scr.zacks.com 111 North Canal Street, Chicago, IL (DEPO-NASDAQ) Update ZACKS ESTIMATES

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1 Small-Cap Research May 9, 2012 Jason Napodano, CFA scr.zacks.com 111 North Canal Street, Chicago, IL Depomed Inc. (DEPO-NASDAQ) DEPO: Digging Into The Q1 Results Current Recommendation Outperform Prior Recommendation Neutral Date of Last Change 08/09/2011 Current Price (05/09/12) $5.69 Target Price $8.50 Update On May 8, 2012, Depomed reported financial results for the first quarter Revenues were better than our expectations on high royalties on Glumetza and milestone payments from Boehringer Ingelheim and Ironwood. Sales of Gralise were just below our expectations on a lower blended price per script per month than our model. Operating expenses were in-line during the quarter. The company reported a net loss of $8.8 million, or 16 cents per share. Depomed exited the first quarter 2012 with $128.6 million in cash and investments. We find this to be sufficient to fund operations for the foreseeable future. Our rating is Outperform and our target, derived by DCF, is $8.50 per share. SUMMARY DATA 52-Week High $ Week Low $4.26 One-Year Return (%) Beta 1.44 Average Daily Volume (sh) 411,989 Shares Outstanding (mil) 56 Market Capitalization ($mil) $317 Short Interest Ratio (days) Institutional Ownership (%) 55 Insider Ownership (%) 3 Annual Cash Dividend $0.00 Dividend Yield (%) Yr. Historical Growth Rates Sales (%) 48.2 Earnings Per Share (%) N/A Dividend (%) N/A P/E using TTM EPS P/E using 2012 Estimate P/E using 2013 Estimate N/M N/M N/A Risk Level Type of Stock Industry ZACKS ESTIMATES Average, Small-Growth Med-Drugs Revenue (In millions of $) Q1 Q2 Q3 Q4 Year (Mar) (Jun) (Sep) (Dec) (Dec) A 21.2 A 16.5 A 12.1 A A A 15.8 E 18.9 E 23.8 E 75.4 E E E Earnings per Share (EPS is operating earnings before non recurring items) Q1 Q2 Q3 Q4 Year (Mar) (Jun) (Sep) (Dec) (Dec) 2011 $1.77 A -$0.11 A -$0.15 E -$0.25 A $1.26 A $0.16 A -$0.21 E -$0.18 E -$0.12 E -$0.66 E $0.12 E 2014 $0.32 E Copyright 2012, Zacks Investment Research. All Rights Reserved.

2 WHAT S NEW Financial Results On May 8, 2012, Depomed reported financial results for the first quarter Total revenues in the first quarter were $16.8 million, nicely above our expectations for revenues of $12.2 million. Revenues decreased by near 80% from the first quarter 2011; however, we note the first quarter 2011 included over $60 million in payments from Abbott Labs and $15.3 million in recorded product sales of Glumetza, now being booked by Santarus. Revenue Line Items Q A Comments Gralise Sales $1.749M Below our estimate of $2.0M Proquin XR Sales $0.360M Glumetza Sales - Total Product Sales $2.109M Glumetza Royalites $9.222M Higher than our estimate of $7.8M Acuform Royalties $0.199M Initial royalties from Merck s Janumet-XR Total Royalty Revenue $9.421M Glumetza Licenses $1.388M Boehringer Ingelheim $2.617M Included $2.5M milestone payment Ironwood $1.300M Included $1.0M milestone payment Merck - Janssen - Covidien - Gralise - Licensing & Collaborative $5.305M Total Revenues $16.835M Above our estimate of $12.2M Revenues consisted of $2.1 million in product sales, of which $1.75 million was Gralise and $0.36 million was from Proquin XR. Gralise sales were just below our estimate of $2.0 million. For the week ending April 27, 2012, Gralise total prescriptions were 2,049, which annualizes to a run-rate of approximately $12 million. Gralise current holds 0.25% of the total gaba-molecule market. Approximately 17,000 prescriptions were written in the first quarter by 3,500 physicians. Revenues also consisted of $9.4 million in royalties, of which $9.2 million was from Glumetza sales at Santarus and $0.2 million as from Janumet-XR sales at Merck. Santarus reported Glumetza revenues in the first quarter of $31.2 million, up 104% year-over-year. Total Glumetza prescriptions were up 36% year-overyear. The rest of the increase came from price increases. Merck reported Janumet sales of $392 million in the first quarter, up 29% year-over-year, but did not break out Janumet vs. Janumet XR revenues. Finally, revenues also consisted of $5.3 million in licensing and collaborative payments. Depomed record a $2.5 million milestone payment from Boehringer Ingelheim during the first quarter relating to development and delivery of prototype formulations of candidates for the treatment of type 2 diabetes using Depomed s Acuform technology. Depomed also earned a $1.0 million milestone payment from Ironwood Pharmaceuticals during the quarter 2012 for delivery of experimental batches of prototype formulations of drug candidates targeting gastrointestinal disorders. Net loss for the first quarter 2012 was $8.8 million, or $0.16 per share. This was better than our expectations on higher total revenues and lower than expected SG&A. R&D expense was in-line with