<PAGE>
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, 1996
------------------
[ ] 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 0-19119
------------------
CEPHALON, INC.
-----------------------
(Exact Name of Registrant as Specified in its Charter)
Delaware 23-2484489
----------------------- ------------------
(State Other Jurisdiction of (I.R.S. Employer Identification
Incorporation or Organization) Number)
145 Brandywine Parkway, West Chester, PA 19380
- ------------------------------------------ ----------------
(Address of Principal Executive Offices) (Zip Code)
Registrant's Telephone Number, Including Area Code (610) 344-0200
---------------------
Not Applicable
- --------------------------------------------------------------------------------
Former Name, Former Address and Former Fiscal Year, If Changed Since Last Report
Indicate by check mark whether the Registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 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 _______
Applicable only to corporate issuers:
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date.
Class Outstanding as of November 8, 1996
-------------- ----------------------------------
Common Stock, par value $.01 24,516,757 Shares
This Report Includes a Total of 23 Pages
<PAGE>
CEPHALON, INC. and SUBSIDIARIES
-------------------------------
INDEX
-----
Page No.
--------
PART I - FINANCIAL INFORMATION
<TABLE>
<CAPTION>
<S> <C> <C>
Item 1. Financial Statements
Consolidated Balance Sheets - 1
September 30, 1996 and
December 31, 1995
Consolidated Statements of 2
Operations - Three and nine months
ended September 30, 1996 and 1995
Consolidated Statements of 3
Cash Flows - Nine months ended
September 30, 1996 and 1995
Notes to Consolidated 4 - 8
Financial Statements
Item 2. Management's Discussion and 9 - 21
Analysis of Financial Condition
and Results of Operations
PART II - OTHER INFORMATION
Item 6. Exhibits and Reports on Form 8-K 22
SIGNATURES 23
</TABLE>
<PAGE>
Part 1 - Financial Information
- ------------------------------
Item 1. Financial Statements
CEPHALON, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
---------------------------
(Unaudited)
<TABLE>
<CAPTION>
September 30, December 31,
1996 1995
---------------- ----------------
<S> <C> <C>
ASSETS
------
CURRENT ASSETS:
Cash and cash equivalents ($4,375,000 and $6,250,000 in custodial account) (Note 2) $ 8,006,000 $ 6,565,000
Short-term investments (Note 2) 136,691,000 171,502,000
Other 5,807,000 10,415,000
---------------- ----------------
Total current assets 150,504,000 188,482,000
PROPERTY AND EQUIPMENT, net of accumulated
depreciation and amortization of $12,541,000 and $9,652,000 28,591,000 30,002,000
OTHER 1,269,000 2,846,000
---------------- ----------------
$ 180,364,000 $ 221,330,000
================ ================
LIABILITIES AND STOCKHOLDERS' EQUITY
------------------------------------
CURRENT LIABILITIES:
Accounts payable $ 2,058,000 $ 4,379,000
Accrued expenses (Note 3) 12,795,000 10,116,000
Current portion of long-term debt 3,983,000 3,907,000
---------------- ----------------
Total current liabilities 18,836,000 18,402,000
LONG-TERM DEBT 19,163,000 21,668,000
OTHER 1,620,000 1,055,000
---------------- ----------------
Total liabilities 39,619,000 41,125,000
---------------- ----------------
COMMITMENTS AND CONTINGENCIES (Note 4)
STOCKHOLDERS' EQUITY: (Note 5)
Preferred stock, $.01 par value,
5,000,000 shares authorized, none issued -- --
Common stock, $.01 par value, 100,000,000 and 40,000,000 shares authorized,
24,475,751 and 23,837,204 shares issued and outstanding 245,000 238,000
Additional paid-in capital 293,581,000 284,649,000
Accumulated deficit (153,081,000) (104,682,000)
---------------- ----------------
Total stockholders' equity 140,745,000 180,205,000
---------------- ----------------
$ 180,364,000 $ 221,330,000
================ ================
</TABLE>
The accompanying notes are an integral part of these financial statements.
1
<PAGE>
CEPHALON, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
-------------------------------------
(Unaudited)
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
September 30, September 30,
-------------------------------------- ---------------------------------------
1996 1995 1996 1995
---------------- ---------------- ---------------- -----------------
<S> <C> <C> <C> <C>
REVENUES (Note 6):
Related party $ -- $ 1,678,000 $ -- $ 5,235,000
Other 3,619,000 17,492,000 11,407,000 31,476,000
---------------- ---------------- ---------------- ----------------
3,619,000 19,170,000 11,407,000 36,711,000
OPERATING EXPENSES (Notes 6 and 7):
Research and development 15,161,000 23,922,000 45,701,000 54,315,000
Selling, general and administrative 6,765,000 4,461,000 18,528,000 10,749,000
---------------- ---------------- ---------------- ----------------
21,926,000 28,383,000 64,229,000 65,064,000
LOSS FROM OPERATIONS (18,307,000) (9,213,000) (52,822,000) (28,353,000)
INTEREST:
Income 2,304,000 5,677,000 6,168,000 9,636,000
Expense (558,000) (1,086,000) (1,745,000) (2,468,000)
---------------- ---------------- ---------------- ----------------
1,746,000 4,591,000 4,423,000 7,168,000
---------------- ---------------- ---------------- ----------------
LOSS $ (16,561,000) $ (4,622,000) $ (48,399,000) $ (21,185,000)
================ ================ ================ ================
LOSS PER SHARE $ (0.68) $ (0.22) $ (2.00) $ (1.10)
================ ================ ================ ================
WEIGHTED AVERAGE NUMBER
OF SHARES OUTSTANDING 24,437,777 20,780,565 24,248,996 19,287,749
================ ================ ================ ================
</TABLE>
The accompanying notes are an integral part of these financial statements.
2
<PAGE>
CEPHALON, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
-------------------------------------
(Unaudited)
<TABLE>
<CAPTION>
Nine Months Ended
September 30,
----------------------------------
1996 1995
--------------- --------------
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Loss $ (48,399,000) $ (21,185,000)
Adjustments to reconcile loss to net cash
used for operating activities:
Depreciation and amortization 2,889,000 4,876,000
(Increase) decrease in operating assets:
Other current assets 3,639,000 (3,951,000)
Other long-term assets (102,000) 131,000
Increase (decrease) in operating liabilities:
Accounts payable (2,321,000) 516,000
Accrued expenses 4,466,000 3,100,000
Other long-term liabilities 565,000 68,000
--------------- --------------
Net cash used for operating activities (39,263,000) (16,445,000)
--------------- --------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Repayments from related party -- 4,435,000
Purchases of property and equipment (1,588,000) (16,078,000)
Sale leaseback of property and equipment -- 237,000
Sales and maturities (purchases) of investments, net 34,811,000 (63,568,000)
--------------- --------------
Net cash provided by (used for) investing activities 33,223,000 (74,974,000)
--------------- --------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from sale of common stock and warrants -- 84,245,000
Proceeds from exercise of common stock options and warrants 8,231,000 6,373,000
Principal payments on long-term debt (2,829,000) (16,461,000)
Proceeds from long-term debt 2,079,000 21,073,000
--------------- --------------
Net cash provided by financing activities 7,481,000 95,230,000
--------------- --------------
NET INCREASE IN CASH AND CASH EQUIVALENTS 1,441,000 3,811,000
CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD 6,565,000 11,063,000
--------------- --------------
CASH AND CASH EQUIVALENTS, END OF PERIOD $ 8,006,000 $ 14,874,000
=============== ==============
</TABLE>
The accompanying notes are an integral part of these financial statements.
3
<PAGE>
CEPHALON, INC. & SUBSIDIARIES
-----------------------------
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
------------------------------------------
(Unaudited)
1. The Company and Summary of Significant Accounting Policies
----------------------------------------------------------
The Company
Cephalon, Inc. ("Cephalon" or the "Company") seeks to discover and
develop pharmaceutical products primarily for the treatment of neurological
disorders, such as ALS, narcolepsy, peripheral neuropathies, Alzheimer's
disease, head and spinal injury and stroke. The Company has not received
regulatory approval for the commercial sale of any of its products under
development. The Company markets and sells, to neurologists in the United
States, two proprietary pharmaceutical products of Bristol-Myers Squibb ("BMS")
under a co-promotion agreement. The Company has funded its operations primarily
from the proceeds of public and private placements of its equity securities and
the receipt of payments under research and development agreements.
