Item
1. Business
Company
Overview We are a
development stage company engaged in the development of new and proprietary
oral drug delivery technologies. Our
primary oral drug delivery system is the patented Gastric Retention System (the
“GR System”). 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, on a continuous, controlled release basis. By incorporation into the GR System, a drug
currently taken two or three times a day may be administered only once a
day. At present, several drug compounds
incorporated in the GR System are in advanced clinical trial development. In January 2002, a patent on our GR System
was issued, which expands the coverage of our technology for the controlled
delivery of a broad range of drugs from a gastric retained polymer matrix
tablet to maximize therapeutic benefits.
Our intellectual property position includes four issued patents and
eleven patent applications pending in the United States. We have also developed the Reduced
Irritation System (the “RI System”), (together with the GR System, the “DepoMed
Systems”) which is designed to provide for significant reduction in local upper
gastrointestinal (“GI”) irritation from the effects of certain drugs.
In this Annual
Report on Form 10-K, the “company,” “DepoMed,” “we,” “us,” and “our,” refer to
DepoMed, Inc.
We develop
proprietary products utilizing our technology internally, as well as in
collaboration with pharmaceutical and biotechnology companies. Regarding our collaborative programs, we
apply our technology to the partner’s compound and from these collaborations we
expect to receive research and development funding, milestone payments, license
fees and royalties. For our internal
development programs, we apply our proprietary technology to existing drugs and
fund development through Phase II clinical trials. With the Phase II clinical trial results, we generally seek a
collaborative partner for marketing and sales, as well as to complete the
funding of the clinical trials. We also
expect to receive milestone payments, license fees and royalties from these
later stage collaborations.
We have internally developed a potential once-daily
metformin product for Type II diabetes, Metformin GR™, which is currently in
pivotal Phase III human clinical trials.
In March 2002, the Phase III clinical trials of Metformin GR reached 85%
enrollment. We are currently in
discussions with potential marketing partners for our Metformin GR product;
however, we cannot assure that we will be successful in finding such a partner
or that the terms of any such arrangement will be favorable to us.
In January 2001, we announced that we successfully
completed a Phase I human clinical trial with an internally developed
once-daily formulation of the antibiotic drug ciprofloxacin, called
Ciprofloxacin GR™, for urinary tract infections. Our formulation was found to have comparable bioavailability and
had a significantly extended blood plasma concentration profile compared to
CIPRO®, Bayer Corporation’s currently marketed ciprofloxacin HCl immediate
release product that is taken twice per day.
Late in the third quarter of 2001, we began a Phase II clinical trial
for Ciprofloxacin GR which reached 100% patient enrollment in March 2002. If the trial is successful, we anticipate proceeding
to a Phase III trial later in 2002.
In addition, we are developing other product candidates
expected to benefit from incorporation into our drug delivery systems. For example, we initiated a Phase I clinical
trial of an undisclosed drug incorporated into the GR System for cardiovascular
indications in the March 2002.
In November 1999, we entered into an agreement to form a
joint venture with Elan Corporation, plc, Elan Pharma International, Ltd. and
Elan International Services, Ltd. (together “Elan”) to develop products using
drug delivery technologies and expertise of both Elan and DepoMed. This joint venture, DepoMed Development,
Ltd. (DDL), a Bermuda limited liability company, is initially owned 80.1% by
DepoMed and 19.9% by Elan. DepoMed
began subcontract development work for DDL in January 2000 and an undisclosed
product entered Phase I clinical trials in December 2000. Patent applications have been filed for this
product and we are currently seeking a marketing partner for it. DDL’s second product candidate is currently
in Phase I clinical trials and DDL’s third product candidate is in preclinical
testing.
In addition to research
and development conducted on our own behalf and through collaborations with
pharmaceutical partners, our activities since inception (August 7, 1995) have
included establishing our offices and research facilities, recruiting
personnel, filing patent applications, developing a business strategy and
raising capital. To date, we have
received only limited revenue, all of which has been from these collaborative
research and development arrangements and feasibility studies.
The
Drug Delivery Industry Drug delivery companies apply proprietary technologies to
create new pharmaceutical products utilizing drugs developed by others. These
products are generally novel, cost-effective dosage forms that provide any of
several benefits, including better control of drug concentration in the blood,
improved safety and efficacy, improved patient compliance and ease of use. We
believe that drug delivery technologies can provide pharmaceutical companies
with a means of developing new and/or improved products as well as of extending
existing patent franchises.
The increasing need to deliver medication to patients
efficiently and with fewer side effects has accelerated the pace of invention
of new drug delivery systems and the development and maturation of the drug
delivery 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 initially 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. We believe that the need for frequent
dosing of many drugs administered by capsules and tablets also can impede
patient compliance with the prescribed regimen.
The
DepoMed Systems The DepoMed Systems are based on our 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 our formulations are proprietary, the polymers
utilized in the DepoMed Systems are commonly used in the food and drug
industries and are included in the list of excipients approved by the FDA for
use in oral pharmaceuticals. We have
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, we believe
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. We believe 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.
• Proprietary Reformulation of Generic Products. We believe that the DepoMed Systems may
offer the potential to produce improved formulations of off-patent drugs. These
newly-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 proprietary formulations 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 at a controlled rate.
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 inadequately absorbed when delivered as conventional tablets or
capsules. Many drugs are primarily absorbed in the stomach, duodenum or upper
small intestine regions, through which drugs administered in conventional oral
dosage forms transit quickly. In contrast, the GR System is designed to be
retained in the stomach, allowing for constant multi-hour flow of drugs to
these regions of the 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 are developing metformin and ciprofloxacin products
which utilize the GR System, both of which are currently in human clinical
trials. We believe that the GR System
will provide for the more efficient delivery and absorption of these drugs by
retaining them in the stomach and upper small intestine for an extended period
of time. We are currently seeking
marketing partners to commercialize these products.
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 both immediate and 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® or
Tagamet®, which have a longer onset of action.
Rational Drug Combinations. We believe
that the GR System may allow for rational combinations of drugs with different
biological half-lives. Physicians frequently prescribe multiple drugs for
treatment of a single medical condition. Single product combinations have not
been considered feasible because the different biological half-lives of these
combination drugs would result in an overdosage of one drug and/or an
underdosage of the other. By appropriately incorporating different drugs into a
GR System we believe that we can provide for the release of each incorporated
drug continuously at a rate and duration (dose) appropriately adjusted for the
specific biological half-lives of the drugs. 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. We are
collaborating with AVI BioPharma, Inc. on a project to develop the GR System
for the delivery of large molecules.
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.
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. Although no partner has as yet been
identified to undertake the expense of advancing the product through human
clinical trials and the regulatory process, the aspirin product has
demonstrated “proof of principle” for reduced irritation. 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.
Product
Development Initiatives In addition to the
products listed in the table below, we enter into feasibility studies with
collaborative partners that, if successful, may be followed by definitive
agreements to complete development of the product. The following table summarizes our principal product development
initiatives:
(1) See the section below
entitled “Government Regulation” for additional information regarding the
phases of drug development.
(2) Undisclosed.
(3) The potential
indication may not be disclosed pursuant to the terms of the agreement between
the company and Elan Corporation, plc.
See “Collaborative Relationships.”
(4) The potential
indication may not be disclosed pursuant to the terms of the agreement between
the company and AVI BioPharma, Inc. See
“Collaborative Relationships.”
(5) Neither the drug, the
indication nor the delivery technology may be disclosed pursuant to the terms
of the agreement between the company and the undisclosed NYSE-listed
pharmaceutical company.
Collaborative
Relationships Elan Corporation, plc.
In November 1999, we entered into an 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.
Development work performed for DDL is funded by the joint venture
partners at the partners’ pro rata ownership percentage. DepoMed and Elan have
initially agreed upon an aggregate maximum funding amount of $10,000,000 and a
two-year funding term that expired January 21, 2002. While the funding period terminated on January 21, 2002, the
partners continue to perform development work for DDL. We expect that the partners will formally
agree to extend the funding period through at least December 2002. Although the funding period may not be
extended, the joint venture will endure until terminated upon written agreement
by the partners. DDL has the ability to
license its products to any third party; however, Elan has a limited right of
first negotiation. Any license granted
to Elan must be done on the basis of “arm’s length” pricing.
AVI BioPharma, Inc. In June 2000, we entered into a joint
collaboration to investigate the feasibility of controlled oral delivery of
AVI’s proprietary NEUGENE antisense agents.
The purpose of the collaboration is to study the feasibility of oral
drug formulations based on DepoMed’s GR controlled release system that will
deliver an antisense agent into the upper gastrointestinal tract. We have developed candidate dosage forms
incorporating one of AVI’s antisense agents and preclinical testing is
underway.
New York Stock
Exchange-Listed Pharmaceutical Company. We have an agreement with an undisclosed New York Stock
Exchange-listed pharmaceutical company related to the development of an
undisclosed drug. To date, all of the
research and development work with the partner’s drug has been funded by the
partner. The clinical status is
currently under evaluation by the partner.
Competition Other companies
that have oral drug delivery technologies competitive with the DepoMed Systems
include ALZA Corporation, a subsidiary of Johnson & Johnson, Elan
Corporation plc, SkyePharma plc, Biovail Corporation International, Flamel
Technologies S.A. and Andrx Corporation, all of which have oral tablet products
designed to release the incorporated drugs over time. Each of these companies
has patented technologies with attributes different from those of DepoMed’s, and
in some cases with different sites of delivery to the gastrointestinal
tract. We believe that we are the only
drug delivery company that is currently developing products for oral drug
delivery systems for enhanced retention in the stomach of an orally administered
tablet.
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 could 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 eleven 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 us will not be challenged, invalidated or circumvented; or
• the rights granted under the patents issued to us will
provide proprietary protection or commercial advantage to us.
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 us 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 us, the
diversion of our financial and managerial resources to such litigation could
have a material adverse effect on us.
We may also be required to participate in interference proceedings
declared by the United States Patent and Trademark Office for the purpose of
determining the priority of inventions in connection with our patent
applications or other parties’ patent applications. Adverse determinations in litigation or interference proceedings
could require us to seek licenses (which may not be available on commercially
reasonable terms, or at all) or subject us to significant liabilities to third
parties. These events could have a
material adverse effect on us.
In
January 2002, a broad patent covering our GR System was issued. We subsequently filed and served a complaint
against Bristol-Myers Squibb Company (“BMS”) claiming that BMS’s once-daily
metformin product, Glucophage® XR, infringes our United States Patent No.
