10-Q 1 a12-19999_110q.htm 10-Q

Table of Contents

 

 

 

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

 

FORM 10-Q

 

x  QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

FOR THE QUARTERLY PERIOD ENDED September 30, 2012

 

OR

 

o  TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

FOR THE TRANSITION PERIOD FROM        TO       

 

COMMISSION FILE NUMBER 001-13111

 

DEPOMED, INC.

(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)

 

CALIFORNIA

 

94-3229046

(STATE OR OTHER JURISDICTION OF

 

(I.R.S. EMPLOYER

INCORPORATION OR ORGANIZATION)

 

IDENTIFICATION NUMBER)

 

1360 O’BRIEN DRIVE

MENLO PARK, CALIFORNIA 94025

(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES, INCLUDING ZIP CODE)

 

(650) 462-5900

(REGISTRANT’S TELEPHONE NUMBER, INCLUDING AREA CODE)

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Exchange Act during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  Yes x No o

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).  Yes x No o

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company, as defined in Rule 12b-2 of the Exchange Act.

 

Large accelerated filer o

 

Accelerated filer x

 

 

 

Non-accelerated filer o

 

Smaller reporting company o

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).  Yes o No x

 

The number of issued and outstanding shares of the Registrant’s Common Stock, no par value, as of November 2, 2012 was 56,103,162.

 

 

 



Table of Contents

 

DEPOMED, INC.

 

 

PAGE

 

 

PART I — FINANCIAL INFORMATION

 

 

 

Item 1. Condensed Financial Statements:

 

 

 

Condensed Balance Sheets at September 30, 2012 (unaudited) and December 31, 2011

3

 

 

Condensed Statements of Operations and Comprehensive Income for the three and nine months ended September 30, 2012 and 2011 (unaudited)

4

 

 

Condensed Statements of Cash Flows for the nine months ended September 30, 2012 and 2011 (unaudited)

5

 

 

Notes to Condensed Financial Statements (unaudited)

6

 

 

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

21

 

 

Item 3. Quantitative and Qualitative Disclosure About Market Risk

35

 

 

Item 4. Controls and Procedures

35

 

 

PART II — OTHER INFORMATION

 

 

 

Item 1. Legal Proceedings

36

 

 

Item 1A. Risk Factors

38

 

 

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds

49

 

 

Item 3. Defaults upon Senior Securities

49

 

 

Item 4. Mine Safety Disclosures

49

 

 

Item 5. Other Information

49

 

 

Item 6. Exhibits

49

 

 

Signatures

50

 

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Table of Contents

 

PART I — FINANCIAL INFORMATION

ITEM 1. CONDENSED FINANCIAL STATEMENTS

 

DEPOMED, INC.

CONDENSED BALANCE SHEETS

(in thousands, except share amounts)

 

 

 

September 30,

 

December 31,

 

 

 

2012

 

2011

 

 

 

(Unaudited)

 

(1)

 

 

 

 

 

 

 

ASSETS

 

 

 

 

 

Current assets:

 

 

 

 

 

Cash and cash equivalents

 

$

27,372

 

$

24,043

 

Marketable securities

 

52,537

 

62,106

 

Accounts receivable

 

4,848

 

4,420

 

Receivables from collaborative partners

 

10,054

 

8,135

 

Inventories

 

7,795

 

5,395

 

Prepaid and other current assets

 

2,748

 

5,390

 

Total current assets

 

105,354

 

109,489

 

Marketable securities, long-term

 

7,749

 

53,644

 

Property and equipment, net

 

5,250

 

1,070

 

Intangible assets, net

 

26,037

 

 

Other assets

 

526

 

169

 

 

 

$

144,916

 

$

164,372

 

LIABILITIES AND SHAREHOLDERS’ EQUITY

 

 

 

 

 

Current liabilities:

 

 

 

 

 

Accounts payable and accrued liabilities

 

$

32,240

 

$

26,784

 

Deferred product sales

 

4,535

 

6,960

 

Deferred license revenue

 

5,781

 

6,032

 

Other current liabilities

 

332

 

64

 

Total current liabilities

 

42,888

 

39,840

 

Deferred license revenue, non-current portion

 

13,770

 

17,932

 

Other long-term liabilities

 

2,610

 

682

 

Commitments

 

 

 

 

 

Shareholders’ equity:

 

 

 

 

 

Preferred stock, no par value, 5,000,000 shares authorized; Series A convertible preferred stock, 25,000 shares designated, 18,158 shares issued and surrendered, and zero shares outstanding at September 30, 2012 and December 31, 2011

 

 

 

Common stock, no par value, 100,000,000 shares authorized; 56,085,641 and 55,506,120 shares issued and outstanding at September 30, 2012 and December 31, 2011, respectively

 

209,217

 

203,511

 

Accumulated deficit

 

(123,657

)

(97,580

)

Accumulated other comprehensive gain (loss)

 

88

 

(13

)

Total shareholders’ equity

 

85,648

 

105,918

 

 

 

$

144,916

 

$

164,372

 

 


(1) Derived from the audited financial statements included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2011.

 

See accompanying notes to Condensed Financial Statements.

 

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Table of Contents

 

DEPOMED, INC.

CONDENSED STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME

(in thousands, except share and per share amounts)

(Unaudited)

 

 

 

Three Months Ended September 30,

 

Nine Months Ended September 30,

 

 

 

2012

 

2011

 

2012

 

2011

 

 

 

 

 

 

 

 

 

 

 

Revenues:

 

 

 

 

 

 

 

 

 

Product sales

 

$

9,684

 

$

9,205

 

$

14,994

 

$

40,669

 

Royalties

 

12,201

 

2,179

 

31,199

 

2,412

 

License and other revenue

 

11,397

 

5,138

 

18,033

 

77,760

 

Total revenues

 

33,282

 

16,522

 

64,226

 

120,841

 

 

 

 

 

 

 

 

 

 

 

Costs and expenses:

 

 

 

 

 

 

 

 

 

Cost of sales

 

1,763

 

1,150

 

3,723

 

4,925

 

Research and development expense

 

5,270

 

3,208

 

12,277

 

12,405

 

Selling, general and administrative expense:

 

 

 

 

 

 

 

 

 

Promotion fee expense

 

 

6,023

 

 

27,339

 

Other selling, general and administrative expense

 

26,832

 

15,451

 

73,625

 

32,667

 

Total selling, general and administrative expense

 

26,832

 

21,474

 

73,625

 

60,006

 

Amortization of intangible assets

 

958

 

 

1,063

 

 

Gain on settlement agreement

 

 

 

 

(40,000

)

Total costs and expenses

 

34,823

 

25,832

 

90,688

 

37,336

 

 

 

 

 

 

 

 

 

 

 

Income (loss) from operations

 

(1,541

)

(9,310

)

(26,462

)

83,505

 

 

 

 

 

 

 

 

 

 

 

Other income (expense):

 

 

 

 

 

 

 

 

 

Interest and other income

 

96

 

410

 

444

 

846

 

Interest expense

 

(39

)

(24

)

(39

)

(133

)

Total other income

 

57

 

386

 

405

 

713

 

 

 

 

 

 

 

 

 

 

 

Net income (loss) before income taxes

 

(1,484

)

(8,924

)

(26,057

)

84,218

 

 

 

 

 

 

 

 

 

 

 

Benefit from (provision for) income taxes

 

(11

)

348

 

(20

)

345

 

 

 

 

 

 

 

 

 

 

 

Net income (loss)

 

$

(1,495

)

$

(8,576

)

$

(26,077

)

$

84,563

 

Unrealized gains (losses) on available-for-sale securities

 

17

 

(187

)

101

 

(101

)

Comprehensive income (loss)

 

$

(1,478

)

$

(8,763

)

$

(25,976

)

$

84,462

 

 

 

 

 

 

 

 

 

 

 

Basic net income (loss) per common share

 

$

(0.03

)

$

(0.15

)

$

(0.47

)

$

1.56

 

Diluted net income (loss) per common share

 

$

(0.03

)

$

(0.15

)

$

(0.47

)

$

1.51

 

 

 

 

 

 

 

 

 

 

 

Shares used in computing basic net income (loss) per common share

 

56,039,186

 

55,371,954

 

55,794,357

 

54,267,829

 

Shares used in computing diluted net income (loss) per common share

 

56,039,186

 

55,371,954

 

55,794,357

 

56,071,870

 

 

See accompanying notes to Condensed Financial Statements.

 

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DEPOMED, INC.

CONDENSED STATEMENTS OF CASH FLOWS

(in thousands)

(Unaudited)

 

 

 

Nine Months Ended September 30,

 

 

 

2012

 

2011

 

 

 

 

 

 

 

Operating Activities

 

 

 

 

 

Net income (loss)

 

$

(26,077

)

$

84,563

 

Adjustments to reconcile net income (loss) to net cash (used in) provided by operating activities:

 

 

 

 

 

Depreciation and amortization

 

1,405

 

296

 

Amortization of investments

 

267

 

(64

)

Gain on bargain purchase

 

(92

)

 

Allowance for inventory obsolescence

 

696

 

 

Stock-based compensation

 

3,822

 

2,807

 

Changes in assets and liabilities:

 

 

 

 

 

Accounts receivable

 

(2,347

)

(1,125

)

Inventories

 

(667

)

(1,722

)

Prepaid and other assets

 

2,384

 

(4,157

)

Accounts payable and other accrued liabilities

 

2,309

 

6,862

 

Accrued compensation

 

(129

)

189

 

Deferred revenue

 

(6,838

)

(15,268

)

Net cash (used in) provided by operating activities

 

(25,267

)

72,381

 

 

 

 

 

 

 

Investing Activities

 

 

 

 

 

Purchases of property and equipment

 

(2,149

)

(665

)

Acquisition of businesses

 

(26,435

)

 

Purchases of marketable securities

 

(29,993

)

(153,875

)

Maturities of marketable securities

 

44,880

 

41,117

 

Sales of marketable securities

 

40,408

 

32,832

 

Net cash provided by (used in) investing activities

 

26,711

 

(80,591

)

 

 

 

 

 

 

Financing Activities

 

 

 

 

 

Principal payments on long-term debt

 

 

(2,243

)

Proceeds from issuance of common stock

 

1,885

 

7,872

 

Net cash provided by financing activities

 

1,885

 

5,629

 

 

 

 

 

 

 

Net increase (decrease) in cash and cash equivalents

 

3,329

 

(2,581

)

Cash and cash equivalents at beginning of period

 

24,043

 

22,526

 

Cash and cash equivalents at end of period

 

$

27,372

 

$

19,945

 

 

See accompanying notes to Condensed Financial Statements.

 

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DEPOMED, INC.

NOTES TO CONDENSED FINANCIAL STATEMENTS

(Unaudited)

 

NOTE 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

 

Organization

 

Depomed, Inc. (Depomed or the Company) was incorporated in California in 1995 and is a specialty pharmaceutical company focused on pain and other conditions and diseases of the central nervous system. The Company has developed two products approved by the U.S. Food and Drug Administration (FDA) that are currently being marketed.  Gralise® (gabapentin) is the Company’s once-daily tablet for the management of postherpetic neuralgia that was launched and made commercially available in October 2011. Glumetza® (metformin hydrochloride extended release tablets) is the Company’s once-daily treatment for adults with type 2 diabetes that is commercialized in the United States by Santarus, Inc. (Santarus).

 

On June 21, 2012, the Company acquired all rights to Zipsor® (diclofenac potassium) liquid filled capsules (Zipsor), from Xanodyne Pharmaceuticals, Inc (Xanodyne).  Zipsor is a non-steroidal anti-inflammatory drug (NSAID) indicated for the relief of mild to moderate acute pain in adults. The purchase price for this transaction was $26.4 million in cash for the rights to Zipsor and related inventory as well as potential milestone payments based on sales of Zipsor and assumption of certain liabilities. The Company began distributing Zipsor to wholesalers and retail pharmacies subsequent to the acquisition date. See Note 14 for further information on the acquisition of Zipsor.

 

The Company also has two product candidates under clinical development, Serada for the treatment of menopausal hot flashes and DM-1992 for Parkinson’s disease.

 

Basis of Presentation

 

These unaudited condensed financial statements and the related footnote information of the Company have been prepared pursuant to the requirements of the Securities and Exchange Commission (SEC) for interim reporting. As permitted under those rules and regulations, certain footnotes or other financial information that are normally required by U.S. generally accepted accounting principles have been condensed or omitted pursuant to such rules and regulations. In the opinion of the Company’s management, the accompanying interim unaudited condensed financial statements include all adjustments (consisting only of normal recurring adjustments) necessary for a fair presentation of the information for the periods presented. The results for the interim period ended September 30, 2012 are not necessarily indicative of results to be expected for the entire year ending December 31, 2012 or future operating periods.

 

The accompanying condensed financial statements and related financial information should be read in conjunction with the audited consolidated financial statements and the related notes thereto for the year ended December 31, 2011, included in the Company’s Annual Report on Form 10-K filed with the SEC. The balance sheet at December 31, 2011 has been derived from the audited financial statements at that date.

 

Use of Estimates

 

The preparation of financial statements in conformity with U.S. generally accepted accounting principles requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Although management believes these estimates are based upon reasonable assumptions within the bounds of its knowledge of the Company’s business and operations, actual results could differ materially from those estimates.

 

Revenue Recognition

 

The Company recognizes revenue from the sale of its products, royalties earned, and on payments received and services performed under contractual arrangements. Revenue arrangements with multiple elements are evaluated to determine whether the multiple elements met certain criteria for dividing the arrangement into separate units of accounting, including whether the delivered element(s) have stand-alone value to the Company’s customer or licensee. Where there are multiple deliverables combined as a single unit of accounting, revenues are deferred and recognized over the period that we remain obligated to perform services.

 

Revenue is recognized when there is persuasive evidence that an arrangement exists, delivery has occurred and title has passed, the price is fixed or determinable and the Company is reasonably assured of collecting the resulting receivable.

 

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·                  Product Sales:

 

·                  Gralise: The Company sells Gralise (gabapentin) once-daily tablets to wholesalers and retail pharmacies and began shipping to customers in October 2011. The Company accepts returns of unsalable product from customers within a return period of six months prior to, and twelve months following product expiration. Gralise tablets currently have a shelf-life of 24 months from date of manufacture. In October 2011, the Company offered launch incentives for customers to stock Gralise at pharmacies and wholesalers, which included discounts and extended payment terms. Given the limited history of prescriptions of Gralise and launch incentives associated with stocking Gralise, the Company currently cannot reliably estimate expected returns of the product at the time of shipment. Accordingly, the Company defers recognition of revenue on product shipments of Gralise until the right of return no longer exists, which occurs at the earlier of the time Gralise units are dispensed through patient prescriptions or expiration of the right of return. The Company estimates patient prescriptions dispensed using an analysis of third-party information, including third-party market research data and information obtained from wholesalers with respect to inventory levels and inventory movement. As a result of this policy, the Company has a deferred revenue balance of $4.5 million at September 30, 2012 related to Gralise product shipments that have not been recognized as revenue, which is net of wholesaler fees, retail pharmacy discounts, launch discounts and prompt payment discounts. The Company has recognized $4.8 million and $9.7 million in product sales, which is net of wholesaler fees, retail pharmacy discounts, prompt payment discounts, managed care rebates, patient support programs, and government chargebacks and rebates for the three and nine months ended September 30, 2012, respectively. If the Company underestimates or overestimates patient prescriptions dispensed for a given period, adjustments to revenue may be necessary in future periods.

 

In addition, the costs of manufacturing Gralise associated with the deferred revenue are recorded as deferred costs, which are included in inventory until the related deferred revenue is recognized.