The Company's business of developing and marketing pharmaceutical
products is subject to a number of significant risks, including risks inherent
in research and development activities and in conducting business in a highly
regulated environment. The success of the Company depends to a large degree upon
obtaining FDA and foreign regulatory approval to market products currently under
development. There can be no assurance that any of the Company's product
candidates will be approved by any regulatory authority for marketing in any
jurisdiction, or if approved, that such products can be marketed profitably.
Basis of presentation
These consolidated financial statements of Cephalon, Inc. are unaudited
and include all adjustments which, in the opinion of management, are necessary
to present fairly the financial condition and results of operations as of and
for the periods set forth in the Consolidated Balance Sheets, Consolidated
Statements of Operations and Consolidated Statements of Cash Flows. All such
adjustments are of a normal, recurring nature. The consolidated financial
statements do not include all of the information and footnote disclosures
normally included in financial statements prepared in accordance with generally
accepted accounting principles and should be read in conjunction with the
consolidated financial statements and notes thereto included in the Company's
annual report on Form 10-K, filed with the Securities and Exchange Commission,
which includes financial statements as of and for the three years ended December
31, 1995. The results of the Company's operations for any interim period are not
necessarily indicative of the results of the Company's operations for any other
interim period or for a full year.
2. Cash, Cash Equivalents and Investments
--------------------------------------
Cash, cash equivalents and investments are valued at market as of the
indicated dates and were as follows:
<TABLE>
<CAPTION>
September 30, 1996 December 31, 1995
------------------ -----------------
<S> <C> <C>
Cash and cash equivalents........... $ 8,006,000 $ 6,565,000
Repurchase agreements collateralized
by U.S. Treasury securities....... 3,034,000 23,126,000
U.S. Treasury bills and notes....... 120,127,000 140,966,000
Corporate obligations............... 13,530,000 7,410,000
------------ ------------
$144,697,000 $178,067,000
============ ============
</TABLE>
The Company considers all highly liquid instruments purchased with an
original maturity of three months or less to be cash equivalents.
4
<PAGE>
3. Accrued Expenses
----------------
Accrued expenses consisted of the following:
<TABLE>
<CAPTION>
September 30, 1996 December 31, 1995
------------------ -----------------
<S> <C> <C>
Accrued compensation and benefits....... $ 2,967,000 $ 501,000
Accrued professional fees............... 1,445,000 894,000
Accrued clinical trial fees and related
expenses............................... 2,607,000 5,021,000
Accrued license fees and royalties...... -- 1,633,000
Accrued co-promotion expenses........... 95,000 605,000
Deferred revenue........................ 4,335,000 500,000
Other accrued expenses.................. 1,346,000 962,000
----------- -----------
$12,795,000 $10,116,000
=========== ===========
</TABLE>
4. Commitments and Contingencies
-----------------------------
Leases
The Company leases certain of its offices, automobiles and equipment
under operating leases. The Company's future annual minimum payments under these
leases are approximately $331,000 for the remainder of 1996, $271,000, $258,000
and $142,000 in 1997, 1998 and 1999, respectively. The above payments have been
adjusted to reflect the transfer of certain lease obligations to the purchaser
of the assets of the Company's Beltsville, Maryland pilot-scale manufacturing
facility (the "Beltsville Facility") (See Note 8).
Other
The Company maintains a number of agreements to fund research by third
parties. These agreements are generally renewable on an annual basis and provide
the Company with the right to obtain royalty-bearing licenses to the results of
the research. The Company is obligated under several other cancelable
agreements, including those entered into for the purpose of conducting clinical
trials. The Company has obligations to fund certain marketing programs under its
co-promotion agreement with BMS, including an obligation of approximately
$810,000 in the remainder of 1996. The Company is obligated to make royalty,
license fee and milestone payments under certain of its licensing and research
and development agreements.
Related party
In 1992, the Company entered into a research and development agreement
(the "Partnership Development Agreement") with Cephalon Clinical Partners, L.P.
(the "Partnership") under which the Company granted the Partnership an exclusive
license in the United States, Canada and Europe (''the Territory'') to certain
technology, principally MYOTROPHIN(R) (recombinant human IGF-1; "rhIGF-1"), and
received a non-refundable license fee of $500,000. The Partnership depleted its
available funds late in 1995 and the Company has agreed to fund the development
of MYOTROPHIN (rhIGF-1) in the Territory under certain circumstances (see Note
6).
The Partnership granted the Company an exclusive license (the "Interim
License") to manufacture and market MYOTROPHIN (rhIGF-1) within the Territory in
return for certain royalty payments and a payment of approximately $16,000,000
(the ''Milestone Payment'') that is to be made if MYOTROPHIN (rhIGF-1) receives
regulatory approval in the United States or certain other countries within the
Territory. The Company has the option to pay the Milestone Payment in cash,
common stock, or a combination thereof.
The Company has a contractual option to purchase all of the limited
partnership interests in the Partnership (the ''Purchase Option''). To exercise
the Purchase Option, Cephalon will be required to make an advance payment of
$40,275,000 in cash or, at Cephalon's election, $42,369,000 in shares of the
Company's Common Stock, valued at the market price at the time the Purchase
Option is exercised. The Purchase Option will become exercisable for a 45-day
period commencing on the date which is the earlier of (a) the date which is the
later of (i) the last day of the first month in which the Partnership shall have
received Interim License payments equal to fifteen percent (15%) of the limited
partners' capital contributions (excluding the Milestone Payment), and (ii) the
last day of the 24th full month after the date of the Company's first commercial
sale, if any, of MYOTROPHIN (rhIGF-1) within the Territory that generates a
payment to the Partnership, and (b) the last day of the 48th full month after
the date of such first commercial sale, if any, in the Territory. In addition to
the advance
5
<PAGE>
payment, the exercise of the Purchase Option requires the Company to make future
payments to the former limited partners for a period of eleven years after
exercise at a royalty rate of 10.1% (reducing to 5.0% after a specified return
is earned by the former limited partners) of MYOTROPHIN sales in the Territory,
provided that royalties on sales of MYOTROPHIN (rhIGF-1) in Europe will only be
paid to the extent necessary to meet specified sales targets. If the Company
does not exercise the Purchase Option prior to its expiration date the Interim
License will terminate and all development and marketing rights to MYOTROPHIN
(rhIGF-1) in the Territory would revert to the Partnership, which may
commercialize MYOTROPHIN (rhIGF-1) itself or license or assign its rights to a
third party. The Company would not receive any benefits from any such
commercialization.
Legal proceedings
The Company and certain of its officers have been named as defendants in
a number of civil actions filed in the U.S. District Court for the Eastern
District of Pennsylvania, which have been consolidated. Several of the
plaintiffs, at the request of their respective counsel, have been designated,
collectively, as the "lead plaintiff" by the Court for purposes of the Private
Securities Litigation Reform Act of 1995. The consolidated complaint filed in
October 1996 by the lead plaintiffs extended and expanded the class period to
include purchasers of the Company's securities and options to purchase or sell
those securities during the period between June 12, 1995 and June 7, 1996.
Plaintiffs allege, based in part on statements and opinions expressed at the
June 7, 1996 meeting of an FDA advisory committee, that earlier statements by
the Company about the North American and European trial results were misleading.
The plaintiffs seek unspecified damages and other relief. Discovery related to
the merits of the allegations in the complaint has been postponed until the
Company responds to the complaint. The Company intends to vigorously defend the
actions. However, management is evaluating the new complaint, and it is too
early in the proceedings to predict the outcome of these actions with any
certainty.
5. Stockholders' Equity
--------------------
At September 30, 1996, the Company had 2,910,157 stock options
outstanding at exercise prices ranging from $0.15 per share to $31.00 per share,
of which 1,420,726 options were exercisable, including 463,000 options
exercisable at prices below $10.00 per share.