6,340,475, as well as other matters set forth in the complaint. Although we intend to vigorously enforce our
intellectual property rights, there can be no assurance that we would be
successful in any litigation against BMS.
Manufacturing,
Marketing and Sales We
do not have and we do not intend to establish in the foreseeable future
internal commercial scale manufacturing, marketing or sales capabilities. Rather, we intend to use the facilities of
our collaborative partners or those of contract manufacturers to manufacture
commercial quantities of 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 deliver such products on a timely and competitive basis. There may not be sufficient manufacturing
capacity available to us when, if ever, we are 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. 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
current Good Manufacturing Practices (“cGMP”) requirements and other rules and
regulations prescribed by foreign regulatory authorities will apply to the
manufacture of products using the 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.
In
the United States, the Food and Drug Administration (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.
We
generally must conduct preclinical testing on laboratory animals of new
pharmaceutical products prior to commencement of clinical studies involving
human beings. These studies evaluate
the potential efficacy and safety of the product. We then submit the results of these studies to the FDA as part of
an Investigational New Drug application, which must become effective before
beginning clinical testing in humans.
Typically, human clinical evaluation involves a
time-consuming and costly three-phase process:
• In Phase I, we conduct clinical trials
with a small number of subjects to determine a drug’s early safety profile and
its pharmacokinetic pattern.
• In Phase II, we conduct limited clinical
trials with groups of patients afflicted with a specific disease in order to
determine preliminary efficacy, optimal dosages and further evidence of safety.
• In Phase III, we conduct large-scale, multi-center,
comparative trials with patients afflicted with a target disease in order to
provide enough data to demonstrate the efficacy and safety required by the FDA
prior to commercialization.
The
FDA closely monitors the progress of each phase of clinical testing. The FDA may, at its discretion, re-evaluate,
alter, suspend or terminate testing based upon the data accumulated to that
point and the FDA’s assessment of the risk/benefit ratio to patients.
The
results of the preclinical and clinical testing are submitted to the FDA in the
form of a New Drug application (NDA) for approval prior to commercialization.
An NDA requires that our products are compliant with cGMP. Failure to achieve or maintain cGMP
standards for products using the DepoMed Systems would adversely impact their
marketability. In responding to an NDA,
the FDA may grant marketing approval, request additional information or deny the
application. Failure to receive approval
for any products using the DepoMed Systems would have a material adverse effect
on the company.
Various FDA regulates not only prescription and
over-the-counter drugs approved by NDAs, but also over-the-counter products
that comply with monographs issued by the FDA.
These regulations include:
• cGMP requirements;
• general and specific over-the-counter
labeling requirements (including warning statements);
• advertising restrictions; and
• requirements regarding the safety and suitability of
inactive ingredients.
In
addition, the FDA may inspect over-the-counter products and manufacturing
facilities. A failure to comply with
applicable regulatory requirements may lead to administrative or judicially
imposed penalties. If an over-the-counter product differs from the terms of a
monograph, it will, in most cases, require FDA approval of an NDA for the
product to be marketed.
Foreign
regulatory approval of a product must also be obtained prior to marketing the
product internationally. Foreign
approval procedures vary from country to country. The time required for approval may delay or prevent marketing in
certain countries. In certain instances
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.
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, but 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,
2001, we had forty-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 could have a material adverse effect on the company.
Item 2.
Item 2. Properties
In February 2000, we entered into a five-year
non-cancelable lease of approximately 21,000 square feet of laboratory and
office facilities in Menlo Park, California.
The lease includes an option to renew for one additional term of five
years. Based on our current level of
research and development activity, we expect that this facility will
accommodate our growth for the near term.
Item 3.
Item 3. Legal Proceedings
We are involved in legal proceedings relating to some
of our intellectual property rights. In
January 2002, we filed a complaint against Bristol-Myers Squibb Company (“BMS”)
in the United States District Court for the Northern District of California for
infringement of U.S. Patent No. 6,340,475, issued on January 22, 2002 and
assigned to DepoMed. The patent, titled
“Extending the Duration of Drug Release Within the Stomach During the Fed
Mode,” covers our technology for the controlled delivery of a broad range of
drugs from a gastric retained polymer matrix tablet to maximize therapeutic
benefits. The complaint alleges infringement by BMS’s once-daily Glucophage® XR
tablet, as well as other matters set forth in the complaint.
Item 4.
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, 2001.
Executive
Officers The executive officers of the company
and their ages as of December 31, 2000 are as follows:
John W. Fara, Ph.D., has served as a director of the company
since November 1995 and as its President and Chief Executive Officer since
December 1996. In April 2000, he became Chairman of the Board of Directors of
the company succeeding Dr. John W. Shell, the founder of the company. From February 1990 to June 1996 Dr. Fara was
President and Chief Executive Officer of Anergen, Inc., a biotechnology
company. Prior to February 1990 he was President of Prototek, Inc., a
biotechnology company. Prior to Prototek, he was Director of Biomedical
Research and then Vice President of Business Development during ten years with
ALZA. Dr. Fara received a B.S.
from the University of
Wisconsin and a Ph.D. from University of California, Los Angeles. He is also a member of the board of directors
of AVI BioPharma, Inc. and Iomed, Inc.
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, analytical chemistry, toxicology, project management, and new drug
delivery technology. From 1984 through
1994, Dr. Berner acted as the director of Basic Pharmaceutics Research at
Ciba-Geigy. Prior to 1984, he also held
the position of staff scientist at The Procter & Gamble Company. Dr. Berner holds 18 patents and has authored
more than 70 publications, including the editorship of two books on controlled
drug delivery. He received his B.A.
from the University of Rochester and a Ph.D. from the University of California,
Los Angeles.
John F. Hamilton has served as the company’s Vice
President, Finance and Chief Financial Officer since January 1997. Prior to
joining the company, Mr. Hamilton was Vice President and Chief Financial
Officer of Glyko, Inc. and Glyko Biomedical Ltd., a carbohydrate instrument and
reagents company from May 1992 to September 1996. Previously he was President
and Chief Financial Officer of Protos Corporation, a drug design subsidiary of
Chiron Corporation, from June 1988 to May 1992 and held various positions with
Chiron Corporation, including Treasurer, from September 1987 to May 1992. Mr.
Hamilton received a B.A. from the University of Pennsylvania and a M.B.A. from
the University of Chicago.
John N. Shell has served as a director of the company
since its inception in August 1995 and Director of Operations for the company
until December 1996, when he was named Vice President, Operations. From May
1994 to August 1995, Mr. Shell served in a similar capacity at the DepoMed
Division of M6. Prior to 1994, Mr. Shell served as Materials Manager for Ebara
International Corporation, a multi-national semiconductor equipment
manufacturer, and as Materials Manager for ILC Technology, an electro-optics and
electronics manufacturer. Mr. Shell received his B.A. from the University of
California, Berkeley.
PART II
Item 5.
Item 5. Market for Registrant’s Common Equity
and Related Stockholder Matters
Our common stock commenced trading on
the Nasdaq SmallCap under the symbol “DPMD” on December 1, 1997. On November 9,
1998 our 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 our common stock as reported by the AMEX from January 1,
2000:
Our 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 AMEX from January 1, 2000:
As of March 25, 2002, the numbers of holders of record of
the common stock and the warrants were 124 and 8, respectively, and there were
approximately 3,000 beneficial shareholders.
We have never paid a cash
dividend on our common stock and we do not anticipate paying any cash dividends
for the foreseeable future. Further,
our equipment financing credit facility precludes us from declaring or paying
dividends on our common stock.
Recent
Sales of Unregistered Securities In June 2001, we sold to
accredited investors a combination of 2,908,922 shares of common stock and
warrants to purchase 1,672,630 shares of common stock, for net proceeds of
$11,331,000. All of the warrants are
exercisable until June 2006 at a weighted-average exercise price of $4.38. These transactions did not involve public
offerings and therefore were exempt from registration under Section 4(2) of the
Securities Act of 1933. We filed a
registration statement on Form S-3 in August 2001 covering the resale of shares
sold in the June 2001 private placement and the shares issuable upon exercise
of the warrants. The proceeds from the
offerings were used to fund our ongoing operations.
In March 2002, we sold to
institutional and accredited investors 2,300,000 shares of common stock at
$3.83 per share, for net proceeds of $8,304,000. This transaction did not involve a public offering and therefore
was exempt form registration under Section 4(2) of the Securities Act of
1933. We intend to file a registration
statement on Form S-3 covering the resale of shares sold in this offering. The proceeds from this offering will be used
to fund ongoing operations.
Item 6.
Item 6. Selected
Financial Data
(1) Beginning in 2000, our loss applicable to
common shareholders increased relative to our net loss due to dividends
accreted on our Series A convertible exchangeable preferred stock that was
issued in connection with the formation of our joint venture with Elan
Corporation, plc. The dividend is
described in Item 7
Item
7. 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-K that are not statements of historical fact are
forward-looking statements within the meaning of Section 27A of the Securities
Act of 1933, as amended (the “Securities Act”), and Section 21E of the
Securities Exchange Act of 1934, as amended.
A number of risks and uncertainties, including those discussed under the
caption “ADDITIONAL FACTORS THAT MAY AFFECT FUTURE RESULTS” below and elsewhere
in this Annual Report on Form 10-K 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.
General
Overview
We are a
development stage company engaged in the development of new and proprietary
oral drug delivery technologies. Our
primary oral drug delivery system is the patented Gastric Retention System (the
“GR™ System”). 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, on a continuous, controlled release
basis. By incorporation into the GR
System, a drug currently taken two or three times a day may be administered
only once a day. At present, several
drug compounds incorporated in the GR System are in advanced clinical trial
development. In January 2002, a patent
on our GR System was issued, which expands the coverage of our technology for
the controlled delivery of a broad range of drugs from a gastric retained
polymer matrix tablet to maximize therapeutic benefits. Our intellectual property position includes
four issued patents and eleven patent applications pending in the United
States. We have also developed the
Reduced Irritation System (the “RI™ System”), (together with the GR System, the
“DepoMed Systems”) which is designed to provide for significant reduction in
local upper gastrointestinal irritation from the effects of certain drugs.
In this Annual
Report on Form 10-K, the “company,” “DepoMed,” “we,” “us,” and “our,” refer to
DepoMed, Inc.