 

Glumetza: The Company sold and recorded product sales on shipments of Glumetza (metformin hydrochloride extended release tablets) to wholesalers and retail pharmacies through August 2011.  The Company and Santarus entered into a commercialization agreement in August 2011 under which Depomed transferred the rights to manufacture and distribute Glumetza in the United States to Santarus. Santarus commenced selling Glumetza in September 2011 and began recording product sales.  See Note 4 for further information on the Santarus commercialization agreement.

 

Product distributed by Depomed through August 2011 is subject to rights of return six months before product expiration and up to twelve months after product expiration. The Company recognized revenue for Glumetza sales at the time title transferred to its customers, which occurred at the time product was delivered to its customers.  Revenue from sales of Glumetza was recorded net of estimated allowances for returns, wholesaler and retail pharmacy fees, prompt pay discounts, patient discount programs, government rebates and chargebacks and managed care rebates.

 

·                  Zipsor: On June 21, 2012 (the acquisition date), the Company acquired all rights to Zipsor (diclofenac potassium) liquid filled capsules from Xanodyne and began distributing Zipsor to wholesalers and retail pharmacies. The Company accepts returns of unsalable product from customers within a return period of six months prior to, and twelve months following product expiration. The Company recognizes revenue for Zipsor sales at the time title transfers to its customers, which occurs at the time product is delivered to its customers. Revenue from sales of Zipsor is recorded net of estimated allowances for returns, wholesaler and retail pharmacy fees, prompt pay discounts, patient discount programs, government rebates and chargebacks. See Note 14 for further information on the acquisition of Zipsor.

 

·                  Product Sales Allowances - The Company recognizes product sales allowances as a reduction of product sales in the same period the related revenue is recognized. Product sales allowances are based on amounts owed or to be claimed on related sales. These estimates take into consideration the terms of the Company’s agreements with customers, historical product returns, rebates or discounts taken, estimated levels of inventory in the distribution channel, the shelf life of the product, and specific known market events, such as competitive pricing and new product introductions. If actual future results vary from the Company’s estimates, the Company may adjust these estimates, which could have an effect on product sales and earnings in the period of adjustment. The Company’s product sales allowances include:

 

·                  Product Returns - The Company estimates product returns on sales of Glumetza through August 2011 and on sales of Zipsor since the acquisition date. Under the terms of the Zipsor Asset Purchase Agreement, the

 

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Company also assumed certain liabilities relating to product returns, governmental rebates and chargebacks and patient discount programs associated with Zipsor sales that were previously recorded by Xanodyne. See Note 14 for further information on the acquisition of Zipsor.

 

The Company allows customers to return product that is within six months before, and up to twelve months after, its product expiration date.  The shelf life of the 500mg Glumetza is currently 48 months from the date of tablet manufacture. The shelf life of the 1000mg Glumetza is 24 to 36 months from the date of tablet manufacture. The shelf life of Zipsor is 36 months from the date of tablet manufacture. The Company monitors actual return history on an individual product lot basis since product launch, which provides it with a basis to reasonably estimate future product returns, taking into consideration the shelf life of product, shipment and prescription trends, estimated distribution channel inventory levels, and consideration of the introduction of competitive products.

 

As noted earlier, the Company currently does not estimate product returns on sales of Gralise.

 

·                  Managed Care Rebates - The Company offers rebates under contracts with certain managed care organizations. The Company establishes an accrual equal to its estimates of future managed care rebates attributable to sales and recognizes the estimated rebates as a reduction of revenue in the same period the related revenue is recognized. The Company estimates its managed care rebates based on the terms of each agreement, estimated levels of inventory in the distribution channel, and historical and expected future utilization of product by the managed care organization.

 

·                  Wholesaler and Retail Pharmacy Discounts - The Company offers discounts to certain wholesale distributors and retail pharmacies based on contractually determined rates. The Company accrues the applicable contractual discount on shipment to wholesale distributors and retail pharmacies and recognizes the discount as a reduction of revenue in the same period the related revenue is recognized.

 

·                  Prompt Pay Discounts - The Company offers cash discounts to its customers, generally 2% of the sales price, as an incentive for prompt payment. Based on the Company’s experience, the Company expects its customers to comply with the prompt payment terms to earn the cash discount. The Company accounts for cash discounts by reducing accounts receivable by the full amount and recognizes the discount as a reduction of revenue in the same period the related revenue is recognized.

 

·                  Medicaid Rebates - The Company participates in Medicaid rebate programs, which provide assistance to eligible low-income patients based on each individual state’s guidelines regarding eligibility and services. Under the Medicaid rebate programs, the Company pays a rebate to each participating state, generally two to three months after the quarter in which the prescription is filled. The Company estimates and accrues Medicaid rebates based on product pricing, current rebates and changes in the level of discounts the Company offers that may affect the level of Medicaid discount, historical and estimated future percentages of product sold to Medicaid recipients and estimated levels of inventory in the distribution channel.

 

·                  Chargebacks - The Company provides discounts to authorized users of the Federal Supply Schedule (FSS) of the General Services Administration under an FSS contract with the Department of Veterans Affairs.  These federal entities purchase products from wholesale distributors at a discounted price, and the wholesale distributors then charge back to the Company the difference between the current retail price and the price the federal entity paid for the product.  The Company estimates and accrues chargebacks based on estimated wholesaler inventory levels, current contract prices and historical chargeback activity.

 

·                  Medicare Part D Coverage Gap - The Company participates in the Medicare Part D Coverage Gap Discount Program under which the Company provides rebates on prescriptions that fall within the “donut hole” coverage gap. The Company estimates and accrues rebates based on historical utilization and recognizes the rebate as a reduction of revenue in the same period the related revenue is recognized.

 

·                  Patient Discount Programs - The Company offers patient discount card programs in which patients receive discounts at participating retail pharmacies that are reimbursed by the Company.  The Company estimates and accrues future redemptions based on historical redemption activity.

 

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·                  Royalties - Royalties are recognized as earned in accordance with the contract terms when royalties from licensees can be reliably measured and collectability is reasonably assured.

 

Under the commercialization agreement between the Company and Santarus, the Company receives royalties on net sales of Glumetza distributed by Santarus in the United States. Santarus commenced distributing and recording product sales on shipments of Glumetza in September 2011. See Note 4 for further information on the Santarus commercialization agreement.

 

Royalties received from Santarus, Merck, Inc. (Merck) and Janssen Pharmaceuticals, Inc. (Janssen) are recognized in the period earned as the royalty amounts can be estimated and collectability is reasonably assured.

 

Royalties received under the Company’s agreements with Valeant Pharmaceuticals International, Inc. (Valeant) and LG Life Sciences (LG) are recognized when the royalty payments are received as they cannot reliably be estimated.

 

·                  License and other arrangements - Revenue from license and collaborative arrangements is recognized when the Company has substantially completed its obligations under the terms of the arrangement and the Company’s remaining involvement is inconsequential and perfunctory. If the Company has significant continuing involvement under such an arrangement, license and collaborative fees are recognized over the estimated performance period. The Company recognizes milestone payments for its research and development collaborations upon the achievement of specified milestones if (1) the milestone is substantive in nature, and the achievement of the milestone was not reasonably assured at the inception of the agreement; (2) consideration earned relates to past performance, and (3) the milestone payment is nonrefundable. A milestone is considered substantive if the consideration earned from the achievement of the milestone is consistent with the Company’s performance required to achieve the milestone or consistent with the increase in value to the collaboration resulting from the Company’s performance, the consideration earned relates solely to past performance, and the consideration earned is reasonable relative to all of the other deliverables and payments within the arrangement. License, milestones and collaborative fee payments received in excess of amounts earned are classified as deferred revenue until earned.

 

Recently Issued Accounting Standards

 

In June 2011, the FASB issued guidance amending the presentation requirements for comprehensive income. Companies have the option to report total comprehensive income, including components of net income and components of other comprehensive income, as a single continuous statement or in two separate but consecutive statements. The Company adopted the presentation requirement effective January 1, 2012 and elected to report the components of comprehensive income in one single continuous statement as part of the Condensed Statement of Operations and Comprehensive Income. The adoption of this guidance did not have a material impact on the Company’s financial statements.

 

In May 2011, the FASB issued Accounting Standards Update No. 2011-04, Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and International Financial Reporting Standards (ASU 2011-4). ASU 2011-04 is intended to provide a consistent definition of fair value and improve the comparability of fair value measurements presented and disclosed in financial statements prepared in accordance with U.S. GAAP and IFRS.  The amendments include those that clarify the FASB’s intent about the application of existing fair value measurement and disclosure requirements, as well as those that change a particular principle or requirement for measuring fair value or for disclosing information about fair value measurements.  This update is effective for annual and interim periods beginning after December 15, 2011. This ASU did not have a material impact on the Company’s financial statements.

 

In December 2011, the FASB issued ASU 2011-11, “Balance Sheet: Disclosures about Offsetting Assets and Liabilities”.  The differences in the requirements for offsetting assets and liabilities in the presentation of financial statements prepared in accordance with U.S. GAAP and financial statements prepared in accordance with International Financial Reporting Standards (IFRS) makes the comparability of those statements difficult.  The objective of this update is to facilitate comparison between those financial statements, specifically within the scope instruments and transaction eligible for offset in the form of derivatives, sale and repurchase agreements and reverse sale and repurchase agreements, and securities borrowing and securities lending arrangements.  This ASU is effective for annual reporting periods beginning on or after January 1, 2013 and interim periods within that fiscal year.  Management does not expect this ASU to have a material impact on the Company’s financial statements.

 

In December 2011, the FASB issued Accounting Standards Update No. 2011-12, “Deferral of the Effective Date for Amendments to the Presentation of Reclassification of Items Out of Accumulated Other Comprehensive Income in Accounting Standards Update No. 2011-05” (ASU 2011-12). ASU 2011-12 defers the requirement in ASU 2011-05 to present reclassification adjustments for each component of accumulated other comprehensive income in both other comprehensive income and net income on the face of the

 

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financial statements and the presentation of reclassification adjustments is not required in interim periods. The effective dates of ASU 2011-12 are consistent with the effective dates of ASU 2011-05, which is effective for fiscal years and interim periods beginning after December 15, 2011. The adoption of this standard did not have a material impact on our consolidated financial statements.

 

NOTE 2. CASH, CASH EQUIVALENTS AND MARKETABLE SECURITIES

 

Securities classified as cash and cash equivalents and available-for-sale marketable securities as of September 30, 2012 and December 31, 2011 are summarized below (in thousands). Estimated fair value is based on quoted market prices for these investments.

 

 

 

 

 

Gross

 

Gross

 

 

 

 

 

Amortized

 

Unrealized

 

Unrealized

 

 

 

 

 

Cost

 

Gains

 

Losses

 

Fair Value

 

September 30, 2012

 

 

 

 

 

 

 

 

 

Cash and cash equivalents:

 

 

 

 

 

 

 

 

 

Cash

 

$

23,699

 

$

 

$

 

$

23,699

 

Money market funds

 

3,673

 

 

 

3,673

 

Total cash and cash equivalents

 

$

27,372

 

$

 

$

 

$

27,372

 

 

 

 

 

 

 

 

 

 

 

Available-for-sale securities:

 

 

 

 

 

 

 

 

 

Total maturing within 1 year and included in marketable securities:

 

 

 

 

 

 

 

 

 

Corporate debt securities

 

$

30,657

 

$

55

 

$

 

$

30,712

 

Government agency debt securities

 

19,801

 

16

 

 

19,817

 

U.S. Treasury securities

 

2,008

 

 

 

2,008

 

Total maturing between 1 and 2 years and included in marketable securities:

 

 

 

 

 

 

 

 

 

Corporate debt securities

 

2,226

 

5

 

 

2,231

 

U.S. government agency debt securities

 

5,506

 

12

 

 

5,518

 

Total available-for-sale securities

 

$

60,198

 

$

88

 

$

 

$

60,286

 

 

 

 

 

 

 

 

 

 

 

Total cash, cash equivalents and marketable securities

 

$

87,570

 

$

88

 

$

 

$

87,658

 

 

 

 

 

 

Gross

 

Gross

 

 

 

 

 

Amortized

 

Unrealized

 

Unrealized

 

 

 

 

 

Cost

 

Gains

 

Losses

 

Fair Value

 

December 31, 2011

 

 

 

 

 

 

 

 

 

Cash and cash equivalents:

 

 

 

 

 

 

 

 

 

Cash

 

$

5,629

 

$

 

$

 

$

5,629

 

Money market funds

 

12,467

 

 

 

12,467

 

U.S. corporate debt securities

 

5,947

 

 

 

5,947

 

Total cash and cash equivalents

 

$

24,043

 

$

 

$

 

$

24,043

 

Available-for-sale securities:

 

 

 

 

 

 

 

 

 

Total maturing within 1 year and included in marketable securities:

 

 

 

 

 

 

 

 

 

Corporate debt securities

 

$

49,717

 

$

10

 

$

(9

)

$

49,718

 

U.S. government agency debt securities

 

5,503

 

2

 

 

5,505

 

U.S. Treasury securities

 

6,870

 

13

 

 

6,883

 

Total maturing between 1 and 2 years and included in marketable securities:

 

 

 

 

 

 

 

 

 

Corporate debt securities

 

17,767

 

7

 

(62

)

17,712

 

U.S. government agency debt securities

 

35,906

 

30

 

(4

)

35,932

 

Total available-for-sale securities

 

$

115,763

 

$

62

 

$

(75

)

$

115,750

 

 

 

 

 

 

 

 

 

 

 

Total cash, cash equivalents and marketable securities

 

$

139,806

 

$

62

 

$

(75

)

$

139,793

 

 

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The Company considers all highly liquid investments with a 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 U.S. Treasury and government agency securities, and high quality securities of U.S. and international financial and commercial institutions and, to date has not experienced material losses on any of its balances. All marketable securities are classified as available-for-sale since these instruments are readily marketable. These securities are carried at fair value, which is based on readily available market information, with unrealized gains and losses included in accumulated other comprehensive gain (loss) within shareholders’ equity. The Company uses the specific identification method to determine the amount of realized gains or losses on sales of marketable securities. Realized gains or losses have been insignificant and are included in “interest and other income” in the condensed statement of operations.

 

At September 30, 2012 the Company had four securities in an unrealized loss position. The following table shows the gross unrealized losses and fair value of the Company’s investments with unrealized losses that are not deemed to be other-than-temporarily impaired, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position, at September 30, 2012 (in thousands):

 

 

 

Less than 12 months

 

12 months or greater

 

Total

 

 

 

 

 

Gross

 

 

 

Gross

 

 

 

Gross

 

 

 

 

 

Unrealized

 

 

 

Unrealized

 

 

 

Unrealized

 

 

 

Fair Value

 

Losses

 

Fair Value

 

Losses

 

Fair Value

 

Losses

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Corporate debt securities

 

$

3,553

 

$

(1

)

$

 

$

 

$

3,553

 

$

(1

)

 

The gross unrealized losses above were caused by interest rate increases. No significant facts or circumstances have arisen to indicate that there has been any deterioration in the creditworthiness of the issuers of the securities held by the Company. Based on the Company’s review of these securities, including the assessment of the duration and severity of the unrealized losses and the Company’s ability and intent to hold the investments until maturity, there were no material other-than-temporary impairments for these securities at September 30, 2012.

 

Fair value is defined as the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. Valuation techniques used to measure fair value must maximize the use of observable inputs and minimize the use of unobservable inputs.

 

The Company utilizes the following fair value hierarchy based on three levels of inputs:

 

·                  Level 1: Quoted prices in active markets for identical assets or liabilities.

·                  Level 2: Inputs other than Level 1 that are observable, either directly or indirectly, such as quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities.

·                  Level 3: Unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities.