In addition, at September 30, 1996, warrants to purchase 2,959,620
shares of the Company's common stock were outstanding, as follows:
<TABLE>
<CAPTION>
Number of shares issuable Exercise Price
upon exercise of warrants Exercise Period per share
- --------------------------- ----------------------------------- --------------
<S> <C> <C>
1,801,017 September 1, 1993 - August 31, 1997 $11.32
September 1, 1997 - August 31, 1999 $13.82
387,900 September 1, 1994 - August 31, 1999 $13.70
20,703 September 1, 1993 - August 31, 1999 $11.77
750,000 February 9, 1994 - February 8, 2002 $18.50
</TABLE>
During the nine months ended September 30, 1996, 521,328 warrants and
102,587 stock options were exercised for an aggregate exercise price of
$6,083,000 and $787,000, respectively.
6. Revenues
--------
Related Party - Cephalon Clinical Partners, L.P.
Under the Partnership Development Agreement, the Company is performing
the development and clinical testing of MYOTROPHIN (rhIGF-1) within the
Territory and was reimbursed by the Partnership for 110% of the Company's
incurred costs, based upon budgetary maximums and the Partnership's available
funding.
For the three and nine month period ended September 30, 1995, the
Company recorded revenue of $1,678,000 and $5,235,000, respectively, and
incurred related budgeted expense of $1,773,000 and $5,500,000 for
6
<PAGE>
the same period under the Partnership Development Agreement, net of warrant
amortization. For the three and nine month period ended September 30, 1995, the
Company incurred expenses of approximately $7,080,000 and $16,415,000,
respectively, for which it was not reimbursed. Also in August 1995, the Company
purchased 67 limited partnership interests in the Partnership at a cost of
$3,350,000. The cost of the acquisition was charged to research and development
expense in the third quarter of 1995.
Late in 1995, the Partnership depleted all of its available funding and
will not provide further funding of MYOTROPHIN development costs to the Company.
The amount of additional funding required for further development will be
determined by the Partnership's general partner in advance of each quarter, and
each quarter, the Company will have the right, but not the obligation, to
contribute such funds (see Note 4). The January 1994 collaboration between the
Company and Chiron is subject to the rights of the Partnership (see Note 7).
Revenue - Other
Other revenues consisted primarily of the revenue recorded under the
Company's collaboration agreements as follows:
<TABLE>
<CAPTION>
Three months ended September 30, Nine months ended September 30,
-------------------------------- -------------------------------
1996 1995 1996 1995
--------------- --------------- -------------- ---------------
<S> <C> <C> <C> <C>
Bristol-Meyers Squibb............ $ -- $ 500,000 $ -- $ 500,000
TAP Holdings..................... 1,472,000 1,323,000 4,475,000 3,753,000
SmithKline Beecham............... 716,000 698,000 2,138,000 2,089,000
Kyowa Hakko Kogyo................ 681,000 569,000 1,600,000 1,309,000
Schering-Plough.................. 750,000 -- 2,250,000 500,000
Chiron (see Note 7).............. -- 14,112,000 944,000 22,929,000
</TABLE>
Schering-Plough
In August 1996, the Company and Schering-Plough revised the terms of the
May 1990 research and development agreement, as renewed in November 1995, to
reduce the notice period to 90 days if Schering-Plough elects to terminate
funding. In the event of such termination, Cephalon has agreed not to enter into
any arrangement with a third party for research and development in the same
field of activity for a period of one year following notice of termination.
7. Research and Development
------------------------
Chiron Corporation
The Company and Chiron are jointly developing MYOTROPHIN (rhIGF-1) for
the treatment of ALS and certain peripheral neuropathies. Under the
collaboration, each party funded its own collaboration-related expenses through
1994. Chiron provided the Company with a revolving credit facility (the "Note")
to assist the Company in funding its costs incurred. During the nine months
ended September 30, 1995, the Company drew down $5,274,000 against the Note and
repaid in full the outstanding balance of $13,882,000 and related interest of
$315,000. In September 1995, the Company and Chiron adjusted their contributions
to the collaboration program to result in equal aggregate funding by each party
through that date and agreed to fund equal amounts of MYOTROPHIN program costs
thereafter. As a result of this equalization, the Company received $22,929,000
from Chiron representing reimbursement of the Company's prior costs incurred for
the peripheral neuropathy and European ALS programs and payment to equalize the
companies' funding of the North American ALS program costs incurred by the
Company through September 1995. The Company also received interest on the
reimbursement payments in the amount of $2,051,000.
For the quarter ended March 31, 1996, the equalization of program costs
resulted in net revenue from Chiron of $944,000. For the quarters ended June
30, 1996 and September 30, 1996, the equalization of program costs resulted in
the Company recording $838,000 and $249,000, respectively, of expense and a
corresponding liability to Chiron for estimated second and third quarter program
costs incurred, related primarily to manufacturing activities conducted by
Chiron.
7
<PAGE>
Laboratoire L. Lafon
The license agreement with Lafon requires Cephalon to endeavor to file
an NDA for PROVIGIL(R) (modafinil) by July 31, 1996, but provides that Cephalon
will not be deemed to be in breach of that provision if Cephalon is required to
submit to the FDA any preclinical data other than the data provided by Lafon, or
for any other reason outside of Cephalon's control. Cephalon is collecting
additional data, including preclinical data, to supplement the data provided by
Lafon, which Cephalon believes is required to be included in the NDA. The
Company believes that the NDA filing requirement has been postponed pending
completion of this activity. In each of the nine months ended September 30, 1996
and 1995, the Company paid $1,633,000 to Lafon to maintain the license to
modafinil.
8. Subsequent Event
----------------
Sale of the Beltsville Facility- In November 1996, the Company sold the
assets of its Beltsville, Maryland pilot-scale manufacturing facility for a
total purchase price of approximately $24,900,000. In the transaction, the
Company received approximately $17,200,000 and transferred approximately
$7,700,000 of equipment lease obligations to the purchaser. The Company has
agreed to provide indemnification to the purchaser under the purchase agreement
in certain circumstances (see Note 4).
8
<PAGE>
ITEM 2. Management's Discussion and Analysis of Financial Condition And Results
-----------------------------------------------------------------------
Of Operations
- -------------
The discussion under this caption (particularly the text under the
captions "Outlook") contains, in addition to historic information, forward-
looking statements about the business and financial condition of Cephalon, which
are subject to certain risks and uncertainties that could cause actual results
to differ materially from those set forth in this discussion. Factors which
could cause or contribute to such differences include, but are not limited to,
the factors identified under the caption "Certain Risks Related to Cephalon's
Business." Shareholders and potential investors are urged to consider those
factors in evaluating the forward-looking statements in this Report and
presented elsewhere by management from time to time.
The following discussion also should be read in conjunction with the
Consolidated Financial Statements and Notes to the Consolidated Financial
Statements on pages 1 to 8 of this Report.
Since its inception in 1987, Cephalon has been engaged in the discovery
and development of pharmaceutical products, primarily for the treatment of
neurological disorders. The Company has not received regulatory approval to
market or any revenue from the sale of, any product developed by the Company and
has been unprofitable since inception. As of September 30, 1996, the Company had
an accumulated deficit of $153,081,000.
The Company has funded its operations primarily from the proceeds of
public and private placements of its equity securities and the receipt of
payments under research and development agreements. The Company entered into a
collaborative research agreement (the "Schering-Plough Agreement") with
Schering-Plough Corporation ("Schering-Plough" or "SP") in May 1990. In May
1992, the Company licensed from Kyowa Hakko Kogyo Co., Ltd. ("Kyowa Hakko") a
class of small molecules that the Company refers to as tyrosine kinase ("TK")
modulators. In August 1992, the Company formed Cephalon Clinical Partners, L.P.
(the "Partnership") and entered into agreements with the Partnership including
an agreement (the "Partnership Development Agreement") for the research and
development of MYOTROPHIN(R) (recombinant human IGF-1; "rhIGF-1") in the United
States, Canada and Europe (the "Territory"). In January 1993, the Company
entered into a licensing agreement with Laboratoire L. Lafon ("Lafon"), in which
the Company received the exclusive rights to market and sell PROVIGIL(R)
(modafinil) in the United States, Mexico, the United Kingdom, Ireland and Japan.