We develop
proprietary products utilizing our technology internally, as well as in
collaboration with pharmaceutical and biotechnology companies. Regarding our collaborative programs, we
apply our technology to the partner’s compound and from these collaborations we
expect to receive research and development funding, milestone payments, license
fees and royalties. For our internal
development programs, we apply our proprietary technology to existing drugs and
fund development through Phase II clinical trials. With the Phase II clinical trial results, we generally seek a
collaborative partner for marketing and sales, as well as to complete the
funding of the clinical trials. We also
expect to receive milestone payments, license fees and royalties from these
later stage collaborations.
We have internally developed a potential once-daily
metformin product for Type II diabetes, Metformin GR™, which is currently in
pivotal Phase III human clinical trials.
In March 2002, the Phase III clinical trials of Metformin GR reached 85%
patient enrollment. We are currently in
discussions with potential marketing partners for our Metformin GR product;
however, we cannot assure that we will be successful in finding such a partner
or that the terms of any such arrangement will be favorable to us.
In
January 2002, a broad patent covering our GR System was issued. We subsequently filed and served a complaint
against Bristol-Myers Squibb Company (“BMS”) claiming that BMS’s once-daily
metformin product, Glucophage® XR, infringes our United States Patent No.
6,340,475 (the “BMS Lawsuit”) as well as other matters set forth in the
complaint. Although we intend to
vigorously enforce our intellectual property rights, there can be no assurance
that we would be successful in any litigation against BMS.
In January 2001, we announced that we completed a Phase I
human clinical trial with an internally developed once-daily formulation of the
antibiotic drug ciprofloxacin, called Ciprofloxacin GR™, for urinary tract
infections. Our formulation was found
to have comparable bioavailability and had a significantly extended blood
plasma concentration profile compared with CIPRO®, a currently marketed
ciprofloxacin HCl immediate release product that is taken twice per day. Late in the third quarter of 2001, we began
a Phase II clinical trial for Ciprofloxacin GR
which reached 100%
patient enrollment in March 2002. If
the trial is successful, we anticipate proceeding to a Phase III trial later in
2002.
In addition, we
are developing other product candidates expected to benefit from incorporation
into our drug delivery systems. For
example, we initiated a Phase I clinical trial of an undisclosed drug
incorporated into the GR System for cardiovascular indications in March 2002.
Future clinical progress
of our products depends primarily on the result of each ongoing study. There can be no assurance that a clinical
trial will be successful or that the product will gain regulatory
approval. For a more complete discussion
of the risks and uncertainties associated with completing development of a
potential product, see the sections of Item 1 entitled “Patents and Proprietary
Rights”, “Manufacturing, Marketing and Sales”, “Government Regulation”, the
section of Item 7 entitled “Additional Factors that May Affect Future Results”
and elsewhere in this Form 10-K.
In November 1999, we entered into an agreement to form a
joint venture with Elan Corporation, plc, Elan Pharma International, Ltd. and
Elan International Services, Ltd. (together “Elan”) to develop products using
drug delivery technologies and expertise of both Elan and DepoMed. This joint venture, DepoMed Development,
Ltd. (DDL), a Bermuda limited liability company, is initially owned 80.1% by
DepoMed and 19.9% by Elan. DepoMed
began subcontract development work for DDL in January 2000 and an undisclosed
product entered Phase I clinical trials in December 2000. Patent applications have been filed for this
product and we are currently seeking a marketing partner for it. DDL’s second product candidate is currently
in Phase I clinical trials and DDL’s third product candidate is in preclinical
testing.
In addition to research
and development conducted on our own behalf and through collaborations with
pharmaceutical partners, our activities since inception (August 7, 1995) have
included establishing our offices and research facilities, recruiting
personnel, filing patent applications, developing a business strategy and
raising capital. To date, we have
received only limited revenue, all of which has been from these collaborative
research and feasibility arrangements.
We intend to continue investing in the further development of our drug
delivery technologies and the DepoMed Systems.
We will need to make additional capital investments in laboratories and
related facilities. As additional personnel
are hired in 2002 and our potential products proceed through the development
process, expenses can be expected to increase from their 2001 levels.
DepoMed has generated a
cumulative net loss of approximately $49,601,000 for the period from inception
through December 31, 2001. Of this
loss, $17,376,000 is attributable to our share of the equity in the net loss of
DDL.
Critical Accounting Policies
We consider certain accounting policies related to
revenue recognition and use of estimates to be critical policies.
Revenue Recognition
Revenue related to
collaborative research agreements with corporate partners and from DDL is
recognized as the expenses are incurred for each contract. We are required to perform research
activities as specified in each respective agreement on a best efforts basis,
and we are reimbursed based on the costs associated with supplies, other
outsourced activities and the hours worked by employees on each specific
contract. Our business strategy
includes performing additional development work for our partners, which we
expect will include milestone payments and license fees. We will recognize nonrefundable milestone
payments pursuant to collaborative agreements upon the achievement of specified
milestones where no further obligation to perform exists under that provision
of the arrangement. License fees will
be recognized over the period of a specific contract or, if no continuing
involvement exists, such license fees will be recognized upon receipt.
Use of Estimates
In preparing our financial statements
to conform with accounting principles generally accepted in the United States,
we make estimates and assumptions that affect the amounts reported in our
financial statements and accompanying notes.
These estimates include useful lives for fixed assets for depreciation
calculations and assumptions for valuing options and warrants. Estimates in the future may include
estimated lives for license agreements and the related recognition of
revenue. Actual results could differ
from these estimates.
RESULTS
OF OPERATIONS Years
Ended December 31, 2001, 2000 and 1999
Revenues Revenues for the years ended December 31, 2001, 2000 and
1999 were approximately $3,673,000, $1,776,000 and $115,000, respectively. In 2001, these revenues consisted of
$2,126,000 earned for development work performed for DDL, our joint venture
with Elan, and $1,547,000 earned from our collaboration with an undisclosed New
York Stock Exchange-listed pharmaceutical company. We expect to perform additional development work for the
undisclosed New York Stock Exchange-listed pharmaceutical company in 2002. Development
work performed for DDL is funded by the joint venture partners at the partners’
pro rata ownership percentage, up to an aggregate maximum amount of
$10,000,000. As of December 31, 2001,
the amount available for development funding was $3,307,000. While the funding period terminated on
January 21, 2002, we expect that the partners will agree to extend the period
though at least December 2002. We
expect to continue to perform development work for DDL through at least
December 2002. In 2000, our revenues consisted of $1,754,000 earned
for development work performed for DDL and $22,000 earned from another small
collaboration. In 1999, our revenues
consisted entirely of amounts earned under a feasibility arrangement with R. W.
Johnson Pharmaceutical Research Institute (PRI). In the first quarter of 1999, we successfully completed the first
phase of formulation development under a feasibility agreement with PRI. PRI has requested no further development
work from us and therefore we do not expect to receive any additional revenue
from this agreement.
Research
and Development Expense Research and development
expense for the year ended December 31, 2001 was approximately $15,461,000,
compared to approximately $7,488,000 and $3,734,000 during the years ended
December 31, 2000 and 1999, respectively. The increase in 2001 was primarily
due to expense of $6,102,000 for clinical trials with DepoMed proprietary
products, including a Phase III trial with Metformin GR and a Phase II trial
with Ciprofloxacin GR, which began in the third and fourth quarters of 2001,
respectively. Other increases included
$781,000 related to the hiring of additional employees and related expenses,
$329,000 related to increased laboratory supplies for additional projects, and
$208,000 related to increased depreciation and amortization expense of
additional equipment and facilities improvements.
The scope and magnitude
of future research and development expenses are difficult to predict at this
time given the number of studies that will need to be conducted for any of our
potential products or those of potential collaborative partners. As potential products proceed through the
development process, each step is typically more expensive than the previous
step. Success in development therefore
results in increasing expenditures. Our
research and development expenses currently include costs for scientific
personnel, supplies, equipment, outsourced activities, consultants, patent
filings, depreciation, utilities, administrative expenses and an allocation of
corporate costs. Our largest research
and development expense over the last three years has been expense related to
clinical trials. We expect our research
and development expense will continue to increase in the foreseeable future.
The
following table summarizes our principal product development initiatives. In addition to those listed, we enter into
feasibility studies with collaborative partners that, if successful, may be
followed by definitive agreements to complete development of the product.
(1) See the section in
Item 1 entitled “Government Regulation” for additional information regarding
the phases of drug development.
(2) Undisclosed.
(3) The potential
indication may not be disclosed pursuant to the terms of the agreement between
the company and Elan Corporation, plc.
See “Collaborative Relationships.”
(4) The potential
indication may not be disclosed pursuant to the terms of the agreement between
the company and AVI BioPharma, Inc. See
“Collaborative Relationships.”
(5) Neither the drug nor
the indication may be disclosed pursuant to the terms of the agreement between
the company and the undisclosed NYSE-listed pharmaceutical company.
General
and Administrative Expense General and
administrative expense for the year ended December 31, 2001 was approximately
$2,534,000, compared to approximately $2,026,000 and $1,872,000 during the
years ended December 31, 2000 and 1999, respectively. The increase in 2001 was primarily due to expense of $322,000
related to increased patent and other legal services in regard to business
development. Other increases included
expense of $84,000 related to stock listing fees and expense of $64,000 related
to increased insurance limits on directors and officers insurance. We expect general and administrative expense
to increase, but at a lower rate than research and development expenses. However, as a result of the BMS Lawsuit, our
legal fees will increase in the future and may impact our results of
operations.
Equity in Loss of Joint
Venture
In the fourth
quarter of 1999, our joint venture with Elan, DDL, was formed. While we own 80.1% of the outstanding
capital stock (and 100% 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 do
not consolidate the financials statements of DDL, but instead account for our
investment in DDL under the equity method of accounting. Separate financial statements for DDL are
included elsewhere in this Form 10-K.
