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

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1 Small-Cap Research December 19, 2013 Jason Napodano, CFA scr.zacks.com 111 North Canal Street, Chicago, IL Depomed Inc. (DEPO-NASDAQ) DEPO: Another Fine Deal For Depomed Current Recommendation Outperform Prior Recommendation Neutral Date of Last Change 08/09/2011 Current Price (12/18/13) $9.50 Target Price $12.00 UPDATE On December 17, 2013, Depomed, Inc. (DEPO) announced it had acquired the U.S. rights to CAMBIA (diclofenac potassium for oral solution) from Nautilus Neurosciences for $48.7 million in cash. CAMBIA is a non-steroidal anti-inflammatory drug (NSAID) indicated for the acute treatment of migraine attacks with or without aura in adults (18 years of age or older). The company held a conference call after the close of the market on the 17 th to discuss the details of the product acquisition with investors. We view the transaction as yet another fine deal for Depomed, a company with significant cash and a growing special pharmaceutical business focused on pain and neurology. Below we discuss the details of the transaction, provide some background information on CAMBIA and the migraine market, and conclude with how the transaction impacts our financial forecasts for Depomed in 2014 and beyond. SUMMARY DATA 52-Week High $ Week Low $5.13 One-Year Return (%) Beta 1.07 Average Daily Volume (sh) 578,785 Shares Outstanding (mil) 57 Market Capitalization ($mil) $560 Short Interest Ratio (days) 5.38 Institutional Ownership (%) 66 Insider Ownership (%) 4 Annual Cash Dividend $0.00 Dividend Yield (%) Yr. Historical Growth Rates Sales (%) 7.9 Earnings Per Share (%) Dividend (%) P/E using TTM EPS P/E using 2013 Estimate P/E using 2014Estimate N/M Risk Level Type of Stock Industry ZACKS ESTIMATES Average, Small-Blend Med-Drugs Revenue (in millions of $) Q1 Q2 Q3 Q4 Year (Mar) (Jun) (Sep) (Dec) (Dec) A 14.1 A 33.3 A 26.6 A 90.8 A A 30.0 A 37.5 A 20.0 E E E E Earnings per Share Q1 Q2 Q3 Q4 Year (Mar) (Jun) (Sep) (Dec) (Dec) $0.16 A -$0.28 A -$0.03 A -$0.07 A -$0.53 A $0.10 A $0.01 A $0.11 A -$0.21 E -$0.18 E $0.30 E 2015 $0.17 E Copyright 2013, Zacks Investment Research. All Rights Reserved.

2 WHAT S NEW Another Fine Deal For Depomed On December 17, 2013, Depomed, Inc. (DEPO) announced it had acquired the U.S. rights to CAMBIA (diclofenac potassium for oral solution) from Nautilus Neurosciences for $48.7 million in cash. CAMBIA is a non-steroidal antiinflammatory drug (NSAID) indicated for the acute treatment of migraine attacks with or without aura in adults (18 years of age or older). The company held a conference call after the close of the market on the 17 th to discuss the details of the product acquisition with investors. We view the transaction as yet another fine deal for Depomed, a company with significant cash and a growing special pharmaceutical business focused on pain and neurology. Below we discuss the details of the transaction, provide some background information on CAMBIA and the migraine market, and conclude with how the transaction impacts our financial forecasts for Depomed in 2014 and beyond. Transaction Details To acquire U.S. rights to CAMBIA, Depomed paid Nautilus $48.7 million in cash, $7.5 million of which was placed into an escrow account. Depomed will pay Nautilus up to $5 million in sales related milestones and will assume certain liabilities associated with the product, including third party royalties and up to $10 million in third party sales milestones. On the conference call to discuss the transaction, CFO August J. Moretti, noted these milestones ranged from trailing twelve month sales eclipsing $30 million to calendar sales eclipsing $100 million. Based on the previous twelve month sales of roughly $18 million at Nautilus, we believe it is very likely that Depomed will pay at least the $5 million sales milestone and a good portion of the third party milestone in the coming years. The transaction price equates to roughly 2.7x trailing twelve month sales far more expensive than previous transactions the