 

The following table represents the Company’s fair value hierarchy for its financial assets and liabilities measured at fair value on a recurring basis as of September 30, 2012 (in thousands):

 

 

 

Level 1

 

Level 2

 

Level 3

 

Total

 

Assets:

 

 

 

 

 

 

 

 

 

Money market funds

 

$

3,673

 

$

 

$

 

$

3,673

 

Corporate debt securities

 

 

32,944

 

 

32,944

 

Government agency debt securities

 

 

25,334

 

 

25,334

 

U.S. Treasury securities

 

 

2,008

 

 

2,008

 

Total

 

$

3,673

 

$

60,286

 

$

 

$

63,959

 

 

 

 

 

 

 

 

 

 

 

Liabilities:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Contingent consideration

 

$

 

$

 

$

1,342

 

$

1,342

 

 

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The fair value measurement of the contingent consideration obligations arises from the Zipsor acquisition and relates to the potential future milestone payments under the Zipsor agreement which is determined using Level 3 inputs. The key assumptions in determining the fair value are the discount rate and the probability assigned to the potential milestones being achieved. At each reporting date, the Company will re-measure the contingent consideration obligation arising from the Zipsor acquisition to its estimated fair value. Any changes in the fair value of contingent consideration will be recognized in operating expenses until the contingent consideration arrangement is settled.

 

The following table represents the Company’s fair value hierarchy for its financial assets measured at fair value on a recurring basis as of December 31, 2011 (in thousands):

 

 

 

Level 1

 

Level 2

 

Level 3

 

Total

 

 

 

 

 

 

 

 

 

 

 

Money market funds

 

$

12,467

 

$

 

$

 

$

12,467

 

U.S. corporate debt securities

 

 

73,378

 

 

73,378

 

U.S. Government agency debt securities

 

 

41,437

 

 

41,437

 

U.S. Treasury securities

 

 

6,882

 

 

6,882

 

Total

 

$

12,467

 

$

121,697

 

$

 

$

134,164

 

 

There were no financial liabilities measured at fair value on a recurring basis as of December 31, 2011.

 

NOTE 3.  NET INCOME (LOSS) PER COMMON SHARE

 

Basic net income (loss) per share is calculated by dividing the net income (loss) by the weighted-average number of shares of common stock outstanding during the period. Diluted net loss per share is calculated by dividing the net income (loss) by the weighted-average number of shares of common stock outstanding during the period, plus dilutive common shares for the period determined using the treasury-stock method. For purposes of this calculation, options to purchase stock are considered to be potential common shares and are only included in the calculation of diluted net income (loss) per share when their effect is dilutive. Basic and diluted earnings per share are calculated as follows:

 

 

 

Three Months Ended September 30,

 

Nine Months Ended September 30,

 

(in thousands, except for per share amounts)

 

2012

 

2011

 

2012

 

2011

 

 

 

 

 

 

 

 

 

 

 

Numerator:

 

 

 

 

 

 

 

 

 

Net income (loss)

 

$

(1,495

)

$

(8,576

)

$

(26,077

)

$

84,563

 

 

 

 

 

 

 

 

 

 

 

Denominator for basic net income (loss) per share

 

56,039

 

55,372

 

55,794

 

54,268

 

Net effect of dilutive common stock equivalents

 

 

 

 

1,804

 

Denominator for diluted net income (loss) per share:

 

56,039

 

55,372

 

55,794

 

56,072

 

 

 

 

 

 

 

 

 

 

 

Basic net income (loss) per share

 

$

(0.03

)

$

(0.15

)

$

(0.47

)

$

1.56

 

Diluted net income (loss) per share

 

$

(0.03

)

$

(0.15

)

$

(0.47

)

$

1.51

 

 

For the three and nine months ended September 30, 2012, 6.0 million common stock equivalents were not included in dilutive shares because their effect is anti-dilutive. For the three and nine months ended September 30, 2011, the total number of antidilutive outstanding common stock equivalents excluded from the diluted net income per share computation was 4.9 million and 1.2 million, respectively.

 

NOTE 4. LICENSE AND COLLABORATIVE ARRANGEMENTS

 

Janssen Pharmaceuticals, Inc.

 

In August 2012, the Company entered into a non-exclusive license agreement with Janssen Pharmaceuticals, Inc. (Janssen) granting Janssen a license to the Company’s Acuform gastric retentive drug delivery technology as well as other rights to certain Acuform patents.

 

In exchange, the Company received a $10.0 million upfront fee in the third quarter of 2012. The Company is also eligible to receive a one-time sales milestone upon achievement of a specified level of quarterly net sales, as well as low single digit royalties on net sales of NUCYNTA® ER (tapentadol extended-release tablets) in the U.S., Canada and Japan from and after July 2, 2012 through December 31, 2021. The Company has no development obligations under the agreement. The Company recognized the entire $10.0 million upfront fee as license revenue in the third quarter of 2012.

 

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Santarus, Inc.

 

In August 2011, the Company entered into a commercialization agreement with Santarus granting Santarus exclusive rights to manufacture and commercialize Glumetza in the United States. The commercialization agreement supersedes the previous promotion agreement between the parties originally entered into in July 2008.

 

Under the commercialization agreement, the Company transitioned to Santarus responsibility for manufacturing, distribution, pharmacovigilance and regulatory affairs. The Company ceased shipments of Glumetza in August 2011 and Santarus began distributing and recording product sales on shipments of Glumetza in September 2011. Santarus will continue to be responsible at its expense for advertising and promotional marketing activities for Glumetza.

 

Santarus is required to pay the Company royalties on net product sales of Glumetza in the United States of 26.5% in 2011; 29.5% in 2012; 32.0% in 2013 and 2014; and 34.5% in 2015 and beyond prior to generic entry of a Glumetza product. In the event of generic entry of a Glumetza product in the United States, the parties will equally share proceeds based on a gross margin split. Santarus has the exclusive right to commercialize authorized generic versions of the Glumetza products. Santarus will not pay additional sales milestones to the Company as was required under the prior promotion agreement. Royalty revenue from Santarus for the three and nine months ended September 30, 2012 was $11.6 million and $30.2 million, respectively.

 

In connection with its assumption of distribution and sales responsibility of Glumetza, Santarus purchased Depomed’s existing inventory of Glumetza and bulk metformin hydrochloride at cost.  Depomed is financially responsible for returns of Glumetza distributed by Depomed, up to the amount of the product returns reserve account for Glumetza product returns on the date immediately before Santarus began distributing Glumetza.  Depomed is financially responsible for Glumetza rebates and chargebacks up to the amount of its reserve accounts for those items. Santarus is responsible for all other Glumetza returns, rebates and chargebacks.

 

Under the commercialization agreement, Depomed is responsible for managing the patent infringement lawsuit against Sun Pharmaceutical Industries, Inc. (Sun) subject to certain consent rights in favor of Santarus, including with regard to any proposed settlements.  Santarus will reimburse Depomed for 70% of its out-of-pocket costs, and Depomed will reimburse Santarus for 30% of its out-of-pocket costs related to this infringement case. The Company was previously responsible for managing the patent infringement lawsuit against Lupin Limited (Lupin), which was settled in February 2012.

 

During 2011, Depomed distributed Glumetza for the first eight months of the year, recognized Glumetza product sales on those respective sales and paid Santarus a promotion fee equal to 75% of Glumetza gross margin. For the three and nine months ended September 30, 2011, the Company recognized $6.0 million and $27.3 million, respectively, in promotion fee expense to Santarus related to sales of Glumetza by Depomed. In August 2011, the distribution and sales responsibility transitioned to Santarus, and Depomed no longer recorded sales of Glumetza and no longer was responsible for paying promotion fees to Santarus.  Accordingly, there was no promotion fee expense in 2012.

 

Pursuant to the promotion agreement originally entered into in July 2008, Santarus paid the Company a $12.0 million upfront fee. The upfront payment received was originally being amortized as revenue ratably until October 2021, which represented the estimated length of time the Company’s obligations existed under the promotion agreement related to manufacturing Glumetza and paying Santarus promotion fees on gross margin of Glumetza. The commercialization agreement in August 2011 superseded the promotion agreement and removed the manufacturing and promotion fee obligations of the Company. The commercialization agreement includes obligations with respect to manufacturing and regulatory transition to Santarus, managing the ongoing patent infringement lawsuit against Sun and managing the patent infringement lawsuit against Lupin. These obligations are estimated to be completed in December 2013. Accordingly, on the effective date of the commercialization agreement, the amortization period related to remaining deferred revenue on the $12.0 million upfront fee has been adjusted, and the remaining deferred revenue will be recognized ratably until December 2013. The Company recognized approximately $1.0 million and $3.0 million of license revenue associated with this upfront license fee for the three and nine months ended September 30, 2012, respectively. The Company recognized approximately $0.6 million and $1.0 million of license revenue associated with this upfront license fee for the three and nine months ended September 30, 2011, respectively. The remaining deferred revenue balance related to this upfront payment is $4.8 million at September 30, 2012.

 

Ventiv Commercial Services, LLC

 

In June 2011, the Company entered into a service agreement with Ventiv Commercial Services, LLC (Ventiv), pursuant to which inVentiv Selling Solutions, Ventiv’s outsourced sales business, provides sales force recruiting, training, deployment and ongoing operational support to the Company to promote Gralise. The agreement provided for a sales force of 164 full-time sales representatives dedicated to the Company, all of whom were employees of Ventiv.

 

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Under the terms of the agreement, the Company paid Ventiv an upfront implementation fee and an agreed upon fixed monthly management fee of approximately $1.8 million, which was subject to adjustment based on actual staffing levels. During the term of the agreement, a portion of Ventiv’s monthly management fee was subject to payment by the Company only to the extent that specified performance objectives were met. The Company also paid certain pass-through costs of Ventiv incurred in connection with the agreement, which primarily included bonuses, travel costs and certain administrative expenses. The agreement provided for conversion of sales representatives from Ventiv employees to Depomed employees beginning in September 2012 at an agreed-upon cost per employee converted.  In June 2012, the Company exercised an early termination clause under the agreement to end the agreement in September 2012 in conjunction with converting the sales representatives to Depomed employees at that time. In September 2012, the Company established 155 full-time field sales territories and converted 142 of the Ventiv employees to Depomed employees.

 

In May 2012, the Company entered into an additional service agreement with Ventiv that provides for a sales force of 78 part-time sales representatives dedicated to the Company, all of whom are employees of Ventiv. Under the terms of the agreement, the Company paid Ventiv an upfront implementation fee and will pay an agreed upon fixed monthly management fee of approximately $0.5 million, which is subject to adjustment based on actual staffing levels. The term of the agreement is for one year beginning in June 2012.

 

The Company incurred $8.8 million and $23.3 million of expense related to Ventiv under these two agreements for the three and nine months ended September 30, 2012. The Company incurred $1.6 million and $2.5 million of expense related to Ventiv for the three and nine months ended September 30, 2011.

 

Abbott Products Inc. (formerly Solvay Pharmaceuticals, Inc.)

 

In November 2008, the Company entered into an exclusive license agreement with Solvay Pharmaceuticals, Inc. (Solvay) granting Solvay exclusive rights to develop and commercialize Gralise for pain indications in the United States, Canada and Mexico. In February 2010, Abbott Laboratories acquired the pharmaceutical business of Solvay and Abbott Products (Abbott Products), a subsidiary of Abbott Laboratories, became responsible for the Gralise license agreement with the Company.

 

In January 2011, Abbott Products received FDA approval of Gralise for the management of postherpetic neuralgia. This triggered a $48.0 million development milestone from Abbott to the Company, which the Company received in February 2011. As the nonrefundable milestone was substantive in nature, achievement of the milestone was not reasonably assured at the inception of the agreement and the milestone was related to past performance, the Company recognized the entire $48.0 million as revenue in the first quarter of 2011.

 

In January 2011, Abbott Products notified the Company that Abbott Products did not intend to commercialize Gralise. In March 2011, the Company entered into a settlement agreement with Abbott Laboratories which provided for (i) the immediate termination of the Gralise license agreement, (ii) the transition of Gralise back to Depomed; and (iii) a $40.0 million payment to Depomed which the Company received in March 2011. The $40.0 million payment was recognized as a gain within operating income in the first quarter of 2011.

 

Pursuant to the exclusive license agreement originally entered into in November 2008, Solvay paid the Company a $25.0 million upfront fee in February 2009. The upfront payment received was originally being amortized as revenue ratably until January 2013, which represented the estimated length of time the Company’s development and supply obligations existed under the agreement. In connection with the termination of the license agreement with Abbott Products, the Company no longer has continuing obligations to Abbott Products. Accordingly, all remaining deferred revenue related to the $25.0 million upfront license fee previously received from Abbott Products was fully recognized as revenue in March 2011, resulting in immediate recognition of approximately $11.3 million of license revenue in the first quarter of 2011.

 

Boehringer Ingelheim International GMBH

 

In March 2011, the Company entered into a license and service agreement with Boehringer Ingelheim International GMBH (Boehringer Ingelheim) granting Boehringer Ingelheim a license to certain patents related to the Company’s Acuform drug delivery technology to be used in developing fixed dose combinations of extended release metformin and proprietary Boehringer Ingelheim compounds in development for type 2 diabetes. Under the terms of the agreement, Boehringer Ingelheim was also granted a right of reference to the New Drug Application covering the Company’s Glumetza product and associated data for use in potential regulatory submission processes.

 

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In connection with the license and service agreement, the Company received an upfront payment of $10.0 million less applicable withholding taxes of approximately $1.5 million, for a net receipt of approximately $8.5 million in April 2011. The Company received the remaining $1.5 million of taxes previously withheld directly from German tax authorities in June 2011.

 

The $10.0 million upfront was amortized ratably through November 2011, which was the estimated length of time Depomed was obligated to perform formulation work under the agreement. Accordingly, the Company recognized approximately $3.8 million and $8.6 million of revenue associated with this upfront license fee during the three and nine months ended September 30, 2011, respectively.

 

Under the terms of the agreement, the Company received an additional nonrefundable $2.5 million payment in March 2012 upon delivery of experimental batches of prototype formulations that met required specifications. As the milestone event was substantive in nature, achievement was not reasonably assured at the inception of the agreement and the milestone was related to past performance, the Company recognized the entire amount of this payment as revenue in the first quarter of 2012.  The Company is also eligible to receive additional milestone payments based on regulatory filing and approval events, as well as royalties on worldwide net sales of products.

 

Depomed is responsible for providing certain initial formulation work associated with the fixed dose combination products. Work performed by the Company under the service agreement will be reimbursed by Boehringer Ingelheim on an agreed-upon FTE rate per hour plus out-of-pocket expenses. The Company recognized approximately zero and $0.1 million of revenue associated with the reimbursement of formulation work under the service agreement during the three and nine months ended September 30, 2012, respectively. The Company recognized approximately $0.1 million and $0.8 million of revenue associated with the reimbursement of formulation work under the service agreement during the three and nine months ended September 30, 2011, respectively.

 

Ironwood Pharmaceuticals, Inc.

 

In July 2011, the Company entered into a collaboration and license agreement with Ironwood Pharmaceuticals, Inc. (Ironwood) granting Ironwood a license for worldwide rights to the Company’s Acuform drug delivery technology for an undisclosed Ironwood early stage development program.

 

In connection with the agreement, the Company received an upfront payment of $0.9 million which was amortized ratably through June 2012, which was the estimated length of time Depomed was obligated to perform formulation work under the agreement. The Company recognized approximately zero and $0.5 million of revenue associated with this upfront license fee during the three and nine months ended September 30, 2012. The Company recognized approximately $0.2 million of revenue associated with this upfront license fee during the three and nine months ended September 30, 2011. There is no remaining deferred revenue related to this upfront payment at September 30, 2012.

 

Under the terms of the agreement, the Company will assist with initial product formulation and Ironwood will be responsible for all development and commercialization of the product. The initial formulation work performed by the Company under the agreement will be reimbursed by Ironwood on an agreed-upon FTE rate per hour plus out-of-pocket expenses. The Company recognized approximately $0.1 million of revenue associated with the reimbursement of formulation work under the agreement during the nine months ended September 30, 2012 and 2011.