In 2001, DDL
recognized a loss of $3,962,000, which included $3,927,000 in research and
development expense and $35,000 in general and administrative expense. In 2000, DDL recognized a loss of
$2,731,000, which
included $2,709,000 in
research and development expense and $22,000 in general and administrative
expense. The increase in research and development expense was due to increased
clinical trials activity and increased development work conducted on additional
product candidates. In 1999, DDL
recognized a loss of $15,000,000 related to a charge for acquiring in-process
research and development rights related to certain Elan drug delivery
technologies. Our 80.1% share of the
DDL’s loss was $3,173,000, $2,188,000 and $12,015,000 for 2001, 2000 and 1999,
respectively. We were responsible, at
our sole discretion, for funding 80.1% of DDL’s cash requirements up to a
maximum of $8,010,000 through January 21, 2002. Elan made available to us a convertible loan facility to assist
us in funding our portion of the joint venture losses up to a maximum of
$8,010,000 through January 21, 2002. We are currently in negotiations with Elan to
extend the funding period for research and development as well as the funding
period of the loan facility through at least December 2002. We expect that both funding periods will be
extended and that our share of DDL’s losses will be approximately $2,500,000 in
2002. Although the funding periods have
not formally been extended, as of March 31, 2002 we continue to perform work
for DDL and Elan has allowed funding under the facility. As our funding of DDL equals our equity in
the net loss of DDL, we had no carrying value in the DDL investment as of
December 31, 2001, 2000 and 1999.
Interest
Expense
Net interest expense was approximately $105,000 for the
year ended December 31, 2001 compared to net interest income of approximately
$223,000 and $297,000 for the years ended December 31, 2000 and 1999,
respectively. In 2001, interest income
decreased to $257,000 from $317,000 and $372,000 in 2000 and 1999,
respectively. The decrease was due to
declining cash and investment balances.
In 2001, the interest expense accrued on the Elan convertible loan
facility increased to $235,000 from $30,000 and interest expense on long-term
debt and capital leases increased to $126,000 in 2001 from $64,000 and $76,000
in 2000 and 1999, respectively. The
increase in interest expense from year to year was due to increasing debt
balances on the Elan convertible loan facility and the equipment loans (See
Note 5 of the Notes to Financial Statements).
Net interest income also includes immaterial gains realized on the sale
of some of our marketable securities.
Series
A Preferred Stock Dividend In January 2000,
we issued 12,015 shares of Series A convertible exchangeable preferred stock at
a price of $1,000 per share to fund our 80.1% share of the initial
capitalization of DDL. The Series A
preferred stock accrues a dividend of 7% per annum, compounded semi-annually
and payable in shares of Series A preferred stock. The Series A preferred stock is convertible at anytime after
January 2002, at Elan’s option, into DepoMed’s common stock. The original conversion price of the Series
A preferred stock was $12.00; however, as a result of our March 2002 financing,
the conversion price has been adjusted to $10.66 per share. For the years ended December 31, 2001 and
2000, we accrued a dividend on the Series A preferred stock of $913,000 and
$807,000, respectively. As of December
31, 2001, we had reserved 1,144,583 shares of our common stock related to these
convertible preferred shares.
Stock Option Grants
In June 2001, the Board
of Directors authorized an increase in the number of shares authorized for
issuance under the Plan by 500,000 shares.
This increase will not be submitted for shareholder approval until the
2002 Annual Meeting of Shareholders. In
November and December 2001, we granted options to purchase approximately
310,000 shares out of the proposed 500,000 share increase of common stock at
exercise prices of $5.50 and $5.80,
which represent the fair market value of our common stock on the respective
dates of grant. However, as the options
will not be deemed authorized for grant until the shareholders have approved
the increase in the number of shares authorized under the Plan, the applicable
measurement date for accounting purposes will be the date such approval is
obtained. Accordingly, if on such date
the fair market value of the underlying common stock is greater than the
exercise price, we will be required to recognize the difference as a non-cash
compensation expense. If the fair
market value of our common stock is significantly higher than the exercise
price on this date, our results could be materially impacted in the second
quarter of 2002. The fair market value
of our common stock at December 31, 2001 was $6.90; the fair market value of our
common stock on March 25, 2002 was $5.00.
Net
Operating Losses We have not generated any
taxable income to date. At December 31,
2001, the net operating losses available to offset future taxable income for
federal income tax purposes were approximately $34,000,000. 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 2003 through 2021 if not utilized.
As a result of the annual
limitation,
anticipated and future losses or changes in ownership of the company, all or a
portion of these carryforwards may expire before becoming available to reduce
our federal income tax liabilities.
LIQUIDITY
AND CAPITAL RESOURCES Cash used in
operations in the year ended December 31, 2001 was approximately $12,398,000,
compared to approximately $6,652,000 and $3,945,000 for the years ended
December 31, 2000 and 1999. In 2001, the change in cash used in operations was
due primarily to the net loss offset by our share of the loss of the joint
venture and increases in accounts payable due to increased clinical trials
activity. During the years ended
December 31, 2000 and 1999, the change in cash used in operations was due
primarily to our net loss offset by our share of the net loss of the joint
venture.
Cash used in
investing activities in the year ended December 31, 2001 totaled approximately
$1,722,000 and consisted of approximately $3,012,000 related to the investment
in our joint venture and $1,325,000 related to purchases of lab equipment,
leasehold improvements, furniture and computers, which were offset by a net
decrease in marketable securities of $2,615,000. Cash used in investing activities in the year ended December 31,
2000 totaled approximately $13,435,000 and consisted of approximately
$13,518,000 related to the investment in our joint venture and $900,000 related
to leasehold improvement expenditures and the purchase of lab equipment, which
were partially offset by a net decrease in marketable securities of
$983,000. 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, which was offset by purchases of laboratory equipment, fixtures and
office equipment. We expect that future
capital expenditures may include additional product development and quality
control laboratory equipment as we work towards implementation of current Good
Manufacturing Practices (cGMP) in our laboratories.
Cash provided by
financing activities for the year ended December 31, 2001 was $15,392,000 and
consisted primarily of net proceeds of $11,331,000 received in June in a
private placement of a combination of common stock and warrants (See Note 7 of
the Notes to Financial Statements, Shareholders’ Equity, Private Placements). Proceeds of
$3,012,000 were received on the convertible loan facility provided by Elan to
fund our share of DDL’s expenses and $1,347,000 was received on our equipment
loan facility (See Note 5 of the Notes to Financial Statements). Proceeds from financing activities were
offset by $305,000 in payments on the equipment loan and capital lease
obligations. Cash provided by financing
activities for the year ended December 31, 2000 was $23,031,000 and consisted
primarily of proceeds received in private placements of common stock and
warrants and preferred stock. In
January 2000, we completed a private placement of 714,286 shares of common
stock, sold to Elan at a price of $7.00 per share, with net proceeds of
approximately $4,915,000. Also in
January 2000, we sold 12,015 shares of convertible preferred stock to Elan for
$1,000 per share, and these proceeds were used for the initial capitalization
of DDL. Additionally, proceeds of
$1,503,000 were received on the loan facility provided by Elan. In November 2000, we completed a private
placement of 1,428,550 shares of common stock and 357,100 warrants for net
proceeds of $4,762,000. Proceeds
received were offset by $165,000 in payments on equipment loans and capital
leases. 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 1998 equipment financing credit facility.
As of December 31, 2001 and 2000, there was $4,779,000 and
$1,533,000 outstanding related to the loan facility provided by Elan. The outstanding amounts include accrued
interest of $264,000 and $30,000 at December 31, 2001 and 2000,
respectively. The amount available for
funding through the facility was approximately $3,464,000 at the end of
2001. The funding term of the loan
expired on January 21, 2002, however we are in negotiations with Elan to extend
the funding period through December 2002.
Although the funding term has not formally been extended as of March 31,
2002, Elan has allowed funding under the facility. We expect we will continue to draw on the facility through at
least December 2002. The loan and
accrued interest are payable in January 2006 in cash or our common stock, at
Elan’s option.
Through December 31, 2001, we have invested approximately
$3,403,000 in equipment, furniture and leasehold improvements, of which
approximately $1,947,000 was financed through long-term debt equipment
financing arrangements. As of December
31, 2001, the borrowing terms of the financing arrangements have expired.
If we do not obtain
additional credit arrangements, we will need to spend our own resources for
future equipment purchases.
As of December 31, 2001, our contractual
obligations are as follows:
As of
December 31, 2001, we had approximately $5,150,000 in cash and cash
equivalents, working capital of $1,730,000, and we had accumulated net losses
of $49,601,000. We expect to continue
to incur operating losses over the next several years. On March 22, 2002 we
completed an equity private placement for net proceeds of $8,304,000 (See Note
10 of the Notes to Financial Statements, Subsequent
Events). We anticipate that
our existing capital resources, including the proceeds from our March 2002
financing, will permit us to meet our capital and operational requirements
through at least December 31, 2002.
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;
• results of license negotiations;
• relationships with collaborative partners;
• costs of litigation;
• 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.
Recently
Issued Accounting Standards In July 1999, the
Financial Accounting Standards Board (FASB) announced the delay of the
effective date of Statement of Financial Reporting Standards No. 133,
“Accounting for Derivative Instruments and Hedging
Activities” (SFAS
133), and also, in June 2000, the FASB issued SFAS No. 138, an amendment to
SFAS 133. SFAS 133, as amended,
requires that all derivative instruments be recorded on the balance sheet at
their fair value. Change in the fair
value of derivatives is recorded each period in current earnings or other
comprehensive income, depending on whether a derivative is designed as part of
a hedge transaction, and, if so, the type of hedge transaction. We adopted SFAS 133, as amended, on January
1, 2001. The adoption of SFAS 133, as
amended, had no impact on our financial position or results of operations.
In July 2001, the FASB
issued Statement of Financial Reporting Standards No. 141 on Business
Combinations (SFAS 141) and Statement of Financial Reporting Standards No. 142
on Goodwill and Other Intangible Assets (SFAS 142). SFAS 141 is effective for any business combinations initiated
after June 30, 2001 and also includes the criteria for the recognition of intangible
assets separately from goodwill. SFAS
142 will be effective for fiscal years beginning after December 15, 2001 and
will require that goodwill not be amortized, but rather be subject to an
impairment test at least annually.
Separately identified and recognized intangible assets resulting from
business combinations completed before July 1, 2001 will be reassessed and the
remaining amortization periods adjusted accordingly. The adoption of SFAS 141 and 142 had no impact on our financial
position or results of operations.
In October 2001, the FASB issued Financial Reporting
Standard No. 144 (FAS 144), “Accounting for the Impairment or Disposal of
Long-Lived Assets.” FAS 144 supersedes
Financial Reporting Standard No. 121 (FAS 121), “Accounting for the Impairment
of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of.” The primary objectives of FAS 144 are to
develop one accounting model based on the framework established in FAS 121 for
long-lived assets to be disposed of by sale, and to address significant
implementation issues. Our adoption of
FAS 144 on January 1, 2002 is not expected to have an impact on our financial
position and results of operations.
