Chairman and Chief Executive Officer until its merger with M6 Pharmaceuticals, Inc. ("M6") in 1994, and served as President of the DepoMed Division of M6 from March 1994 until May 1995. In keeping with longstanding retirement plans, in March 2000, Dr. Shell resigned as the company's Chairman and Chief Scientific Officer, effective April 1, 2000. Dr. Shell will continue to serve as a consultant and director of the company. Prior to founding DSI, from 1987 until 1990 he was Vice President for Research at Johnson & Johnson's IOLAB division. His experience also includes eight years as a Senior Research Scientist at The Upjohn company, six years as Director of Research for Allergan Pharmaceuticals and fifteen years with ALZA Corporation ("ALZA") dating from its founding in 1968. Dr. Shell served as Vice President of ALZA Pharmaceuticals, and later as Vice President of Business Development for ALZA. Dr. Shell received B.A., B.S. and Ph.D. degrees from the University of Colorado. John W. Fara, Ph.D., has served as a director of the company since November 1995 and as its President and Chief Executive Officer since December 1996. In March 2000, he was elected Chairman of the Board of Directors of the company to succeed Dr. Shell, effective April 1, 2000. From February 1990 to June 1996 Dr. Fara was President and Chief Executive Officer of Anergen, Inc., a biotechnology company. Prior to February 1990 he was President of Prototek, Inc., a biotechnology company ("Prototek"). Prior to his tenure at Prototek, he was Director of Biomedical Research and then Vice President of Business Development during ten years with ALZA. Dr. Fara received a B.S. from the University of Wisconsin and a Ph.D. from University of California, Los Angeles. Bret Berner, Ph.D. has served as the company's Vice President, Product Development since December 1998. Before joining DepoMed, Dr. Berner served as Vice President of Development at Cygnus, Inc. for four years, where he was responsible for formulation, toxicology, project management, and new drug delivery technology. From 1984 through 1994, Dr. Berner acted as the director of basic pharmaceutics research at Ciba-Geigy. Prior to 1984, he also held the position of staff scientist at The Procter & Gamble Company. Dr. Berner holds 18 patents and has authored more than 70 publications, including the editorship of two books on controlled drug delivery. He received his B.A. in neurosciences, cum laude, from the University of Rochester and his Ph.D. in physical chemistry from the University of California, Los Angeles. John F. Hamilton has served as the company's Vice President, Finance and Chief Financial Officer since January 1997. Prior to joining the company, Mr. Hamilton was Vice President and Chief Financial Officer of Glyko, Inc. and Glyko Biomedical Ltd., a carbohydrate instrument and reagents company from May 1992 to September 1996. Previously he was President and Chief Financial Officer of Protos Corporation, a drug design subsidiary of Chiron Corporation, from June 1988 to May 1992 and held various positions with Chiron Corporation, including Treasurer, from September 1987 to May 1992. Mr. Hamilton received a B.A. from the University of Pennsylvania and a M.B.A. from the University of Chicago. John N. Shell has served as a director of the company since its inception in August 1995 and Director of Operations for the company until December 1996, when he was named Vice President, Operations. From May 1994 to August 1995, Mr. Shell served in a similar capacity at the DepoMed Division of M6. Prior to 1994, Mr. Shell served as Materials Manager for Ebara International Corporation, a multi-national semiconductor equipment manufacturer, and as Materials Manager for ILC Technology, an electro-optics and electronics manufacturer. Mr. Shell received his B.A. from the University of California, Berkeley. 10 PART II ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS The company's Common Stock commenced trading on the Nasdaq SmallCap under the symbol "DPMD" on December 1, 1997. On November 9, 1998 the company's Common Stock ceased trading on the Nasdaq and began trading on the American Stock Exchange ("AMEX") under the symbol "DMI". The following table sets forth the high and low closing prices of the company's Common Stock as reported by the Nasdaq to November 8, 1998 and by the AMEX from November 9, 1998:
1998 HIGH LOW ---- ---- --- First Quarter ......... $ 14-1/4 $ 4 Second Quarter ........ $ 12-1/4 $9-11/16 Third Quarter ......... $ 11-3/4 $ 8-1/8 Fourth Quarter ........ $ 12-1/2 $ 6-3/4 1999 ---- First Quarter ......... $ 12-1/4 $ 7-3/4 Second Quarter ........ $ 14-3/8 $2-13/16 Third Quarter ......... $3-15/16 $1-15/16 Fourth Quarter ........ $ 7-3/8 $ 2-1/2
The Warrants commenced trading under the symbol "DPMDW" on the Nasdaq SmallCap on December 1, 1997. On November 9, 1998 the Warrants ceased trading on the Nasdaq and began trading on the AMEX under the symbol "DMI/WS". The following table sets forth the high and low closing prices of the Warrants, as reported by the Nasdaq to November 8, 1998 and by the AMEX from November 9, 1998:
1998 HIGH LOW ---- ---- --- First Quarter ......... $ 7-1/2 $ 1-1/2 Second Quarter ........ $5-15/16 $ 4-1/2 Third Quarter ......... $ 5-3/4 $ 3 Fourth Quarter ........ $ 4 $ 2-1/8 1999 ---- First Quarter ......... $ 7 $ 3-1/4 Second Quarter ........ $ 8-7/8 $ 3/4 Third Quarter ......... $ 2-1/4 $ 5/8 Fourth Quarter ........ $ 2-5/8 $ 5/8
As of March 6, 2000, the numbers of holders of record of the Common Stock and the Warrants were 33 and 9, respectively, and there were approximately 650 beneficial shareholders. The company has never paid a cash dividend on its Common Stock and does not anticipate paying any cash dividends for the foreseeable future. RECENT SALES OF UNREGISTERED SECURITIES In February 1998, the company sold 1,000,000 shares of its Common Stock to accredited investors for $8.00 per share in a private placement exempt from registration under Rule 506 of the regulations promulgated under the Securities Act of 1933, as amended. Net of commissions paid to the placement agent and other expenses related to the private placement, the company received proceeds of approximately $7,500,000 from the private placement. The company filed a Registration Statement on Form S-3 in November 1998 covering resale of the shares sold in the private placement. 11 ITEM 6. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS FORWARD-LOOKING INFORMATION Statements made in this "Management's Discussion and Analysis of Financial Condition and Results of Operations" and elsewhere in this Annual Report on Form 10-KSB that are not statements of historical fact are forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended (the "Securities Act"), and Section 21E of the Securities Exchange Act of 1934, as amended (the "Exchange Act"). A number of risks and uncertainties, including those discussed under the caption "FACTORS THAT MAY AFFECT FUTURE RESULTS" below and elsewhere in this Annual Report on Form 10-KSB could affect such forward-looking statements and could cause actual results to differ materially from the statements made. The company expressly disclaims any obligation or undertaking to release publicly any updates or revisions to any forward-looking statements contained herein to reflect any changes in the company's expectations with regard thereto or any change in events, conditions or circumstances on which any such statements are based. OVERVIEW GENERAL We are a development stage company engaged in the development of new and proprietary oral drug delivery technologies. We have developed two types of oral drug delivery systems, the Gastric Retention System (the "GR System") and the Reduced Irritation System (the "RI System" and together, the "DepoMed Systems"). The GR System is designed to be retained in the stomach for an extended period of time while it delivers the incorporated drug or drugs, and the RI System is designed to reduce the gastrointestinal irritation that is a side effect of many orally administered drugs. In addition, the DepoMed Systems are designed to provide continuous, controlled delivery of an incorporated drug. In this "Management's Discussion and Analysis of Financial Condition and Results of Operations", the "company," "DepoMed," "we," "us," and "our," refer to DepoMed, Inc. Since the company's inception in August 1995, we have devoted substantially all our efforts to research and development conducted on our own behalf and through collaborations with pharmaceutical partners in connection with the DepoMed Systems. Our primary activities since inception (August 7, 1995) have been, in addition to research and development, establishing our offices and research facilities, recruiting personnel, filing patent applications, developing a business strategy and raising capital. We have also been involved in revenue generating research and development projects for clients including R.W. Johnson Pharmaceutical Research Institute ("PRI"). To date, we have received only limited revenue, all of which has been from these collaborative research and feasibility arrangements. DepoMed has generated a cumulative net loss of approximately $22,298,000 for the period from inception through December 31, 1999. $12,015,000 of this loss is attributable to our share of the loss in a joint venture as described below. We intend to continue investing in the further development of our drug delivery technologies and the DepoMed Systems. We also intend to internally develop and find partners to commercialize products based on generic and over-the-counter compounds, such as a reduced irritation aspirin product and an enhanced absorption calcium supplement product. Depending upon a variety of factors, including collaborative arrangements, available personnel and financial resources, we will conduct or fund clinical trials on such products and will undertake the associated regulatory activities. We will need to make additional capital investments in laboratories and related facilities. As additional personnel are hired in 2000 and beyond, expenses can be expected to increase from their 1999 levels. 12 On November 30, 1999, we signed a legally binding letter agreement with Elan Corporation, plc, Elan Pharma International, Ltd. and Elan International Services, Ltd. (together "Elan") to form a joint venture to develop products using drug delivery technologies and expertise of both companies. This joint venture, DepoMed Development, Ltd. ("DDL"), a Bermuda limited liability company, is initially owned 80.1% by DepoMed and 19.9% by Elan. DDL will subcontract research and development efforts to DepoMed, Elan and others. Under the terms of the agreement, DDL paid $15,000,000 to Elan for a license giving DDL non-exclusive rights to use certain Elan drug delivery technologies. DepoMed will also license certain drug delivery technologies to DDL on a non-exclusive basis. As a legally binding agreement, the transaction was recorded in the fourth quarter of 1999. All final documents, cash payments and stock issuances were completed on January 21, 2000. The agreement also provided for the following transactions: - Elan purchased 717,286 shares of DepoMed's common stock at $7.00 per share. The shares purchased are unregistered and have registration rights. The proceeds may be used by DepoMed without restriction. - Elan purchased 12,015 shares of DepoMed Series A convertible exchangeable preferred stock (the "Series A Preferred Stock") at $1,000 per share. The Series A Preferred Stock accrues a dividend of 7% per annum, compounded semi-annually and payable in shares of our Series A Preferred Stock. The Series A Preferred Stock is convertible at anytime after two years, at Elan's option, into the Company's common stock at a price of $12.00 per share. Additionally, Elan has an option to exchange 12,015 shares of Series A Preferred Stock for a 30.1% interest in DDL, increasing Elan's ownership in DDL to 50%. This exchange option is exercisable after two years from original issue date and within six years of such date. The exchange right will terminate if the Series A Preferred Stock is converted into the DepoMed's common stock unless this conversion occurs as a result of a liquidation or certain transactions involving a change of control of DepoMed. DepoMed used the proceeds of the Series A Preferred Stock sale to purchase 6,000 shares of DDL common stock and 3,612 shares of DDL preferred stock to fund our share of DDL's initial capitalization. - Elan purchased 2,388 shares of DDL preferred shares for $2,985,000, a 19.9% interest in DDL. - DepoMed will fund 80.1% of the joint venture research and development costs over the next two years. If Elan elects to exercise its exchange option on the Series A Preferred Stock, it will also repay DepoMed 30.1% of joint venture funding paid by DepoMed. Upon repayment by Elan, both DepoMed and Elan will have shared evenly in funding the joint venture. - Elan has made a loan facility available to DepoMed for up to $8,010,000. The purpose of this facility is to support DepoMed's share of the joint venture's research and development costs pursuant to a convertible promissory note issued by DepoMed to Elan. The note has a six-year term and bears interest of 9% per annum, compounded semi-annually, on any amounts borrowed under the facility. Elan may convert all or any portion of the outstanding principal amount and accrued and unpaid interest into DepoMed's common stock at a conversion price of $10.00. As of March 30, 2000, there was no amount outstanding related to the note. While we own 80.1% of the outstanding common stock of DDL, Elan and its subsidiaries have retained significant minority investor rights that are considered "participating rights" as defined in the Emerging Issues Task Force Consensus No. 96-16. Accordingly, we will not consolidate the financial statements of DDL, but will instead account for our investment in DDL under the equity method of accounting. DepoMed Development, Ltd., for the quarter ended December 31, 1999, recognized a net loss of $15,000,000 reflecting a charge to research and development expense for a license fee paid to Elan for non-exclusive access to certain Elan drug delivery technologies. We recorded 80.1% of the loss as our share in the loss of the joint venture for the quarter ended December 31, 1999. We had a zero basis in the DDL investment at December 31, 1999. Final closing agreements were signed among DepoMed, Elan and DDL on January 21, 2000. 