 

In March 2012, the Company achieved the first milestone under the agreement with respect to delivery of experimental batches of prototype formulations that meet required specifications. The associated $1.0 million milestone payment is nonrefundable and was received in June 2012. As the nonrefundable milestone was substantive in nature, achievement of the milestone was not reasonably assured at the inception of the agreement, the milestone was related to past performance, the Company recognized the $1.0 million as revenue during the first quarter of 2012. Under the terms of the agreement, the Company may receive additional payments pending achievement of certain development and regulatory milestones, as well as royalties on product sales.

 

NOTE 5.  LONG-TERM DEBT

 

In June 2008, the Company entered into a loan and security agreement with General Electric Capital Corporation, as agent (GECC), and Oxford Finance Corporation (Oxford) that provided the Company with a $15.0 million credit facility. The credit facility was available in up to three tranches.  The first tranche of $3.8 million was advanced to the Company upon the closing of the loan agreement.  The second tranche of $5.6 million was advanced to the Company in July 2008. The third tranche of $5.6 million was not drawn and is no longer available to the Company, and GECC and Oxford waived the 2% unused line fee related to the unused portion of the credit facility.

 

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The Company paid interest only on the first tranche for the first six months at an interest rate of 11.59%.  Beginning in January 2009, the Company began principal payments on the first tranche, plus interest at such rate, which was paid in 30 equal monthly installments. The second tranche was interest-only through December 31, 2008, with principal and interest paid thereafter in 30 equal monthly installments at an interest rate of 11.59%. Interest expense, which includes amortization of debt issuance costs, was approximately $24,000 and $133,000 for the three and nine months ended September 30, 2011, respectively. The credit facility was paid in full by July 2011.

 

NOTE 6.  STOCK-BASED COMPENSATION

 

The following table presents stock-based compensation expense recognized for stock options, stock awards, restricted stock units and the Company’s employee stock purchase program (ESPP) in the Company’s statements of operations (in thousands):

 

 

 

Three Months Ended September 30,

 

Nine Months Ended September 30,

 

 

 

2012

 

2011

 

2012

 

2011

 

Cost of sales

 

$

10

 

$

17

 

$

32

 

$

50

 

Research and development expense

 

114

 

155

 

460

 

465

 

Selling, general and administrative expense

 

1,157

 

769

 

3,330

 

2,292

 

Total

 

$

1,281

 

$

941

 

$

3,822

 

$

2,807

 

 

At September 30, 2012, the Company had $8.7 million of total unrecognized compensation expense, net of estimated forfeitures, related to stock option grants and restricted stock units that will be recognized over an average vesting period of 2.6 years.

 

For the nine months ended September 30, 2011, the Company recognized approximately $0.4 million in stock-compensation expense associated with the accelerated vesting of stock options in connection with a separation agreement and release with Carl A. Pelzel, the Company’s former President and Chief Executive Officer. See Note 11 for further information with regards to the separation agreement and release.

 

NOTE 7.  COMPREHENSIVE INCOME (LOSS)

 

The following table summarizes components of total comprehensive income (loss) (in thousands):

 

 

 

Three Months Ended September 30,

 

Nine Months Ended September 30,

 

 

 

2012

 

2011

 

2012

 

2011

 

Net income (loss)

 

$

(1,495

)

$

(8,576

)

$

(26,077

)

$

84,563

 

Change in unrealized gains (losses) on available-for-sale securities

 

17

 

(187

)

101

 

(101

)

Total comprehensive income (loss)

 

$

(1,478

)

$

(8,763

)

$

(25,976

)

$

84,462

 

 

NOTE 8.  INVENTORIES

 

Inventories consist of finished goods, raw materials and work in process and are stated at the lower of cost or market and consist of the following (in thousands):

 

 

 

September 30,

 

December 31,

 

 

 

2012

 

2011

 

Raw materials

 

$

1,415

 

$

1,244

 

Work-in-process

 

1,316

 

643

 

Finished goods

 

5,382

 

2,831

 

Deferred costs

 

378

 

677

 

Less: allowance for obsolescence

 

(696

)

 

Total

 

$

7,795

 

$

5,395

 

 

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The fair value of inventories acquired included a step-up in the value of Zipsor inventories of $1.9 million which is being amortized to cost of sales as the acquired inventories are sold.

 

Deferred costs at September 30, 2012 represent the costs of Gralise product shipped for which recognition of revenue has been deferred. Deferred costs at December 31, 2011 represent the costs of Gralise and Proquin XR products shipped for which recognition of revenue was deferred.

 

NOTE 9.   ACCOUNTS PAYABLE AND ACCRUED LIABILITIES

 

Accounts payable and accrued liabilities consist of the following (in thousands):

 

 

 

September 30,

 

December 31,

 

 

 

2012

 

2011

 

 

 

 

 

 

 

Accounts payable

 

$

2,857

 

$

2,417

 

Accrued compensation

 

3,105

 

3,235

 

Accrued rebates and sales discounts

 

3,167

 

2,626

 

Allowance for product returns

 

10,718

 

9,843

 

Accrued contract sales organization fees

 

3,448

 

3,365

 

Other accrued liabilities

 

8,945

 

5,298

 

Total accounts payable and accrued liabilities

 

$

32,240

 

$

26,784

 

 

The other accrued liabilities include approximately $2.0 million costs related to leasehold improvements being performed at the new office building in Newark.

 

NOTE 10.  SHAREHOLDERS’ EQUITY

 

Option Exercises

 

For the three and nine months ended September 30, 2012, employees and consultants exercised options to purchase 167,323 and 470,239 shares of the Company’s common stock with net proceeds to the Company of approximately $0.4 million and $1.4 million, respectively.

 

Employee Stock Purchase Plan

 

In May 2012, the Company sold 109,282 shares under the ESPP. The shares were purchased at a weighted average purchase price of $4.18 per share with proceeds of approximately $0.5 million.

 

NOTE 11.  RELATED PARTY TRANSACTIONS

 

Carl A. Pelzel

 

In April 2011, the Company entered into a separation agreement and release with Carl A. Pelzel, the Company’s former President and Chief Executive Officer. Pursuant to the separation agreement, Mr. Pelzel was being paid $520,000, which is equivalent to one year of his base salary.  Payments are being made over one year, and will be reduced dollar-for-dollar by any compensation Mr. Pelzel receives in connection with employment (or full-time consulting) by another employer (or third party).  The Company is also paying Mr. Pelzel’s health and dental insurance COBRA premiums for up to 18 months following his separation from the Company.  The separation agreement further provides for three months’ accelerated vesting of Mr. Pelzel’s options to purchase the Company’s common stock, and a release of claims in favor of the Company.  The Company incurred a one-time severance charge of approximately $1.0 million in the second quarter of 2011 with respect to this separation agreement, consisting of approximately $0.4 million in stock-based compensation related to the accelerated vesting of Mr. Pelzel’s awards and approximately $0.6 million of severance expense related to future payments and health care benefits.

 

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NOTE 12.  INCOME TAXES

 

As of September 30, 2012 and December 31, 2011, the Company had $3.6 million and $3.6 million of unrecognized tax benefits, respectively. All tax years since inception remain open to examination by the Internal Revenue Service and the California Franchise Tax Board until such time the Company’s net operating losses and credits are either utilized or expire. Interest and penalties, if any, related to unrecognized tax benefits, would be recognized as income tax expense by the Company. The Company does not have any accrued interest or penalties associated with unrecognized tax benefits.  The Company does not foresee any material changes to unrecognized tax benefits within the next twelve months except as related to any new items impacting the current year operations.

 

NOTE 13. LEASES

 

In April 2012, the Company entered into an office and laboratory lease agreement to lease approximately 52,500 rentable square feet in Newark, California commencing on December 1, 2012. The Company is obligated to lease approximately 8,000 additional rentable square feet commencing no later than December 1, 2015.  The Lease will expire on November 30, 2022.  However, the Company has the right to renew the lease for one additional five year term, provided that written notice is made to the landlord no later than 12 months prior to the lease expiration. The Company will have the one-time right to terminate the lease in its entirety effective as of November 30, 2017 by delivering written notice to the landlord on or before December 1, 2016.  In the event of such termination, the Company will pay the landlord the unamortized portion of the tenant improvement allowance, specified additional allowances made by the landlord, waived base rent and leasing commissions, in each case amortized at 8% interest.

 

The Company was allowed to control physical access to the premises upon signing the lease therefore, in accordance with the applicable accounting guidance, the lease term was deemed to have commenced in April 2012. Accordingly, the rent free periods and the escalating rent payments contained within the lease are being recognized on a straight-line basis from April 2012. The Company will pay approximately $12.2 million in aggregate as rent over the term of the lease for the above premises. Rent expense and deferred rent for the new lease was approximately $0.3 million and $0.6 million for the three and nine months ended September 30, 2012.

 

NOTE 14. BUSINESS COMBINATIONS

 

On June 21, 2012, the Company entered into an Asset Purchase Agreement with Xanodyne, pursuant to which Depomed acquired Xanodyne’s product Zipsor and related inventory for $26.4 million in cash, and assumed certain product related liabilities relating to Zipsor. In addition, the Company will make a one-time contingent payment to Xanodyne of $2.0 million in cash at the end of the first calendar year in which Depomed’s net sales of Zipsor® products exceed $30.0 million and an additional, one-time contingent payment to Xanodyne of $3.0 million in cash at the end of the first year in which Depomed’s net sales of Zipsor® products exceed $60.0 million.

 

In accordance with the authoritative guidance for business combinations, the Asset Purchase Agreement with Xanodyne was determined to be a business combination and was accounted for using the acquisition method of accounting. Neither separate financial statements nor pro forma results of operations have been presented because the acquisition transaction does not meet the qualitative or quantitative materiality tests under Regulation S-X.

 

Pursuant to the Asset Purchase Agreement, $3.0 million of the initial payment will be held in escrow for eighteen months and applied towards the indemnification obligations of Xanodyne as set forth in the Asset Purchase Agreement.

 

The following table presents a summary of the purchase price consideration for the Zipsor acquisition (in thousands):

 

Cash for Zipsor and related inventories

 

$

26,436

 

Fair Value of contingent consideration

 

1,303

 

Purchase Price

 

$

27,739

 

 

The contingent consideration was recognized and measured at fair value as of the acquisition date and is included within other long-term liabilities in the accompanying balance sheet. The Company determined the acquisition date fair value of the contingent consideration obligation based on an income approach derived from Zipsor revenue estimates and a probability assessment with respect to the likelihood of achieving the level of net sales that would trigger the contingent payment. The fair value measurement is based on significant inputs not observable in the market and thus represents a Level 3 measurement as defined in fair value measurement accounting. The key assumptions in determining the fair value are the discount rate and the probability assigned to the potential milestones being achieved. At each reporting date, the Company will re-measure the contingent consideration obligation to estimated fair value. Any changes in the fair value of contingent consideration will be recognized in operating expenses until the contingent consideration arrangement is settled.

 

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The following table summarizes the fair values of the tangible and identifiable intangible assets acquired and liabilities assumed at the acquisition date (in thousands):

 

Intangible asset - Zipsor product rights

 

$

27,100

 

Inventories

 

2,428

 

Other assets

 

100

 

Property, plant and equipment

 

43

 

Current liabilities

 

(1,840

)

Bargain purchase

 

(92

)

 

 

$

27,739

 

 

The Zipsor product rights of $27.1 million have been recorded as intangible assets on the accompanying condensed balance sheet and are being amortized over the estimated useful life of the asset on a straight-line basis through July 2019. Total amortization expense for the three and nine months ended September 30, 2012 was approximately $1.0 million and $1.1 million, respectively.

 

The fair value of inventories acquired included a step-up in the value of Zipsor inventories of $1.9 million which is being amortized to cost of sales as the acquired inventories are sold. The bargain purchase amount has been recorded within Interest and other income in the accompanying condensed statement of operations and comprehensive income.

 

NOTE 15. COMMITMENTS AND CONTINGENCIES

 

Legal matters

 

Depomed v. Sun Pharmaceuticals and Depomed v. Watson Laboratories (Glumetza ANDA Litigation)

 

In June 2011, the Company filed a lawsuit in the United States District Court for the District of New Jersey against Sun Pharmaceutical Industries Inc., Sun Pharma Global FZE and Sun Pharmaceuticals Industries Ltd. (collectively, Sun), for infringement of five (5) U.S. patents listed in the Orange Book for the Glumetza product. The lawsuit is in response to an Abbreviated New Drug Application (ANDA) filed by Sun with the FDA regarding Sun’s intent to market generic versions of 500mg and 1000mg dosage strengths of Glumetza prior to the expiration of the Orange Book patents, which includes U.S. Patent Nos.: 6,340,475, 6,488,962, 6,635,280, 6,723,340 and 7,780,987. U.S. Patent No. 7,736,667 is also being asserted against Sun in the lawsuit. Valeant International Bermuda (f/k/a Valeant International (Barbados) SRL) is joined in the lawsuit as a co-plaintiff as the owner of U.S. Patent No. 7,780,987.  The lawsuit commenced within the 45 days required to automatically stay, or bar, the FDA from approving Sun’s ANDA for 30 months or until a district court decision that is adverse to the patents, whichever occurs earlier.  A claim construction hearing, known as a “Markman hearing,” was conducted before Judge Pisano on July 18, 2012.  Absent a court order, the 30-month stay is expected to expire in November 2013.

 

In April 2012, the Company filed a lawsuit in the United States District Court for the District of Delaware against Watson Laboratories, Inc. — Florida, Watson Pharmaceuticals, Inc. and Watson Pharma, Inc. (collectively, Watson), for infringement of the two patents listed in the Orange Book for Glumetza 1000 mg (U.S. Patent Nos. 6,488,962 and 7,780,987).  The lawsuit is in response to an ANDA filed by Watson with the FDA regarding Watson’s intent to market a generic version of the 1000 mg dosage strength of Glumetza prior to the expiration of the asserted patents.  Valeant International Bermuda (f/k/a Valeant International (Barbados) SRL) is joined in the lawsuit as a co-plaintiff as the owner of U.S. Patent No. 7,780,987.  The Company commenced the lawsuit within the 45 days required to automatically stay, or bar, the FDA from approving Watson’s ANDA for 30 months or until a district court decision that is adverse to the patents, whichever may occur earlier.  Absent a court order, the 30-month stay is expected to expire in September 2014.

 

Depomed v. Gralise ANDA Filers

 

In March 2012, the Company filed a lawsuit in the United States District Court for the District of New Jersey against Actavis Elizabeth LLC and Actavis Inc. (collectively Actavis), Watson Laboratories, Inc. — Florida, Watson Pharma, and Watson Laboratories (collectively Watson) and Incepta Pharmaceuticals (Incepta) for infringement of six (6) U.S. patents listed in the Orange Book for the Gralise product.  The lawsuit is in response to ANDAs filed by each of Actavis, Watson and Incepta with the FDA regarding the defendants’ intent to market generic versions of 300mg and 600mg dosage strengths of Gralise prior to the expiration of the Orange Book patents, which includes U.S. Patent Nos.: 6,340,475, 6,488,962, 6,635,280, 6,723,340, 7,438,927 and 7,731,989.  The Company commenced the lawsuit within the 45 days required to automatically stay, or bar, the FDA from approving the ANDAs for 30 months or until a district court decision that is adverse to the asserted patents, whichever may occur earlier. Absent a court order, the 30-month stays are expected to expire in July 2014 and August 2014.  In August 2012, the Company amended the complaint to assert U.S. Patent No. 8,192,756 and add Abon Pharmaceuticals LLC as a defendant.  In September 2012, the Company amended the complaint to assert U.S. Patent No. 8,252,332. Each of these patents is listed in the Orange Book.