ADDITIONAL FACTORS
THAT MAY AFFECT FUTURE RESULTS
In addition to
other information in this report, the following factors should be considered
carefully in evaluating the company.
The risks and uncertainties described below are not the only ones facing
the company. Additional risks and
uncertainties of which we are unaware or currently deem immaterial may also
become important factors that may harm our business.
We are
at an early stage of development and are expecting operating losses in the
future.
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.
We may
not be able to develop a successful product.
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.
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 and may not be successful.
In
June 2001, we announced the initiation of Phase III human clinical trials of
Metformin GR and in October 2001 we announced the initiation of Phase II
clinical trials of Ciprofloxacin GR.
There can be no assurance that these clinical trials will be successful,
or that regulatory approval will be obtained.
Successful commercial sales of Metformin GR or any
other product would require:
• entering into a license agreement with a
capable marketing and sales partner;
• 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.
Most of
our revenues are derived from our relationship with Elan and our strategy is
dependent upon entering into additional collaborative relationships.
We
have generated all of our revenues through collaborative arrangements with
pharmaceutical and biotechnology companies.
Currently, most of our revenues are derived from our joint venture with
Elan. If our joint venture with Elan is
terminated or fails to produce desired results, our revenues and results of
operations will suffer.
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. We may not be able to
enter into future collaborative arrangements on acceptable terms, which would
have a material adverse effect us. The
success of the Elan joint venture and other 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.
Our
collaborative agreements may give rise to disputes.
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. In addition, the terms of our past and future collaborative
partner agreements may limit or preclude us from developing products or
technologies developed pursuant to such agreements. Moreover, collaborative agreements often take considerably longer
to conclude than the parties initially anticipate, which could cause us to
agree to less favorable agreement terms or to reduced rates of spending in
support of key programs.
It is possible that our collaborative partners may not
choose to develop and make commercial sales of products using the DepoMed
Systems technologies. Any of 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.
In
July 1996, the company and Bristol-Myers Squibb Company (“BMS”) entered into a
letter agreement regarding a joint research project relating to the development
of a product consisting of formulations of a BMS drug incorporated in the GR
System (the “BMS Agreement”). After we
completed our research under the BMS Agreement, BMS decided in early 1999 not
to exercise its option to license the resulting product and to proceed instead
with its own internally-developed product.
The BMS Agreement by its terms prohibits us from exploiting any
formulations of the BMS drug developed pursuant to the BMS Agreement or any
proprietary information or invention relating solely to the BMS drug developed
under the BMS Agreement.
Independent
of the BMS Agreement, we developed a proprietary product, currently in clinical
trials, incorporating the BMS drug (which is no longer covered by a U.S.
patent) into the GR System. We believe
that our development of this product does not contravene any of our obligations
under the BMS Agreement. However, there
can be no assurance that BMS will not assert that we have violated the terms of
the BMS Agreement or dispute our sole ownership of any patent that relates to
the product. If BMS were to make such
an assertion, we could be subject to costly and time-consuming litigation, the
outcome of which would be uncertain and in which we would be at a disadvantage
because of BMS’s considerably greater financial resources.
Our
quarterly operating results may fluctuate and affect our stock price.
The
following factors will affect our quarterly operating results and may result in
a material adverse effect on our stock price:
• 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;
• costs of litigation;
• 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.
Business
interruptions could harm our business.
Our
operations are vulnerable to damage or interruption from computer viruses,
human error, natural disasters, telecommunications failures, intentional acts
of vandalism and similar events. In
particular, our corporate headquarters are located in the San Francisco Bay
area, which is known for seismic activity. We have not established a formal
disaster recovery plan, and our back-up operations and our business
interruption insurance may not be adequate to compensate us for losses that
occur. A significant business
interruption would result in losses or damages incurred by us and would harm
our business.
Our
advisors have relationships 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 us and at our direction, 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 us 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, if at all.
Reform
of the healthcare industry may affect our business and the 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.
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 7A.
Item 7A. Quantitative and Qualitative Disclosures
about Market Risk
Interest
Rate Sensitivity Our operating
results have not been sensitive to changes in the general level of U.S.
interest rates, particularly because most of our cash equivalents are invested
in short-term debt instruments. If
market interest rates were to change immediately and uniformly by 10% from
levels at December 31, 2001, the fair value of our cash equivalents would not
change by a significant amount.
Foreign
Currency Fluctuations We have not had
any significant transactions in foreign currencies, nor did we have any
significant balances that were due or payable in foreign currencies at December
31, 2001. Therefore, a hypothetical 10%
change in foreign currency rates would not have a significant impact on our
financial position and results of operations.
We do not hedge any of our foreign currency exposure.
Item 8.
Item 8. Financial
Statements and Supplementary Data
The financial statements and supplementary data required
by Item 8 are set forth below on pages through.
Item
9.
Item
9. Changes in
and Disagreements with Accountants on Accounting and Financial Disclosure
None.
PART
III
Item 10.
Item 10. Directors
and Executive Officers of the Registrant
The information required by this Item with respect to
executive officers is set forth in Part I of this report and the information
with respect to directors is incorporated by reference to the information set
forth under the caption “Election of Directors” in the company’s Proxy
Statement for the 2002 Annual Meeting of Shareholders.
The section entitled “Compliance Under Section 16(a) of
the Securities Exchange Act of 1934” appearing in the Proxy Statement for the
2002 Annual Meeting of Shareholders sets forth the information concerning
compliance by officers, directors and 10% shareholders of the company with
Section 16 of the Exchange Act of 1934 and is incorporated herein by reference.
Item 11.
Item 11. Executive Compensation
The information required by this Item is incorporated
herein by reference to the information set forth under the caption “Executive
Compensation” in the Proxy Statement for the 2002 Annual Meeting of
Shareholders.
Item 12.
Item 12. 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
for the 2002 Annual Meeting of Shareholders.
Item 13.
Item 13. Certain Relationships and Related
Transactions
The information
required by this Item is incorporated herein by reference to the information
set forth under the caption “Certain Relationships and Related Transactions” in
the Proxy Statement for the 2002 Annual Meeting of Shareholders.
PART
IV
Item 14.
Item 14. Exhibits,
Financial Statement Schedules, and Reports on Form 8-K
(a)1. Financial Statements
Included in Part II of this report.
(a)2. Financial Statement Schedules
All schedules have been omitted because the required
information is not present or because the information required is included in
the financial statements, including the notes thereto.
(a)3. Exhibits:
α 3.1
Third Amended and Restated Articles of Incorporation
α 3.2
Form of Amended and Restated Articles of
Incorporation
α 3.3
Bylaws
α 3.4
Certificate of Amendment to the Third Amended and
Restated Articles of Incorporation
α 4.1
Specimen Common Stock Certificate
α 4.2
Specimen Warrant Certificate (filed as Exhibit A to
the Form of Warrant Agreement)
α 4.3
Form of Representative’s Warrant Agreement including
form of Representative’s Warrant
α 4.4
Form of Warrant Agreement
β 10.1
1995 Stock Option Plan, as amended
α 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.
α 10.10
Form of Indemnification Agreement between the
company and its directors and executive officers
α 10.12
Form of Agreement between the company and Burrill
& Company
γ 10.15
Securities Purchase Agreement dated January 21, 2000
between the company and Elan International
Services, Ltd.
γ 10.16
Company Registration Rights Agreement dated January
21, 2000 between the company and Elan
International Services, Ltd.
γ 10.17
Newco Registration Rights Agreement dated January
21, 2000 among the company, Newco and Elan
International Services, Ltd.
γ 10.18
Funding Agreement dated January 21, 2000 among the
company, Elan Corporation, plc, Elan Pharma
International, Ltd. and Elan International Services,
Ltd.
γ 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.
γ 10.20
Convertible Promissory Note dated January 21, 2000
issued by the company to Elan International
Services, Ltd.
γ 10.21
Company License Agreement dated January 21, 2000
among the company, Newco and Elan Corporation,
plc.
γ 10.22
Elan License Agreement dated January 21, 2000 among
the company, Newco, Elan Corporation, plc and
Elan Pharma International, Ltd.
γ 10.23
Certificate of Determination of Rights and
Preferences of Series A Preferred Stock filed with the State of
California on January 14, 2000
δ 10.24
Loan agreement dated March 29, 2001 between the
company and GATX Ventures, Inc.
23.1
Consent of Ernst & Young LLP, Independent
Auditors
24.1
Power of Attorney (see page 25)
α
Incorporated by reference to the company’s
registration statement on Form SB-2 (File No. 333-25445)
β
Incorporated by reference to Exhibit 10.1 of the
company’s registration statement on Form S-8 (File No. 333-54982)
γ
Incorporated by reference to the company’s Form 8-K
filed on February 18, 2000
δ
Incorporated by reference to the company’s Form 10-Q
filed on November 14, 2001
+
Confidential treatment granted.
(b) Reports
on Form 8-K:
None.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the
Securities Exchange Act of 1934, the issuer, a corporation organized and
existing under the laws of the State of California, has duly caused this report
to be signed on its behalf by the undersigned thereunto duly authorized, in the
City of Menlo Park, State of California, on the 1st day of April, 2002.
POWERS OF ATTORNEY
KNOW ALL PERSONS BY THESE PRESENTS, each person whose signature
appears below constitutes and appoints John W. Fara 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-K, 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-K has been signed
by the following persons in the capacities and on the dates indicated.
Signature
/s/ John W. Fara, Ph.D.
Chairman, President and
April 1, 2002
John
W. Fara, Ph.D.
Chief Executive Officer
(Principal Executive Officer)
/s/ John F. Hamilton
Vice President,
April 1, 2002
John
F. Hamilton
Finance and Chief
Financial Officer
(Principal Financial Officer)
/s/ John N. Shell
Vice President,
April 1, 2002
John
N. Shell
Operations and Director
/s/ G. Steven Burrill
Director
April 1, 2002
G.
Steven Burrill
/s/ John W. Shell, Ph.D.
Director
April 1, 2002
John
W. Shell, Ph.D.
/s/ Julian N. Stern
Director and Secretary
April 1, 2002
Julian
N. Stern
/s/ W. Leigh Thompson, M.D., Ph.D.
Director
April 1, 2002
W.
Leigh Thompson, M. D., Ph.D.
DEPOMED, INC.
(A Development Stage Company)
DEPOMED, INC.