company has entered into. For example, Depomed acquired the rights to Zipsor (diclofenac potassium liquid filled capsules) in June 2012 for $25.9 million. Zipsor trailing twelve month sales at the time of the deal totaled $19 million, equating to only 1.4x sales. Depomed has since been able to grow Zipsor to an annualized rate of roughly $25 million. In July 2013, Depomed announced the acquisition of rights to Lazanda (transmucosal immediate-release fentanyl) nasal spray for only $4.0 million in cash. Trailing twelve month sales of the product at privately-held Archimedes Pharma Limited were $3.3 million, equating to 1.2x sales. Despite the fact that it looks like Depomed has dramatically upped its valuation budge for acquiring new products, the roughly 2.7x trailing twelve month sales for CAMBIA is still a frugal transaction. In fact, we believe investors may have been a little spoiled with Depomed past two transactions, as they were both significantly below the industry average multiple of 5.2x, and still well below Depomed s current valuation of roughly 4.1x sales. We note that Depomed immediately raised the price of CAMBIA by 26% upon the close of the transaction. This suggests, assuming no loss of accounts, future twelve month sales could be in the range of $23 million. Additionally, on the conference call on the 17 th to announce the deal, CEO James A. Schoeneck noted that prescriptions in the third quarter ended September 30, 2013 were up 30% year over year. That s a very nice trajectory. Finally, Depomed plans to promote CAMBIA with its 155 sales reps currently promoting Gralise, Zipsor, and Lazanda. Nautilus generated $18 million in trailing twelve month sales and 30% prescription growth in the third quarter with only 35 representatives. These factors lead us to believe that Depomed could eclipse $30 million in CAMBIA sales in Under that scenario, even when including an additional $5 million to Nautilus, the sales price drops to 1.8x, and thus another very fine and frugal transaction for the company. Background On CAMBIA CAMBIA was approved by the U.S. FDA in June The original application was filed in September 2007 by ProEthic Pharmaceuticals. ProEthic Pharma was acquired by Kowa Pharmaceuticals in August The application for approval was submitted as a 505(b)(2) application, with reference to previously approved diclofenac products, Cataflam and Voltaren. ProEthic s application contained two randomized controlled trials, one in the U.S. and one in Europe, in patients with acute migraine, several Phase 1 studies including comparative bioavailability studies between CAMBIA and the two reference products, and CMC information. The majority of the reference data included three randomized controlled studies with Cataflam conducted by Novartis. We note at the time of the application, generic diclofenac potassium in an equal 50 mg dose was available in the U.S., although unlike NSAIDs such as naproxen and ibuprofen, diclofenac is available by prescription only. Zacks Investment Research Page 2 scr.zacks.com

3 The two randomized Phase 3 efficacy trials conducted by ProEthic had four co-primary endpoints in acute migraine. These endpoints were pain free, nausea free, photophobia free, and phonophobia free at 2 hours. In both Phase 3 studies, all co-primary endpoints were met. A key secondary endpoint in reduction of migraine recurrence with 24 hours of dosing was also met. The data below is from the 807 patient U.S. study that compared CAMBIA to placebo: Phase 1 pharmacokinetic data comparing CAMBIA 50 mg packet to Cataflam 50 mg tablet showed dramatically shorter T MAX. This is suggestive of significantly more rapid onset of action. Specifically, CAMBIA was absorbed with a mean time of 15 minutes versus 30 minutes under fasted conditions, and 10 minutes versus 75 minutes under fed conditions. The FDA reviewer for the application concluded that these data might plausibly lead to clinically meaningful effects in the treatment of migraine. Despite the positive Phase 3 data and pharmacokinetic and bioavailability data required to qualify