In June 1993, the Company entered into a collaborative research, development and
commercialization agreement (the "SmithKline Beecham Agreement") with SmithKline
Beecham ("SB"). In July 1993, the Company entered into an agreement (the "Kyowa
Hakko Myotrophin Agreement") with Kyowa Hakko to develop and market MYOTROPHIN
(rhIGF-1) in Japan. In January 1994, the Company entered into a collaboration
with Chiron Corporation ("Chiron") for the development of MYOTROPHIN (rhIGF-1)
and certain other compounds in the neurology field worldwide, excluding Japan
and subject to the rights of the Partnership. In May 1994, the Company and TAP
Holdings Inc. ("TAP") entered into a research and development and license
agreement (the "TAP Agreement") to develop and commercialize specific compounds
for the treatment of prostate disease in the United States. In July 1994, the
Company and Bristol-Myers Squibb Company ("BMS") entered into a co-promotion
agreement (the "BMS Agreement") to market the BMS proprietary product, Stadol
NS(R) (butorphanol tartrate) Nasal Spray ("Stadol NS"), to neurologists in the
United States. The arrangement was expanded in February 1996 to include the co-
promotion of another BMS proprietary product, Serzone(R) (nefazodone
hydrochloride), to neurologists in the United States.
Certain Risks Related to Cephalon's Business
The statements under this caption are intended to serve as cautionary
statements within the meaning of the Private Securities Litigation Reform Act of
1995 and should be read in conjunction with the forward-looking statements in
this Report as well as statements presented elsewhere by management of the
Company. The following information is not intended to limit in any way the
characterization of other statements or information in this Report as cautionary
statements for such purpose.
The Company's business of developing and marketing pharmaceutical
products is subject to a number of significant risks, including those inherent
in pharmaceutical research and development activities and in conducting business
in a regulated environment. The success of the Company depends to a large degree
upon obtaining favorable action and approvals by the U.S. Food and Drug
Administration ( the "FDA") and foreign regulatory
9
<PAGE>
authorities to clinically test and ultimately market products currently under
development by the Company. The Company has had only limited experience in
preparing, filing and pursuing the applications necessary to gain such
regulatory approvals. The Company's analysis of the results of its clinical
studies is subject to confirmation and interpretation by regulatory authorities,
whose conclusions may differ from those of the Company. There can be no
assurance that any regulatory authority will review any Company application to
test or market a product in a timely manner, will accept any application as
adequate for filing, or will grant approval to test or market any product.
Late-Stage Products
- -------------------
The Company is developing MYOTROPHIN (rhIGF-1) in collaboration with
Chiron Corporation for use in the treatment of ALS and other neurological
indications. During 1995, the Company and Chiron announced that, based on their
analysis and interpretation of data from two Phase III studies of MYOTROPHIN
(rhIGF-1) in patients suffering from ALS, MYOTROPHIN (rhIGF-1) showed a
beneficial effect in slowing the progression of the disease. The first such
study was conducted in North America and the second study was conducted in
Europe. In October 1995, the Company submitted the results of the North American
study to the FDA in support of a treatment investigational new drug application
("T-IND") to permit the Company and Chiron to provide expanded access to
MYOTROPHIN (rhIGF-1) by patients suffering from ALS. The T-IND process was
developed by the FDA to make available promising investigational drugs with
sufficient evidence of safety and effectiveness to treat patients with serious
or immediately life-threatening diseases, where no comparable or satisfactory
alternative therapies exist. While the FDA was reviewing that application, the
Company and Chiron announced certain results of the European study, which were
also supplied to the FDA. The FDA subsequently requested additional information
about the European study as part of its review of the T-IND.
In January 1996, the Company and Chiron announced that the FDA had
raised concerns as to whether the data submitted and reviewed by the FDA from
the European study confirm the results from the North American study. The FDA's
Peripheral and Central Nervous System Drugs Advisory Committee held a public
hearing on June 7, 1996 to review data for purposes of recommending to the FDA
whether there was sufficient evidence to support use of MYOTROPHIN (rhIGF-1)
under a T-IND. At the hearing, representatives of the FDA indicated their
disagreement with the Company's various analyses of the European study and their
opinion that the study failed to support the results of the North American
study. At the conclusion of the Advisory Committee hearing, the panel members
unanimously recommended approval of the T-IND.
The FDA approved the T-IND application on June 19, 1996. The FDA's
approval letter noted the views of several Advisory Committee members expressed
at the hearing, including the chairman, concerning the need for an additional
study to support an NDA, and invited Cephalon and Chiron to work with the Agency
to develop plans for future studies. The Company continues to believe that the
two completed studies show the beneficial treatment effect of MYOTROPHIN
(rhIGF-1) in ALS patients, particularly those with more rapidly progressing
disease. However, the Company and Chiron have indicated their willingness to
conduct an additional study of MYOTROPHIN (rhIGF-1) as a post-approval activity,
and plan to initiate in the near future a study of MYOTROPHIN (rhIGF-1) in
combination with Rilutek(R) (riluzole), a drug approved by the FDA for use in
treating ALS. The companies are currently completing the NDA for filing with the
FDA as soon as possible.
There can be no assurance that the FDA ultimately will approve
MYOTROPHIN (rhIGF-1) on the basis of the results of the two completed studies.
If the FDA were to require additional data to support approval of MYOTROPHIN
(rhIGF-1), there can be no assurance that the Company and Chiron would be
willing to conduct the planned study or any other additional study as a pre-
approval activity. Furthermore, even if an additional study were conducted, the
results may not be sufficient to support FDA approval. A new study also would be
costly and would take several years to complete.
Based on the Company's review to date of the safety data from the two
Phase III studies, the Company believes that MYOTROPHIN (rhIGF-1) was well-
tolerated. Generally mild injection site inflammation, changes in hair growth or
texture, sweating, mild knee pain, sinusitis and hip pain were observed in all
study groups but occurred more frequently in MYOTROPHIN-treated patients.
Because ALS is a fatal disease, it is expected that some mortalities will occur
while conducting clinical trials in ALS patients. Mortalities have occurred
during the Company's Phase III studies of MYOTROPHIN (rhIGF-1). During the
double-blind portion of the European study, an imbalance in death rates was
observed in the drug-treated group compared to the placebo-treated group. The
Company believes those mortalities are due to the normal progression of the
disease or other circumstances not
10
<PAGE>
attributable to MYOTROPHIN (rhIGF-1). FDA regulations require the reporting of
all patient adverse events experienced in ongoing trials. The Company plans to
initiate the T-IND program for ALS patients in the near future and is continuing
to furnish MYOTROPHIN (rhIGF-1) to patients who participated in the ALS studies
and to patients in its Phase II program in peripheral neuropathies. There can be
no assurance that adverse events will not occur and that the reporting of any
such events will not result in any subsequent FDA action adverse to the Company.
The efficacy and safety data from the North American and European
studies of MYOTROPHIN (rhIGF-1) have not yet been formally reviewed by any
regulatory authority outside the United States. If foreign regulatory
authorities do not agree with the Company's interpretation of the results from
the two studies, one or more additional positive studies might be required to be
completed and submitted before MYOTROPHIN (rhIGF-1) could be marketed in such
territories.
There can be no assurance that any regulatory authority will accept the
North American and European studies as evidence of sufficient safety and
efficacy to support marketing approval or that MYOTROPHIN (rhIGF-1) will receive
marketing approval in any jurisdiction for any indication. A failure to obtain
any regulatory approval for MYOTROPHIN (rhIGF-1) would seriously adversely
affect the Company's business and the price of its common stock. A delay in
obtaining approval to market MYOTROPHIN (rhIGF-1) would have a negative effect
on the Company and its common stock because of the lost revenue during the delay
and because of reduced revenues resulting from competition from other products
and potential limitations on reimbursement, discussed below.
Cephalon recently sold its pilot-scale manufacturing facility for
rhIGF-1 and will rely on Chiron for all of its manufacturing requirements for
rhIGF-1 (except for commercial supplies of rhIGF-1 for Japan, as to which supply
arrangements have not been established). Cephalon and Chiron expect that
MYOTROPHIN (rhIGF-1) will be produced at Chiron's Vacaville, California
facility, which was recently completed. There can be no assurance that Chiron
will be able to produce adequate quantities of MYOTROPHIN (rhIGF-1) at that
facility or that such production will be cost-effective. The Company and Chiron
also will be required to demonstrate that the material produced from the Chiron
facility is equivalent to the material used in the ALS clinical trials. Although
the companies believe that the material is equivalent, if bioequivalence can not
be demonstrated to the satisfaction of regulatory authorities, regulatory
approval of MYOTROPHIN (rhIGF-1) could be delayed. If for any reason Chiron does
not or can not produce IGF-1 for use in the collaboration, Cephalon does not
believe that an alternative source of supply could be obtained readily, and
therefore a disruption of supply could result before an alternative supply
arrangement was established.