 

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In April 2012, the Company filed a lawsuit in the United States District Court for the District of New Jersey against Impax Laboratories (Impax) and Par Pharmaceuticals (Par) for infringement of six (6) U.S. patents listed in the Orange Book for the Gralise product.  The lawsuit is in response to ANDAs filed by each of Impax and Par with the FDA regarding the defendants’ intent to market generic versions of 300mg and 600mg dosage strengths of Gralise prior to the expiration of the Orange Book patents, which includes U.S. Patent Nos.: 6,340,475, 6,488,962, 6,635,280, 6,723,340, 7,438,927 and 7,731,989.  In October 2012, Impax withdrew its Gralise ANDA.  As a result, we and Impax agreed to stipulate to this dismissal of the Company’s lawsuit against Impax for infringement of the Gralise Orange Book listed patents. The Company commenced the lawsuit against Par within the 45 days required to automatically stay, or bar, the FDA from approving the ANDAs for 30 months or until a district court decision that is adverse to the asserted patents, whichever may occur earlier.  Absent a court order, the 30-month stay is expected to expire in September 2014. In August 2012 and September 2012, the Company amended the complaint to assert respectively U.S. Patent No. 8,192,756 and U.S. Patent No. 8,252,332, which are now listed in the Orange Book.

 

In May 2012, the Company filed lawsuit in the United States District Court for the District of New Jersey against Zydus Pharmaceuticals Inc. and Cadila Healthcare Limited (collectively Zydus) for infringement of six (6) U.S. patents listed in the Orange Book for the Company’s Gralise product.  The lawsuit is in response to the ANDAs filed by Zydus with the FDA regarding Zydus’s intent to market generic versions of 300mg and 600mg dosage strengths of Gralise prior to the expiration of the Orange Book patents, which includes U.S. Patent Nos.: 6,340,475, 6,488,962, 6,635,280, 6,723,340, 7,438,927 and 7,731,989.  The Company commenced the lawsuit within the 45 days required to automatically stay, or bar, the FDA from approving the ANDAs for 30 months or until a district court decision that is adverse to the asserted patents, whichever may occur earlier.  Absent a court order, the 30-month stays are expected to expire in October and November 2014.  In August 2012 and September 2012, the Company amended the complaint to assert respectively U.S. Patent No. 8,192,756 and U.S. Patent No. 8,252,332, which are now listed in the Orange Book.

 

On June 13, 2012, the Court held the Case Management Conference.  The Court ordered all three suits to be consolidated for purposes of all pretrial proceedings.  The Pretrial Conference in the suits is scheduled for March 13, 2014.  No specific trial date has been set.  The Company expects a Markman claim construction hearing to occur in the spring 2013.  No specific date for the Markman hearing has been set.

 

Depomed v. FDA

 

In November 2010, the FDA granted Gralise Orphan Drug designation for the management of PHN based on a plausible hypothesis that Gralise is “clinically superior” to immediate release gabapentin due to the incidence of adverse events observed in Gralise clinical trials relative to the incidence of adverse events reported in the package insert for immediate release gabapentin. Generally, an Orphan-designated drug approved for marketing is eligible for seven years of regulatory exclusivity for the orphan-designated indication. If granted, Orphan Drug exclusivity for Gralise will run for seven years from January 28, 2011. However, the FDA has indicated to us that Gralise is not currently eligible for Orphan Drug exclusivity because the hypothesis upon which the product’s Orphan Drug designation was granted has not been proven. In September 2012, the Company filed an action in federal district court for the District of Columbia against the FDA seeking an order requiring the FDA to grant Gralise Orphan Drug exclusivity for the management of PHN. The Company believes Gralise is entitled to Orphan Drug exclusivity as a matter of law, and the FDA’s action is not consistent with the statute or FDA’s regulations related to orphan drugs. The lawsuit seeks a determination by the court that Gralise is protected by Orphan Drug exclusivity, and an order that FDA act accordingly. The FDA has not yet filed an answer to the complaint filed by the Company.

 

The Company cannot reasonably predict the outcome of these legal proceedings, nor can it estimate the amount of loss, or range of loss, if any, that may result from these proceedings. As such the Company is not currently able to estimate the impact of the above litigations on its financial position or results of operations.

 

NOTE 16. SUBSEQUENT EVENTS

 

In October 2012, the FDA accepted for review the NDA filing for Serada for the treatment of menopausal hot flashes. The NDA will be subject to a standard review and will have a Prescription Drug User Fee Act (PDUFA) action date of May 31, 2013. The FDA has informed the Company that the FDA’s Reproductive Health Drugs Advisory Committee will discuss the Serada NDA at an Advisory Committee meeting tentatively scheduled for March 4, 2013.

 

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ITEM 2. 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 Quarterly Report on Form 10-Q that are not statements of historical fact are forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended (the Securities Act), and Section 21E of the Securities Exchange Act of 1934, as amended.  We have based these forward-looking statements on our current expectations and projections about future events.  Our actual results could differ materially from those discussed in, or implied by, these forward-looking statements. Forward-looking statements are identified by words such as “believe,” “anticipate,” “expect,” “intend,” “plan,” “will,” “may” and other similar expressions.  In addition, any statements that refer to expectations, projections or other characterizations of future events or circumstances are forward-looking statements. Forward-looking statements include, but are not necessarily limited to, those relating to:

 

·                  the commercial success and market acceptance of Gralise® (gabapentin), our once-daily product for the management of postherpetic neuralgia, and Zipsor® (diclofenac potassium) liquid filled capsules, our NSAID for the treatment of mild to moderate pain in adults;

·                  the commercial success of Glumetza® (metformin hydrochloride extended-release tablets) in the United States, and the efforts of our Glumetza commercial partner, Santarus, Inc. (Santarus);

·                  the results of our ongoing litigation against filers of abbreviated New Drug Applications (each, an ANDA) to market generic Gralise in the United States;

·                  the results of our ongoing litigation with the FDA to obtain orphan drug exclusivity for Gralise in the United States;

·                  the outcome of our ongoing litigation against filers of ANDAs to market generic Glumetza in the United States;

·                  any additional patent infringement or other litigation that may be instituted related to Gralise, Zipsor, Glumetza or any other of our products or product candidates;

·                  our and our collaborative partners’ compliance or non-compliance with legal and regulatory requirements related to the promotion of pharmaceutical products in the United States;

·                  our plans to in-license, acquire or co-promote other products;

·                  the commercial success and market acceptance of Serada if we receive approval to market Serada in the United States;

·                  the results and timing of our clinical trials;

·                  the results of our research and development efforts;

·                  submission, acceptance and approval of regulatory filings;

·                  our need for, and ability to raise, additional capital; and

·                  our collaborative partners’ compliance or non-compliance with obligations under our collaboration agreements.

 

Factors that could cause actual results or conditions to differ from those anticipated by these and other forward-looking statements include those more fully described in the “RISK FACTORS” section and elsewhere in this Quarterly Report on Form 10-Q. We disclaim any intent or obligation to update or revise these forward-looking statements to reflect new events or circumstances.

 

ABOUT DEPOMED

 

Depomed is a specialty pharmaceutical company initially focused on pain and other conditions and diseases of the central nervous system.  The centerpieces of our specialty pharmaceutical business are Gralise® (gabapentin), a once-daily product for the management of postherpetic neuralgia that we launched and made commercially available in October 2011, and Zipsor® (diclofenac potassium) liquid filled capsules, a product for the treatment of mild to moderate acute pain that we acquired from Xanodyne Pharmaceuticals, Inc. (Xanodyne) in June 2012.  We promote Gralise and Zipsor with a field force of 155 full-time sales representatives who are Depomed employees, and 78 part-time sales representatives dedicated to the Company and employed by a contract sales organization.  We are actively seeking to expand our product portfolio through in-licensing, acquiring or obtaining co-promotion rights to commercially available products or late-stage product candidates that could be marketed and sold effectively with our existing products through our sales and marketing capability.

 

We also have a portfolio of royalty and milestone producing assets based on our proprietary drug delivery technologies.  The cornerstone of that portion of our business is Glumetza®, a once-daily treatment for adults with type 2 diabetes that we licensed to, and is currently being commercialized by, Santarus, Inc. (Santarus) in the United States.  We have license and development arrangements associated with our Acuform gastroretentive drug delivery technology with Covidien, Ltd. (Covidien), Janssen Pharmaceutica N.V. (Janssen N.V.), Janssen Pharmaceuticals, Inc. (Janssen), Boehringer Ingelheim International GMBH (Boehringer Ingelheim) and Ironwood Pharmaceuticals, Inc. (Ironwood) and a license agreement with Merck & Co., Inc. (Merck).

 

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In addition, we have two product candidates in clinical development, Serada® and DM-1992. We submitted a New Drug Application, or NDA, in July 2012 for Serada for the treatment of menopausal hot flashes.  The NDA has been accepted for review by the United States Food and Drug Administration, or FDA, and we have a Prescription Drug User Fee Act, or PDUFA, goal date of May 31, 2013.  The FDA has tentatively scheduled an Advisory Committee meeting to discuss the Serada NDA for March 4, 2013.  DM-1992 is currently in Phase 2 trials for Parkinson’s disease.

 

Commercialized Products and Product Candidate Development Pipeline

 

The following table summarizes our and our partners’ commercialized products and product candidate development pipeline:

 

Depomed Commercialized Products

 

Product

 

Indication

 

Status

 

 

 

 

 

Gralise®

 

Postherpetic neuralgia

 

Currently sold in the United States.
Launched in October 2011

 

 

 

 

 

Zipsor®

 

Mild to moderate acute pain

 

Currently sold in the United States.
Acquired by Depomed in June 2012

 

Partner Commercialized Products and Product Candidates

 

Product / Product
Candidate

 

Indication

 

Partner

 

Status

 

 

 

 

 

 

 

Glumetza®

 

Type 2 diabetes

 

United States rights held by Santarus; Canadian rights held by Valeant

 

Currently sold in the United States and Canada

 

 

 

 

 

 

 

Janumet® XR

 

Type 2 diabetes

 

Merck

 

Currently sold in the United States, Foreign regulatory filings in process

 

 

 

 

 

 

 

NUCYNTA® ER

 

Moderate to severe chronic pain; neuropathic pain associated with diabetic peripheral neuropathy (DPN)

 

Janssen

 

License covers sales of NUCYNTA®ER in the United States, Canada and Japan

 

 

 

 

 

 

 

SGLT2 inhibitor/metformin XR combination product

 

Type 2 diabetes

 

Janssen N. V.

 

NDA for SGLT2 inhibitor filed June 2012

 

 

 

 

 

 

 

Boehringer compounds/metformin XR combination product

 

Type 2 diabetes

 

Boehringer Ingelheim

 

Twice daily combination of metformin and DPP4 inhibitor approved in United States in February 2012

 

 

 

 

 

 

 

Acetaminophen/opiate combination

 

Pain

 

Covidien

 

1st and 2nd formulation

 

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products

 

 

 

 

 

launch as early as 2014

 

 

 

 

 

 

 

Undisclosed Ironwood compounds using Acuform® drug delivery technology

 

Gastrointestinal

 

Ironwood

 

Early stage development

 

Depomed Product Pipeline

 

Product

 

Indication

 

Status

 

 

 

 

 

Serada®

 

Menopausal hot flashes

 

Three Phase 3 studies completed (Breeze 1, Breeze 2, and Breeze 3); NDA submitted July 31, 2012; FDA accepted for review the NDA filing in October 2012

 

 

 

 

 

DM-1992

 

Parkinson’s disease

 

Phase 2 study completed in September 2012 Data evaluation and program assessment ongoing

 

Significant Developments and Highlights for the Quarter Ended September 30, 2012

 

·                  In July 2012, we submitted a New Drug Application (NDA) for Serada for the treatment of menopausal hot flashes to the FDA. In October 2012, the FDA accepted for review the NDA filing for Serada.

·                  In July 2012, our sales force began promotion of Zipsor, which we acquired in June 2012.

·                  In August 2012, we entered into a non-exclusive license agreement with Janssen Pharmaceuticals, Inc granting Janssen a license to certain patents related to the Company’s Acuform technology for Nucynta ER, which triggered a $10.0 million upfront payment which was received and recognized in the third quarter.

·                  In September 2012, we converted our full-time contract sales representatives to direct Depomed employees.

·                  In September, we filed an action in federal district court for the District of Columbia against the Food and Drug Administration, seeking an order requiring the FDA to grant Gralise Orphan Drug exclusivity for the management of postherpetic neuralgia.

 

PRODUCT DEVELOPMENTS AND TRANSACTIONS

 

Gralise® (gabapentin) tablets for the Management of Postherpetic Neuralgia

 

In October 2011, we launched and announced the commercial availability of Gralise. Gralise product sales for the three and nine months ended September 30, 2012 were $4.8 million and $9.7 million, respectively.

 

Ventiv Commercial Services, LLC. In June 2011, we entered into a service agreement with Ventiv Commercial Services, LLC (Ventiv), pursuant to which Ventiv’s outsourced sales business, inVentiv Selling Solutions, provided us with sales force recruiting, training, deployment and ongoing operational support to promote Gralise. The agreement provided for a sales force of 164 full-time sales representatives dedicated to the Company, all of whom were employees of Ventiv. The sales representatives were hired in September 2011, began promoting Gralise to physicians in October 2011 and began promoting Zipsor to physicians at the end of July 2012. Members of sales management are our employees.

 

Under the terms of the agreement, we incurred an upfront implementation fee, and we paid fixed monthly management fees. The monthly management fee was subject to adjustment for actual staffing levels. A portion of the monthly management fee was payable only on Ventiv’s achievement of specified performance objectives. We also paid certain pass-through costs of Ventiv. In June 2012, we exercised an early termination clause under the agreement to end the agreement in September 2012 in conjunction with converting the sales representatives to Depomed employees. In September 2012, the Company converted the full-time sales representatives to Depomed employees to fill 155 territories.

 

In May 2012, we entered into an additional service agreement with Ventiv, which provides for 78 part-time contract sales representatives dedicated to the Company, all of whom are employees of Ventiv. Under the terms of the agreement, we incurred an upfront implementation fee, and we pay fixed monthly management fees. The monthly management fee is subject to adjustment for actual staffing levels.  The initial term of the agreement is for one year, with the option to extend the agreement for a longer period.

 

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Zipsor (diclofenac potassium) liquid-filled capsules for Mild to Moderate Acute Pain

 

On June 21, 2012, we entered into an Asset Purchase Agreement with Xanodyne, pursuant to which we acquired Xanodyne’s product Zipsor and related inventory for $26.4 million in cash, and assumed certain liabilities relating to Zipsor. In addition, the agreement requires a one-time contingent payment to Xanodyne of $2.0 million in cash at the end of the first calendar year in which our net sales of Zipsor products exceed $30.0 million and an additional, one-time contingent payment to Xanodyne of $3.0 million in cash at the end of the first year in which our net sales of Zipsor products exceed $60.0 million. We also purchased Xanodyne’s existing inventory and samples of Zipsor for approximately $0.5 million.  We assumed responsibility for returns on product previously sold by Xanodyne with a fair value of $1.8 million as of the date of purchase. We began commercial sales of Zipsor in June 2012. We recognized $4.9 million in Zipsor revenue for the three months ended September 30, 2012.

 

Glumetza for Type 2 Diabetes

 

Santarus.  In August 2011, we entered into a commercialization agreement with Santarus granting Santarus exclusive rights to manufacture and commercialize Glumetza in the United States. The commercialization agreement supersedes the previous promotion agreement between the parties originally entered into in July 2008. Under the commercialization agreement, we granted Santarus exclusive rights to manufacture and commercialize Glumetza in the United States in return for a royalty on Glumetza net sales.