13 RESULTS OF OPERATIONS YEARS ENDED DECEMBER 31, 1999 AND 1998 Revenues for the years ended December 31, 1999 and 1998 were approximately $115,000 and $763,000, respectively. In 1999, these revenues consisted entirely of amounts earned under the feasibility arrangement with PRI. In 1998, these revenues consisted of amounts earned under the feasibility and the research and development arrangements with PRI and Bristol-Myers Squibb Company ("BMS"), respectively. Research and development payments from PRI declined as a result of our having completed the first phase of formulation development in March 1999, the product is currently under review at PRI. Revenues from BMS ended in March 1998 as a result of our having completed our research activities for BMS. In April 1999, we were notified by BMS that BMS would not exercise its license and development option to use the DepoMed Gastric Retention System for an undisclosed pharmaceutical product. Research and development expense for the year ended December 31, 1999 was approximately $3,734,000 compared to approximately $2,062,000 during the year ended December 31, 1998. The increase was primarily due to expenses for clinical trials with DepoMed proprietary products which began in the third quarter as well as the hiring of additional employees and related expenses, increased laboratory supplies, and increased depreciation and amortization expense of equipment and facilities improvements. General and administrative expense for the year ended December 31, 1999 was approximately $1,872,000 compared to approximately $1,966,000 during the year ended December 31, 1998. Increased salaries and the additional expense incurred as a result of expanded investor relations activities were offset by decreased legal and accounting fees realized as we reduced our reliance on outside professionals for some reporting services. The cost of obtaining directors and officers insurance also decreased from 1998 levels. In October 1999, our sublessor notified us that our facility would not be available for lease after March 31, 2000, the end of our sublease term. In February 2000, we signed a five-year lease for a new facility located at 1360 O'Brien Drive in Menlo Park, California. As a result, building and occupancy expense will increase approximately $90,000 per quarter and there will be expenses for relocation to the new facility in the first quarter of 2000. In the fourth quarter of 1999, we recognized 80.1%, or $12,015,000, of the loss in our joint venture with Elan. Our joint venture, DDL, paid $15,000,000 as a one-time license fee for non-exclusive access to certain Elan drug delivery technologies. DDL will subcontract research and development activities to DepoMed, Elan and others. Over the next two years, we expect our share of DDL's losses will be approximately $8,000,000. Elan has made available to us a convertible loan facility assisting us to fund our portion of the joint venture research and development costs. Net interest income was approximately $297,000 for the year ended December 31, 1999 compared to approximately $486,000 during the year ended December 31, 1998. The decrease was due to declining cash and investment balances. Net interest income also includes immaterial gains realized on the sale of some of our marketable securities. LIQUIDITY AND CAPITAL RESOURCES Cash used in operations in the year ended December 31, 1999 was approximately $3,945,000 compared to approximately $2,522,000 for the year ended December 31, 1998. During the year ended December 31, 1999, the change in cash used was due primarily to the net loss offset by our share in the loss of a joint venture. In 1998, the change in cash used in operations was due primarily to the increase in net loss. Cash provided by investing activities in the year ended December 31, 1999 totaled approximately $885,000 and consisted of a net decrease of approximately $1,023,000 of marketable securities offset by purchases of laboratory equipment, fixtures and office equipment. Cash used in investing activities in the year ended December 31, 1998 totaled approximately $5,478,000 and consisted of purchases of marketable securities totaling $4,624,000 as well as laboratory equipment, fixtures and office equipment. We expect that future capital expenditures may 14 include additional product development and quality control laboratory equipment as we work towards implementation of current Good Manufacturing Practices ("cGMP") in our laboratories. We also expect to spend approximately $350,000 over the next three quarters of 2000 for leasehold improvements at our new facility in Menlo Park, California. Cash used in financing activities in the year ended December 31, 1999 was approximately $65,000 and consisted of payments on an equipment financing credit facility established in 1998 and capital lease obligations totaling approximately $175,000 offset against $106,000 in proceeds from the equipment financing credit facility. (See Note 5 of Notes to Financial Statements). Cash provided by financing activities in the year ended December 31, 1998 was approximately $7,929,000, which primarily consisted of the proceeds received in February 1998 from a private placement of 1,000,000 shares of common stock at a price of $8.00 per share, with net proceeds of approximately $7,500,000. Also in 1998, we financed $494,000 of equipment under the credit facility. As of December 31, 1999, we had approximately $4,466,000 in cash, cash equivalents and marketable securities, working capital of $8,845,000 and accumulated losses of $22,298,000. In January 2000, we completed a private placement with proceeds of approximately $5,000,000. (See Note 9 of Notes to Financial Statements.) We expect to continue to incur operating losses over the next several years. We anticipate that our existing capital resources will permit us to meet our capital and operational requirements through the next twelve to fifteen months. However, we base this expectation on our current operating plan that may change as a result of many factors. Accordingly, we could require additional funding sooner than anticipated. Our cash needs may also vary materially from our current expectations because of numerous factors, including: - results of research and development; - relationships with collaborative partners; - changes in the focus and direction of our research and development programs; - technological advances; and - results of clinical testing, requirements of the FDA and comparable foreign regulatory agencies. We will need substantial funds of our own or from third parties to: - conduct research and development programs; - conduct preclinical and clinical testing; and - manufacture (or have manufactured) and market (or have marketed) potential products using the DepoMed Systems. Our existing capital resources may not be sufficient to fund our operations until such time as we may be able to generate sufficient revenues to support our operations. We have limited credit facilities and no other committed source of capital. To the extent that our capital resources are insufficient to meet our future capital requirements, we will have to raise additional funds to continue our development programs. We may not be able to raise such additional capital on favorable terms, or at all. If the company raises additional capital by selling its equity or convertible debt securities, the issuance of such securities could result in dilution of our shareholders' equity positions. If adequate funds are not available the company may have to: - curtail operations significantly; or - obtain funds through entering into collaboration agreements on unattractive terms. The inability to raise capital would have a material adverse effect on the company. 15 YEAR 2000 Year 2000 ("Y2K") exposure was the result of some computer programs using two instead of four digits to represent the year. Computer programs may have erroneously interpreted dates beyond the year 1999 causing system failures or other computer errors, possibly leading to disruptions in operations. In response to this potentiality, we developed and implemented a program to eliminate Y2K exposures. Computer systems and applications were reviewed for Y2K compliance, remedied as necessary and tested. Third-party relationships were reviewed and monitored for Y2K compliance. We developed a contingency plan to stockpile materials from any vendors that did not meet Y2K compliance by year-end; however, we were sufficiently confident in our preparation, and in our vendors', that we did not implement our contingency plan. We have not experienced any system failures, errors or disruptions in our operations due to Y2K and we do not expect any in the future. As of December 31, 1999 we paid approximately $15,000 related to Y2K compliance. The funds for compliance were part of our cash flow from operations and capital expenditures. NET OPERATING LOSSES We have not generated any taxable income to date. At December 31, 1999, the net operating losses available to offset future taxable income for federal income tax purposes were approximately $9,300,000. Because we have experienced ownership changes, future utilization of carryforwards may be limited in any fiscal year pursuant to Internal Revenue Code regulations. The carryforwards expire at various dates beginning in 2010 through 2018 if not utilized. As a result of the annual limitation, anticipated and future losses, all or a portion of these carryforwards may expire before becoming available to reduce our federal income tax liabilities. FACTORS THAT MAY AFFECT FUTURE RESULTS EARLY STAGE OF DEVELOPMENT; LIMITED REVENUES We are at an early stage of development. Accordingly, our business is subject to all of the business risks associated with a new enterprise, including: - uncertainties regarding product development; - dependence on collaborative partnering relationships; - lack of revenue and uncertainty regarding future revenues; - limited financial and personnel resources; and - lack of established credit facilities. As we expand our research and development efforts, we anticipate that we will continue to incur substantial operating losses for at least the next several years. Therefore, we expect our cumulative losses to increase. To date, we have had no revenues from product sales and only minimal revenues from our collaborative research and development arrangements and feasibility studies. Our success will depend on commercial sales of products that generate significant revenues for us. We cannot predict whether we will be able to achieve commercial sales of any revenue-generating products. NO ASSURANCE OF SUCCESSFUL PRODUCT DEVELOPMENT Our research and development programs are at an early stage. In order for us to incorporate a pharmaceutical product into a DepoMed System, we would need to complete substantial additional research and development on a drug provided by a collaborative partner. Even if we are successful, the collaborative partner's drug incorporated in the DepoMed System: - may not be offered for commercial sale; or - may prove to have undesirable or unintended side effects that prevent or limit its commercial use. 16 Before we or others make commercial sales of products using the DepoMed Systems, we or our collaborative partners would need to: - conduct clinical tests showing that these products are safe and effective; and - obtain regulatory approval. This process involves substantial financial investment. Successful commercial sales of any of these products require: - market acceptance; - cost-effective commercial scale production; and - reimbursement under private or governmental health plans. We will have to curtail, redirect or eliminate our product development programs if we or our collaborative partners find that: - the DepoMed Systems prove to have unintended or undesirable side effects; or - products which appear promising in preclinical studies do