FINANCIAL STATEMENTS
Report
of Ernst & Young LLP, Independent Auditors
Balance Sheets
Statements
of Operations
Statement
of Shareholders’ Equity
Statements
of Cash Flows
Notes to Financial
Statements
DEPOMED
DEVELOPMENT, LTD. FINANCIAL STATEMENTS
Report of Ernst & Young LLP,
Independent Auditors
Balance Sheets
Statements
of Operations
Statement of
Shareholders’ Deficit
Statements
of Cash Flows
Notes to Financial
Statements
REPORT
OF ERNST & YOUNG LLP, INDEPENDENT
AUDITORS
The Board of Directors
and Shareholders
DepoMed, Inc.
We have audited the
accompanying balance sheets of DepoMed, Inc. (a development stage company) as
of December 31, 2001 and 2000, and the related statements of operations,
shareholders’ equity (net capital deficiency), and cash flows for each of the
three years in the period ended December 31, 2001 and for the period from
inception (August 7, 1995) to December 31, 2001. 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, 2001 and 2000, and the results of its operations and its cash flows for
each of the three years in the period ended December 31, 2001 and for the
period from inception (August 7, 1995) to December 31, 2001, in conformity with
accounting principles generally accepted in the United States.
/s/ ERNST &
YOUNG LLP
Palo Alto, California
February 21, 2002, except
for Note 10 of the
Notes to Financial
Statements, as to which
the date is March 28,
BALANCE SHEETS
See accompanying notes.
STATEMENTS
OF OPERATIONS
See
accompanying notes.
STATEMENT OF SHAREHOLDERS’ EQUITY (NET CAPITAL DEFICIENCY)
Period from inception (August 7, 1995) to December 31, 2001
See
accompanying notes.
See
accompanying notes.
See
accompanying notes.
STATEMENTS
OF CASH FLOWS
See
accompanying notes.
NOTES
TO FINANCIAL STATEMENTS
1. Organization and Basis of Presentation
Organization
DepoMed, Inc. (the
“Company” or “DepoMed”), 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.
As of December 31, 2001, the Company had approximately
$5,150,000 in cash, cash equivalents and marketable securities, working capital
of $1,760,000 and accumulated net losses of $49,601,000. In the course of its development activities,
the Company expects such losses to continue over the next several years. Management plans to continue to finance the operations
with a combination of equity and debt financing and revenue from corporate
alliances and technology licenses, including revenue from its joint
venture. If adequate funds are not
available, the Company may be required to delay, reduce the scope of, or
eliminate one or more of its development programs. On March 22, 2002, the Company completed an equity private
placement with net proceeds of $8,304,000 (See Note 10 of the Notes to
Financial Statements, Subsequent Events). The Company expects its existing capital
resources, including the proceeds from the March 2002 financing, will permit it
to meet its capital and operational requirements at least through December 31,
2002.
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 Company uses the specific identification
method to determine the amount of realized gains or losses on sales of
marketable securities. At December 31,
2001, the contractual period for all available-for-sale debt securities is
within one year. 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 (net capital deficiency).
Securities
classified as available-for-sale as of December 31, 2001 and 2000 are
summarized below. Estimated fair value
is based on quoted market prices for these investments.
Property and Equipment
Property and
equipment are stated at cost, less accumulated depreciation and amortization
(See Note 4 of the Notes to Financial Statements). 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 five years.
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
As permitted under
Statement of Financial Accounting Standards No. 123 (FAS 123), Accounting for
Stock-Based Compensation, the Company has elected to follow Accounting
Principles Board Opinion No. 25, Accounting for Stock Issued to Employees (APB
25) in accounting for stock-based awards to its employees. Accordingly, 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 7of the Notes to Financial
Statements.
Options granted to
non-employees are accounted for at fair value using the Black-Scholes option
valuation model in accordance with FAS 123 and Emerging Issues Task Force
Consensus No. 96-18 (EITF 96-18), and may be subject to periodic revaluation
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 Common 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, warrants and other
convertible securities and loans are not included as their effect is
antidilutive. For the three years ended
December 31, the following potentially dilutive securities were not included in
the computation of diluted earnings per share:
Revenue Recognition
Revenue related to
collaborative research agreements with corporate partners and the Company’s
joint venture 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
milestone 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, 2001, 2000 and 1999 has been reflected in the Statement of Shareholders’
Equity.
Long-Lived
Assets In accordance with
Statement of Financial Accounting Standards No. 121, “Accounting for the
Impairment of Long-Lived Assets to be Disposed Of” (FAS 121), the Company
identifies and records impairment losses, as circumstances dictate, on
long-lived assets used in operations when events and circumstances indicate
that the assets might be impaired and the discounted cash flows estimated to be
generated by those assets are less than the carrying amounts of those
assets. No such impairments have been
identified with respect to the Company’s long-lived assets, which consist
primarily of property and equipment.
Income Taxes Income taxes are
computed in accordance with Statement of Financial Accounting Standards No.
109, “Accounting for Income Taxes” (FAS 109) which requires the use of the
liability method in accounting for income taxes. Under FAS 109, deferred tax assets and liabilities are measured
based on differences between the financial reporting and tax basis of assets
and liabilities using enacted rates and laws that are expected to be in effect
when the differences are expected to reverse.
Fair Value of
Financial Instruments The estimated fair
value of long-term debt and notes payable is estimated based on current
interest rates available to the Company for debt instruments with similar
terms, degrees of risk and remaining maturities. The carrying values of these obligations approximate their respective
fair values.
Segment
Information The Company
follows Statement of Financial Standards No. 131, “Disclosures about Segments
of an Enterprise and Related Information” (FAS 131). FAS 131 establishes standards for reporting financial information
about operating segments in financial statements, as well as additional
disclosures about products and services, geographic areas, and major
customers. The Company operates in one
operating segment and has operations solely in the United States.
Recently
Issued Accounting Standards
In July 1999, the
Financial Accounting Standards Board (FASB) announced the delay of the
effective date of Statement of Financial Reporting Standards No. 133,
“Accounting for Derivative Instruments and Hedging Activities” (SFAS 133), and
also, in June 2000, the FASB issued SFAS No. 138, an amendment to SFAS
133. SFAS 133, as amended, requires
that all derivative instruments be recorded on the balance sheet at their fair
value. Change in the fair value of
derivatives is recorded each period in current earnings or other comprehensive
income, depending on whether a derivative is designed as part of a hedge
transaction, and, if so, the type of hedge transaction. The Company adopted SFAS 133, as amended, on
January 1, 2001. The adoption of SFAS
133, as amended, had no impact on the Company’s financial position or results
of operations.
In July 2001, the FASB
issued Statement of Financial Reporting Standards No. 141 on Business
Combinations (SFAS 141) and Statement of Financial Reporting Standards No. 142
on Goodwill and Other Intangible Assets (SFAS 142). SFAS 141 is effective for any business combinations initiated
after June 30, 2001 and also includes the criteria for the recognition of
intangible assets separately from goodwill.
SFAS 142 will be effective for fiscal years beginning after December 15,
2001 and will require that goodwill not be amortized, but rather be subject to
an impairment test at least annually.
Separately identified and recognized intangible assets resulting from
business combinations completed before July 1, 2001 will be reassessed and the
remaining amortization periods adjusted accordingly. The adoption of SFAS 141 and 142 had no impact on the Company’s
financial position.
In October 2001, the FASB issued Financial Reporting
Standard No. 144 (FAS 144), “Accounting for the Impairment or Disposal of
Long-Lived Assets.” FAS 144 supersedes
Financial Reporting Standard No. 121 (FAS 121), “Accounting for the Impairment
of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of.” The primary objectives of FAS 144 are to
develop one accounting model based on the framework established in FAS 121 for
long-lived assets to be disposed of by sale, and to address significant
implementation issues. The adoption of
FAS 144 on January 1, 2002 is not expected to have an impact on the Company’s
financial position and results of operations.
3. Research Arrangements
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 was paid for actual costs, as incurred, at the fees
stipulated in the agreement.
In the first quarter of 1999, the Company successfully
completed the first phase of formulation development under the PRI feasibility
agreement. PRI has requested no further
development work from the Company and the Company does not expect to receive
any additional revenue from this agreement.
The Company recognized revenues of $115,327 during 1999, in accordance
with the agreement. The costs incurred
for research and development approximated the revenue recognized under the
agreement. The Company did not
recognize any revenues under the agreement in 2000 and 2001.
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. 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. On January 21,
2000, the final closing agreements were signed, cash payments were received and
stock was issued to complete the transaction.
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 subcontracts 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 providing DDL non-exclusive rights to use certain Elan in-process
drug delivery technologies. The Elan
technology rights acquired relate to very early stage technology that, in the
opinion of management, have not reached technological feasibility and have no
future alternative uses. DepoMed also
licensed certain drug delivery technologies to DDL on a non-exclusive basis.
The Agreement also
provided for the following terms and 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 the Series A Preferred Stock.
The Series A Preferred Stock is convertible at anytime after January
2002, at Elan’s option, into DepoMed’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 between January 2002 and
January 2006. 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
DepoMed. DepoMed was required to 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
were purchased at $1,250 per share, to fund DepoMed’s share of DDL’s initial
capitalization.
• Elan purchased 2,388
shares of DDL preferred stock for $1,250 per share, a 19.9% interest in DDL.
• DepoMed, at its sole discretion, will fund
80.1% of the joint venture research and development costs up to $8,010,000
through January 21, 2002. DepoMed and
Elan are currently in negotiations to extend the term of development. If Elan elects to exercise its exchange
option on the Series A Preferred Stock, Elan must 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’s historical operating loss.
• Elan made a loan facility available to
DepoMed for up to $8,010,000. The
funding term of the loan will terminate on January 21, 2002. DepoMed and Elan are currently in
negotiations to extend the funding term of the loan. 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 are
convertible into DepoMed’s common stock at a conversion price of $10.00 per
share at Elan’s option.
• DDL has the ability to license any future products to a third
party; however, Elan has a limited right of first negotiation. Any license granted to Elan must be done on
the basis of “arm’s length” pricing.
While DepoMed owns
80.1% of the outstanding capital stock (and 100% 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 does not consolidate the financial
statements of DDL, but instead accounts for its investment in DDL under the
equity method of accounting. Separate financials
statements for DDL are included elsewhere in this Form 10-K.