 

Pursuant to the commercialization agreement, we transitioned to Santarus responsibility for manufacturing, distribution, pharmacovigilance and regulatory affairs. We ceased shipments of Glumetza in August 2011, and Santarus began selling Glumetza in September 2011. Santarus is responsible for advertising and promotional marketing activities for Glumetza. In November 2011, we and Santarus entered into an assignment and assumption agreement pursuant to which Santarus assumed all of our rights and obligations under our commercial manufacturing agreement with Patheon, which provides that Patheon will serve as Santarus’ sole commercial supplier of the 500mg Glumetza in the United States. Santarus pays us royalties on net product sales of Glumetza in the United States of 29.5% in 2012; 32.0% in 2013 and 2014; and 34.5% in 2015 and beyond prior to generic entry of a Glumetza product.  Santarus has the exclusive right to commercialize authorized generic versions of the Glumetza products. In the event of generic entry of a Glumetza product in the territory, the parties will equally share proceeds based on a gross margin split.

 

In connection with its assumption of distribution and sales responsibility of Glumetza, Santarus purchased our existing inventory of Glumetza and bulk metformin hydrochloride at cost.  We will be financially responsible for returns of Glumetza distributed by us, up to the amount of our product returns reserve account for Glumetza product returns on the date immediately before Santarus began distributing Glumetza.  We will also be financially responsible for Glumetza rebates and chargebacks up to the amount of our reserve account for those items.  Santarus will be responsible for all other Glumetza returns, rebates and chargebacks.

 

Under the commercialization agreement, we will continue to manage the ongoing patent infringement lawsuit against Sun Pharmaceutical Industries, Inc. (Sun), subject to certain consent rights in favor of Santarus, including with regard to any proposed settlements.  Santarus will reimburse us for 70% of our out-of-pocket costs, and we will reimburse Santarus for 30% of its out-of-pocket costs related to these two infringement cases. We were also responsible for managing the patent infringement lawsuit with Lupin Limited (Lupin), which was settled in February 2012.

 

During 2011, we sold Glumetza for the first eight months of the year, recognized Glumetza product sales and paid Santarus a promotion fee equal to 75% of Glumetza gross margin. In August 2011, the distribution and sales responsibility transitioned to Santarus and Santarus started paying us a royalty on net sales of Glumetza. For the three and nine months ended September 30, 2011, the Company recognized $6.0 million and $27.3 million, respectively, in promotion fee expense to Santarus related to sales of Glumetza by Depomed.

 

We recognized $11.6 million and $30.2 million in royalty revenue for the three and nine months ended September 30, 2012, respectively, under the commercialization agreement.

 

Litigation.

 

We are involved in patent litigation associated with Glumetza against Sun and Watson, as described below under “Legal Proceedings”. In February 2012, we and Santarus entered into a settlement and license agreement with Lupin to resolve patent litigation involving Glumetza.  The agreement grants Lupin the right to begin selling a generic version of Glumetza on February 1, 2016, or earlier under certain circumstances.

 

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Serada® for Menopausal Hot Flashes

 

Serada is our proprietary extended release formulation of gabapentin in development for the treatment of menopausal hot flashes. We have completed three Phase 3 clinical trials evaluating Serada for menopausal hot flashes.

 

Study Design.  Breeze 3 was a randomized, double-blind, placebo-controlled study of 600 patients. Patients were randomized into one of two treatment arms, with patients receiving either placebo or a total dose of 1800mg of Serada dosed 600mg in the morning and 1200mg in the evening. The co-primary efficacy endpoints in the study were reductions in the mean frequency of moderate-to-severe hot flashes, and the average severity of hot flashes, measured after four and 12 weeks of stable treatment. As in the prior Breeze 1 trial, the treatment duration of the study was 24 weeks, to address the FDA’s view that an effective drug should also show statistically significant persistence of efficacy at 24 weeks. The trial also included a responder analysis to assess the clinical meaningfulness of any reduction in the frequency of hot flashes in the active arm relative to the placebo arm.

 

In August 2010, we reached agreement with the FDA regarding a Special Protocol Assessment (SPA) on the design and analysis of Breeze 3. An SPA is an agreement with the FDA that a proposed trial protocol design, clinical endpoints and statistical analyses are acceptable to support a product candidate’s regulatory approval. We began enrollment in Breeze 3 in August 2010 and completed enrollment in March 2011.

 

Study Results.  Under the statistical analyses set forth in the SPA, certain primary endpoints did not meet statistical significance. The primary severity endpoints were achieved with statistical significance at four weeks (p < 0.001) and 12 weeks (p < 0.01). The frequency endpoint at four weeks was achieved with statistical significance (p < 0.001). The frequency endpoint at 12 weeks, as well as the key secondary frequency and severity endpoints at 24 weeks, were not met.

 

Serada was generally well tolerated in Breeze 3. The most common adverse events were dizziness and somnolence. The incidence of dizziness in the active arm was 12.7% compared to 3.4% for the placebo arm. Somnolence was 6.0% in the active arm compared to 2.7% in the placebo arm. Withdrawals due to adverse events in the active arm were 17%, compared to 12% in the placebo arm.

 

In April 2012, we completed a Type B Pre-NDA meeting with the FDA to discuss the results of our three completed Phase 3 clinical trials for Serada. Based on the results of that meeting, we submitted a New Drug Application with the FDA in July 2012. In October 2012, the FDA accepted for review the NDA filing for Serada.  The NDA will be subject to a standard review and will have a Prescription Drug User Fee Act (PDUFA) action date of May 31, 2013. The FDA has informed us that the FDA’s Reproductive Health Drugs Advisory Committee will discuss the Serada NDA at an Advisory Committee meeting tentatively scheduled for March 4, 2013.

 

Janssen Pharmaceutica N.V.

 

In August 2010, we entered into a non-exclusive license agreement with Janssen N.V. granting Janssen N.V. a license to certain patents related to our Acuform drug delivery technology to be used in developing fixed dose combinations of canagliflozin and extended release metformin. Janssen paid us a $5.0 million upfront license fee associated with the license agreement. The $5.0 million was amortized ratably through March 2011, which is the estimated length of time we were obligated to perform formulation work under the agreements. We recognized approximately $1.9 million of revenue associated with this upfront license fee during the first quarter of 2011.

 

We also entered into a service agreement with Janssen under which we provide formulation work for Janssen and are reimbursed by Janssen on an agreed-upon FTE rate per hour plus out-of-pocket expenses. We recognized approximately $0.3 million of revenue associated with the reimbursement of formulation work under the service agreement during the first quarter of 2011.

 

All formulation work under the agreement was completed at March 31, 2011 and there is no remaining deferred revenue.

 

Janssen Pharmaceuticals, Inc.

 

In August 2012, we entered into a non-exclusive license agreement with Janssen Pharmaceuticals, Inc. (Janssen) granting Janssen a license to the Company’s Acuform technology as well as other rights to certain Acuform patents. In exchange, we received a $10.0 million upfront fee in the third quarter of 2012. We are also eligible to receive a one-time sales milestone upon achievement of a specified level of quarterly net sales, as well as low single digit royalties on net sales of NUCYNTA® ER (tapentadol extended-release tablets) in the U.S., Canada and Japan from and after July 2, 2012 through December 31, 2021. We have no development obligations under the agreement. We recognized the entire $10.0 million as license revenue in the third quarter of 2012.

 

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Merck & Co., Inc.

 

We have received $12.5 million in upfront and milestone payments and will receive very low single digit royalties on Merck’s net sales of Janumet XR in the United States and other licensed territories through the expiration of the licensed patents under a July 2009 license agreement with Merck & Co., Inc. (Merck). The non-exclusive license agreement grants Merck a license as well as other rights to certain of our patents directed to metformin extended release technology for Janumet XR, Merck’s fixed-dose combination product for type 2 diabetes containing sitagliptin and extended release metformin that was approved by the FDA in January 2012. Merck began selling Janumet XR during the first quarter of 2012.

 

Boehringer Ingelheim

 

In March 2011, we entered into a license and service agreement with Boehringer Ingelheim granting Boehringer Ingelheim a license to certain patents related to our Acuform drug delivery technology to be used in developing fixed dose combinations of extended release metformin and proprietary Boehringer Ingelheim compounds in development for type 2 diabetes.

 

In connection with the license and service agreement, we received the upfront license payment of $10.0 million less applicable withholding taxes of approximately $1.5 million, for a net receipt of approximately $8.5 million in April 2011. We received the remaining $1.5 million of taxes previously withheld directly from German tax authorities in June 2011.

 

In March 2012, we received an additional $2.5 million upon delivery of experimental batches of prototype formulations that met agreed-upon specifications, and we may receive additional milestone payments based on regulatory filings and approval events, as well as royalties on worldwide net sales of products.

 

We were responsible for providing certain initial formulation work associated with the fixed dose combination products. Services performed by us under the agreement were reimbursed by Boehringer Ingelheim on an agreed-upon rate, and out-of-pocket expenses were reimbursed.  All formulation work required by Depomed has been completed.

 

Ironwood Pharmaceuticals, Inc.

 

In July 2011, we entered into a collaboration and license agreement with Ironwood Pharmaceuticals, Inc. (Ironwood) granting Ironwood a license for worldwide rights to certain patents and other intellectual property rights to our Acuform drug delivery technology for an undisclosed Ironwood early stage development program. In connection with the research collaboration and license agreement, we received an upfront payment of $0.9 million.

 

In March 2012, we achieved the first milestone under the agreement upon delivery of experimental batches of prototype formulations that met agreed-upon specifications. This triggered a nonrefundable $1.0 million milestone payment which we received in May 2012. We may also receive milestone payments based on achievement of certain development and regulatory milestones, as well as royalties on product sales.

 

Under the agreement, we are responsible for assisting with initial product formulation and Ironwood is responsible for all development and commercialization of the product. The initial formulation work we perform is reimbursed by Ironwood on an agreed-upon FTE rate per hour plus out-of-pocket expenses.

 

DM-1992 for Parkinson’s Disease

 

In January 2012, we initiated a Phase 2 study to evaluate DM-1992 for the treatment of motor symptoms associated with Parkinson’s disease. The trial enrolled 34 patients at 8 U.S. centers and enrollment was completed in July 2012. The trial is a randomized, active-controlled, open-label, crossover study testing DM-1992 dosed twice daily against a generic version of immediate-release carbidopa-levodopa dosed as needed. The study will assess efficacy, safety and pharmacokinetic variables. The primary endpoint for the study is change in off time as measured by patient self-assessment and clinician assessment.

 

CRITICAL ACCOUNTING POLICIES

 

Critical accounting policies are those that require significant judgment and/or estimates by management at the time that the financial statements are prepared such that materially different results might have been reported if other assumptions had been made. We consider certain accounting policies related to revenue recognition, accrued liabilities and stock-based compensation to be critical policies. There have been no changes to our critical accounting policies since we filed our 2011 Annual Report on Form 10-K with the Securities and Exchange Commission on March 8, 2012. For a description of our critical accounting policies, please refer to our 2011 Annual Report on Form 10-K.

 

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RESULTS OF OPERATIONS

 

Our results of operations in 2012 will differ significantly from our reported results for 2011. For example, in 2011 we recognized $48 million in milestone revenue and a $40 million gain on settlement with regard to termination of our agreement with Abbott relating to Gralise. These were one-time payments and will not recur in 2012. In 2011, we reflect eight months of Glumetza product revenue, cost of sales and corresponding promotion expense to Santarus and four months of Glumetza royalty revenue from Santarus. As a result of the restructuring of our agreement with Santarus in August 2011, we will recognize royalty revenue from Santarus in 2012, but no product revenue or promotion expense for Glumetza. In 2011, we recognized $0.5 million of revenue from sales of Gralise and a partial year of corresponding sales and marketing expense. We expect to recognize a full year of Gralise sales in 2012 and to incur a full year of sales and marketing expense in 2012. Accordingly, we expect Gralise product sales and selling, general and administrative expense to be substantially higher in 2012 than in 2011. In addition, we acquired Zipsor in June 2012 and Zipsor revenue and expense is reflected in our results of operations for the quarter ended September 30, 2012.

 

Three and Nine Months Ended September 30, 2012 and 2011

 

Revenue

 

Total revenues are summarized in the following table (in thousands):

 

 

 

Three Months Ended September 30,

 

Nine Months Ended September 30,

 

 

 

2012

 

2011

 

2012

 

2011

 

 

 

 

 

 

 

 

 

 

 

Product sales:

 

 

 

 

 

 

 

 

 

Gralise

 

$

4,758

 

$

 

$

9,708

 

$

 

Zipsor

 

4,926

 

 

4,926

 

 

Glumetza

 

 

9,205

 

 

40,657

 

Proquin XR

 

 

 

360

 

12

 

Total product sales

 

9,684

 

9,205

 

14,994

 

40,669

 

 

 

 

 

 

 

 

 

 

 

Royalties:

 

 

 

 

 

 

 

 

 

Santarus

 

11,603

 

2,091

 

30,249

 

2,105

 

Other

 

598

 

88

 

950

 

307

 

Total royalty revenue

 

12,201

 

2,179

 

31,199

 

2,412

 

 

 

 

 

 

 

 

 

 

 

License and other revenue:

 

 

 

 

 

 

 

 

 

Gralise

 

$

 

$

 

$

 

$

60,592

 

Glumetza

 

1,388

 

962

 

4,162

 

5,222

 

Boehringer Ingelheim

 

 

3,902

 

2,617

 

9,368

 

Janssen

 

10,005

 

 

10,005

 

2,251

 

Other

 

4

 

274

 

1,249

 

327

 

Total license and other revenue:

 

11,397

 

5,138

 

18,033

 

77,760

 

 

 

 

 

 

 

 

 

 

 

Total revenues

 

$

33,282

 

$

16,522

 

$

64,226

 

$

120,841

 

 

Product sales

 

Gralise. In October 2011, we announced the commercial availability of Gralise and began distributing Gralise to wholesalers and retail pharmacies. We defer recognition of revenue on product shipments of Gralise until the right of return no longer exists, which occurs at the earlier of (a) the time Gralise units are dispensed through patient prescriptions or (b) expiration of the right of return. At September 30, 2012, we have a deferred revenue balance, which is classified as a liability on the balance sheet, of $4.5 million associated with the deferral of revenue on Gralise product shipments, which is net of estimated wholesaler fees, retail pharmacy discounts, stocking allowances and prompt payment discounts. We will recognize revenue upon the earlier of prescription units dispensed or expiration of the right of return until we can reliably estimate product returns, at which time we will record a one-time increase in net revenue related to the recognition of revenue previously deferred.  We expect Gralise product sales and prescriptions to increase for the remainder of 2012.

 

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Zipsor. We acquired Zipsor in June 2012 and our sales force began promoting Zipsor at the end of July 2012.  Product sales for the period between the acquisition date and June 30, 2012 were immaterial. Product sales for the quarter ended September 30, 2012 were $4.9 million.

 

Glumetza. In August 2011, we restructured our agreement with Santarus and entered into a commercialization agreement that superseded the July 2008 promotion agreement.  Under the commercialization agreement, we granted Santarus exclusive rights to manufacture and commercialize Glumetza in the United States in return for a royalty on Glumetza net sales. We ceased shipments of Glumetza in August 2011, and Santarus began selling Glumetza in September 2011.

 

Proquin XR. We ceased shipments of Proquin XR in the fourth quarter of 2010 and because of estimated significant levels of inventory at wholesalers and pharmacies in comparison to prescription demand, we deferred revenue recognition on product shipments of Proquin XR until the right of return no longer existed, which occurred at the earlier of the time Proquin XR units were dispensed through patient prescriptions or expiration of the right of return.  At March 31, 2012, all rights of return expired and the remaining deferred revenue balance for Proquin XR was recognized as revenue during the first quarter of 2012.

 

Royalties

 

Santarus. Santarus royalties relate to royalties we receive from Santarus based on net sales of Glumetza in the United States. Royalty revenue from Santarus for the three and nine months ended September 30, 2012 was $11.6 million and $30.2 million and represents a 29.5% royalty on Santarus’ net sales of Glumetza. Santarus royalties for the three and nine months ended 2011 only reflect one month of royalties as we began receiving royalties from Santarus in September 2011.