not demonstrate efficacy in larger scale clinical trials. These events could have a material adverse effect on the company. DEPENDENCE ON AND NEED FOR COLLABORATIVE PARTNERS We have generated all of our revenues through collaborative arrangements with pharmaceutical and biotechnology companies. Our strategy to continue the research, development, clinical testing, manufacturing and commercial sale of products using the DepoMed Systems requires that we enter into additional collaborative arrangements. The success of any such collaborative arrangements requires that our collaborative partners: - perform their obligations as expected; and - devote sufficient resources to the development, clinical testing and marketing of products developed under collaborations. Even when such arrangements are entered into, our collaborative partners may not continue to: - fund their particular projects; - perform their agreed-to obligations; or - choose to develop and make commercial sales of products using the DepoMed Systems. For example, in April 1999, BMS informed the company of its decision not to exercise its option under a 1996 agreement to license the DepoMed Gastric Retention System for a product. Additionally, we are not currently conducting research and development under the PRI feasibility agreement while we await a PRI decision on whether or not to proceed. There can be no assurance that PRI will support further development of its program based on our technology. Further, we may not be able to enter into future collaborative arrangements on acceptable terms. The following events could have a material adverse effect on the company: - any parallel development by a collaborative partner of competitive technologies or products; - arrangements with collaborative partners that limit or preclude the company from developing products or technologies; - premature termination of an agreement; or - failure by a collaborative partner to devote sufficient resources to the development; and commercial sales of products using the DepoMed Systems. 17 Collaborative agreements are generally complex and may contain provisions which give rise to disputes regarding the relative rights and obligations of the parties. Any such dispute could delay collaborative research, development or commercialization of potential products, or could lead to lengthy, expensive litigation or arbitration. FLUCTUATIONS IN OPERATING RESULTS The following factors will affect our quarterly operating results and may result in a material adverse effect on the company: - variations in revenues obtained from collaborative agreements, including milestone payments, royalties, license fees and other contract revenues; - success or failure of the company in entering into further collaborative relationships; - decisions by collaborative partners to proceed or not to proceed with subsequent phases of the relationship or program; - the timing of any future product introductions by us or our collaborative partners; - market acceptance of the DepoMed Systems; - regulatory actions; - adoption of new technologies; - the introduction of new products by our competitors; - manufacturing costs and capabilities; - changes in government funding; and - third-party reimbursement policies. RELATIONSHIPS OF ADVISORS WITH OTHER ENTITIES Two groups (the Policy Advisory Board and Development Advisory Board) advise the company on business and scientific issues and future opportunities. Certain members of our Policy Advisory Board and Development Advisory Board work full-time for academic or research institutions. Others act as consultants to other companies. In addition, except for work performed specifically for and at the direction of the company, any inventions or processes discovered by such persons will be their own intellectual property or that of their institutions or other companies. Further, invention assignment agreements signed by such persons in connection with their relationships with the company may be subject to the rights of their primary employers or other third parties with whom they have consulting relationships. If we desire access to inventions which are not our property, we will have to obtain licenses to such inventions from these institutions or companies. We may not be able to obtain these licenses on commercially reasonable terms. HEALTHCARE REFORM; UNCERTAIN AVAILABILITY OF HEALTHCARE REIMBURSEMENT The healthcare industry is changing rapidly as the public, government, medical professionals, third-party payors and the pharmaceutical industry examine ways to contain or reduce the cost of health care. Changes in the healthcare industry could impact our business, particularly to the extent that the company develops the DepoMed Systems for use in prescription drug applications. Certain foreign governments regulate pricing or profitability of prescription pharmaceuticals sold in their countries. There have been a number of federal and state proposals to implement similar government control in the United States, particularly with respect to Medicare payments. We expect that these proposals will continue to be advanced. In addition, downward pressure on pharmaceutical pricing in the United States has increased due to an enhanced emphasis on managed care. We expect this pressure to continue to increase. We cannot predict whether any such legislative or regulatory proposals will be adopted or the effect such proposals or managed care efforts may have on its business. However, the announcement of such proposals or efforts could have a material adverse effect on the company's ability to raise capital. Further, the adoption of such proposals or efforts would have a material adverse effect on the company and any prospective collaborative partners. 18 Sales of products using the DepoMed Systems in domestic and foreign markets will depend in part on the availability of reimbursement from third-party payors, such as government health administration authorities and private health insurers. Third-party payors are increasingly challenging the price and cost-effectiveness of prescription pharmaceutical products. Significant uncertainty exists as to the reimbursement status of newly approved healthcare products. Accordingly, products using the DepoMed Systems may not be eligible for third-party reimbursement at price levels sufficient for us or our collaborative partners to realize appropriate returns on our investments in the DepoMed Systems. ITEM 7. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA The financial statements and supplementary data required by Item 7 are set forth below on pages F-1 through F-19. ITEM 8. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE Not applicable. 19 PART III ITEM 9. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT The information required by this Item with respect to executive officers is set forth in Part I of this report and the information with respect to directors is incorporated by reference to the information set forth under the caption "Election of Directors" in the proxy statement (the "Proxy Statement") for the 2000 Annual Meeting of Shareholders. The section entitled "Compliance Under Section 16(a) of the Securities Exchange Act of 1934" appearing in the Proxy Statement sets forth the information concerning compliance by officers, directors and 10% shareholders of the company with Section 16 of the Exchange Act and is incorporated herein by reference. ITEM 10. EXECUTIVE COMPENSATION The information required by this Item is incorporated herein by reference to the information set forth under the caption "Executive Compensation" in the Proxy Statement. ITEM 11. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT The information required by this Item is incorporated herein by reference to the information set forth under the caption "Security Ownership of Certain Beneficial Owners and Management" in the Proxy Statement. ITEM 12. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS The information required by this Item is incorporated herein by reference to the information set forth under the caption "Certain Relationships and Related Transactions" in the Proxy Statement. ITEM 13. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K (a)1. FINANCIAL STATEMENTS Included in Part II of this report. (a)2. FINANCIAL STATEMENT SCHEDULES All schedules have been omitted because the required information is not present or because the information required is included in the financial statements, including the notes thereto. 20 (a)3. EXHIBITS: *3.1 Third Amended and Restated Articles of Incorporation *3.2 Form of Amended and Restated Articles of Incorporation *3.3 Bylaws *3.4 Certificate of Amendment to the Third Amended and Restated Articles of Incorporation *4.1 Specimen Common Stock Certificate *4.2 Specimen Warrant Certificate (filed as Exhibit A to the Form of Warrant Agreement) *4.3 Form of Representative's Warrant Agreement including form of Representative's Warrant *4.4 Form of Warrant Agreement **10.1 1995 Stock Option Plan, as amended *10.9 Agreement re: Settlement of Lawsuit, Conveyance of Assets and Assumption of Liabilities dated August 28, 1995 by and among DepoMed Systems, Inc., Dr. John W. Shell and M6 Pharmaceuticals, Inc. *10.10 Form of Indemnification Agreement between the company and its directors and executive officers *10.12 Form of Agreement between the company and Burrill & Company ***+10.13 Joint Research Agreement dated February 20, 1998 between the company and R.W. Johnson Pharmaceutical Research Institute ****10.14 Sublease dated February 18, 1998 between the company and Cell Genesys, Inc. *****10.15 Securities Purchase Agreement dated January 21, 2000 between the company and Elan International Services, Ltd. *****10.16 Company Registration Rights Agreement dated January 21, 2000 between the company and Elan International Services, Ltd. *****10.17 Newco Registration Rights Agreement dated January 21, 2000 among the company, Newco and Elan International Services, Ltd. *****10.18 Funding Agreement dated January 21, 2000 among the company, Elan Corporation, plc, Elan Pharma International, Ltd. and Elan International Services, Ltd. *****10.19 Subscription, Joint Development Operating Agreement dated January 21, 2000 among the company, Newco, Elan Corporation, plc, Elan Pharma International, Ltd. and Elan International Services, Ltd. *****10.20 Convertible Promissory Note dated January 21, 2000 issued by the company to Elan International Services, Ltd. *****10.21 Company License Agreement dated January 21, 2000 among the company, Newco and Elan Corporation, plc. *****10.22 Elan License Agreement dated January 21, 2000 among the company, Newco, Elan Corporation, plc and Elan Pharma International, Ltd. *****10.23 Certificate of Determination of Rights and Preferences of Series A Preferred Stock filed with the State of California on January 14, 2000 23.1 Consent of Ernst & Young LLP, Independent Auditors 24.1 Power of Attorney (see page 22) 27.1 Financial Data Schedule
- ------------- * Incorporated by reference to the company's registration statement on Form SB-2 (File No. 333-25445) ** Incorporated by reference to Exhibit 99.1 of the company's registration statement on Form S-8 (File No. 333-66923) *** Incorporated by reference to Exhibit 10.1 of the company's quarterly report on Form 10-QSB filed on May 17, 1998 **** Incorporated by reference to Exhibit 10.2 of the company's quarterly report on Form 10-QSB filed on May 17, 1998 ***** Incorporated by reference to the company's Form 8-K filed on February 18, 2000 + Confidential treatment granted. (b) REPORTS ON FORM 8-K: None 21 SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the issuer, a corporation organized and existing under the laws of the State of California, has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized, in the City of Foster City, State of California, on the 30th day of March, 2000. DEPOMED, INC. By /S/ John W. Fara, Ph.D. --------------------------------------- JOHN W. FARA, PH.D. PRESIDENT AND CHIEF EXECUTIVE OFFICER POWERS OF ATTORNEY KNOW ALL PERSONS BY THESE PRESENTS, each person whose signature appears below constitutes and appoints John W. Fara, John W. Shell and John F. Hamilton his true and lawful attorneys-in-fact and agents, each acting alone, with full power of substitution and resubstitution, for him and in his name, place and stead, in any and all capacities, to sign any or all amendments to the Annual Report on Form 10-KSB, and to file the same, with all exhibits thereto, and all documents in connection therewith, with the Securities and Exchange Commission, granting unto said attorneys-in-fact and agents, full power and authority to do and perform each and every act and thing requisite and necessary to be done in and about the premises, as fully to all intents and purposes as he might or could do in person, hereby ratifying and confirming all that said attorneys-in-fact and agents, each acting alone, or his substitute or substitutes, may lawfully do or cause to be done by virtue hereof. PURSUANT TO THE REQUIREMENTS OF THE SECURITIES EXCHANGE ACT OF 1934, THIS ANNUAL REPORT ON FORM 10-KSB HAS BEEN SIGNED BY THE FOLLOWING PERSONS IN THE CAPACITIES AND ON THE DATES INDICATED.