For the years ended December 31, 2001
and 2000 and for the period from formation (November 30, 1999) to December 31,
2001, DDL recognized a net loss of approximately $3,962,000, $2,731,000 and
$21,693,000, respectively. The net loss
from formation to December 31, 2001 includes a $15,000,000 payment to Elan for
the acquisition of in-process research and development rights related to
certain Elan drug delivery technologies.
DepoMed recognized 80.1% of DDL’s loss, or approximately $3,173,000,
$2,188,000 and $17,376,000 for the years ended December 31, 2001 and 2000 and
for the period from formation to December 31, 2001, respectively. The costs incurred by DepoMed approximated
the revenue recognized under the arrangement.
To date, DDL has not recognized any revenue. At December 31, 2001 and 2000, DDL had current liabilities of
$1,056,000 and $854,000, respectively.
As DepoMed’s funding obligation equals its equity in net loss of DDL, DepoMed
had no carrying value of its DDL investment at December 31, 2001, 2000 and
1999.
New York Stock Exchange-Listed
Pharmaceutical Company
In January 2001,
the Company signed an interim letter agreement with an undisclosed New York
Stock Exchange- listed pharmaceutical company to begin feasibility studies with
an undisclosed drug. Under the interim
letter agreement, all research and development work with the partner’s drug
will be funded by the partner. In
accordance with the agreement, the Company recognized revenues of approximately
$1,414,000 during 2001. The costs
associated with research and development approximated the revenue recognized
under the agreement. The amount
receivable at December 31, 2001 under this agreement totaled $314,000.
4. Property
and Equipment
For the
years ended December 31, property and equipment consists of the following:
Property and equipment includes assets
under capitalized leases of $148,966 at December 31, 2001 and 2000. Accumulated
amortization related to assets under capital leases is included in accumulated
depreciation and amortization and totals $33,762 and $85,181 at December 31,
2001 and 2000, respectively.
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 DDL, its joint venture.
As of December 31, 2001 and 2000, there was $4,779,000 and
$1,533,000, respectively, outstanding related to the note. The outstanding amounts include accrued
interest of $264,000 and $30,000 at December 31, 2001 and 2000,
respectively. (See Note 3 of the Notes
to Financial Statements, Research Arrangements, Elan Corporation, plc)
Long-term
Debt
The Company entered into
a $600,000 equipment financing credit facility with a third party in 1998. The credit facility allowed the Company to
borrow 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.
In March 2001, the Company
entered into a secured equipment financing credit facility. The credit facility allowed the Company to
finance up to $2,000,000 of equipment and leasehold improvements purchased from
August 2000 through December 31, 2001.
The interest rate was recalculated with each draw at 750 basis points
above the current thirty-six (36) month US Treasury Note rate. At the end of December 2001, the Company had
utilized approximately $1,347,000 of the credit facility. The first draw under the facility, completed
in March 2001, was $587,500, at an annual interest rate of 12.0%. Equal payments of principal and interest of
approximately $20,000 are due monthly through April 2004. The second draw under the facility,
completed in September 2001, was $567,900, at an annual interest rate of
11.64%. Equal payments of principal and
interest of approximately $16,500 are due monthly through March 2005. The third and final draw under the facility,
completed in December 2001, was $192,000, at an annual interest rate of
11.65%. Equal payments of principal and
interest of approximately $5,600 are due monthly through July 2005. Loans under the facility are collateralized
initially by a security interest in all of the Company’s assets until the
Company completes one or more financings of an aggregate of at least
$10,000,000. Upon the completion of
qualified financing, the security interest in the Company’s assets will be
released and the financed equipment will serve as collateral for the
loans. The unused portion of the credit
facility of $653,000 expired on December 31, 2001.
In connection with the March
2001 credit facility, the Company issued warrants to the lender to purchase
40,000 shares of the Company’s common stock at $3.98 per share. The warrants are exercisable until March
2006. The Company valued the warrants
using the Black-Scholes model and treated the resulting value of $112,400 as
debt issuance costs. These costs are
offset against the debt obligation and will be amortized to interest expense
over approximately four years, the term of the borrowing arrangement, using the
effective interest method. During the
year, $19,800 was amortized into interest expense.
Leases
The Company leases
its facilities under a non-cancelable operating lease 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, capital leases and long-term debt at December 31,
2001, together with the present value of those minimum payments, are as
follows:
Rent expense for the
years ended December 31, 2001, 2000, 1999 and for the period from inception to
December 31, 2001 was approximately $713,000, $554,000, $350,000 and
$2,001,000, 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
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 was $430,200, as determined using
the Black-Scholes Estimation Pricing Model.
The value of these options was amortized ratably over the three-year
term of the consulting agreement which ended December 31, 2001.
6. Related
Party Transactions
Consulting Agreements
In September 1998,
the Company entered into a consulting 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.
The principal of Burrill & Co. is a director of the Company. Through December 31, 2001, 2000 and 1999,
the Company paid a total of $60,000, $55,000 and $62,699, respectively, in
connection with this agreement. The
Company may terminate the arrangement at any time with sixty days notice.
In May 2000, the Company entered
into a consulting agreement with John W. Shell, Ph.D. to provide services
related to business development, new product opportunities and intellectual
property. Dr. Shell is the founder of
the Company and retired as Chairman and Chief Scientific Officer of the Company
in April 2000. Dr. Shell is currently
serving as a director of the Company.
For the years ended December 31, 2001 and 2000, the Company paid a total
of $375 and $44,204, respectively, in fees associated with the agreement.
Elan Corporation, plc
In
November 1999, we signed an 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 (See Note 3 of the Notes to Financial Statements,
Research Arrangements, Elan Corporation, plc).
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 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
previously issued 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 (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,
2001, 3,592,565 shares of common stock were reserved for issuance for all
outstanding warrants.
Private Placements
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.
On January 21,
2000, the Company issued 714,286 shares of common stock and 12,015 shares of
Series A convertible exchangeable preferred stock to Elan Corporation for
consideration of $5,000,000 and $12,015,000, respectively. These transactions were completed in
conjunction with the formation of a joint venture between Elan Corporation, plc
and the Company. (See Note 3 of the Notes to Financial Statements, Research
Arrangements, Elan Corporation, plc)
On November 15, 2000, the
Company completed a private placement of a combination of common stock and
warrants, with net proceeds of approximately $4,762,000. The private placement consisted of 50 units,
each unit consisting of 28,571 shares of common stock, no par value, and 7,142
warrants to purchase 7,142 shares of common stock at an exercise price of $5.50
per share. The warrants may be exercised at any time beginning November 15,
2000 until November 14, 2004. The Company offered these units to private
investors at a price of $100,000 per unit.
Additionally, the Company issued 42,856 of the redeemable warrants as a
commission to a broker.
On June 14, 2001 the
Company completed a private placement of a combination of 2,908,922 shares of
common stock and warrants to purchase 1,672,630 shares of common stock, for net
proceeds of $11,331,000. All of the
warrants are exercisable until June 2006 at a weighted-average exercise price
of $4.38.
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 2001, the Board of Directors approved an increase to the Plan of 500,000
shares subject to shareholders’ approval at the Company’s Annual Meeting of
Shareholders on May 30, 2002. As of
December 31, 2001, a total of 2,900,000 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, directors 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% by the
end of the first year and then ratably in monthly installments over the
remaining vesting period of the option.
A summary of the
Company’s stock option activity and related information for the period from
inception (August 7, 1995) to December 31, 2001 follows:
* In December 1998, the Board of Directors
approved an increase of 200,000 shares to the plan which
was approved by the shareholders at the Annual
Meeting of Shareholders on June 2, 1999.
** In June 2001,
the Board of Directors approved an increase of 500,000 shares to the plan
subject to
shareholder approval at the
Annual Meeting of Shareholders on May 30, 2002.
In June 2001, the Board
of Directors authorized an increase in the number of shares authorized for
issuance under the Plan by 500,000 shares.
This increase will not be submitted for shareholder approval until the
2002 Annual Meeting of Shareholders. In
November and December 2001, the Company granted options to purchase
approximately 310,000 shares out of the proposed 500,000 share increase of
common stock at exercise prices of $5.50 and $5.80, which represent the fair market value of our common stock on
the respective dates of grant. However,
as the options will not be deemed authorized for grant until the shareholders
have approved the increase in the number of shares authorized under the Plan,
the applicable measurement date for accounting purposes will be the date such
approval is obtained. Accordingly, if
on such date the fair market value of the underlying common stock is greater
than the exercise price, the Company will be required to recognize the
difference as a non-cash compensation expense.
If the fair market value of the Company’s common stock is significantly
higher than the exercise price on this date, the Company’s results could be
materially impacted in the second quarter of 2002. The fair market value of the Company’s common stock at December
31, 2001 was $6.90.
Exercisable options at
December 31, 2001, totaled 1,453,848.
Exercise prices for options outstanding as of December 31, 2001 ranged
from $0.09 to $10.25. The following table summarizes information about options
outstanding at December 31, 2001:
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 2001, 2000 and 1999 were as follows:
The
weighted-average estimated fair value of employee stock options was $3.04, $2.47
and $1.83 for stock options granted in 2001, 2000 and 1999, respectively.
The option valuation models used in
2001, 2000 and 1999, were developed for use in estimating the fair value of
traded options which have no vesting restrictions and are fully transferable.
In addition, option valuation models require the input of highly subjective assumptions
including the expected stock price volatility. Because the Company’s employee
stock options have characteristics significantly different from those of traded
options, and because changes in the subjective input assumptions can materially
affect the fair value estimate, in management’s opinion, the existing models do
not necessarily provide a reliable single measure of the fair value of its
employee stock options.
For pro forma purposes,
the estimated fair value of the options is amortized to expense over the
option’s vesting period. If the Company
had elected to recognize compensation expense based on the fair value of the
options granted on the date of grant as prescribed by SFAS 123, net loss and
net loss per share would have increased as reflected in the pro forma amounts
shown in the table below:
Deferred Stock-Based Compensation
For options
granted through the initial public offering date, November 5, 1997, the Company
recognized an aggregate of $517,000 as deferred stock-based 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 stock-based compensation
expense was recognized over the vesting period of the options. Compensation expense relating to the
amortization of deferred stock-based compensation recorded in the 2001, 2000
and 1999 statements of operations was $25,000, $257,000 and $228,000,
respectively. Further, the Company
recognized expense of $58,000 in 2001, $126,000 in 2000 and none in 1999
relating to the value of stock options granted to consultants in exchange for
services.