 

Other Royalties. Under our license agreement with Janssen with respect to NUCYNTA ER, we are entitled to receive low single digit royalties on net sales of NUCYNTA ER in the United States, Canada and Japan beginning on sales made on July 2, 2012. We began recognizing NUCYNTA ER royalty revenue in the third quarter of 2012.

 

In January 2012, Merck received FDA approval to market Janumet XR in the United States, and Merck began selling Janumet XR during the first quarter of 2012. We currently receive very low single digit royalties on net product sales of Janumet XR.

 

Other royalties also include royalties we received from Valeant on net sales of Glumetza in Canada and from LG Life Sciences on net sales of LG’s version of Glumetza, Novamet GR, in Korea.

 

License and other revenue

 

Gralise. In January 2011, Abbott Products received FDA approval of Gralise for the management of postherpetic neuralgia, which triggered a $48.0 million development milestone from Abbott to us, which we received in February 2011. Because the milestone was substantive in nature, achieved and based on past performance, the entire $48.0 million was recognized as license revenue in the first quarter of 2011.

 

Pursuant to the exclusive license agreement originally entered into in November 2008, Solvay paid us a $25.0 million upfront fee in February 2009. The upfront payment received was originally scheduled to be recognized as revenue ratably until January 2013, which represented the estimated length of time our development and supply obligations existed under the agreement. In connection with the termination of the license agreement with Abbott Products, we no longer have continuing obligations to Abbott Products. Accordingly, all remaining deferred revenue related to the $25.0 million upfront license fee previously received from Abbott Products was fully recognized as revenue in March 2011, resulting in immediate recognition of approximately $11.3 million of license revenue.

 

Glumetza. Glumetza license revenue for the three and nine months ended September 30, 2012 and 2011 consisted of license revenue recognized from the $25.0 million upfront license fee received from Biovail in July 2005 and the $12.0 million upfront fee received from Santarus in July 2008.

 

We are recognizing the $25.0 million upfront license fee payment from Biovail as revenue ratably until October 2021, which represents the estimated length of time our obligations exist under the arrangement related to royalties we are obligated to pay Biovail on net sales of Glumetza in the United States and for our obligation to use Biovail as our sole supplier of the 1000mg Glumetza.

 

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Pursuant to the promotion agreement originally entered into in July 2008, Santarus paid us a $12.0 million upfront fee. The upfront payment received was originally being amortized as revenue ratably until October 2021, which represented the estimated length of time our obligations existed under the promotion agreement related to manufacturing Glumetza and paying Santarus promotion fees on gross margin of Glumetza. The commercialization agreement in August 2011 superseded the promotion agreement and removed our manufacturing and promotion fee obligations. The commercialization agreement includes obligations with respect to manufacturing and regulatory transition to Santarus and managing the patent infringement lawsuits against Sun and Lupin. These obligations are estimated to be completed in December 2013. Accordingly, on the effective date of the commercialization agreement, the amortization period related to remaining deferred revenue on the $12.0 million upfront fee has been adjusted, and the remaining deferred revenue will be recognized ratably until December 2013. We recognized approximately $1.0 million and $3.0 million of revenue associated with this upfront license fee during the three and nine months ended September 30, 2012, respectively. We recognized approximately $0.6 million and $1.0 million of revenue associated with this upfront license fee during the three and nine months ended September 30, 2011, respectively. The remaining deferred revenue balance is $4.8 million at September 30, 2012.

 

In January 2011, we achieved the first sales milestone under the promotion agreement with Santarus related to net sales of Glumetza reaching $50.0 million for the 13 month period ending January 31, 2011, which triggered a milestone payment of $3.0 million, which we received in March 2011.  As the milestone was achieved and related to past performance the entire $3.0 million was recognized as milestone revenue in the first quarter of 2011.

 

Boehringer Ingelheim.  Under our license and services agreement with Boehringer Ingelheim entered into in March 2011, Boehringer Ingelheim paid us a $10.0 million upfront license fee which we received in April 2011, less applicable withholding taxes of approximately $1.5 million, for a net receipt of approximately $8.5 million. We received the remaining $1.5 million of taxes previously withheld directly from German tax authorities in June 2011.

 

The $10.0 million was amortized ratably through November 2011, which was the estimated length of time we were obligated to perform formulation work under the agreements. As such the entire amount was recognized as license revenue in 2011. We recognized approximately $3.8 million and $8.6 million of revenue associated with this upfront license fee for the three and nine months ended September 30, 2011, respectively.

 

Under the terms of the agreement, we received an additional nonrefundable $2.5 million payment in March 2012 upon delivery of experimental batches of prototype formulations that meet required specifications. As the milestone event was substantive in nature, achievement was not reasonably assured at the inception of the agreement and the milestone was related to past performance, we recognized the entire amount of this payment as revenue during the first quarter of 2012.

 

We also provided certain initial formulation work associated with the fixed dose combination products. Work performed by us under the service agreement was reimbursed by Boehringer Ingelheim on an agreed-upon FTE rate per hour plus out-of-pocket expenses. We recognized approximately zero and $0.1 million of revenue associated with the reimbursement of formulation work under the service agreement during the three and nine months ended September 30, 2012. We recognized approximately $0.1 million and $0.8 million of revenue associated with the reimbursement of formulation work under the service agreement during the three and nine months ended September 30, 2011, respectively.

 

Janssen N.V.  In August 2010, we entered into a non-exclusive license agreement with Janssen N.V. granting Janssen N.V. a license to certain patents related to our Acuform drug delivery technology to be used in developing fixed dose combinations of canagliflozin and extended release metformin. Janssen N.V. paid us a $5.0 million upfront license fee associated with the license agreement. The $5.0 million was amortized ratably through March 2011, which is the estimated length of time we were obligated to perform formulation work under the agreements. We recognized approximately $1.9 million of revenue associated with this upfront license fee during the first quarter of 2011.

 

We also entered into a service agreement with Janssen N.V. under which we provide formulation work for Janssen N.V. and are reimbursed by Janssen N.V. on an agreed-upon FTE rate per hour plus out-of-pocket expenses. We recognized approximately $0.3 million of revenue associated with the reimbursement of formulation work under the service agreement during the first quarter of 2011.

 

All formulation work under the agreement was completed at March 31, 2011 and there is no remaining deferred revenue.

 

Nucynta. In August 2012, we entered into a non-exclusive license agreement with Janssen Pharmaceuticals, Inc. (Janssen) granting Janssen a license to the Company’s Acuform gastric retentive drug delivery technology to be used in developing products that compromises tapentadol in extended release formulation.

 

In exchange, we received a $10.0 million upfront fee in the third quarter of 2012. We are also eligible to receive a one-time sales milestone upon achievement of a specified level of quarterly net sales, as well as low single digit royalties on net sales of NUCYNTA® ER (tapentadol extended-release tablets) in the U.S., Canada and Japan from and after July 2, 2012 through December 31, 2021. We have no development obligations under the agreement. We recognized the entire $10.0 million as license revenue in the third quarter of 2012.

 

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Other. In July 2011, we entered into a collaboration and license agreement with Ironwood granting Ironwood a license for worldwide rights to the Company’s Acuform drug delivery technology for an undisclosed Ironwood early stage development program. In connection with the research collaboration and license agreement, the Company received an upfront payment of $0.9 million which was amortized ratably through June 2012, which is the estimated length of time Depomed is obligated to perform formulation work under the agreement. We recognized zero and $0.5 million of revenue associated with this upfront license fee for the three and nine months ended September 30, 2012. We recognized approximately $0.2 million of revenue associated with this upfront license fee during the three and nine months ended September 30, 2011. There is no remaining deferred revenue related to this upfront payment at September 30, 2012.

 

In March 2012, we achieved a milestone under the agreement with respect to delivery of experimental batches of prototype formulations that meet required specifications. The associated $1.0 million milestone payment is nonrefundable and was received in May 2012. As the nonrefundable milestone was substantive in nature, achievement of the milestone was not reasonably assured at the inception of the agreement, the milestone was related to past performance, and the collectability of the milestone is reasonably assured, we recognized the $1.0 million as revenue during the first quarter of 2012.

 

Under the terms of the agreement, the Company will assist with initial product formulation and Ironwood will be responsible for all development and commercialization of the product. The initial formulation work performed by the Company under the agreement will be reimbursed by Ironwood on an agreed-upon FTE rate per hour plus out-of-pocket expenses. We recognized approximately zero and $0.1 million of revenue associated with the reimbursement of formulation work under the agreement during the three and nine months ended September 30, 2012.

 

Cost of Sales

 

Cost of sales consists of costs of the active pharmaceutical ingredient, contract manufacturing and packaging costs, inventory write-downs, product quality testing, internal employee costs related to the manufacturing process, distribution costs and shipping costs related to our product sales of Gralise, Glumetza, Zipsor and Proquin XR. Total cost of sales for the three and nine months ended September 30, 2012, as compared to the prior year, was as follows (in thousands):

 

 

 

Three Months Ended September 30,

 

Nine Months Ended September 30,

 

 

 

2012

 

2011

 

2012

 

2011

 

 

 

 

 

 

 

 

 

 

 

Cost of sales

 

$

1,763

 

$

1,150

 

$

3,723

 

$

4,925

 

 

Cost of sales for the three and nine months ended September 30, 2012 relates to Gralise and Zipsor. Cost of sales for the nine months ended September 30, 2012 includes a $0.7 million charge related to slow-moving Gralise starter pack inventory that is not expected to be sold prior to expiry. We commenced product sales of Zipsor in June 2012. The fair value of inventories acquired included a step-up in the value of Zipsor inventories of $1.9 million which is being amortized to cost of sales as the acquired inventories are sold. The unamortized amount is $1.2 million at September 30, 2012. We expect cost of sales to increase in the fourth quarter of 2012 as we expect product sales of Gralise to increase from current levels.

 

Cost of sales for the three and nine months ended September 30, 2011 primarily relates to Glumetza.

 

Research and Development Expense

 

Our research and development expenses currently include salaries, clinical trial costs, consultant fees, supplies, manufacturing costs for research and development programs and allocations of corporate costs. The scope and magnitude of future research and development expenses cannot be predicted at this time for our product candidates in research and development, as it is not possible to determine the nature, timing and extent of clinical trials and studies, the FDA’s requirements for a particular drug and the requirements and level of participation, if any, by potential partners. As potential products proceed through the development process, each step is typically more extensive, and therefore more expensive, than the previous step. Success in development therefore, generally results in increasing expenditures until actual product approval. Total research and development expense for the three and nine months ended September 30, 2012 as compared to the prior year, was as follows (in thousands):

 

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Three Months Ended September 30,

 

Nine Months Ended September 30,

 

 

 

2012

 

2011

 

2012

 

2011

 

 

 

 

 

 

 

 

 

 

 

Research and development expense

 

$

5,270

 

$

3,208

 

$

12,277

 

$

12,405

 

Dollar change from prior year

 

2,062

 

 

 

(128

)

 

 

Percentage change from prior year

 

64.3

%

 

 

-1.0

%

 

 

 

We categorize our research and development expense by project. The table below shows research and development costs for our major clinical development programs, as well as other expenses associated with all other projects in our product pipeline.

 

 

 

Three Months Ended September 30,

 

Nine Months Ended September 30,

 

(In thousands)

 

2012

 

2011

 

2012

 

2011

 

 

 

 

 

 

 

 

 

 

 

Serada

 

$

3,043

 

$

2,519

 

$

5,760

 

$

8,258

 

DM-1992

 

1,181

 

659

 

3,304

 

1,147

 

Other projects

 

1,046

 

30

 

3,214

 

3,000

 

Total research and development expense

 

$

5,270

 

$

3,208

 

$

12,277

 

$

12,405

 

 

The increase in research and development expense for the three months ended September 30, 2012 as compared to the three months ended September 30, 2011 was due to costs related to the Serada New Drug Application (NDA) filed in July 2012 and costs related our Phase 2 trial for DM-1992.  Research and development expenses in 2011 primarily related to clinical research organization costs associated with our Breeze 3 Phase 3 trial costs for Serada, which was completed in October 2011.

 

In the third quarter of 2012, we incurred expense of $1.8 million for the Serada NDA application fee and $0.6 million in milestone expense to PharmaNova related to the NDA application submission, under our sublicense agreement for Serada. We expect research and development expense to decrease in the fourth quarter of 2012 because of the one-time nature of these expenses.

 

Selling, General and Administrative Expense

 

Selling, general and administrative expenses primarily consist of personnel, contract personnel, marketing and promotion expenses associated with our commercial products, personnel expenses to support our administrative and operating activities, facility costs and professional expenses, such as legal fees. Total selling, general and administrative expense, as compared to the prior year, were as follows (in thousands):

 

 

 

Three Months Ended September 30,

 

Nine Months Ended September 30,

 

 

 

2012

 

2011

 

2012

 

2011

 

 

 

 

 

 

 

 

 

 

 

Selling, general and administrative expense:

 

 

 

 

 

 

 

 

 

Promotion fee expense

 

$

 

$

6,023

 

$

 

$

27,339

 

Other selling, general and administrative expense

 

26,832

 

15,451

 

73,625

 

32,667

 

Total selling, general and administrative expense

 

$

26,832

 

$

21,474

 

$

73,625

 

$

60,006

 

 

 

 

 

 

 

 

 

 

 

Dollar change from prior year

 

5,358

 

 

 

13,619

 

 

 

Percentage change from prior year

 

25.0

%

 

 

22.7

%

 

 

 

The increase in selling, general and administrative expenses in 2012 primarily relates to the build out of our commercial infrastructure related to the launch of Gralise in October 2011 and acquisition of Zipsor in June 2012. In October 2011, we began promoting Gralise through an agreement with our contract sales organization, Ventiv, which provided for 164 full-time sales representatives. In June 2012, we expanded our sales force and added an additional 78 part-time sales representatives through Ventiv. In September 2012, we established 155 full-time field sales territories and converted 142 of the Ventiv employees to Depomed employees. We did not convert the part-time sales representatives, and the conversion of the full-time sales representatives is not expected to materially change selling, general and administrative expense. We expect selling, general and administrative expense to decrease slightly in the fourth quarter of 2012.

 

The promotion fee expense in 2011 relates to our promotion fees to Santarus related to Glumetza. As a result of the Santarus commercialization agreement entered into in August 2011, we no longer have promotion fee expense to Santarus.

 

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Amortization of Intangible Assets

 

 

 

Three Months Ended September 30,

 

Nine Months Ended September 30,

 

(In thousands)

 

2012

 

2011

 

2012

 

2011

 

 

 

 

 

 

 

 

 

 

 

Amortization of intangible assets

 

$

958

 

$

 

$

1,063

 

$

 

 

The Zipsor product rights of $27.1 million have been recorded as intangible assets on the accompanying condensed balance sheet and are being amortized over the estimated useful life of the asset on a straight-line basis through July 2019. Amortization commenced on June 21, 2012, the date we acquired Zipsor.

 

Gain on Settlement with Abbott Products

 

In March 2011, we entered into a settlement agreement with Abbott Products which provided for (i) the immediate termination of the parties’ license agreement; (ii) the transition of Gralise back to Depomed; and (iii) a $40.0 million payment from Abbott to us which was paid in March 2011. The $40.0 million payment was recognized as a gain within operating income in the first quarter of 2011.

 

Interest Income and Expense

 

 

 

Three Months Ended September 30,

 

Nine Months Ended September 30,

 

(In thousands)

 

2012

 

2011

 

2012

 

2011

 

 

 

 

 

 

 

 

 

 

 

Interest and other income

 

$

96

 

$

410

 

$

444

 

$

846

 

Interest expense

 

(39

)

(24

)

(39

)

(133

)

Net interest income (expense)

 

$

57

 

$

386

 

$

405

 

$

713

 

 

Interest and other income for the nine months ended September 30, 2012 include $0.1 million in respect of the gain from a bargain purchase relating to the Zipsor acquisition.