SIGNATURE --------- /s/ John W. Shell, Ph.D. Chairman of the March 30, 2000 - ----------------------------------------- Board of Directors JOHN W. SHELL, PH.D. and Chief Scientific Officer /s/ John W. Fara, Ph.D. President, Chief March 30, 2000 - ----------------------------------------- Executive Officer JOHN W. FARA, PH.D. and Director (Principal Executive Officer) /s/ John N. Shell Vice President, March 30, 2000 - ----------------------------------------- Operations and Director JOHN N. SHELL /s/ John F. Hamilton Vice President, March 30, 2000 - ----------------------------------------- Finance and Chief JOHN F. HAMILTON Financial Officer (Principal Financial Officer) /s/ G. Steven Burrill Director March 30, 2000 - ----------------------------------------- G. STEVEN BURRILL /s/ W. Leigh Thompson, Ph.D. Director March 30, 2000 - ----------------------------------------- W. LEIGH THOMPSON, PH.D.
22 DEPOMED, INC. (A DEVELOPMENT STAGE COMPANY) INDEX TO FINANCIAL STATEMENTS
FINANCIAL STATEMENTS Report of Ernst & Young LLP, Independent Auditors ................................................................. F-2 Balance Sheet ..................................................................................................... F-3 Statements of Operations .......................................................................................... F-4 Statement of Shareholders' Equity ................................................................................. F-5 Statements of Cash Flows .......................................................................................... F-7 Notes to Financial Statements ..................................................................................... F-8
REPORT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS The Board of Directors and Shareholders DepoMed, Inc. We have audited the accompanying balance sheet of DepoMed, Inc. (a development stage company) as of December 31, 1999, and the related statements of operations, shareholders' equity, and cash flows for the years ended December 31, 1999 and 1998 and for the period from inception (August 7, 1995) to December 31, 1999. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with auditing standards generally accepted in the United States. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of DepoMed, Inc. (a development stage company) at December 31, 1999, and the results of its operations and its cash flows for the years ended December 31, 1999 and 1998 and for the period from inception (August 7, 1995) to December 31, 1999, in conformity with accounting principles generally accepted in the United States. /s/ ERNST & YOUNG LLP Palo Alto, California February 25, 2000 F-2 DEPOMED, INC. (A DEVELOPMENT STAGE COMPANY) BALANCE SHEET DECEMBER 31, 1999 ASSETS Current assets: Cash and cash equivalents .................................... $ 934,317 Marketable securities ........................................ 3,532,065 Receivable for capital stock ................................. 17,015,000 Prepaid and other current assets ............................. 169,385 ------------ Total current assets ................................. 21,650,767 Property and equipment, net ........................................ 779,631 Other assets ....................................................... 4,467 ------------ $ 22,434,865 ------------ ------------ LIABILITIES AND SHAREHOLDERS' EQUITY Current liabilities: Accounts payable ............................................. $ 219,675 Accrued compensation ......................................... 275,047 Other accrued liabilities .................................... 131,889 Payable to joint venture ..................................... 12,015,000 Capital lease obligation, current portion .................... 41,131 Long-term debt, current portion .............................. 123,042 ------------ Total current liabilities ............................ 12,805,784 Capital lease obligation, non-current portion ...................... 53,952 Long-term debt, non-current portion ................................ 356,649 Commitments Shareholders' equity: Preferred stock, no par value; 5,000,000 shares authorized; no shares issued and outstanding .............. - Common stock, no par value, 25,000,000 shares authorized; 6,475,077 shares issued and outstanding ....... 14,797,072 Capital stock issuable ....................................... 17,015,000 Deferred compensation ........................................ (282,184) Deficit accumulated during the development stage ............. (22,298,416) Accumulated other comprehensive loss ......................... (12,992) ------------ Total shareholders' equity ........................... 9,218,480 ------------ $ 22,434,865 ------------ ------------
See accompanying notes. F-3 DEPOMED, INC. (A DEVELOPMENT STAGE COMPANY) STATEMENTS OF OPERATIONS
PERIOD FROM YEAR ENDED DECEMBER 31, INCEPTION ---------------------------------- (AUGUST 7, 1995) TO 1999 1998 DECEMBER 31, 1999 ------------ ----------- ------------------- Product development revenue ................. $ 115,327 $ 763,138 $ 1,801,312 Operating expenses: Research and development .............. 3,734,196 2,061,983 7,178,615 General and administrative ............ 1,871,596 1,966,458 5,346,946 Purchase of in-process research and development ........... - - 298,154 ------------ ----------- ------------ Total operating expenses .................... 5,605,792 4,028,441 12,823,715 ------------ ----------- ------------ Loss from operations ........................ (5,490,465) (3,265,303) (11,022,403) Other income (expenses): Equity in loss of joint venture ....... (12,015,000) - (12,015,000) Interest income, net .................. 296,665 485,580 738,987 ------------ ----------- ------------ Total other income (expenses) ............... (11,718,335) 485,580 (11,276,013) ------------ ----------- ------------ Net loss .................................... $(17,208,800) $(2,779,723) $(22,298,416) ------------ ----------- ------------ ------------ ----------- ------------ Basic and diluted net loss per share ........ $ (2.66) $ (0.44) ------------ ----------- ------------ ----------- Shares used in computing basic and diluted net loss per share .......... 6,474,538 6,318,233 ------------ ----------- ------------ -----------
See accompanying notes. F-4 DEPOMED, INC. (A DEVELOPMENT STAGE COMPANY) STATEMENT OF SHAREHOLDERS' EQUITY PERIOD FROM INCEPTION (AUGUST 7, 1995) TO DECEMBER 31, 1999
Convertible Preferred Stock Common Stock Capital ----------------------------- ------------------------ Stock Shares Amount Shares Amount Issuable -------------- ------------- ---------- ------------ ----------- Balances at inception (August 7, 1995) ............ - $ - - $ - $ - Issuance of common stock to founders on August 7, 1995 in exchange for shares held by them in M6 ... - - 2,066,666 - - Pharmaceuticals, Inc. Issuance of common stock for cash to investors at approximately $0.0009 per share on November 15, 1995 ........... - - 1,196,491 1,000 - Issuance of Series A convertible preferred stock for cash to investors at approximately $0.31 per share on November 15, 1995 net of issuance costs of $67,241............. 2,447,368 682,759 - - - Comprehensive loss .............. - - - - - -------------- ------------- ---------- ------------ ----------- Balances at December 31, 1995 ........... 2,447,368 682,759 3,263,157 1,000 - Issuance of common stock for cash at various dates at $0.09 per share to employees and the Company's counsel pursuant to stock option agreements .................. - - 91,666 8,250 - Deferred compensation related to grants of certain stock options ....... - - - 275,000 - Comprehensive loss .............. - - - - - -------------- ------------- ---------- ------------ ----------- Balances at December 31, 1996 ........... 2,447,368 682,759 3,354,823 284,250 - Issuance of Series B convertible preferred stock to investors for cash at $1.00 per share ..... 278,500 278,500 - - - Conversion of preferred stock to common stock on November 5, 1997 at a ratio of one share of common for three shares of preferred ......... (2,725,868) (961,259) 908,615 961,259 - Issuance of common stock and warrants for $6.10 per unit on November 5, 1997 in connection with the initial public offering, net of issuance costs of $1,963,889 ......... - - 1,200,000 5,356,111 -
Deficit Total Accumulated Accumulated Shareholders' During Other Equity (Net Deferred Development Comprehensive Capital Compensation Stage Income (Loss) Deficiency) ------------- ------------- --------------- -------------- Balances at inception (August 7, 1995) ............ $ - $ - $ - $ - Issuance of common stock to founders on August 7, 1995 in exchange for shares held by them in M6 ... - - - - Pharmaceuticals, Inc. Issuance of common stock for cash to investors at approximately $0.0009 per share on November 15, 1995 ........... - - - 1,000 Issuance of Series A convertible preferred stock for cash to investors at approximately $0.31 per share on November 15, 1995 net of issuance costs of $67,241............. - - - 682,759 Comprehensive loss .............. - (600,668) - (600,668) ------------- ------------- --------------- -------------- Balances at December 31, 1995 ........... - (600,668) - 83,091 Issuance of common stock for cash at various dates at $0.09 per share to employees and the Company's counsel pursuant to stock option agreements .................. - - - 8,250 Deferred compensation related to grants of certain stock options ....... (275,000) - - - Comprehensive loss .............. - (472,773) - (472,773) ------------- ------------- --------------- -------------- Balances at December 31, 1996 ........... (275,000) (1,073,441) - (381,432) Issuance of Series B convertible preferred stock to investors for cash at $1.00 per share ..... - - - 278,500 Conversion of preferred stock to common stock on November 5, 1997 at a ratio of one share of common for three shares of preferred ......... - - - - Issuance of common stock and warrants for $6.10 per unit on November 5, 1997 in connection with the initial public offering, net of issuance costs of $1,963,889 ......... - - - 5,356,111
See accompanying notes. F-5 DEPOMED, INC. (A DEVELOPMENT STAGE COMPANY) STATEMENT OF SHAREHOLDERS' EQUITY PERIOD FROM INCEPTION (AUGUST 7, 1995) TO DECEMBER 31, 1999 (CONTINUED)