The manufacturing facilities used to produce MYOTROPHIN (rhIGF-1) are
required to comply with all applicable regulatory requirements, including Good
Manufacturing Practices, and are subject to inspection by regulatory authorities
to determine compliance with those requirements. There can be no assurance that
the manufacturing facilities for MYOTROPHIN (rhIGF-1) will comply with
applicable requirements.
During the first quarter of 1996, the Company announced positive results
from two Phase III studies of PROVIGIL (modafinil) in the treatment of the
excessive daytime sleepiness associated with narcolepsy. The results of those
clinical trials have not been reviewed by the FDA or any other regulatory
authority. There can be no assurance that the FDA or other regulatory
authorities will consider that the results generated from the Company's clinical
trials demonstrate sufficient safety and efficacy to allow the filing of an NDA
to obtain marketing approval, or that, if such application is filed that any
such approval could be obtained. The license agreement with Lafon requires
Cephalon to endeavor to file an NDA for PROVIGIL (modafinil) by July 31, 1996,
but provides that Cephalon will not be deemed to be in breach of that provision
if Cephalon is required to submit to the FDA any preclinical data other than the
data provided by Lafon, or for any other reason outside of Cephalon's control.
Cephalon is collecting additional data, including preclinical data, which
Cephalon believes is required to be included in the NDA, to supplement the data
provided by Lafon. The Company believes that the NDA filing requirement has been
postponed pending completion of this activity.
Lafon has filed for marketing approval of modafinil throughout the
European Union through the multi-state procedures promulgated by the Committee
for Proprietary Medicinal Products ("CPMP"), which includes applications in the
United Kingdom and the Republic of Ireland, territories included in Cephalon's
license from Lafon. As part of the CPMP review process, Lafon has received
questions from the CPMP regarding its
11
<PAGE>
application. The CPMP hearing on Lafon's application is expected to occur in
December 1996. There can be no assurance that the questions can be answered to
the satisfaction of the CPMP member countries, that the application will be
reviewed by the CPMP in a timely manner, or that modafinil will be approved by
the CPMP. Even if the CPMP approves the application, the Company will be
required to obtain separate marketing authorizations from the applicable
regulatory authorities in the United Kingdom and the Republic of Ireland prior
to marketing PROVIGIL (modafinil) in those countries. The Company expects that
the national applications will be accompanied by requests to vary the CPMP
application with respect to certain manufacturing procedures and other matters.
There can be no assurance that any such approvals will be obtained at all or in
a timely manner. The Company is in the process of establishing a sales force in
the U.K. and Ireland to sell PROVIGIL (modafinil). Any delays in accomplishing
these activities could delay launch of the product, if it is approved.
The third party manufacturing facilities for the PROVIGIL-active
substance and finished tablets are required to comply with all applicable FDA
requirements, and are subject to FDA inspection both before and after NDA
approval. There can be no assurance that the manufacturing facilities for
PROVIGIL materials and tablets will comply with applicable requirements.
Lafon has licensed rights to modafinil to third parties in Canada as
well as certain countries in Europe, and may license other territories to other
third parties in the future. There is no contractual requirement that the
licensees and Lafon coordinate their marketing activities related to modafinil.
Furthermore, individual reimbursement policies in each country and applicable
antitrust laws prohibit the coordination of the pricing of modafinil in various
jurisdictions. The marketing activities of the other licensees, therefore, may
affect the Company's marketing of PROVIGIL (modafinil) in its territories.
The results of clinical studies of MYOTROPHIN (rhIGF-1) to be conducted
by the Company's licensee in Japan and the results of clinical studies of
modafinil being conducted by licensees of Lafon in other countries are required
to be reported by the Company to the FDA and other regulatory authorities. The
reporting of the results of these other studies, if negative, could adversely
affect the regulatory review of the Company's product approval applications.
Negative results from trials by third parties or negative assessments from
regulatory authorities would adversely affect the Company's business and the
price of its common stock.
Even if MYOTROPHIN (rhIGF-1) and PROVIGIL (modafinil) are approved for
commercialization, the Company can not predict at this time the potential
revenues to be received from sales of MYOTROPHIN (rhIGF-1) for use in treating
ALS or from sales of PROVIGIL (modafinil) for use in connection with narcolepsy.
ALS and narcolepsy each qualify as orphan diseases under the Orphan Drug Law,
which generally means that the potential patient population for each indication
is limited. Rilutek (riluzole) is being commercialized in the United States and
Europe by Rhone-Poulenc Rorer for use in treating ALS. It is not clear whether
ALS patients, given the constraints of drug reimbursement programs, would be
able to support both Rilutek and MYOTROPHIN (rhIGF-1) (as well as any other
drugs which may be approved in the future for use in treating ALS), especially
if MYOTROPHIN (rhIGF-1) has a higher price than competitive drugs. Competition
for PROVIGIL (modafinil) also is likely, because narcolepsy is currently treated
with several drugs, all of which are available generically and have been
available for a number of years.
Other
- -----
The Company recently announced that TAP has begun a Phase I clinical
study of a compound being developed by both companies for the treatment of
various cancers, including prostate cancer. The objective of the multi-center
study is to examine the drug's pharmacokinetic and safety profile in patients
with advanced cancer. Because the compound has never been tested in humans, the
risk of safety problems is unknown. There can be no assurance that the compound
will prove to be safe in humans, or that it will show any therapeutic benefit.
The major source of the Company's current revenue is derived from
collaborative research and development agreements that are subject to periodic
review by the respective third parties and achievement of certain milestones by
the Company. There can be no assurance that any of the collaborations will
continue in the future.
The Company's business is subject to additional significant risks
including, but not limited to, the need to obtain additional funds to support
its research, development and commercialization efforts, the Company's
12
<PAGE>
dependence on collaborative partners and third party suppliers and other
manufacturing uncertainties, the Company's relative inexperience in marketing
and distributing commercial products, uncertainties associated with obtaining
and enforcing its patents and uncertainties associated with the patent rights of
others, uncertainties regarding government reforms and of product pricing and
reimbursement levels, technological change and competition from companies and
institutions developing products for the same indications as the Company's
product candidates, the product liability risks associated with being the
manufacturer or seller of pharmaceutical products, and reliance by the Company
on key personnel.
Future announcements concerning the Company's competitors or other
companies in the biopharmaceutical industry, including regulatory delays,
technological innovations or commercial products, patents, government
regulations, developments concerning proprietary rights, litigation or public
concern as to the safety or commercial value of the Company's products may have
a significant effect on the market price of the Company's common stock.
13
<PAGE>
Liquidity and Capital Resources
Cash, cash equivalents and investments at September 30, 1996 and
December 31, 1995 were $144,697,000 and $178,067,000, respectively, representing
80% of total assets for each period.
Cash equivalents and investments consisted primarily of short to
intermediate term obligations of the United States government, repurchase
agreements collateralized by such obligations, and short to intermediate term
corporate obligations. Certain of the Company's debt and lease agreements
contain covenants that obligate the Company to maintain certain minimum cash and
investment balances and financial ratios, under one of which, $4,375,000 was
held in a custodial account as of September 30, 1996.
The following is a summary of selected cash flow information for the
nine months ended September 30:
<TABLE>
<CAPTION>
1996 1995
------------- -------------
<S> <C> <C>
Net cash used for operating activities.. $(39,263,000) $(16,445,000)
Net cash provided by (used for)
investing activities................... 33,223,000 (74,974,000)
Net cash provided by financing
activities............................. 7,481,000 95,230,000
</TABLE>
Net cash used for operating activities
Operating cash inflows
A summary of the major sources of receipts reflected in net cash used
for operating activities for the nine months ended September 30 is as follows:
<TABLE>
<CAPTION>
1996 1995
---------- -----------
<S> <C> <C>
Cephalon Clinical Partners.. $ -- $ 4,155,000
Bristol-Myers Squibb........ 3,557,000 2,032,000
TAP Holdings................ 4,365,000 3,477,000
SmithKline Beecham.......... 2,138,000 2,083,000
Schering-Plough............. 2,250,000 500,000
Chiron...................... 3,747,000 22,929,000
</TABLE>
Pursuant to the Partnership Development Agreement, the Company's share
of the costs to develop MYOTROPHIN (rhIGF-1) within the Territory were
reimbursed by the Partnership to the extent of the Partnership's available
funds. Due to the depletion of the Partnership's available funding late in 1995,
the Company has not received payments from the Partnership in 1996.