8. Income Taxes
As of December 31,
2001, the Company had federal and state net operating loss carryforwards of
approximately $34,000,000 each. The
Company also had federal and California research and development tax credit
carryforwards of approximately $600,000 each.
The net operating loss and credit carryforwards will expire at various
dates beginning in 2003 through 2021 if not utilized.
Utilization of the
Company’s net operating loss and credit carryforwards may be subject to a
substantial annual limitation due to 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.
Deferred income
taxes reflect the net tax effects of temporary differences between the carrying
amounts of assets for financial reporting purposes and the amount used for
income tax purposes. Significant components of the Company’s deferred tax
assets are as follows:
Realization of deferred
tax assets is dependent upon future earnings, if any, the timing and amount of
which are uncertain. Accordingly, the
net deferred tax assets have been fully offset by a valuation allowance. The valuation allowance increased by
$7,200,000, $2,900,000 and $7,300,000 during the years ended December 31, 2001,
2000 and 1999, respectively.
9. Summarized Quarterly Data (Unaudited)
The following tables set
forth certain statements of operations data for each of the eight quarters
beginning with the quarter ended March 31, 2000 through the quarter ended
December 31, 2001. This quarterly
information is unaudited, but has been prepared on the same basis as the annual
financial statements and, in the opinion of management, reflects all
adjustments, consisting only of normal recurring adjustments necessary for a
fair representation of the information for the periods presented. Operating results for any quarter are not
necessarily indicative of results for any future period.
10. Subsequent Events
Private
Placement
On March 25, 2002, the Company completed a private
placement of 2,300,000 common shares at $3.83 per share with net proceeds of
$8,304,000. In connection with the
financing, anti-dilution provisions in the Elan agreements were triggered,
which adjusted the price at which the Series A preferred stock and dividends
convert to common stock from $12.00 per share to $10.66 per share and which
adjusted the price at which the Elan convertible loan facility and interest
convert to common stock from $10.00 per share to $9.07 per share.
AUDITORS’ REPORT
To the Shareholders of
DepoMed Development, Ltd.
We have audited
the accompanying balance sheet of DepoMed Development, Ltd. (a development
stage company) as of December 31, 2000 and the related statements of
operations, shareholders’ deficit and cash flows for the period from formation
(November 30, 1999) to December 31, 2000. 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 audit.
We conducted our
audit in accordance with auditing standards generally accepted in the United
States. Those standards require that we plan and perform an 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 audit
provides 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 Development, Ltd. (a development
stage company) at December 31, 2000 and the results of its operations and its
cash flows for the period from formation (November 30, 1999) to December 31,
2000 in conformity with accounting principles generally accepted in the United
States.
Ernst & Young
Chartered
Accountants
February 23, 2001
Hamilton, Bermuda
DEPOMED DEVELOPMENT, LTD.
(A Development Stage Company)
(Incorporated in Bermuda)
BALANCE
SHEET
(expressed
in United States dollars)
STATEMENT OF OPERATIONS
(expressed in United States dollars)
See
accompanying notes.
STATEMENT OF SHAREHOLDERS’ DEFICIT
Period from
formation to December 31, 2001 (expressed in United States dollars)
STATEMENT OF CASH FLOWS
(expressed in United States
dollars)
See
accompanying notes.
NOTES TO THE FINANCIAL STATEMENTS
Information as of and for the year ended December, 31, 2001
is unaudited
December 31, 2001
1. Organization and Basis of
Presentation
DepoMed
Development, Ltd. (the Company) was incorporated on January 7, 2000 in Bermuda.
The Company is owned jointly by Elan International Services, Ltd. (EIS), a
wholly-owned subsidiary of Elan Corporation plc, (Elan), and DepoMed, Inc.
(DMI), holding 19.9% (non-voting shares) and 80.1% of the shares, respectively.
The primary objective of the Company is to carry on the business of the
development, testing, registration, manufacturing, commercialization, and
licensing of “Products” (as defined in the Subscription, Joint Development and
Operating Agreement (JDOA) dated January 21, 2000 between DepoMed Development,
Ltd. (DDL), EIS, DMI and others). The focus of the collaborative venture is to
develop “Products” using the intellectual property of Elan, and DMI and the DDL
technology pursuant to the JDOA.
The Company’s
financial statements are presented based on the assumption that it was formed
pursuant to the execution of a legally binding letter agreement between DMI and
EIS and certain Elan affiliates on November 30, 1999. Based on the legally binding agreement, DMI and EIS both recorded
their respective shares of operating results for the period from November 30,
1999 to December 31, 1999 in their own separate financial statements for the
year ended December 31, 1999.
The Company’s ability to
continue as a going concern is entirely dependent upon the funds it receives
from its shareholders in connection with the shareholders’ respective
obligations to fund the Company’s operations.
The financial information at December 31, 2001 is
unaudited but includes all adjustments (consisting of only normal recurring
adjustments) that the Company considers necessary for a fair presentation of
its financial position at such date and the operating results and cash flows
for that period.
2. Significant Accounting Policies
The Company
follows accounting principles generally accepted in the United States.
Significant accounting policies are as follows:
Research and Development Costs
Research costs are
charged as an expense of the period in which they are incurred. Development
costs are deferred to future periods if certain criteria relating to future
benefits are satisfied and if the costs do not exceed the expected future
benefits.
Use of Estimates
The preparation of
financial statements in accordance with accounting principles generally
accepted in the United States requires management to make estimates and
assumptions that affect the reported amount of assets and liabilities and the
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amount of revenues and expenses during the
reporting period. Actual results could differ significantly from those
estimates.
Comprehensive
Income
Comprehensive income (loss) approximates net loss for the
period ended December 31, 2001 and 2000.
3. Related Party Transactions
At the end of the
period, the amount due to shareholders and companies related through common
ownership represents costs for research and development that are subcontracted
to DMI and Elan. Research and
development expense of $3,27,332, $17,709,017 and $21,636,349 represents costs
under such agreements for the year ended December 31, 2001, and for the periods
from formation to December 2000 and 2001, respectively. These transactions are in the normal course
of operations and are measured at the exchange amount, which is the amount of
consideration established and agreed to by the related parties. Further, the amount due to shareholders is
unsecured, and interest free with no set terms of repayment.
4. In-Process Research and Development
During the period
from formation to December 31, 2000, the Company paid a license fee to Elan
Corporation plc in the amount of $15,000,000 to acquire rights to certain Elan
intellectual property. The license
acquired related to early stage technology that, in the opinion of management,
had not reached technological feasibility.
In addition, management concluded that such technology had no
alternative future uses. Therefore, the
license fee was deemed to be in-process research and development and charged to
research and development expense for the period.
5. Shareholders’ Equity
Preferred Shares
In January 2000, the Company issued 6,000 non-voting
convertible preference shares (Preferred Shares) for $1,250 per share with a
par value of $1.00 each. 3,612
Preferred Shares were issued to DMI and 2,388 Preferred Shares were issued to
EIS for net proceeds of $7,500,000. At
any time after January 21, 2002, the holders of the Preferred Shares have the
right to convert all, or a portion, of such Preferred Shares into common shares
on a one-to-one basis. Upon liquidation
of the Company, the holders of the Preferred Shares will be entitled to be paid
out of the assets of the Company available for distribution to shareholders
before any distribution or payment is made to the holders of any other classes
of stock.
Common Shares
In January 2000, the Company issued 6,000 voting common
shares to DMI for $1,250 per share with a par value of $1.00 each. The Company received net proceeds of
$7,500,000 related to this issuance.
Contributed Surplus
Contributed
surplus of $20,624,943 and $16,864,777 at December 31, 2001 and 2000,
respectively, represents the share premium of $14,988,000 on amounts initially
contributed by shareholders, as well as additional amounts received from
shareholders which represents capital contributions to fund the Company’s
operating costs.
6. Taxes
Under current
Bermuda law the Company is not required to pay any taxes in Bermuda on either
income or capital gains. The Company has received an undertaking from the
Minister of Finance in Bermuda that in the event of such taxes being imposed,
the Company will be exempted from taxation until the year 2016.
INDEX TO EXHIBITS
α 3.1
Third Amended and Restated Articles of Incorporation
α 3.2
Form of Amended and Restated Articles of
Incorporation
α 3.3
Bylaws
α 3.4
Certificate of Amendment to the Third Amended and
Restated Articles of Incorporation
α 4.1
Specimen Common Stock Certificate
α 4.2
Specimen Warrant Certificate (filed as Exhibit A to
the Form of Warrant Agreement)
α 4.3
Form of Representative’s Warrant Agreement including
form of Representative’s Warrant
α 4.4
Form of Warrant Agreement
β 10.1
1995 Stock Option Plan, as amended
α 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.
α 10.10
Form of Indemnification Agreement between the
company and its directors and executive officers
α 10.12
Form of Agreement between the company and Burrill
& Company
γ 10.15
Securities Purchase Agreement dated January 21, 2000
between the company and Elan International
Services, Ltd.
γ 10.16
Company Registration Rights Agreement dated January
21, 2000 between the company and Elan
International Services, Ltd.
γ 10.17
Newco Registration Rights Agreement dated January
21, 2000 among the company, Newco and Elan
International Services, Ltd.
γ 10.18
Funding Agreement dated January 21, 2000 among the
company, Elan Corporation, plc, Elan Pharma
International, Ltd. and Elan International Services,
Ltd.
γ 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.
γ 10.20
Convertible Promissory Note dated January 21, 2000
issued by the company to Elan International
Services, Ltd.
γ 10.21
Company License Agreement dated January 21, 2000
among the company, Newco and Elan Corporation,
plc.
γ 10.22
Elan License Agreement dated January 21, 2000 among
the company, Newco, Elan Corporation, plc and
Elan Pharma International, Ltd.
γ 10.23
Certificate of Determination of Rights and
Preferences of Series A Preferred Stock filed with the State of
California on January 14, 2000
δ 10.24
Loan agreement dated March 29, 2001 between the
company and GATX Ventures, Inc.
23.1
Consent of Ernst & Young LLP, Independent
Auditors
24.1
Power of Attorney (see page 25)
α
Incorporated by reference to the company’s
registration statement on Form SB-2 (File No. 333-25445)
β
Incorporated by reference to Exhibit 10.1 of the
company’s registration statement on Form S-8 (File No. 333-54982)
γ
Incorporated by reference to the company’s Form 8-K
filed on February 18, 2000
δ
Incorporated by reference to the company’s Form 10-Q
filed on November 14, 2001
+
Confidential treatment granted.