Convertible Preferred Stock Common Stock Capital Stock Shares Amount Shares Amount Issuable ------------- ---------------- --------------- --------------- ------------ Deferred compensation related to grants of certain stock options .............. - - - 242,050 - Amortization of deferred compensation .............. - - - - - Comprehensive loss ..................... - - - - - ------------- ---------------- --------------- --------------- ------------ Balances at December 31, 1997 .................. - - 5,463,438 6,843,670 - Issuance of common stock to investors for $8.00 per share on February 23, 1998, net of issuance costs of $507,846 ........................ - - 1,000,000 7,492,154 - Deferred compensation related to grants of certain stock options .............. - - - 430,200 - Amortization of deferred compensation .............. - - - - - Issuance of common stock options to a consultant for services with an exercise price of $11.25 per share on June 18, 1998 ................... - - - 26,050 - Comprehensive loss: Net loss ........................... - - - - - Unrealized gains on available-for-sale securities .... - - - - - Comprehensive loss ..................... ------------- ---------------- --------------- --------------- ------------ Balances at December 31, 1998 .................. - - 6,463,438 14,792,074 - Issuance of common shares for cash on February 16, 1999 for $3.00 per share to a consultant pursuantto a stock option agreement ............. - - 1,666 4,998 - Net exercise of common stock warrants at $7.63 per share in January and April 1999 .......... - - 9,973 - - Common stock issuable to Elan Corporation for $7.00 per share with proceeds of $5,000,000 ......................... - - - - 5,000,000 Series A preferred stock issuable to Elan Corporation for $1,000 per share with proceeds of $12,015,000 ............ - - - - 12,015,000 Amortization of deferred compensation ....................... - - - - - Comprehensive loss: Net loss ........................... - - - - - Unrealized losses on ............... - - - - - available-for-sale securities Comprehensive loss ..................... ------------- ---------------- --------------- --------------- ------------ Balances at December 31, 1999 .................. - $ - 6,475,077 $ 14,797,072 $ 17,015,000 ------------- ---------------- --------------- --------------- ------------ ------------- ---------------- --------------- --------------- ------------
Deficit Total Accumulated Accumulated Shareholders' During Other Equity (Net Deferred Development Comprehensive Capital Compensation Stage Income (Loss) Deficiency) ----------------- --------------- ---------------- -------------- Deferred compensation related to grants of certain stock options .............. (242,050) - - - Amortization of deferred compensation .............. 116,336 - - 116,336 Comprehensive loss ..................... - (1,236,452) - (1,236,452) Balances at December 31, 1997 .................. (400,714) (2,309,893) - 4,133,063 Issuance of common stock to investors for $8.00 per share on February 23, 1998, net of issuance costs of $507,846 ........................ - - - 7,492,154 Deferred compensation related to grants of certain stock options .............. (430,200) - - - Amortization of deferred compensation .............. 320,582 - - 320,582 Issuance of common stock options to a consultant for services with an exercise price of $11.25 per share on June 18, 1998 ................... - - - 26,050 Comprehensive loss: Net loss ........................... - (2,779,723) - (2,779,723) Unrealized gains on available-for-sale securities .... - - 13,887 13,887 -------------- Comprehensive loss ..................... (2,765,836) ----------------- --------------- ---------------- -------------- Balances at December 31, 1998 .................. (510,332) (5,089,616) 13,887 9,206,013 Issuance of common shares for cash on February 16, 1999 for $3.00 per share to a consultant pursuantto a stock option agreement ............. - - - 4,998 Net exercise of common stock warrants at $7.63 per share in January and April 1999 .......... - - - - Common stock issuable to Elan Corporation for $7.00 per share with proceeds of $5,000,000 ......................... - - - 5,000,000 Series A preferred stock issuable to Elan Corporation for $1,000 per share with proceeds of $12,015,000 ............ - - - 12,015,000 Amortization of deferred compensation ....................... 228,148 - - 228,148 Comprehensive loss: Net loss ........................... - (17,208,800) - (17,208,800) Unrealized losses on ............... - - (26,879) (26,879) -------------- available-for-sale securities Comprehensive loss ..................... (17,235,679) ----------------- --------------- ---------------- -------------- Balances at December 31, 1999 .................. $ (282,184) $(22,298,416) $ (12,992) $ 9,218,480 ================= =============== ================ ==============
See accompanying notes. F-6 DEPOMED, INC. (A DEVELOPMENT STAGE COMPANY) STATEMENTS OF CASH FLOWS
PERIOD FROM INCEPTION YEAR ENDED DECEMBER 31, (AUGUST 7, 1995) ----------------------------- TO 1999 1998 DECEMBER 31, 1999 ------------ ----------- ----------------- OPERATING ACTIVITIES Net loss ....................................................................... $(17,208,800) $(2,779,723) $(22,298,416) Adjustments to reconcile net loss to net cash used in operating activities: Equity in loss of joint venture ............................................ 12,015,000 - 12,015,000 Depreciation and amortization .............................................. 415,343 196,967 714,326 Accrued interest expense on shareholder notes .............................. - - 13,618 Amortization of deferred compensation ...................................... 228,148 320,582 665,066 Value of stock options issued for services ................................. - 26,050 26,050 Purchase of in-process research and development ............................ - - 298,154 Changes in assets and liabilities: Accounts receivable .................................................... 306,148 (161,261) - Other current assets ................................................... 17,639 (86,345) (169,385) Other assets ........................................................... 83,465 (77,675) (4,625) Accounts payable and other accrued liabilities ......................... 94,137 (21,829) 351,564 Accrued compensation ................................................... 104,052 135,448 207,571 Other current liabilities .............................................. - (74,086) - ------------ ----------- ------------ Net cash used in operating activities .......................... (3,944,868) (2,521,872) (8,181,077) ------------ ----------- ------------ INVESTING ACTIVITIES Expenditures for property and equipment ........................................ (138,232) (853,600) (1,129,841) Purchases of marketable securities ............................................. (2,264,082) (4,624,175) (6,967,839) Maturities of marketable securities ............................................ 3,287,380 - 3,366,962 ------------ ----------- ------------ Net cash provided by (used in) investing activities ............ 885,066 (5,477,775) (4,730,718) ------------ ----------- ------------ FINANCING ACTIVITIES Payments on capital lease obligations .......................................... (55,153) (57,469) (213,113) Proceeds from equipment loan ................................................... 105,734 494,133 599,867 Payments of equipment loan ..................................................... (120,176) - (120,176) Proceeds from issuance of notes ................................................ - - 1,050,000 Payments of notes .............................................................. - - (1,000,000) Payment of shareholder loans ................................................... - - (294,238) Proceeds on issuance of common stock ........................................... 4,998 7,492,154 13,823,772 ------------ ----------- ------------ Net cash (used in) provided by financing activities ............ (64,597) 7,928,818 13,846,112 ------------ ----------- ------------ Net increase (decrease) in cash and cash equivalents ........................... (3,124,399) (70,829) 934,317 Cash and cash equivalents at beginning of period ............................... 4,058,716 4,129,545 - ------------ ----------- ------------ Cash and cash equivalents at end of period ..................................... $ 934,317 $ 4,058,716 $ 934,317 ------------ ----------- ------------ ------------ ----------- ------------ SUPPLEMENTAL SCHEDULE OF NONCASH FINANCING AND INVESTING ACTIVITIES Payable to joint venture ....................................................... $ 12,015,000 $ - $ 12,015,000 ------------ ----------- ------------ ------------ ----------- ------------ Acquisition of property and equipment under capital leases ..................... $ - $ 144,313 $ 308,196 ------------ ----------- ------------ ------------ ----------- ------------ Assumption of net liabilities of M6 Pharmaceuticals at inception (August 7, 1995) ................................................. $ - $ - $ 298,154 ------------ ----------- ------------ ------------ ----------- ------------ SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION Cash paid during the period for interest ....................................... $ 75,616 $ 21,437 $ 218,864 ------------ ----------- ------------ ------------ ----------- ------------
See accompanying notes F-7 DEPOMED, INC. (A DEVELOPMENT STAGE COMPANY) NOTES TO FINANCIAL STATEMENTS 1. ORGANIZATION AND BASIS OF PRESENTATION ORGANIZATION DepoMed, Inc. (the "Company"), a development stage company, was incorporated in the State of California on August 7, 1995. The Company is engaged in the research and development of oral drug delivery systems. The Company's primary activities since incorporation have been establishing its offices and research facilities, recruiting personnel, conducting research and development, performing business and strategic planning and raising capital. 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES CASH, CASH EQUIVALENTS AND MARKETABLE SECURITIES The Company considers all highly liquid investments with an original maturity (at date of purchase) of three months or less to be cash equivalents. Cash and cash equivalents consist of cash on deposit with banks, money market instruments and commercial paper. The Company places its cash, cash equivalents and marketable securities with high quality, U.S. financial institutions and, to date, has not experienced losses on any of its balances. The Company records cash and cash equivalents at amortized cost, which approximates the fair value. The remaining contractual period until maturity of marketable securities range from 1-24 months. All marketable securities are classified as available-for-sale. These securities are carried at market value with unrealized gains and losses included in accumulated other comprehensive income (loss) in shareholders' equity. Securities classified as available-for-sale as of December 31, 1999 are summarized below. Estimated fair value is based on quoted market prices for these investments.