 

Interest expense in 2011 relates to interest on the credit facility we entered into in June 2008 with General Electric Capital Corporation and Oxford Finance Corporation. The credit facility was fully repaid in July 2011.

 

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LIQUIDITY AND CAPITAL RESOURCES

 

The following table displays a summary of our cash, cash equivalents and marketable securities as of September 30, 2012 and December 31, 2011:

 

 

 

September 30,

 

December 31,

 

(In thousands)

 

2012

 

2011

 

 

 

 

 

 

 

Cash, cash equivalents and marketable securities

 

$

87,658

 

$

139,793

 

 

The decrease in cash, cash equivalents and marketable securities is attributable to the $26.4 million that we paid for the Zipsor acquisition and the utilization of cash to finance our operations.

 

In September 2012, we received a $10.0 million upfront payment from Janssen related to our non-exclusive license agreement with Janssen related to Nucynta ER.

 

Since inception through September 30, 2012, we have financed our product development efforts and operations primarily from private and public sales of equity securities, upfront license, milestone and termination fees from collaborative and license partners, and product sales.

 

As of September 30, 2012, we have accumulated net losses of $123.7 million. We may incur operating losses in future years. We anticipate that our existing capital resources will permit us to meet our capital and operational requirements for at least the next two years. We base this expectation on our current operating plan, which may change as a result of many factors.

 

Our cash needs may also vary materially from our current expectations because of numerous factors, including:

 

·                  sales of our marketed products;

·                  expenditures related to our commercialization of Gralise and Zipsor, including our contractual obligations to Ventiv and other arrangements we make for the commercialization of Gralise and Zipsor;

·                  milestone and royalty revenue we receive under our collaborative development and commercialization arrangements;

·                  acquisitions or licenses of complementary businesses, products or technologies.

·                  expenditures related to our commercialization and development efforts, including arrangements we make for the commercialization of Serada, if the product is approved for marketing;

·                  financial terms of definitive license agreements or other commercial agreements we may enter into;

·                  results of research and development efforts;

·                  changes in the focus and direction of our business strategy and/or research and development programs; and

·                  results of clinical testing requirements of the FDA and comparable foreign regulatory agencies.

 

We will need substantial funds to:

 

·                  conduct preclinical and clinical testing;

·                  manufacture (or have manufactured) and market (or have marketed) our marketed products and product candidates; and

·                  conduct research and development programs.

 

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 sustain our operations. We currently do not have any other committed sources of capital. To the extent that our capital resources are insufficient to meet our future capital requirements, we will have to raise additional funds through the sale of our equity securities or from development and licensing arrangements to continue our commercial and development programs. We may be unable to raise such additional capital on favorable terms, or at all. If we raise additional capital by selling our equity or convertible debt securities, the issuance of such securities could result in dilution of our shareholders’ equity positions. If adequate funds are not available we may have to:

 

·                  significantly curtail commercialization of our marketed products or other operations

·                  obtain funds through entering into collaboration agreements on unattractive terms; and/or

·                  delay, postpone or terminate clinical trials;

 

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The inability to raise any additional capital required to fund our operations could have a material adverse effect on our company.

 

Cash Flows from Operating Activities

 

Cash used in operating activities during the nine months ended September 30, 2012 was approximately $25.3 million, compared to cash provided by operating activities of approximately $72.4 million during the nine months ended September 30, 2011. Cash used in operating activities during the nine months ended September 30, 2012 was primarily due to our net loss adjusted for movements in working capital, stock-based compensation and depreciation expense. Cash provided by operating activities during the nine months ended September 30, 2011 was primarily as a result of the $48.0 million milestone payment and $40.0 million termination fee received from Abbott Products during the first quarter of 2011.

 

Cash Flows from Investing Activities

 

Net cash provided by investing activities during the nine months ended September 30, 2012 was approximately $26.7 million and consisted of a decrease in marketable securities to fund our operations offset by the acquisition of Zipsor for $26.4 million in cash in June 2012.  Net cash used in investing activities during the nine months ended September 30, 2011 was approximately $80.6 million and consisted primarily of a net increase in marketable securities resulting from a partial investment of the milestone payment and settlement fee received from Abbott Products during the first quarter of 2011.

 

Cash Flows from Financing Activities

 

Cash provided by financing activities during the nine months ended September 30, 2012  was approximately $1.9 million and consisted of proceeds from employee and consultant option exercises. Cash provided by financing activities during the nine months ended September 30, 2011 was approximately $5.6 million and consisted of proceeds from employee and consultant option exercises offset by repayments of principal on our credit facility.

 

Contractual Obligations

 

As of September 30, 2012, our aggregate contractual obligations are as shown in the following table (in thousands):

 

 

 

1 Year

 

2-3 Years

 

4-5 Years

 

More than
5 Years

 

Total

 

 

 

 

 

 

 

 

 

 

 

 

 

Operating leases

 

$

992

 

$

2,383

 

$

2,517

 

$

7,234

 

$

13,126

 

Contract sales organization

 

3,600

 

 

 

 

3,600

 

Purchase commitments

 

6,410

 

 

 

 

6,410

 

 

 

$

11,002

 

$

2,383

 

$

2,517

 

$

7,234

 

$

23,136

 

 

At September 30, 2012, we had non-cancelable purchase orders and minimum purchase obligations of approximately $6.4 million under our manufacturing agreements related to Gralise and Zipsor. The amounts disclosed only represent minimum purchase requirements. Actual purchases are expected to exceed these amounts.

 

In May 2012, the Company entered into a service agreement with Ventiv which provides for a sales force of 78 part-time sales representatives dedicated to the Company, all of whom are employees of Ventiv. Under the terms of the agreement, we are required to pay Ventiv a monthly fixed fee of $0.5 million during the term of the agreement. The term of the agreement is for one year beginning in June 2012.

 

In April 2012, the Company entered into an office and laboratory lease agreement to lease approximately 52,500 rentable square feet in Newark, California commencing on December 1, 2012. The Newark lease includes free rent for the first five months of the lease. Lease payments begin in May 2013. The Company’s Menlo Park lease ends in January 2013.

 

The contractual obligations reflected in this table exclude a $2.0 million contingent milestone payment we may be obligated to pay in the future under our sublicense agreement with PharmaNova related to FDA approval of an NDA for Serada. The above table also excludes any future royalty payments we may be required to pay on products we have licensed.

 

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Table of Contents

 

The contractual obligations reflected in the above table also exclude up to $5.0 million in contingent sales milestones we may be obligated to pay in the future under our asset purchase agreement with Xanodyne for Zipsor. The Company is obligated to pay Xanodyne a one-time $2.0 million milestone payment at the end of the first calendar year in which net sales of Zipsor exceed $20 million, and a one-time $3.0 million milestone payment at the end of the first calendar year in which net sales of Zipsor exceed $60 million.

 

The table above also excludes non-cancelable purchase orders and minimum purchase obligations of approximately $2.1 million under our supply agreement with Valeant for the supply of 1000mg Glumetza, which will be fully reimbursed by Santarus.

 

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

 

There have been no significant changes in our market risk compared to the disclosures in Item 7A of our Annual Report on Form 10-K for the year ended December 31, 2011.

 

ITEM 4. CONTROLS AND PROCEDURES

 

Evaluation of Disclosure Controls and Procedures

 

An evaluation was performed under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures as of the end of the period covered by this quarterly report. Based on that evaluation, our management, including our Chief Executive Officer and Chief Financial Officer, concluded that our disclosure controls and procedures were effective.

 

We review and evaluate the design and effectiveness of our disclosure controls and procedures on an ongoing basis to improve our controls and procedures over time and to correct any deficiencies that we may discover in the future. Our goal is to ensure that our senior management has timely access to all material financial and non-financial information concerning our business. While we believe the present design of our disclosure controls and procedures is effective to achieve our goal, future events affecting our business may cause us to significantly modify our disclosure controls and procedures.

 

Changes in Internal Controls

 

There were no changes in our internal controls over financial reporting during the quarter ended September 30, 2012 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

 

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Table of Contents

 

PART II — OTHER INFORMATION

 

ITEM 1.  LEGAL PROCEEDINGS

 

Depomed v. Sun Pharmaceuticals and Depomed v. Watson Laboratories (Glumetza ANDA Litigation)

 

In June 2011, we filed a lawsuit in the United States District Court for the District of New Jersey against Sun Pharmaceutical Industries Inc., Sun Pharma Global FZE and Sun Pharmaceuticals Industries Ltd. (collectively, Sun), for infringement of five (5) U.S. patents listed in the Orange Book for the Glumetza product. The lawsuit is in response to an Abbreviated New Drug Application (ANDA) filed by Sun with the FDA regarding Sun’s intent to market generic versions of 500mg and 1000mg dosage strengths of Glumetza prior to the expiration of the Orange Book patents, which includes U.S. Patent Nos.: 6,340,475, 6,488,962, 6,635,280, 6,723,340 and 7,780,987. U.S. Patent No.7,736,667 is also being asserted against Sun in the lawsuit. Valeant International Bermuda (f/k/a Valeant International (Barbados) SRL) is joined in the lawsuit as a co-plaintiff as the owner of U.S. Patent No. 7,780,987.  The lawsuit commenced within the 45 days required to automatically stay, or bar, the FDA from approving Sun’s ANDA for 30 months or until a district court decision that is adverse to the patents, whichever occurs earlier.  A claim construction hearing, known as a “Markman hearing,” was conducted before Judge Pisano on July 18, 2012.  Absent a court order, the 30-month stay is expected to expire in November 2013.

 

In April 2012, we filed a lawsuit in the United States District Court for the District of Delaware against Watson Laboratories, Inc. — Florida, Watson Pharmaceuticals, Inc. and Watson Pharma, Inc. (collectively, Watson), for infringement of the two patents listed in the Orange Book for Glumetza 1000 mg (U.S. Patent Nos. 6,488,962 and 7,780,987).  The lawsuit is in response to an ANDA filed by Watson with the FDA regarding Watson’s intent to market a generic version of the 1000 mg dosage strength of Glumetza prior to the expiration of the asserted patents.  Valeant International Bermuda (f/k/a Valeant International (Barbados) SRL) is joined in the lawsuit as a co-plaintiff as the owner of U.S. Patent No. 7,780,987.  We commenced the lawsuit within the 45 days required to automatically stay, or bar, the FDA from approving Watson’s ANDA for 30 months or until a district court decision that is adverse to the patents, whichever may occur earlier.  Absent a court order, the 30-month stay is expected to expire in September 2014.

 

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Table of Contents

 

Depomed v. Gralise ANDA Filers

 

In March 2012, we filed a lawsuit in the United States District Court for the District of New Jersey against Actavis Elizabeth LLC and Actavis Inc. (collectively Actavis), Watson Laboratories, Inc. — Florida, Watson Pharma, and Watson Laboratories (collectively Watson) and Incepta Pharmaceuticals (Incepta) for infringement of six (6) U.S. patents listed in the Orange Book for our Gralise product.  The lawsuit is in response to ANDAs filed by each of Actavis, Watson and Incepta with the FDA regarding the defendants’ intent to market generic versions of 300mg and 600mg dosage strengths of Gralise prior to the expiration of the Orange Book patents, which includes U.S. Patent Nos.: 6,340,475, 6,488,962, 6,635,280, 6,723,340, 7,438,927 and 7,731,989.  We commenced the lawsuit within the 45 days required to automatically stay, or bar, the FDA from approving the ANDAs for 30 months or until a district court decision that is adverse to the asserted patents, whichever may occur earlier.   Absent a court order, the 30-month stays are expected to expire in July 2014 and August 2014.  In August 2012, we amended our complaint to assert U.S. Patent No. 8,192,756 and add Abon Pharmaceuticals LLC as a defendant.  In September 2012, we amended our complaint to assert U.S. Patent No. 8,252,332. Each of these patents is listed in the Orange Book.

 

In April 2012, we filed a lawsuit in the United States District Court for the District of New Jersey against Impax Laboratories (Impax) and Par Pharmaceuticals (Par) for infringement of six (6) U.S. patents listed in the Orange Book for our Gralise product.  The lawsuit is in response to ANDAs filed by each of Impax and Par with the FDA regarding the defendants’ intent to market generic versions of 300mg and 600mg dosage strengths of Gralise prior to the expiration of the Orange Book patents, which includes U.S. Patent Nos.: 6,340,475, 6,488,962, 6,635,280, 6,723,340, 7,438,927 and 7,731,989.  In October 2012, Impax withdrew its Gralise ANDA.  As a result, we and Impax agreed to stipulate to this dismissal of our lawsuit against Impax for infringement of the Gralise Orange Book listed patents. We commenced the lawsuit against Par within the 45 days required to automatically stay, or bar, the FDA from approving the ANDAs for 30 months or until a district court decision that is adverse to the asserted patents, whichever may occur earlier.  Absent a court order, the 30-month stay is expected to expire in September 2014. In August 2012 and September 2012, we amended our complaint to assert respectively U.S. Patent No. 8,192,756 and U.S. Patent No. 8,252,332, which are now listed in the Orange Book.

 

In May 2012, we filed lawsuit in the United States District Court for the District of New Jersey against Zydus Pharmaceuticals Inc. and Cadila Healthcare Limited (collectively Zydus) for infringement of six (6) U.S. patents listed in the Orange Book for our Gralise product.  The lawsuit is in response to the ANDAs filed by Zydus with the FDA regarding Zydus’s intent to market generic versions of 300mg and 600mg dosage strengths of Gralise prior to the expiration of the Orange Book patents, which includes U.S. Patent Nos.: 6,340,475, 6,488,962, 6,635,280, 6,723,340, 7,438,927 and 7,731,989.  We commenced the lawsuit within the 45 days required to automatically stay, or bar, the FDA from approving the ANDAs for 30 months or until a district court decision that is adverse to the asserted patents, whichever may occur earlier.  Absent a court order, the 30-month stays are expected to expire in October and November 2014.  In August 2012 and September 2012, we amended our complaint to assert respectively U.S. Patent No. 8,192,756 and U.S. Patent No. 8,252,332, which are now listed in the Orange Book.

 

On June 13, 2012, the Court held the Case Management Conference.  The Court ordered all three suits to be consolidated for purposes of all pretrial proceedings.  The Pretrial Conference in the suits is scheduled for March 13, 2014.  No specific trial date has been set.  We expect a Markman claim construction hearing to occur in the spring 2013.  No specific date for the Markman hearing has been set.

 

Depomed v. FDA

 

In November 2010, the FDA granted Gralise Orphan Drug designation for the management of PHN based on a plausible hypothesis that Gralise is “clinically superior” to immediate release gabapentin due to the incidence of adverse events observed in Gralise clinical trials relative to the incidence of adverse events reported in the package insert for immediate release gabapentin. Generally, an Orphan-designated drug approved for marketing is eligible for seven years of regulatory exclusivity for the orphan-designated indication. If granted, Orphan Drug exclusivity for Gralise will run for seven years from January 28, 2011. However, the FDA has indicated to us that Gralise is not currently eligible for Orphan Drug exclusivity because the hypothesis upon which the product’s Orphan Drug designation was granted has not been proven. In September 2012, we filed an action in federal district court for the District of Columbia against the FDA seeking an order requiring the FDA to grant Gralise Orphan Drug exclusivity for the management of PHN. We believe Gralise is entitled to Orphan Drug exclusivity as a matter of law, and the FDA’s action is not consistent with the statute or FDA’s regulations related to orphan drugs. The lawsuit seeks a determination by the court that Gralise is protected by Orphan Drug exclusivity, and an order that FDA act accordingly.  The FDA has not yet filed an answer to our complaint.