expectations. Depomed exited the first quarter 2012 with $128.6 million in cash, investments, and marketable securities and no debt. We find this level of cash to be sufficient to fund operations for the foreseeable future. Management has guided to cash flow positive operations by the end of We model Depomed burning approximately $45 million in Management has guided to cash at the end of 2012 between $88 and $100 million. We model Depomed holding $95 million at the end of the year. However, we note our $95 million estimate assumes no business development activities in 2012, nor does it include potential royalty sale transactions. We remind investors that Depomed collects cash royalties on Glumetza sales from Santarus to the tune of 29.5% in The royalty rate will jump to 32% in 2013 and 2014, and then 34.5% in 2015 and 2016 before a generic Glumetza is expected on February 1, Based on our modeling, we see the remaining Glumetza royalties (after tax), starting in the second quarter 2012 to the end of 2015 with approximately $120 million. We expect that Depomed will continue to collect some royalties in 2016, albeit small. Zacks Investment Research Page 2 scr.zacks.com

3 That said, we would not be surprised to see the company look to monetize this royalty stream in an effort to secure additional cash in We believe if the company can secure north of $110 million, it would be wise to sell the royalty stream and look to acquire another late-stage or commercialized product in the pain / neurology market that Depomed can promote along with Gralise. We believe that shareholders would react favorably to such a move. On the first quarter conference call CEO Jim Schoeneck noted business development activities continue at the company, but we do not expect a deal anytime soon. INVESTMENT UPDATE Gralise Update Gralise total prescriptions remain on track, and in-line with our model. We modeled sales in the first quarter 2012 of $2.0 million based on total prescriptions of roughly 17K and a blended net price of approximately $135 per script. Sales were $1.75 million, meaning the blended price was more around $108 per script. We note the price of the titration starter pack is below that of a full prescription, and Depomed is currently offering a co-pay assistant card to reduce the out-of-pocket expense patients pay for Gralise. Pricing, Dosing, and Competition Depomed also noted on their first quarter conference call that the average Gralise patient is using less than the recommended 1800mg (3 pills per day). During the first quarter, Gralise was priced wholesale at $1.88 per pill. Based on the blended price of around $108 per script, we suspect that the average patient is taking 1200mg (2 pill per day), meaning that a Gralise script is lasting a patient 45 days instead of the modeled 30 days. Depomed believes that older patients are finding pain relief at lower doses and that neurologists have a history of prescribing lower doses of generic gabapentin due to tolerability issues. It will take some time before many are comfortable with Gralise. Management noted that the average pills per day number has been increasing each month, but we have adjusted our model to account for a script running slightly longer than 30 days for the remainder of For the second quarter 2012, we are modeling approximately 29K total prescriptions with a blended price of $115 per script, with the average script lasting around 40 days. This puts Gralise sales at $2.7 million for the second quarter We note that Depomed increased the price of Gralise by 20% on May 1, Gralise now costs $2.25 per pill. This is still 15% below that of Pfizer s Lyrica on a per pill basis. Although, we note the average patient takes 2.3 Lyrica pills per day, so Depomed s price advantage on a daily basis is lower than we originally modeled. We think pricing and dosing will remain a challenge for Depomed for the next few quarters. Depomed has done an excellent job in growing prescriptions and the prescriber base. But patients are not using the full daily dose strength and generic gabapentin and branded Lyrica remain an impediment for future price increases going forward. That said, 70% of the Gralise new prescriptions are from patients switching from generic gabapentin or Lyrica. We are keeping an eye on Glaxo s snda filing for Horizant, approved in July 2011 for RLS, for PHN. A decision from the FDA on Horizant (gabapentin enacarbil) is expected on June 8, Horizant sales at Glaxo were only $1.3 million in the first quarter 2012, but Glaxo is promoting the drug with some 500 sales representatives. If approved in PHN, we expect that Glaxo s presence in the primary care market with Horizant will further intensify competition and put pressure on Depomed to step-up promotion with Gralise. But We re Optimistic Depomed s strategy is to do exactly that step up the sales effort around Gralise. Pain