GROSS AMORTIZED UNREALIZED ESTIMATED COST LOSSES FAIR VALUE ---------- -------- ---------- U.S. corporate securities: Total included in cash and cash equivalents.... $ 498,264 $ - $ 498,264 Total included in short-term investments....... 3,545,057 (12,992) 3,532,065 ---------- -------- ---------- Total available-for-sale.......................... $4,043,321 $(12,992) $4,030,329 ---------- -------- ---------- ---------- -------- ----------
DEPRECIATION AND AMORTIZATION Property and equipment are stated at cost, less accumulated depreciation and amortization. Depreciation is provided using the straight-line method over the estimated useful lives of the respective assets, generally three to five years. Leasehold improvements are amortized over the lesser of the lease term or the estimated useful lives of the related assets, generally two years. F-8 DEPOMED, INC. (A DEVELOPMENT STAGE COMPANY) NOTES TO FINANCIAL STATEMENTS (CONTINUED) 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) USE OF ESTIMATES The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Actual results could differ from those estimates. STOCK-BASED COMPENSATION The Company accounts for grants of stock options and common stock purchase rights to its employees according to the intrinsic value method and, thus, recognizes no stock-based compensation expense for options granted with exercise prices equal to or greater than fair value of the Company's common stock on the date of grant. The Company records deferred stock-based compensation when the deemed fair value of the Company's common stock for financial accounting purposes exceeds the exercise price of the stock options or purchase rights on the date of grant. Any such deferred stock-based compensation is amortized over the vesting period of the individual options. Pro forma net loss information using the fair value method accounting for grants of stock options to employees is included in Note 7. Options granted to non-employees are accounted for at fair value using the Black-Scholes option valuation model and may be subject to periodic re-valuation over their vesting terms. The resulting stock-based compensation expense is recorded over the service period in which the non-employee provides services to the Company. NET LOSS PER SHARE Net loss per share is computed using the weighted-average number of shares of common stock outstanding. Common stock equivalent shares from outstanding stock options and warrants are not included as their effect is antidilutive. Stock options to purchase 1,327,383 shares of common stock at a weighted-average purchase price of $4.29 and warrants to purchase 1,479,979 shares of common stock at a weighted-average purchase price of $7.54 were outstanding as of December 31, 1999. These shares were not included in the computation of diluted earnings per share as they would have had an antidilutive effect on net loss per share. REVENUE RECOGNITION Revenue related to collaborative research agreements with corporate partners is recognized as the expenses are incurred for each contract. The Company is required to perform research activities as specified in each respective agreement on a best efforts basis, and the Company is reimbursed based on the costs associated with supplies and the hours worked by employees on each specific contract. Nonrefundable milestone payments are recognized pursuant to collaborative agreements upon the achievement of specified milestones where no further obligation to perform exists under that provision of the arrangement. COMPREHENSIVE INCOME Comprehensive income (loss) is comprised of net loss and other comprehensive income (loss). Other comprehensive income (loss) includes certain changes in equity of the Company that are excluded from net loss. Specifically, SFAS 130 requires unrealized holding gains and losses on the Company's available-for-sale securities, which were reported separately in shareholders' equity, to be included in accumulated other comprehensive loss. Comprehensive loss for the years ended December 31, 1999 and 1998 has been reflected in the Statement of Shareholders' Equity. F-9 DEPOMED, INC. (A DEVELOPMENT STAGE COMPANY) NOTES TO FINANCIAL STATEMENTS (CONTINUED) 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) RECENT ACCOUNTING STANDARDS In June 1998, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 133, "Accounting for Derivative Instruments and Hedging Activities" ("SFAS 133"). SFAS 133 provides a comprehensive and consistent standard for the recognition and measurement of derivatives and hedging activities. In July 1999, the Financial Accounting Standards Board announced the delay of the effective date of SFAS 133 for one year, to the first quarter of 2001. To date, the Company has not engaged in derivative or hedging activities. In March 1998, the AICPA issued Statement of Position 98-1, "Accounting for the Costs of Computer Software Developed or Obtained for Internal Use" ("SOP 98-1"). SOP 98-1 requires that entities capitalize certain costs related to internal use software once certain criteria have been met. The Company adopted the provisions of SOP 98-1 on January 1, 1999. The Company has not incurred any costs related to internal use software as of December 31, 1999. 3. RESEARCH ARRANGEMENTS BRISTOL-MYERS SQUIBB COMPANY In July 1996, the Company and Bristol-Myers Squibb Company ("BMS") entered into a joint research agreement to develop a product incorporating a BMS proprietary compound into the DepoMed Gastric Retention System ("GR System"). Pursuant to the agreement, the Company achieved all the specified milestones and recorded approximately $198,000 in product development revenues in 1996, the entire fee specified in the agreement. Also in 1996 and continuing through 1998, the Company performed contract research services for BMS under an arrangement whereby BMS reimbursed specific research costs relating to the same product referred to above. Revenue recognized in accordance with this arrangement amounted to $80,280 in 1998. There were no revenues recorded under the arrangement in 1999. Pursuant to the agreement, BMS had an option to obtain an exclusive, worldwide license to products incorporating the BMS compound utilizing the GR System. In April 1999, the Company was notified by BMS that BMS would not exercise its license and development option to use the Company's GR System for the undisclosed pharmaceutical product. R. W. JOHNSON PHARMACEUTICAL RESEARCH INSTITUTE In March 1998, the Company entered into a research agreement with the R. W. Johnson Pharmaceutical Research Institute ("PRI"), a Johnson & Johnson unit, to study the feasibility of an orally administered, controlled release pharmaceutical product using the Company's GR System. The Company is paid for actual costs, as incurred, at the fees stipulated in the agreement. The agreement may be terminated by PRI at any time upon 30 days written notice to the Company. The Company recognized revenues of $115,327 and $682,858 during 1999 and 1998, respectively, in accordance with the agreement. There was no amount receivable at December 31, 1999 under this feasibility agreement. In the first quarter of 1999, the Company successfully completed the first phase of formulation development under the PRI feasibility agreement. The product is currently under review at PRI. F-10 DEPOMED, INC. (A DEVELOPMENT STAGE COMPANY) NOTES TO FINANCIAL STATEMENTS (CONTINUED) 3. RESEARCH ARRANGEMENTS (CONTINUED) ELAN CORPORATION, PLC On November 30, 1999, the Company signed a legally binding letter agreement (the "Agreement") with Elan Corporation, plc, Elan Pharma International, Ltd. and Elan International Services, Ltd. (together "Elan") to form a joint venture to develop products using drug delivery technologies and expertise of both companies. This joint venture, DepoMed Development, Ltd. ("DDL"), a Bermuda limited liability company, is initially owned 80.1% by the Company and 19.9% by Elan. DDL will subcontract research and development efforts to the Company, Elan and others. Under the terms of the Agreement, DDL was to pay $15,000,000 to Elan for a license providing DDL non-exclusive rights to use certain Elan drug delivery technologies. The Company also licensed certain drug delivery technologies to DDL on a non-exclusive basis. Since the agreement was a legally binding agreement as of the date of the execution of such agreement, the Company recorded the transaction in the fourth quarter of 1999, except for actual cash payments and stock issuances. Such amounts were recorded as receivables or payables, as appropriate. The Agreement also provides for the following transactions: - Elan will purchase 717,286 shares of the Company's common stock at $7.00 per share. The shares purchased will be unregistered and have registration rights. The proceeds may be used by the Company without restriction. - Elan will purchase 12,015 shares of DepoMed Series A convertible exchangeable preferred stock (the "Series A Preferred Stock") at $1,000 per share. The Series A Preferred Stock accrues a dividend of 7% per annum, compounded semi-annually and payable in shares of the Series A Preferred Stock. The Series A Preferred Stock is convertible at anytime after two years, at Elan's option, into the Company's common stock at a price of $12.00 per share. Additionally, Elan has the right to exchange 12,015 shares of Series A Preferred Stock for a 30.1% interest in DDL, increasing Elan's ownership in DDL to 50%. This exchange option is exercisable after two years from original issue date and within six years of such date. The exchange right will terminate if the Series A Preferred Stock is converted into the DepoMed's common stock unless this conversion occurs as a result of a liquidation or upon the occurrence of certain transactions involving a change of control of the Company. DepoMed will use the proceeds of the Series A Preferred Stock sale to purchase 6,000 shares of DDL common stock and 3,612 shares of DDL preferred stock, both classes of stock purchased at $1,250 per share, to fund the Company's share of DDL's initial capitalization. - Elan will purchase 2,388 shares of DDL preferred shares, a 19.9% interest in DDL. - DepoMed will fund 80.1% of the joint venture research and development costs over the next two years. If Elan elects to exercise its exchange option on the Series A Preferred Stock, it will also repay DepoMed 30.1% of joint venture funding paid by DepoMed. Upon repayment by Elan, both DepoMed and Elan will have shared evenly in funding the joint venture. - Elan will also make a loan facility available to DepoMed for up to $8,010,000. The purpose of this loan is to support DepoMed's share of the joint venture's research and development costs pursuant to a convertible promissory note issued by the Company to Elan. The note has a six-year term and will bear interest at 9% per annum, compounded semi-annually, on any amounts borrowed under the facility. The note and accrued interest will be convertible at Elan's option. Elan may convert all or any portion of the outstanding principal amount and accrued and unpaid interest into DepoMed's common stock at a conversion price of $10.00 per share. F-11 DEPOMED, INC. (A DEVELOPMENT STAGE COMPANY) NOTES TO FINANCIAL STATEMENTS (CONTINUED) 3. RESEARCH ARRANGEMENTS (CONTINUED) ELAN CORPORATION, PLC (CONTINUED) While the Company owns 80.1% of the outstanding common stock of DDL, Elan and its subsidiaries have retained significant minority investor rights that are considered "participating rights" as defined in the Emerging Issues Task Force Consensus No. 96-16. Accordingly, DepoMed will not consolidate the financial statements of DDL, but will instead account for its investment in DDL under the equity method of accounting. For the quarter ended December 31, 1999, DDL recognized a net loss of $15,000,000, reflecting a charge to research and development expense for a license fee paid to Elan for non-exclusive access to certain Elan drug delivery technologies. The Company recorded 80.1% of the loss as equity in loss of the joint venture for the quarter ended December 31, 1999. The Company had a zero basis in its DDL investment at December 31, 1999. Final closing agreements were signed among the Company, Elan and DDL on January 21, 2000. 4. PROPERTY AND EQUIPMENT At December 31, 1999, property and equipment consists of the following:
Furniture and office equipment ................... $ 264,486 Laboratory equipment ............................. 913,643 Leasehold improvements ........................... 219,464 ----------- 1,397,593 Less accumulated depreciation and amortization ... (617,962) ----------- $ 779,631 ----------- -----------
Property and equipment includes assets under capitalized leases of $186,240 at December 31, 1999. Accumulated amortization related to assets under capital leases totaled $74,246 at December 31, 1999. 5. COMMITMENTS AND CONTINGENCIES CONVERTIBLE PROMISSORY NOTE On November 30, 1999, the Company signed a binding letter agreement to issue a convertible promissory note to Elan Corporation, plc, for $8,010,000 to fund research and development of a joint venture, DDL. As of December 31, 1999 there was no amount outstanding related to the note. (See Note 3, Research Arrangements, Elan Corporation, plc) LONG-TERM DEBT The Company entered into a $600,000 equipment financing credit facility ("Credit Facility") with a third party in 1998. The Credit Facility allowed the Company to incur loans up to $600,000 through July 1999. At December 1998, the Company had utilized approximately $494,000 of the Credit Facility, at an annual percentage rate of 12.2%. Equal payments of principal and interest of approximately $12,000 are due monthly through November 2002 with a balloon payment of approximately $49,000 due December 2002. In June 1999, the Company financed additional equipment of approximately $106,000 under the agreement, at an annual percentage rate of 13.5%. Equal payments of approximately $2,500 are due monthly through May 2003 with a balloon payment of approximately $10,500 due June 2003. The financed equipment serves as collateral for the loan. F-12 DEPOMED, INC. (A DEVELOPMENT STAGE COMPANY) NOTES TO FINANCIAL STATEMENTS (CONTINUED) 5. COMMITMENTS AND CONTINGENCIES (CONTINUED) LEASES The Company leases its facilities under a noncancelable operating sublease that expires in March 2000. In October 1999, the Company was notified by its sublessor that its facility would not be available for lease after the current lease term. In February 2000, the Company leased new facilities in Menlo Park, California, and expects to move its operations and offices by April 2000. The new facility is leased under a non-cancelable agreement that expires in March 2005, with an option to extend the lease term for an additional five years. Future minimum payments under the operating leases, including the new facility lease, capital leases and long-term debt at December 31, 1999, together with the present value of those minimum payments, are as follows:
OPERATING CAPITAL LONG-TERM LEASES LEASES DEBT ----------- --------- -------- Year ending December 31, 2000 ................................ $ 516,661 $ 51,190 $175,816 2001 ................................ 595,410 42,130 175,816 2002 ................................ 613,272 14,187 213,212 2003 ................................ 657,379 4,545 23,748 2004 ................................ 650,620 - - Thereafter .......................... 136,373 - - ----------- --------- -------- $ 3,169,715 112,052 588,592 ----------- ----------- Less amount representing interest ......... (16,969) (108,901) --------- --------- Present value of future lease payments .... 95,083 479,691 Less current portion ...................... (41,131) (123,042) --------- --------- Non-current portion ....................... $ 53,952 $ 356,649 --------- --------- --------- ---------
Rent expense for the years ended December 31, 1999 and 1998 and for the period from inception to December 31, 1999 was approximately $350,000, $282,000 and $734,000, respectively. FINANCIAL CONSULTING AGREEMENT In 1998, the Company entered into a three-year agreement with a financial advisor. As consideration for services to be rendered under this arrangement, the Company has granted the financial advisor options to purchase 40,000 shares of common stock at an exercise price of $4.0625 per share and 20,000 shares of common stock at an exercise price $9.625 per share. The options were fully vested as of the date of grant. The fair value of these options is $430,200, as determined using the Black-Scholes Estimation Pricing Model. The value of these options will be amortized ratably over the three-year term of the consulting agreement. F-13 DEPOMED, INC. (A DEVELOPMENT STAGE COMPANY) NOTES TO FINANCIAL STATEMENTS (CONTINUED) 6. RELATED PARTY TRANSACTIONS CONSULTING AGREEMENT In September 1997, the Company entered into a one-year consulting agreement with Burrill & Co. to provide advisory services. The principal of Burrill & Co. is a director of the Company. The agreement required that the Company pay a monthly retainer of $10,000 as well as additional fees related to Burrill & Co.'s involvement in partnering arrangements. In September 1998, the Company amended the agreement with Burrill & Co., whereby the Company is required to pay a monthly retainer of $5,000 per month and other fees related to partnering arrangements. Through December 31, 1999 and 1998, the Company paid a total of $62,699 and $103,042, respectively, in connection with this agreement. The Company may terminate the arrangement at any time with sixty days notice. 7. SHAREHOLDERS' EQUITY INITIAL PUBLIC OFFERING The Company completed its initial public offering of common stock and common stock purchase warrants on November 5, 1997. The offering consisted of 1,200,000 units ("Units"), each unit consisting of one share of common stock, no par value, and a redeemable warrant to purchase one share of common stock at an exercise price of $7.625 per share. The Warrants may be exercised at any time beginning November 5, 1998 until November 4, 2002. The Company offered these units to the public at a price of $6.10 per unit. Upon the completion of the initial public offering, all of the convertible preferred shares outstanding as of the closing date were automatically converted into 908,615 shares of common stock. The shares and warrants comprising the units were detached and began trading separately on December 1, 1997. In connection with the initial public offering, the Company issued warrants to purchase 117,917 Units (the "Representative's Warrants"). The Representative's Warrants are exercisable at a price of $7.625 per Unit for a period of four years commencing one year after the date of the initial public offering. The warrants issuable upon exercise of the Representative's Warrants are exercisable at $7.625 per warrant for a period of four years, commencing one year from the date of the initial public offering. In connection with a bridge financing, which was funded and repaid in November 1997, the Company issued to the bridge financing investors warrants to purchase 81,254 shares exercisable at $6.00 per share and 2,084 shares exercisable at $7.625 per share. The bridge warrants may be exercised at any time beginning April 7, 1998 until April 7, 2002. The value of the warrants was deemed to be immaterial, therefore, the Company did not record any value for these warrants. As of December 31, 1999, 1,479,979 shares of common stock were reserved for issuance of outstanding warrants. F-14 DEPOMED, INC. (A DEVELOPMENT STAGE COMPANY) NOTES TO FINANCIAL STATEMENTS (CONTINUED) 7. SHAREHOLDERS' EQUITY (CONTINUED) PRIVATE PLACEMENT On February 6, 1998, the Company completed a private placement of 1,000,000 shares of common stock for $8.00 per share, with net proceeds of approximately $7,500,000. 1995 STOCK OPTION PLAN The Company's 1995 Stock Option Plan (the "Plan") was adopted by the Board of Directors and approved by the shareholders in September 1995, and has subsequently been amended. In June 1999, at the Company's Annual Meeting of Shareholders, the stockholders approved an increase to the Plan of 800,000 shares. As of December 31, 1999, a total of 1,800,000 shares of common stock have been reserved for issuance under the Plan. The Plan provides for the granting to employees of the Company, including officers and employee directors, of incentive stock options, and for the granting of nonstatutory stock options to employees and consultants of the Company. Generally, the exercise price of all incentive stock options and non-qualified stock options granted under the Plan must be at least 100% and 85%, respectively, of the fair value of the common stock of the Company on the grant date. The term of an incentive stock option may not exceed 10 years from the date of grant. An option shall be exercisable on or after each vesting date in accordance with the terms set forth in the option agreement. The right to exercise an option generally vests at the rate of at least 25% at the end of the first year and then ratably in monthly installments over the remaining vesting period of the option. F-15 DEPOMED, INC. (A DEVELOPMENT STAGE COMPANY) NOTES TO FINANCIAL STATEMENTS (CONTINUED) 7. SHAREHOLDERS' EQUITY (CONTINUED) 1995 STOCK OPTION PLAN (CONTINUED) A summary of the Company's stock option activity and related information for the period from inception (August 7, 1995) to December 31, 1999 follows:
OUTSTANDING OPTIONS ------------------------ WEIGHTED- SHARES AVERAGE AVAILABLE NUMBER EXERCISE FOR GRANT OF SHARES PRICE --------- ---------- --------- Shares authorized .................... 250,000 - - Options granted ...................... (120,000) 120,000 $0.09 -------- --------- ----- Balance at December 31, 1995 ................. 130,000 120,000 $0.09 Options granted at fair value ........ (3,334) 3,334 $0.09 Options granted below fair value ..... (83,333) 83,333 $0.90 Options exercised .................... - (91,666) $0.09 -------- --------- ----- Balance at December 31, 1996 ................. 43,333 115,001 $0.68 Shares authorized .................... 750,000 - - Options granted at fair value ........ (369,166) 369,166 $4.12 Options granted below fair value ..... (153,333) 153,333 $3.00 Options exercised .................... - - - -------- --------- ----- Balance at December 31, 1997 ................. 270,834 637,500 $3.23 Shares authorized .................... 200,000 * - - Options granted at fair value ........ (296,498) 296,498 $8.10 Options granted below fair value ..... (60,000) 60,000 $5.92 Options forfeited .................... 7,500 (7,500) $3.75 -------- --------- ----- Balance at December 31, 1998 ................. 121,836 986,498 $4.85 Shares authorized ............................ 600,000 - - Options granted at fair value ........ (363,551) 363,551 $2.93 Options exercised .................... - (1,666) $3.00 Options forfeited .................... 21,000 (21,000) $7.29 -------- --------- ----- Balance at December 31, 1999 ................. 379,285 1,327,383 $4.29 -------- --------- -------- ---------