Pursuant to the BMS Agreement, BMS makes quarterly payments to the
Company based primarily on a percentage of certain product sales within the
neurology market in excess of a predetermined base amount. Activity under the
BMS Agreement was initiated in the fourth quarter of 1994. The payments related
to the fourth quarter of 1994 and the first two quarters of 1995 were received
in the third quarter of 1995. The payments received from BMS in 1996 represent
payments earned in the fourth quarter of 1995 and the first two quarters of
1996. At September 30, 1996, $1,309,000 was receivable from BMS, representing
third quarter 1996 payments earned under the co-promotion agreement.
Under the terms of the May 1994 TAP Agreement, the Company performs
research and preclinical development for which it is compensated quarterly by
TAP, based on a contract rate per individual assigned to the program for that
quarter and reimbursement of certain external costs, all subject to annual
budgetary maximums. At September 30, 1996, $1,472,000 was receivable from TAP.
Under the terms of the June 1993 SmithKline Beecham Agreement, the
Company performs research and preclinical development for which it is
compensated quarterly by SB, based on a contract rate per individual assigned to
the program for that quarter, and subject to annual budgetary maximums, periodic
review by SB and achievement of certain milestones by the Company. At September
30, 1996, $179,000 was receivable from SB.
14
<PAGE>
Under the terms of the May 1990 Schering-Plough Agreement, through May
1995, the Company received annual milestone payments from SP, generally in the
second quarter, the last of which in the amount of $500,000 was received in
1995. Under the renewed agreement, effective May 1995, the Company performs
research and development for which it is compensated quarterly by SP based on a
contract rate per individual assigned to the program for that quarter and
reimbursement of certain external costs, all subject to budgetary maximums,
periodic review by SP and achievement of certain milestones by the Company.
The Company and Chiron are jointly developing MYOTROPHIN (rhIGF-1) for
the treatment of ALS and certain peripheral neuropathies. Under the
collaboration, each party funded its own collaboration-related expenses through
1994. Chiron provided the Company with a revolving credit facility (the "Note")
to assist the Company in funding its costs incurred. In September 1995, the
Company and Chiron adjusted their contributions to the collaboration program to
result in equal aggregate funding by each party through that date and agreed to
fund equal amounts of MYOTROPHIN program costs thereafter. As a result of this
equalization, the Company received $22,929,000 from Chiron representing
reimbursement of the Company's prior costs incurred for the peripheral
neuropathy and European ALS programs and payment to equalize the companies'
funding of the North American ALS program costs incurred by the Company through
September 1995. The Company also received interest on the reimbursement payments
in the amount of $2,051,000. The payments received from Chiron in 1996 represent
equalization of fourth quarter 1995 and first quarter 1996 program costs
incurred. At September 30, 1996, $249,000 was payable to Chiron for estimated
third quarter 1996 costs incurred.
Outlook
Late in 1995, the Partnership depleted all of its available funding and
will not provide further funding of MYOTROPHIN development costs to the Company.
The amount of additional funding required for further development will be
determined by the Partnership's general partner in advance of each quarter, and
each quarter, the Company will have the right, but not the obligation, to
contribute such funds. The Company expects to receive payments under the BMS
Agreement in 1996 comparable to the amount received in 1995, but does not expect
receipts to be in excess of related expenses incurred. The Company does not
expect annual payments from BMS to increase significantly from current levels
and the ability to maintain the current level of payments is subject to a number
of factors, including competition and regulatory actions. The agreement with SP
calls for payments in 1996 to approximate payments received in 1995. Payments in
1996 under the TAP and SB agreements are budgeted to approximate 1995 levels.
The continuation of the research funding under the agreements with TAP, SB and
SP in the remainder of 1996 and thereafter, are subject to the achievement of
certain development milestones and periodic review by those companies. Receipts
in 1996 under the collaboration with Chiron will be substantially less than
1995. In future periods, receipt of payments from Chiron or payments by the
Company to Chiron will depend on the relative costs incurred by the two
companies.
Operating cash outflows
The funding of selling, general and administrative increased in the 1996
period as compared to the 1995 period due primarily to the costs associated with
the Company's sales and marketing activities, including pre-marketing efforts in
support of the products in development and a 45% increase in sales and marketing
staffing levels, and increases in administrative external costs. Funding for
research and development expenses decreased in the 1996 period compared to the
1995 period due primarily to decreases in funding clinical trials as the double-
blind portion of clinical studies of MYOTROPHIN (rhIGF-1) and modafinil ended
and because the 1995 period includes payments to former limited partners
totaling $3,350,000 to acquire 67 limited partnership interests and a $1,500,000
payment to SIBIA to exercise the Company's option to reduce the royalty payable
on the potential future sales of MYOTROPHIN (rhIGF-1) under the SIBIA license
agreement.
Outlook
The Company expects to continue substantial spending on research and
development.
The costs to develop MYOTROPHIN (rhIGF-1) are expected to continue to be
significant during the remainder of 1996 due to the cost of conducting
continuing data analyses, continuing open label extensions of two Phase III ALS
clinical studies, preparations for potential filings with regulatory authorities
and continuation of a
15
<PAGE>
Phase II clinical program to test the potential utility of MYOTROPHIN (rhIGF-1)
in the treatment of peripheral neuropathies.
In addition, in future periods, substantial funding will be required for
the MYOTROPHIN program, including the planned T-IND expanded access program in
ALS patients in the U.S. and potential additional clinical studies in ALS
patients. The Company may also seek to acquire additional interests in the
Partnership and may incur significant costs to acquire such interests. In
addition, if MYOTROPHIN (rhIGF-1) receives regulatory approval in certain
countries within the Territory, the Company will pay to the Partnership a
milestone payment of approximately $16,000,000 in cash, common stock or a
combination thereof. The amount the Company spends in the future on its
MYOTROPHIN programs depends to a great degree on the results of discussions with
regulatory authorities (see "Certain Risks Related to Cephalon's Business").
The costs to develop PROVIGIL (modafinil) are expected to continue to be
significant into the fourth quarter of 1996, even though the double-blind
portions of the clinical studies have concluded, due to the cost of conducting
data analyses, the continuation of open label extensions of those studies and
preparations for the filing of an NDA for the treatment of the excessive daytime
sleepiness associated with narcolepsy. In addition, the Company is reviewing
possible Phase II studies to test the use of PROVIGIL (modafinil) in treating
other neurological conditions and may initiate a Phase II study in early 1997.
The overall funding of the PROVIGIL program will be assessed as the analyses of
the results of the clinical trials are further evaluated and are discussed with
regulatory authorities (see "Certain Risks Related to Cephalon's Business").
Pursuant to the BMS Agreement, the Company is obligated to fund $810,000
in the remainder of 1996 and $1,250,000 in 1997 for promotional and support
activities targeting neurologists. The Company also expects to incur significant
expenses under the collaborations with SB, TAP and SP, which may exceed payments
received under the related agreements, as well as significant costs in its other
development programs.
Additionally, the Company has begun to expand its selling, general and
administrative activities in the United States and Europe. The Company will
assess the degree of expansion and funding required in the selling, general and
administrative area as the Company evaluates the progress of potentially
obtaining regulatory approvals of MYOTROPHIN (rhIGF-1) and PROVIGIL (modafinil).
Similarly, the Company will assess the need to buildup inventory of MYOTROPHIN
(rhIGF-1) and PROVIGIL (modafinil), and any such buildup would require
substantial funding. There can be no assurance that the Company will receive
marketing approval for any of its product candidates under development or that
the funds expended if the Company expands these areas will be recovered in the
future by sales, if any, of such products (see "Certain Risks Related to
Cephalon's Business").
The actual costs related to MYOTROPHIN (rhIGF-1), PROVIGIL (modafinil),
and other potential therapeutic products are subject to a number of
uncertainties which could greatly influence the level and timing of costs,
including among other items, actions of regulatory authorities (see "Certain
Risks Related to Cephalon's Business").