specialists and neurologists are writing the majority of the Gralise prescriptions. When launched last October, management initially targeted only approximately 1,200 pain specialists. Realizing the important of this group, management has now expanded its efforts with pain specialists now targeting 6,500 specialists. We think this will clearly help drive prescriptions in the coming months. Plus, to date, primary care has remained relatively untapped. To begin to target the primary care market, Depomed plans to enhance its current 164 full-time sales staff with the addition of 75 flex sales representatives. These part-time reps will focus on the primary care market in areas where Depomed currently has specialist support and good managed care coverage for our drug. To pay for these new flex reps, which cost about one-third of a full-time rep, management will reallocate already budgeted marketing and sales promotion dollars for Gralise. Zacks Investment Research Page 3 scr.zacks.com

4 The plan is to substantially improve the coverage in primary care with a very limited increase in operating expense and very little disruption to the current rep physician relationships. We expect these reps to begin promotion in July, which should help drive a sales bump in the second half of the year. Depomed recently began a post-approval (phase IV) study looking at the real-world use of Gralise. The study should provide valuable information on Gralise titration and tolerability. This is the kind of data that could improve the dosing issues noted above. For the full year 2012, we are modeling sales of Gralise at $15.1 million. Gralise remains the key value driver for Depomed in our view. Serada NDA Expected 2H-2012 On April 17, 2012, Depomed announced it had completed a Type B pre-nda meeting with the U.S. FDA regarding the results of the three phase 3 clinical trials for Serada (extended-release gabapentin tablets). Following the meeting, management believes the data from the BREEZE-1, -2, and -3 trials warrants submission of an NDA for the FDA s review and considering for the treatment of menopausal hot flashes. In preparation for the meeting, management submitted to the FDA a detailed briefing package that includes various types of analysis on the BREEZE data, including parametric and non-parametric analysis, a responder analysis, and a meta-analysis that included the combined data from all three programs together. Included in the data was persistent efficacy data at week 24 from both BREEZE-1 and BREEZE-3. Below we highlight the top-line data from all three programs for the 1800mg dose at least what has been disclosed by management. (n=541) BREEZE-1 Frequency (% Change) Severity (% Change) Serada Placebo p-value Serada Placebo p-value Week 4: -66% -52% p= % -16% p= Week 12: -67% -62% p= % -28% p= Week 24: -68% -66% N/S -38% -30% N/S (n=565) BREEZE-2 Frequency (% Change) Severity (% Change) Serada Placebo p-value Serada Placebo p-value Week 4: -63% -49% p= % -20% p= Week 12: -67% -55% p= % -24% p= (n~600) BREEZE-3 Frequency (% Change) Severity (% Change) Serada Placebo p-value Serada Placebo p-value Week 4:?? p<0.001?? p<0.001 Week 12:?? N/S?? p<0.01 Week 24:?? N/S?? N/S Management has submitted an abstract to the North American Menopause Society annual meeting to take place this October We expect the full data from BREEZE-3 will be presented at that time. We note that data from BREEZE-1 and BREEZE-2 was previously presented at the NAMS meeting in October $5 Million Call Option Looking at the data above, even using a p-value of less than 0.05, in three phase 3 trials we see that Serada hit 10 of the required 12 primary endpoints, including all endpoints for both frequency and severity at week 4, but missed the frequency endpoint at week 12 in all two of the three trials and failed to demonstrate signs of persistent efficacy at week 24 in either BREEZE-1 or BREEZE-3. We have admittedly not seen management s analysis of the data. Management noted that the FDA suggested that Depomed file the application so they can, run their own analyses to decide whether this is an approvable package or not. Zacks Investment Research Page 4 scr.zacks.com