for a 505(b)(2) application, the original filing was met with a complete response letter from the agency in October Back in 2008, the FDA recently became aware of literature suggesting diclofenac may be associated with teratogenic effects in animals. Several years before, Merck withdrew Vioxx (rofecoxib), a cyclooxygenase-2 inhibitor / selective NSAID from the market due to increased risk of heart attack and stroke. The FDA required that all NSAID describe the risk of cardiovascular adverse events with long-term use in the product labels. As such, the agency asked for a revised label and enforced a Risk Evaluation and Mitigation Strategy (REMS) on CAMBIA. The application was resubmitted and eventually approved in June The REMS has since been removed. Nautilus acquired the product from Kowa in December 2009, although terms were not made public. Background On The Migraine Market The migraine market has gone through significant changes over the past decade, mainly the result of the loss of patent exclusivity on the market leading product, Imitrex (sumatriptan) at GlaxoSmithKline in At its peak, Imitrex posted U.S. sales of $1.1 billion, and commanded 75% market share for all migraine therapies. The loss of patent exclusivity on sumatriptan allowed several companies to seek approval for new formulations of the drug, including nasal inhalers, injector pens, transdermal patches, and co-formulations with NSAIDs. Other triptan products, including Maxalt (rizatriptan), Zomig (zolmitriptan), Frova (frovatriptan), and Relpax (almotriptan) also exists, although most are now available generic or will be available as a generic shortly. Migraine drug sales peaked in 2008 at roughly $1.6 billion, and track around $650 million currently, mostly limited by generic alternatives. Allergan s Botox (botulinum toxin type A) received approval for the treatment of chronic migraine attacks in October Botox is injected into the head and neck, and clinical data demonstrates slight improvement in incidence of chronic migraines for migraine sufferers. The drug is used prophylactically in patients who exhibit chronic headache characteristics consistent with migraine attacks. In April 2008, Pozen, Inc. and commercial partner, GlaxoSmithKline, received U.S. FDA approval for Treximet, a combination sumatriptan 85 mg and naproxen sodium 500 mg tablet. Clinical trial data on Treximet demonstrated superior efficacy to individual components, sumatriptan and naproxen, in two large, identical double-blind, randomized, placebo-controlled, parallel-group, multicenter studies of more than 2,900 migraine sufferers. For example, at 2 hour post-dose, 57-65% of migraine suffers were pain free versus 50-55% for sumatriptan, 43-44% for naproxen, and 28-29% for placebo. Despite these impressive data, the best we ve seen in acute migraine attack, Treximet sales have never managed more than $92 million in a calendar year the U.S, and will currently annualize around $80 million for In the U.S., there are an estimated 30 million acute migraine sufferers, roughly 75% of which are female. The average migraine sufferer will typically experience one attack episode per month, although in severe cases patients may experience two or three per week. Migraine prevalence peaks between the ages of 25 and 55, so the majority of patients are private insurance. Roughly two-thirds of patients with migraine are treated by their primary care Zacks Investment Research Page 3 scr.zacks.com

4 physician; we note however that severe cases are often sent to headache specialists or neurologists. Neurologists account for roughly 20% of the migraine market. Given the wide availability of generic products, migraine drugs are typically reimbursed under Tier-3 status, with pharmaceutical companies offering co-pay assistance cards to reduce the out-of-pocket expense. CAMBIA is the only approved single-agent NSAID for the treatment of acute migraine attacks. Compared to Cataflam, the product offers similar efficacy with substantially improved onset of action. The CAMBIA marketing message claims fast-acting relief that can