16
<PAGE>
Operating cash requirements outlook
The Company expects net cash used for operating activities to continue
to be negative, the level of which depends on a number of factors, as further
described above, including the continuation of payments under collaborative
research and development agreements, the funding of additional clinical
trials, the potential further expansion of selling, general and administrative
and potential buildup of inventory of MYOTROPHIN (rhIGF-1) and PROVIGIL
(modafinil).
Net cash provided by investment activities
A summary of net cash provided by (used for) investment activities for
the nine months ended September 30 is as follows:
<TABLE>
<CAPTION>
1996 1995
------------ -------------
<S> <C> <C>
Repayments from related party................. $ -- $ 4,435,000
Purchases of property and equipment........... (1,588,000) (16,078,000)
Sale leaseback of property and equipment...... -- 237,000
Sales and maturities (purchases) of
investments, net............................. 34,811,000 (63,568,000)
Net cash provided by (used for) ----------- ------------
investment activities........................ $33,233,000 $(74,974,000)
</TABLE> =========== ============
In September 1995, the Company received the outstanding balance on the
loan to the Partnership.
Purchases of property and equipment decreased in 1996 as compared to the
same period in 1995 because the 1995 period includes the March 1995 purchase of
the two buildings currently housing the Company's administrative offices and
research facilities in West Chester, Pennsylvania and a third adjacent 49,000
square foot building, for a total purchase price of $11,000,000.
The Company may incur additional capital expenditures as it continues to
assess its facility and equipment requirements.
Sales and maturities (purchases) of investments, net represent the
investment of cash generated primarily from the Company's financing activities,
net of cash used to fund operations and other investing activities.
Net cash provided by financing activities
A summary of cash provided by financing activities for the nine months
ended September 30 is as follows:
<TABLE>
<CAPTION>
1996 1995
------------ -------------
<S> <C> <C>
Proceeds from sale of common stock and
warrants............................... $ -- $ 84,245,000
Proceeds from exercise of common stock
options and warrants................... 8,231,000 6,373,000
Principal payments on long-term debt.... (2,829,000) (16,461,000)
Proceeds from long-term debt............ 2,079,000 21,073,000
----------- ------------
Net cash provided by financing
activities............................. $ 7,481,000 $ 95,230,000
</TABLE> =========== ============
For the nine months ended September 30, 1995, the Company received
aggregate net proceeds of $84,245,000 from the public offering of 3,450,000
shares of common stock and 538,310 shares of common stock issued to Kyowa Hakko
in August 1995.
During the nine months ended September 30, 1996, the Company received
cash from the exercise of 607,191 warrants and 103,137 stock options in the
amount of $7,082,000 and $1,149,000, respectively. The extent and timing of
future warrant and option exercises, if any, are primarily dependent upon the
market price of the Company's common stock and general financial market
conditions, as well as the exercise prices and expiration dates of the warrants
and options.
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<PAGE>
In September 1995, the Company repaid in full $13,822,000 on the then
outstanding balance of the note from Chiron.
Proceeds from long-term debt in the 1995 period include $15,799,000
borrowed to finance the West Chester building purchase. The building purchase
was financed through the assumption of a $6,900,000 first mortgage and from
mortgage loans provided by the Commonwealth of Pennsylvania (the "State
Funding") in the amount of $11,600,000. The State Funding includes a 2% interest
rate that is subject to increase if the Company fails to hire a specified number
of new employees in Chester County, Pennsylvania by the end of 1999. The Company
borrowed an additional $400,000 in State Funding in June 1996 and drew down
$1,679,000 of the remaining $2,700,000, held in escrow, earmarked to fund future
improvements. The Company also drew $5,274,000 in the 1995 period against the
Note provided by Chiron to fund collaboration-related expenses.
Commitments and contingencies
Leases
The Company leases certain of its offices, automobiles and equipment
under operating leases. The Company's future annual minimum payments under these
leases are approximately $331,000 for the remainder of 1996, $271,000, $258,000
and $142,000 in 1997, 1998 and 1999, respectively. The above payments have been
adjusted to reflect the transfer of certain lease obligations to the purchaser
of the assets of the Company's Beltsville, Maryland pilot-scale manufacturing
facility (the "Beltsville Facility").
Other
The Company maintains a number of agreements to fund research by third
parties. These agreements are generally renewable on an annual basis and provide
the Company with the right to obtain royalty-bearing licenses to the results of
the research. The Company is obligated under several other cancelable
agreements, including those entered into for the purpose of conducting clinical
trials. The Company has obligations to fund certain marketing programs under its
co-promotion agreement with BMS, including an obligation of approximately
$810,000 in the remainder of 1996. The Company is obligated to make royalty,
license fee and milestone payments under certain of its licensing and research
and development agreements.
Related party
In 1992, the Company entered into a research and development agreement
(the "Partnership Development Agreement") with Cephalon Clinical Partners, L.P.
(the "Partnership") under which the Company granted the Partnership an exclusive
license in the United States, Canada and Europe ("the Territory") to certain
technology, principally MYOTROPHIN (rhIGF-1), and received a non-refundable
license fee of $500,000. The Partnership depleted its available funds late in
1995 and the Company has agreed to fund the development of MYOTROPHIN (rhIGF-1)
in the Territory under certain circumstances.
The Partnership granted the Company an exclusive license (the "Interim
License") to manufacture and market MYOTROPHIN (rhIGF-1) within the Territory in
return for certain royalty payments and a payment of approximately $16,000,000
(the "Milestone Payment") that is to be made if MYOTROPHIN (rhIGF-1) receives
regulatory approval in the United States or certain other countries within the
Territory. The Company has the option to pay the Milestone Payment in cash,
common stock, or a combination thereof.
The Company has a contractual option to purchase all of the limited
partnership interests in the Partnership (the "Purchase Option"). To exercise
the Purchase Option, Cephalon will be required to make an advance payment of
$40,275,000 in cash or, at Cephalon's election, $42,369,000 in shares of the
Company's Common Stock, valued at the market price at the time the Purchase
Option is exercised. The Purchase Option will become exercisable for a 45-day
period commencing on the date which is the earlier of (a) the date which is the
later of (i) the last day of the first month in which the Partnership shall have
received Interim License payments equal to fifteen percent (15%) of the limited
partners' capital contributions (excluding the Milestone Payment), and (ii) the
last day of the 24th full month after the date of the Company's first commercial
sale, if any, of MYOTROPHIN (rhIGF-1) within the Territory that generates a
payment to the Partnership, and (b) the last day of the 48th full month after
the date of such first commercial sale, if any, in the Territory. In addition to
the advance payment, the exercise of the Purchase Option requires the Company to
make future payments to the former limited partners for a period of eleven years
after exercise at a royalty rate of 10.1% (reducing to 5.0% after a specified
return is earned by the former limited partners) of MYOTROPHIN sales in the
Territory, provided that royalties on MYOTROPHIN sales in Europe will only be
paid to the extent necessary to meet specified sales targets. If the
18
<PAGE>
Company does not exercise the Purchase Option prior to its expiration date the
Interim License will terminate and all development and marketing rights to
MYOTROPHIN (rhIGF-1) in the Territory would revert to the Partnership, which may
commercialize MYOTROPHIN (rhIGF-1) itself or license or assign its rights to a
third party. The Company would not receive any benefits from any such
commercialization.
Legal proceedings
The Company and certain of its officers have been named as defendants in
a number of civil actions filed in the U.S. District Court for the Eastern
District of Pennsylvania, which have been consolidated. Several of the
plaintiffs, at the request of their respective counsel, have been designated,
collectively, as the "lead plaintiff" by the Court for purposes of the Private
Securities Litigation Reform Act of 1995. The consolidated complaint filed in
October 1996 by the lead plaintiffs extended and expanded the class period to
include purchasers of the Company's securities and options to purchase or sell
those securities during the period between June 12, 1995 and June 7, 1996.
Plaintiffs allege, based in part on statements and opinions expressed at the
June 7, 1996 meeting of an FDA advisory committee, that earlier statements by
the Company about the North American and European trial results were misleading.
The plaintiffs seek unspecified damages and other relief. Discovery related to
the merits of the allegations in the complaint has been postponed until the
Company responds to the complaint. The Company intends to vigorously defend the
actions. However, management is evaluating the new complaint, and it is too
early in the proceedings to predict the outcome of these actions with any
certainty.