5 At this point, we think approval is a long-shot; but we do not profess to know how the FDA will rule on data we haven t seen using an analysis we haven t been told about. Nevertheless, Depomed will spend approximately $5 million this year getting the NDA filing ready. This includes the filing fee (~$1.5M), a milestone to license partner PharmaNova (~$1M), external consulting expenses, manufacturing test batches, and other launch preparations. We expect that Depomed will file the NDA on Serada in the fourth quarter 2012, sometime after the BREEZE-3 data has been presented at the NAMS meeting in October At that time, we should have a better sense of the entire NDA package on Serada. We also expect that the U.S. FDA will hold an Advisory Committee meeting on Serada. If the NDA is filed in November 2012, the PDUFA would be scheduled for September That would potentially put an advisory panel meeting on the drug sometime over the summer of The NAMS recently put out updated guidance on the use of hormone therapy (HT) in women suffering from hot flashes. The position statement notes that a combination of estrogen plus progestin therapy (EPT) remains the most effective treatment available for menopausal symptoms, including hot flashes and night sweats that can interrupt sleep and impair quality of life. The NAMS believes that the majority of women can take EPT safely, for periods up to three to five years, with little risk of heart attack, stroke, blood clots, or breast cancer. For women with preexisting risk, an alternative therapy may be more desirable. We expect that these updated guidelines from NAMS will have a negative impact on the overall market potential for Serada if approved. We see Serada relegated to a second-line therapy for women where HT is either not effective or not desirable. We see the peak sales opportunity for Serada in the U.S. at roughly $100 million. If NAMS were to get behind Serada, peak sales could be north of $300 million. We expect that Depomed would like to be involved in the promotion of Serada to high-prescribing OB/GYN s in the U.S. Management noted that there are about 18,000 of these high-prescribing OBGs. We suspect that effective promotion can be accomplished by a small field force of 40 to 60 representatives. The opportunity to expand Serada for promotion to the primary care network presents upside to the story. The ideal situation allows for use of some of the 164 full-time Gralise reps or moving some of the 75 flex reps to full-time if Serada is approved. Our model includes $0 revenues from Serada in the future, and we expect that it will stay that way until the FDA makes a decision. At $100 million in peak sales, we see Serada worth approximately +$2 per share in our current DCF valuation. At $300 million, Serada would boost our target price by +$8 per share. DM-1992 Moves Into Phase 2 In January 2012, Depomed announced that it has initiated a Phase 2 clinical trial of DM-1992, the company s novel gastric-retentive, extended-release formulation of carbidopa/levodopa, in patients with advanced Parkinson's disease with motor fluctuations. The Phase 2 clinical trial is designed to enroll at 8 U.S. clinical centers up to 45 patients with Parkinson's disease with motor fluctuations. The trial is a randomized, active-controlled, open-label, crossover study and will test Depomed s 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. Depomed previously released data from a Phase 1pk/pd study with DM-1992 in Parkinson's patients showing their novel formulation maintained therapeutic blood levels of levodopa over 24 hours with twice-daily dosing. To date, DM-1992 has been well tolerated. Maintaining constant blood levels of levodopa could result in a reduction of side effects (dyskinesia, uncontrolled movements when levels are too high) and symptoms (akinesia, lack of initiation of movement when levels are too low) that are caused by current therapy. Parkinson s patient can take carbidopa/levodopa immediately release formulations as often as 10 times per day. Even then, patients still experience the acute fluctuations noted above. We had previously expected that management will look to monetize (out-license) this candidate at some point in However, given the shift in focus to neurology and pain, DM-1992 could be worth holding on to for the time being. Above we noted that management will most likely seek to in-license another pain or neurology drug to leverage the sales force in The initiation of a Phase 2 program with DM-1992 provides for a potential add-on product in a few years. We see a sizable opportunity here. Depomed could find meaningful synergy promoting DM to neurologists along with Gralise. Zacks Investment Research Page 5 scr.zacks.com

6 Collaborations There s not much significant to report with respect to the pipeline or the company s collaborations / technology licenses. Two things worth noting are: In early February 2012, Merck announced U.S. FDA approval of Janumet-XR (sitagliptin and metformin hydrochloride (HCl) extended-release). The approval of Janumet-XR provides a once-daily dosing advantage, along with added tolerability, over the previous twice-daily Janumet. Depomed record initial royalties from Merck on Janumet XR in the first quarter Janumet is a combination of Januvia and metformin. Merck sold $1,363 million of Janumet in 2011, up a strong 43% YoY. Sales in the first quarter 2012 were $392 million (+29% YoY). Merck continues to transition patients from Januvia to Janumet. Januvia sales in 2011 were $3,324 million (+39%). Now that Janumet-XR is on the market, we expect