last up to 24 hours. CAMBIA is supplied in a 50 mg packet that dissolves in one to two ounces of water. We estimate of the roughly 30 million migraine sufferers in the U.S, only around 4-5 million actively seek prescription pharmaceutical help. We suspect many patients seek over-the-counter medications, including Advil (ibuprofen), Aleve (naproxen), and Excedrin (acetaminophen / aspirin combination). Branded triptan products, including Imitrex and Maxalt, retail for around $35 per pill, whereas Treximet retails for roughly $25 per pill. Branded Cataflam retails for roughly $5 per pill, whereas generic diclofenac 50 mg tablets can be picked-up for $0.25 per pill. Finally, OTC naproxen and ibuprofen costs as little as $0.05 per pill. Why This Makes Sense For Depomed Following the 26% price increase taken by Depomed management upon the close of the transaction, CAMBIA price is now generally in-line with the aforementioned products. The previous price of CAMBIA was roughly $26 per dose, which has now been increased to $33 per dose. According to management, the product has good Tier-3 coverage, and Depomed will continue with the co-pay assistance card put into place by Nautilus. Depomed acquired roughly seven months of inventory as part of the transaction. Once this inventory has been worked through, management believes the produce will yield 85% gross margin, and that includes sub-royalties to third-parties. According to Depomed, roughly 70% of the CAMBIA prescriptions over the past year have been written by neurologists. This is inconsistent with the overall migraine market, where approximately two-thirds of the prescriptions are written by primary-care physicians, but we note that with Nautilus limited sales force of only 35 representatives, the company was only targeting high decile neurologists with the product. We believe that Depomed, with 155 sales representatives targeting primary-care, pain, and neurology will be able to greatly expand the prescriber range for the product. Neurologists and pain doctors are the biggest prescriber of Depomed s Gralise product, so we see significant synergies for the majority of the 155 Depomed sales reps. For example, management noted that roughly 50% of the CAMBIA prescriber base has written a prescription for Gralise in the past year. This is a good number; it means there is synergy within the call detail, but still upside leverage for cross-selling. On the flip-side, the majority of Zipsor prescriptions are coming from primary-care doctors, meaning there will be little overlap between the two diclofenac products at start, and an opportunity for Depomed to promote CAMBIA into primary-care, where the majority of migraine prescriptions are written. Zacks Investment Research Page 4 scr.zacks.com

5 This looks like another strategic and highly astute transaction for Depomed, a company we ve written in the past has a very good track record at creating value through product acquisitions. Depomed still expects to exit 2013 with between $268 and 272 million in cash, meaning the company has maintained its strong financial base and flexibility, but there is plenty of cash left for more deals to come. Over the past two years Depomed has been building out its product suite in an effort to create a specialty pharmaceutical company focused on pain and neurology. The acquisition of CAMBIA is another very good step in the right direction. Financial Implications & Valuation Above we noted that Depomed still expects to exit 2013 with roughly $270 million in cash. We forecast that the company will be able to generate roughly $30 million in CAMBIA revenue in We see this level of revenue being generated with very little added SG&A. In 2015 and 2016, we believe Depomed can further grow CAMBIA revenues to $35 million and $40 million, respectively. We note all generic threat to the product has been settled and there are no active ANDA challenges. Generic CAMBIA is not expected until January Therefore, assuming some modest growth in the migraine market and approximately 5% market share, shy of even what Treximet has been