Funding Requirements Outlook
As described above, the Company expects to continue to use cash to fund
operations. The Company also expects to use cash to fund purchases of property
and equipment and to service its long-term debt.
The Company believes that its cash and investment resources are adequate
to fund its anticipated level of cash requirements for a period in excess of one
year. However, the Company's funding requirements may change due to numerous
factors including, but not limited to, the results of the Company's ongoing
clinical trials and other research and development programs, the expansion of
research and development and administrative facilities, technological advances
and competition and regulatory requirements (see "Certain Risks Related to
Cephalon's Business"). Additionally, the Company may seek to acquire some or all
of the partnership interests in the Partnership or may seek to acquire other
entities, additional technologies, product candidates or products.
Because of the Company's long-term capital requirements it may seek to
access the public or private markets whenever conditions are favorable by
issuing debt, common or preferred stock, warrants or other securities. The
Company may also seek additional funding through corporate collaborations and
other financing vehicles, potentially including "off-balance sheet" financing
through limited partnerships or corporations. There can be no assurance that
such funding will be available at all or on terms acceptable to the Company.
Furthermore, market reaction to the Company's financing activities may
adversely affect the price of the Company's common stock. If adequate funds are
not available, the Company may be required to significantly curtail one or more
of its research, development or strategic initiatives or obtain funds through
arrangements with collaborative partners or others that may require the Company
to relinquish rights to certain of its technologies, product candidates or
products on terms less favorable than if it developed the product on its own.
19
<PAGE>
Results of Operations
This section should be read in conjunction with the more detailed
discussion under "Liquidity and Capital Resources."
A summary of revenues and expenses for the nine months ended September
30 is as follows:
<TABLE>
<CAPTION>
% change
1996 1995 1996 vs. 1995
----------- ----------- --------------
<S> <C> <C> <C>
Revenues.............................. $11,407,000 $36,711,000 (69)%
Research and development expenses..... 45,701,000 54,315,000 (16)
Selling, general and administrative
expenses............................. 18,528,000 10,749,000 72
Interest income, net.................. 4,423,000 7,168,000 (38)
</TABLE>
The decrease in revenues in the 1996 period from the 1995 period
primarily resulted from decreases in revenue recognized under the Chiron
collaboration and the Partnership Development Agreement. The decrease was
partially offset by increases in revenue recognized in the 1996 period under the
agreements with TAP and SP.
In August 1995, the Partnership collected the final limited partner
subscription installment payments. The Company will not recognize any further
revenue from the Partnership under the Partnership Development Agreement. The
Company and Chiron are to share equally in collaboration-related expenses in
1996. Revenues under the Chiron collaboration in 1996 will be substantially less
than 1995 and, depending on the relative costs incurred by the two companies,
the Company may continue to incur expenses for payments made to Chiron. Under
the BMS Agreement, the Company will only recognize revenue upon the attainment
of sales levels in excess of the base amount specified in the agreement, which,
if attained, is expected to occur in the fourth quarter of 1996. Revenues to be
recognized in 1996 under the agreements with TAP, SB and SP are expected to
approximate 1995 levels. Revenues recognized under the supply agreement with
Kyowa are expected to continue in 1996 as the Company makes shipments of
MYOTROPHIN (rhIGF-1) to Kyowa to supply clinical trials in Japan.
Research and development expenses in the 1996 period as compared to the
1995 period decreased primarily due to decreases in the costs associated with
conducting clinical trials of MYOTROPHIN (rhIGF-1) and PROVIGIL (modafinil), due
to the completion of the double-blind portion of those studies and because the
1995 period includes $3,350,000 in payments to acquire 67 partnership interests
and $1,500,000 payment to SIBIA to reduce future royalty payments under the
license agreement.
The significant increase in the selling, general and administrative area
in the 1996 period as compared to the same 1995 period is attributable to the
sales and marketing activities to co-promote Stadol NS and Serzone with BMS,
pre-marketing of other products in development and increased staffing levels,
and compensation and other external expenses in the administrative area.
The decrease in net interest income in the nine month period ending
September 30, 1996 compared to the same 1995 period was primarily due to a one-
time interest payment received from Chiron in 1995.
Results of Operations Outlook
In the future, receipt of payments from Chiron or payments by the
Company to Chiron will depend on the relative costs incurred by the two
companies. A substantial portion of the Company's revenues are derived from
collaboration agreements with TAP, SB and SP, the continuation of which is
subject to periodic review and achievement of certain milestones. The level of
revenue to be recognized under the BMS agreement is dependent upon the success
of marketing the co-promotion products. The Company expects that it will
continue to incur significant research and development costs and also expects
its selling, general and administrative costs to increase as it continues to
further expand its marketing efforts. Additionally, the Company will assess the
need to buildup inventory of MYOTROPHIN (rhIGF-1) and PROVIGIL (modafinil) and
would incur substantial expense if it decides to do so. The Company would also
incur substantial expense related to the acquisition of additional interests in
the Partnership, if the Company decides to acquire such interests. The costs to
be incurred by the
20
<PAGE>
Company depend to a large degree on the results of regulatory actions with
respect to MYOTROPHIN, PROVIGIL and other product programs (see "Certain Risks
Related to Cephalon's Business").
The Company does not believe that inflation has had a material impact on
the results of its operations since inception.
Loss Per Share
Options, restricted stock grants and warrants outstanding have been
excluded from the per share calculations, because their inclusion would be
antidilutive. At September 30, 1996, the Company had approximately 2,910,157
options outstanding under its stock option plan with exercise prices ranging
from $0.15 to $31.00 per share. As further described in the Notes to the
Consolidated Financial Statements, at September 30, 1996, warrants to purchase
2,959,620 shares of common stock were exercisable with prices ranging from
$11.32 to $18.50, with various exercise periods through February 2002.
21
<PAGE>
PART II - OTHER INFORMATION
- ----------------------------
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits: None
(b) Reports on Form 8-K: None
22
<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
CEPHALON, INC.
(Registrant)
November 14, 1996 By /s/ Frank Baldino, Jr., Ph.D.
---------------------------------
Frank Baldino, Jr., Ph.D.
President, Chief Executive Officer
and Director
(Principal executive officer)
By /s/ J. Kevin Buchi
-----------------------
J. Kevin Buchi
Senior Vice President, Finance and Chief
Financial Officer
(Principal financial and accounting officer)
23
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM Cephalon,
Inc.'s Form 10Q for the quarterly period ended June 30, 1996 AND IS
QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS.
</LEGEND>
<CIK> 0000873364
<NAME> CEPHALON, INC.
<S> <C> <C>
<PERIOD-TYPE> 9-MOS 9-MOS
<FISCAL-YEAR-END> DEC-31-1996 DEC-31-1995
<PERIOD-START> JAN-01-1996 JAN-01-1995
<PERIOD-END> SEP-30-1996 SEP-30-1995
<CASH> 8,006,000 6,565,000
<SECURITIES> 136,691,000 171,502,000
<RECEIVABLES> 0 0
<ALLOWANCES> 0 0
<INVENTORY> 0 0
<CURRENT-ASSETS> 5,807,000 10,415,000
<PP&E> 0 0
<DEPRECIATION> 12,541,000 9,652,000
<TOTAL-ASSETS> 180,364,000 221,330,000
<CURRENT-LIABILITIES> 18,836,000 18,402,000
<BONDS> 0 0
0 0
0 0
<COMMON> 245,000 238,000
<OTHER-SE> 140,500,000 179,967,000
<TOTAL-LIABILITY-AND-EQUITY> 180,364,000 221,330,000
<SALES> 0 0
<TOTAL-REVENUES> 17,575,000 46,347,000
<CGS> 0 0
<TOTAL-COSTS> 64,229,000 65,064,000
<OTHER-EXPENSES> 0 0
<LOSS-PROVISION> 0 0
<INTEREST-EXPENSE> 1,745,000 2,468,000
<INCOME-PRETAX> 0 0
<INCOME-TAX> 0 0
<INCOME-CONTINUING> 0 0
<DISCONTINUED> 0 0
<EXTRAORDINARY> 0 0
<CHANGES> 0 0
<NET-INCOME> (48,399,000) (21,185,000)
<EPS-PRIMARY> (2.00) (1.10)
<EPS-DILUTED> 0 0
</TABLE>