Merck to fully-cannibalize Janumet with Janumet-XR. We see peak Janumet-XR sales at $1.5 billion worldwide. We remind investors that Depomed has two additional deals around its Acuform technology with Johnson & Johnson and Boehringer Ingelheim. Depomed has received two $5 million milestone payments from J&J and $12.5 million from Boehringer ($2.5 million in the first quarter 2012). While the J&J and BI deals may be more early-stage than the deal with Merck, they still provide a potential meaningful cash flow stream min the future. In December 2011, Covidien announced it would spin-out its pharmaceutical division to shareholders. We think this is good news for Depomed, as the new stand-alone pharmaceutical company will be seeking to expand its top-line and provide growth through new products. Covidien has been working to develop acetaminophen / opioid analgesic combination products utilizing Depomed's Acuform gastric retentive drug delivery technology. Covidien has stated in the past that they plan to commercialize the first of these candidates in We expect this will be a Vicodin-XR formulation. Covidien expects to follow this up with a second product in We expect this will be a Percocet-XR formulation. Depomed receives milestone upon delivery of the final formulation, potentially up to $15 million worth, and low single-digit royalty on sales. In the first quarter 2012, Depomed record a $1.0 million milestone payment from Ironwood. This deal was originally signed in August 2011 to develop new gastrointestinal disorder candidates. Recommendation We are maintaining our Outperform rating and adjusting our target to $8.50 per share on Depomed. Our target is derived by discounted cash flow (DCF), which is heavily dependent on our forecasts for Gralise. Zacks Investment Research Page 6 scr.zacks.com

7 PROJECTED INCOME STATEMENT Income Statement Copyright 2012, Zacks Investment Research. All Rights Reserved.

8 HISTORICAL ZACKS RECOMMENDATIONS DISCLOSURES The following disclosures relate to relationships between Zacks Investment Research ( ZIR ) and Zacks Small-Cap Research ( Zacks SCR ) and the issuers covered by the Zacks SCR analysts in the Small-Cap Universe. ZIR or Zacks SCR Analysts do not hold or trade securities in the issuers which they cover. Each analyst has full discretion on the rating and price target based on their own due diligence. Analysts are paid in part based on the overall profitability of Zacks SCR. Such profitability is derived from a variety of sources and includes payments received from issuers of securities covered by Zacks SCR for non-investment banking services. No part of analyst compensation was, is or will be, directly or indirectly, related to the specific recommendations or views expressed in any report or blog. ZIR and Zacks SCR do not make a market in any security nor do they act as dealers in securities. Zacks SCR has never received compensation for investment banking services on the small-cap universe. Zacks SCR does not expect received compensation for investment banking services on the small-cap universe. Zacks SCR has received compensation for non-investment banking services on the small-cap universe, and expects to receive additional compensation for non-investment banking services on the small-cap universe, paid by issuers of securities covered by Zacks SCR. Non-investment banking services include investor relations services and software, financial database analysis, advertising services, brokerage services, advisory services, investment research, and investment management. Additional information is available upon request. Zacks SCR reports are based on data obtained from sources we believe to be reliable, but is not guaranteed as to accuracy and does not purport to be complete. Because of individual objectives, the report should not be construed as advice designed to meet the particular investment needs of any investor. Any opinions expressed by Zacks SCR Analysts are subject to change. Reports are not to be construed as an offer or the solicitation of an offer to buy or sell the securities herein mentioned. Zacks SCR uses the following rating system for the securities it covers. Buy/Outperform: The analyst expects that the subject company will outperform the broader U.S. equity market over the next one to two quarters. Hold/Neutral: The analyst expects that the company will perform in line with the broader U.S. equity market over the next one to two quarters. Sell/Underperform: The analyst expects the company will underperform the broader U.S. Equity market over the next one to two quarters. The current distribution of Zacks Ratings is as follows on the 1025 companies covered: Buy/Outperform- 14.0%, Hold/Neutral- 80.7%, Sell/Underperform 4.3%. Data is as of midnight on the business day immediately prior to this publication. Copyright 2012, Zacks Investment Research. All Rights Reserved.