able to capture, we see CAMBIA as a $60 million product for Depomed. In 2014, 2015, and 2016, we are raising our revenue estimates from $109.6 million, $146.1 million, and $170.2 million, to $139.6 million, $179.1 million, and $210.2 million, respectively. Our EPS forecasts for the same years increase from ($0.50), ($0.05), and $0.19, to ($0.30), $0.17, and $0.50, respectively. Depomed is now currently trading at roughly 19.0x our 2016 EPS estimate of $0.50 per share. The price to sales ratio based on 2016 revenues of $210.2 million in 2.7x. We have raised our target on the stock to $12.00 per share, which equates to 24x our 2016 estimate. We think Depomed is getting close to fairly valued, but acknowledge that with still roughly $270 million in cash, there are more deals to come from the company. Management has now demonstrated a track record of adding value by frugally entering into strategic transactions that are quickly accretive to earnings. We suspect that if the company wanted to spend another $100 million on deals in 2014, this activity could probably generate close to $50 million in revenues and another $0.20 in positive EPS contribution in Accordingly, we are maintaining our Buy recommendation on the stock. Zacks Investment Research Page 5 scr.zacks.com

6 PROJECTED INCOME STATEMENT Income Statement DEPOMED, INC A 2012 A Q1A Q2A Q3A Q4E 2013 E 2014 E 2015 E 2016 E Total Product Sales $40.7 $27.5 $9.1 $14.1 $16.3 $18.9 $58.4 $125.6 $165.1 $201.2 YOY Growth -10.8% -32.5% 332.9% 340.7% 68.1% 51.3% 112.5% 115.0% 31.4% 21.9% Total Royalties $10.00 $44.5 $14.1 $15.1 $15.4 $0.1 $44.7 $0.5 $0.5 $0.5 YOY Growth % 345.5% 49.5% 57.6% 26.4% -99.3% 347.1% -99% - - Total Licenses Revenues $81.8 $18.8 $3.0 $0.8 $5.8 $1.0 $10.5 $13.5 $13.5 $8.5 YOY Growth 134.9% -77.0% -44.1% -42.9% -49.5% 30.7% -87.2% 28.8% 0.0% -37.0% Total Revenues $132.5 $90.8 $26.2 $30.0 $37.5 $20.0 $113.6 $139.6 $179.1 $210.2 YOY Growth 64.0% -31.5% 55.5% 112.4% 12.6% -24.8% 25.1% 22.9% 28.3% 17.4% Cost of Goods Sold $5.5 $6.0 $1.5 $1.7 $1.8 $2.0 $6.9 $18.3 $24.6 $30.1 Gross Margin 95.8% 93.4% 94.3% 94.4% 95.3% 90.0% 93.9% 86.9% 86.3% 85.7% SG&A $54.2 $97.6 $26.0 $25.4 $26.4 $27.0 $104.7 $115.0 $120.0 $125.0 % SG&A 40.9% 107.5% 99.2% 84.7% 70.4% 135.0% 92.2% 82.4% 67.0% 59.5% R&D $15.2 $15.5 $3.3 $1.4 $1.3 $1.5 $7.5 $15.0 $15.0 $10.0 % R&D 11.5% 17.0% 12.6% 4.7% 3.6% 7.5% 6.6% 10.7% 8.4% 4.8% Amortization $0 $2.0 $1.0 $1.0 $1.2 $1.2 $4.3 $10.0 $10.0 $10.0 Operating Income $30.2 ($30.4) ($5.5) $0.5 $6.8 ($11.7) ($9.9) ($18.7) $9.5 $35.1 Operating Margin 22.8% -33.4% % -13.4% 5.3% 16.7% Interest & Other Net $40.4 $0.6 $0.1 ($0.1) ($0.3) ($0.2) ($0.5) $0.5 $1.0 $1.0 Pre-Tax Income $71.1 ($29.8) ($5.5) $0.5 $6.5 ($11.9) ($10.4) ($18.2) $10.5 $36.1 Taxes $0.4 $0.0 $0 $0 $0 $0 $0 $0 $0 $3.6 Tax Rate 0% 0% 0% 0% 0% 0% 0% 0% 0% 10% Net Income $70.7 ($29.8) ($5.5) $0.5 $6.5 ($11.9) ($10.4) ($18.2) $10.5 $32.5 Net Margin 53.4% -32.8% % -13.0% 5.9% 15.5% Adjusted EPS $1.26 ($0.53) ($0.10) $0.01 $0.11 ($0.21) ($0.18) ($0.30) $0.17 $0.50 Source: Zacks Investment Research, Inc. YOY Growth % % % % 196.5% Wt. Ave Shares Out Jason Napodano, CFA Copyright 2013, Zacks Investment Research. All Rights Reserved.

7 HISTORICAL ZACKS RECOMMENDATIONS DISCLOSURES The following disclosures relate to relationships between Zacks Investment Research ( ZIR ), Zacks & Company (ZCO ) 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. ZCO and Zacks SCR are separate legal entities. ZCO is U.S. broker-dealer registered with the U.S. Securities and Exchange Commission and a member of the Financial Industry Regulatory Authority and the Securities Investor Protection Corp. This report is for your information only and is not an offer to sell, or a solicitation of an offer to buy, the securities or instruments through ZCO. 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 1032 companies covered: Buy/Outperform- 15.7%, Hold/Neutral- 77.9%, Sell/Underperform 5.5%. Data is as of midnight on the business day immediately prior to this publication. Copyright 2013, Zacks Investment Research. All Rights Reserved.