* On December 9, 1998 the Board of Directors approved an increase of 200,000 shares to the plan which was approved by the stockholders at the Annual Meeting of Shareholders on June 2, 1999. F-16 DEPOMED, INC. (A DEVELOPMENT STAGE COMPANY) NOTES TO FINANCIAL STATEMENTS (CONTINUED) 7. SHAREHOLDERS' EQUITY (CONTINUED) 1995 STOCK OPTION PLAN (CONTINUED) Exercisable options at December 31, 1999, totaled 567,973. Exercise prices for options outstanding as of December 31, 1999 ranged from $0.09 to $11.25. The following table summarizes information about options outstanding at December 31, 1999:
OUTSTANDING OPTIONS EXERCISABLE OPTIONS --------------------------------------------- ---------------------- WEIGHTED- REMAINING WEIGHTED- AVERAGE CONTRACTUAL AVERAGE EXERCISE NUMBER EXERCISE LIFE NUMBER EXERCISE PRICES OF OPTIONS PRICE (IN YEARS) OF OPTIONS PRICE --------- ----------- ---------- ------------ ---------- --------- $0.09-0.90 114,999 $ 0.68 6.49 97,637 $ 0.64 $2.88-4.19 836,217 $ 3.27 8.47 291,902 $ 3.52 $5.25-6.10 71,667 $ 5.69 7.44 61,666 $ 5.76 $7.63-7.75 232,500 $ 7.64 8.93 72,895 $ 7.66 $9.50-9.88 66,000 $ 9.67 8.26 38,394 $ 9.65 $10.25-11.25 6,000 $ 11.08 8.38 5,479 $11.16 --------- ------- 1,327,383 567,973 --------- ------- --------- -------
STOCK-BASED COMPENSATION During 1996, the Company adopted Financial Accounting Standards Board Statement No. 123 ("SFAS 123"). In accordance with SFAS 123, the Company applies APB 25 in accounting for option grants to employees under the Plan and, accordingly, does not recognize compensation expense for options granted to employees at fair value, but does recognize compensation expense for options granted at prices below fair value. The valuation related to stock options granted to non-employees in 1996 was immaterial and, therefore, no value was recorded in the financial statements in 1996. The Company used the minimum value method to determine the fair value of stock options at the grant date issued in 1996, and in 1997, up to the date of the initial public offering. Options granted subsequent to the Company's initial public offering were valued using the Black-Scholes Option Valuation Model. The weighted-average assumptions used for 1999 and 1998 were as follows:
YEAR ENDED DECEMBER 31, ------------------------ 1999 1998 ------ ------ Risk free interest rate 4.81% 4.75% Expected dividend yield 0 0 Expected option life in years 4 4 Expected stock price volatility .80 .80
The weighted-average estimated fair value of employee stock options was $1.83 and $4.92 for stock options granted in 1999 and 1998, respectively. The option valuation models used in 1999 and 1998, were developed for using in estimating the fair value of traded options which have no vesting restrictions and are fully transferable. In addition, option valuation models require the input of highly subjective assumptions including the expected stock price volatility. Because the Company's employee stock options have characteristics significantly different from those of traded options, and because changes in the subjective input assumptions can materially affect the fair value estimate, in management's opinion, the existing models do not necessarily provide a reliable single measure of the fair value of its employee stock options. F-17 DEPOMED, INC. (A DEVELOPMENT STAGE COMPANY) NOTES TO FINANCIAL STATEMENTS (CONTINUED) 7. SHAREHOLDERS' EQUITY (CONTINUED) STOCK-BASED COMPENSATION (CONTINUED) For pro forma purposes, the estimated fair value of the options is amortized to expense over the option's vesting period. If the Company had elected to recognize compensation expense based on the fair value of the options granted on the date of grant as prescribed by SFAS 123, net loss and net loss per share would have increased as reflected in the pro forma amounts shown in the table below:
YEAR ENDED DECEMBER 31, ---------------------------------- 1999 1998 ------------- ------------ Net loss-as reported ................................. $(17,208,800) $(2,779,723) Net loss-pro forma ................................... $(17,827,568) $(3,067,834) Net loss per share-as reported ....................... $ (2.66) $ (0.44) Net loss per share-pro forma ......................... $ (2.75) $ (0.49)
DEFERRED COMPENSATION For options granted through the initial public offering date, November 5, 1997, the Company recognized an aggregate of $517,050 as deferred compensation for the excess of the deemed fair value for financial reporting purposes of the common stock issuable on exercise of such options over the exercise price. The deferred compensation expense is being recognized over the vesting period of the options. Total deferred compensation recorded during 1998 totaled $430,000. There was no deferred compensation recorded in 1999. Compensation expense relating to the amortization of deferred compensation recorded in the 1999 and 1998 statements of operations was $228,000 and $321,000, respectively. Further, the Company recognized expense of $26,000 in 1998 relating to the value of stock options granted to a consultant in exchange for services. 8. INCOME TAXES As of December 31, 1999, the Company had federal and state net operating loss carryforwards of approximately $9,300,000 each. The Company also had federal and California research and development tax credit carryforwards of approximately $200,000 each. The net operating loss and credit carryforwards will expire at various dates beginning on 2003 through 2019 if not utilized. Utilization of the net operating loss and credit carryforwards may be subject to a substantial annual limitation due to the ownership change limitations provided by the Internal Revenue Code of 1986 and similar state provisions. The annual limitation may result in the expiration of net operating losses and credits before utilization. F-18 DEPOMED, INC. (A DEVELOPMENT STAGE COMPANY) NOTES TO FINANCIAL STATEMENTS (CONTINUED) 8. INCOME TAXES (CONTINUED) Deferred income taxes reflect the net tax effects of temporary differences between the carrying amounts of assets for financial reporting and the amount used for income tax purposes. Significant components of the Company's deferred tax assets are as follows:
YEAR ENDED DECEMBER 31, --------------------------------- 1999 1998 ----------- ----------- Net operating loss carryforwards ................... $ 3,700,000 $ 1,500,000 Research credit carryforwards ...................... 400,000 100,000 Technology license ................................. 4,800,000 - ----------- ----------- Total deferred tax assets .......................... 8,900,000 1,600,000 Valuation allowance for deferred tax assets ........ (8,900,000) (1,600,000) ----------- ----------- Total .............................................. $ - $ - ----------- ----------- ----------- -----------
Due to the Company's lack of earnings history, the net deferred tax assets have been fully offset by a valuation allowance. The valuation allowance increased by $800,000 during the year ended December 31, 1998. 9. SUBSEQUENT EVENTS SALE OF SECURITIES On January 21, 2000, 717,286 shares of common stock and 12,015 shares of Series A convertible exchangeable preferred stock were issued to Elan Corporation, plc for consideration of $5,000,000 and $12,015,000, respectively. (See Note 3, Research Arrangements, Elan Corporation, plc) FACILITIES LEASE In February 2000, the Company entered into a five-year lease for a new facility, beginning March 2000, which includes an option to renew for one additional five-year term. (See Note 5, Commitments and Contingencies, Leases) F-19 INDEX TO EXHIBITS *3.1 Third Amended and Restated Articles of Incorporation *3.2 Form of Amended and Restated Articles of Incorporation *3.3 Bylaws *3.4 Certificate of Amendment to the Third Amended and Restated Articles of Incorporation *4.1 Specimen Common Stock Certificate *4.2 Specimen Warrant Certificate (filed as Exhibit A to the Form of Warrant Agreement) *4.3 Form of Representative's Warrant Agreement including form of Representative's Warrant *4.4 Form of Warrant Agreement **10.1 1995 Stock Option Plan, as amended *10.9 Agreement re: Settlement of Lawsuit, Conveyance of Assets and Assumption of Liabilities, dated August 28, 1995 by and among DepoMed Systems, Inc., Dr. John W. Shell and M6 Pharmaceuticals, Inc. *10.10 Form of Indemnification Agreement between the Company and its directors and executive officers *10.12 Form of Agreement between the Company and Burrill & Company ***+10.13 Joint Research Agreement dated February 20, 1998 between the company and R.W. Johnson Pharmaceutical Research Institute ****10.14 Sublease dated February 18, 1998 between the company and Cell Genesys, Inc. *****10.15 Securities Purchase Agreement dated January 21, 2000 between the company and Elan International Services, Ltd. *****10.16 Company Registration Rights Agreement dated January 21, 2000 between the company and Elan International Services, Ltd. *****10.17 Newco Registration Rights Agreement dated January 21, 2000 among the company, Newco and Elan International Services, Ltd. *****10.18 Funding Agreement dated January 21, 2000 among the company, Elan Corporation, plc, Elan Pharma International, Ltd. and Elan International Services, Ltd. *****10.19 Subscription, Joint Development Operating Agreement dated January 21, 2000 among the company, Newco, Elan Corporation, plc, Elan Pharma International, Ltd. and Elan International Services, Ltd. *****10.20 Convertible Promissory Note dated January 21, 2000 issued by the company to Elan International Services, Ltd. *****10.21 Company License Agreement dated January 21, 2000 among the company, Newco and Elan Corporation, plc. *****10.22 Elan License Agreement dated January 21, 2000 among the company, Newco, Elan Corporation, plc and Elan Pharma International, Ltd. *****10.23 Certificate of Determination of Rights and Preferences of Series A Preferred Stock filed with the State of California on January 14, 2000 23.1 Consent of Ernst & Young LLP, Independent Auditors 24.1 Power of Attorney (see page 22) 27.1 Financial Data Schedule
- ------------- * Incorporated by reference to the company's registration statement on Form SB-2 (File No. 333-25445) ** Incorporated by reference to Exhibit 99.1 of the company's registration statement on Form S-8 (File No. 333-66923) *** Incorporated by reference to Exhibit 10.1 of the company's quarterly report on Form 10-QSB filed on May 17, 1998 **** Incorporated by reference to Exhibit 10.2 of the company's quarterly report on Form 10-QSB filed on May 17, 1998 ***** Incorporated by reference to the company's Form 8-K filed on February 18, 2000 + Confidential treatment granted. EX-23.1 2 EXHIBIT 23.1 Exhibit 23.1 CONSENT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS We consent to the incorporation by reference in the Registration Statement on Form S-3 (No. 333-66843) and the related Prospectus and in the Registration Statement on Form S-8 (No. 333-66923) pertaining to the 1995 Stock Option Plan, as amended, of DepoMed, Inc. of our report dated February 25, 2000, with respect to the financial statements of DepoMed, Inc. included in this Annual Report (Form 10-KSB) for the year ended December 31, 1999. /s/ ERNST & YOUNG LLP Palo Alto, California March 29, 2000 EX-27.1 3 EXHIBIT 27.1
5 12-MOS DEC-31-1999 JAN-01-1999 DEC-31-1999 934,317 3,532,065 0 0 0 21,650,767 1,397,593 617,962 22,434,865 12,805,784 0 0 0 14,797,072 0 22,434,865 0 115,327 0 5,605,792 0 0 75,616 (17,208,800) 0 (17,208,800) 0 0 0 (17,208,800) (2.66) (2.66)
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