<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 March 31, 1997
------------------
[_] 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)
<TABLE>
<CAPTION>
<S> <C>
Delaware 23-2484489
-------------------------------------------------- ---------------------------------------------
(State Other Jurisdiction of Incorporation or (I.R.S. Employer Identification Number)
Organization)
145 Brandywine Parkway, West Chester, PA 19380
---------------------------------------- ---------------------------------------------
(Address of Principal Executive Offices) (Zip Code)
Registrant's Telephone Number, Including Area Code (610) 344-0200
---------------------------------------------
</TABLE>
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 May 9, 1997
---------------------------- -----------------------------
Common Stock, par value $.01 24,843,760 Shares
This Report Includes a Total of 22 Pages
<PAGE>
CEPHALON, INC. & SUBSIDIARIES
-----------------------------
INDEX
-----
<TABLE>
<CAPTION>
Page No.
--------
<S> <C>
PART I - FINANCIAL INFORMATION
Item 1. Financial Statements
Consolidated Balance Sheets - 1
March 31, 1997 and December 31, 1996
Consolidated Statements of Operations - 2
Three months ended March 31, 1997 and 1996
Consolidated Statements of Cash Flows - 3
Three months ended March 31, 1997 and 1996
Notes to Consolidated Financial Statements 4 - 9
Item 2. Management's Discussion and Analysis of 10 - 20
Financial Condition and Results of Operations
PART II - OTHER INFORMATION
Item 6. Exhibits and Reports on Form 8-K 21
SIGNATURES 22
</TABLE>
<PAGE>
CEPHALON, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(Unaudited)
<TABLE>
<CAPTION>
March 31, December 31,
1997 1996
---- ----
ASSETS
------
<S> <C> <C>
CURRENT ASSETS:
Cash and cash equivalents (Note 2).................................. $ 3,016,000 $ 5,671,000
Reverse repurchase agreements (Note 2).............................. 8,351,000 5,207,000
Short-term investments (Note 2)..................................... 116,178,000 135,970,000
Accounts receivable - contract...................................... 8,192,000 5,286,000
Other............................................................... 3,493,000 2,410,000
--------- ---------
Total current assets............................................... 139,230,000 154,544,000
PROPERTY AND EQUIPMENT, net of accumulated depreciation and
amortization of $9,493,000 and $8,852,000........................... 22,044,000 22,086,000
OTHER................................................................ 1,409,000 1,261,000
--------- ---------
$ 162,683,000 $ 177,891,000
============= =============
<CAPTION>
LIABILITIES AND STOCKHOLDERS' EQUITY
------------------------------------
<S> <C> <C>
CURRENT LIABILITIES:
Accounts payable.................................................... $ 2,868,000 $ 1,638,000
Accrued expenses (Note 3)........................................... 14,445,000 14,786,000
Current portion of long-term debt................................... 1,499,000 5,164,000
--------- ---------
Total current liabilities.......................................... 18,812,000 21,588,000
LONG-TERM DEBT (Note 2).............................................. 16,861,000 16,974,000
OTHER................................................................ 2,221,000 2,003,000
--------- ---------
Total liabilities.................................................. 37,894,000 40,565,000
---------- ----------
COMMITMENTS AND CONTINGENCIES (Note 4)
STOCKHOLDERS' EQUITY: (Notes 5 and 8)
Preferred stock, $.01 par value, 5,000,000 shares authorized,
none issued....................................................... -- --
Common stock, $.01 par value, 100,000,000 shares authorized,
24,815,386 and 24,618,223 shares issued and outstanding............ 248,000 246,000
Additional paid-in capital.......................................... 299,682,000 296,868,000
Treasury stock...................................................... (1,970,000) (1,778,000)
Accumulated deficit................................................. (173,097,000) (157,967,000)
Cumulative translation adjustment................................... (74,000) (43,000)
------- -------
Total stockholders' equity........................................ 124,789,000 137,326,000
------------ ------------
$ 162,683,000 $ 177,891,000
============= =============
</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 March 31,
1997 1996
-------------- --------------
<S> <C> <C>
REVENUES: (Note 6)
Contract..................................... $ 5,628,000 $ 3,728,000
------------ ------------
OPERATING EXPENSES: (Note 7)
Research and development..................... 13,177,000 14,293,000
Selling, general and administrative.......... 8,697,000 5,495,000
------------ ------------
21,874,000 19,788,000
------------ ------------
LOSS FROM OPERATIONS.......................... (16,246,000) (16,060,000)
------------ ------------
INTEREST:
Income....................................... 1,617,000 1,741,000
Expense...................................... (501,000) (619,000)
------------ ------------
1,116,000 1,122,000
------------ ------------
LOSS.......................................... $(15,130,000) $(14,938,000)
============ ============
LOSS PER SHARE................................ $(.61) $(.62)
============ ============
WEIGHTED AVERAGE NUMBER OF
SHARES OUTSTANDING........................... 24,691,153 24,044,615
============ ============
</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>
Three Months Ended March 31,
1997 1996
-------------- --------------
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Loss........................................ $(15,130,000) $(14,938,000)
Adjustments to reconcile loss to net
cash used for operating activities:
Depreciation and amortization.............. 641,000 958,000
Non-cash compensation expense.............. 773,000 564,000
(Increase) decrease in operating
assets:
Accounts receivable - contract........... (2,906,000) 1,355,000
Related-party receivable................. -- (24,000)
Other current assets..................... (970,000) (603,000)
Other long-term assets................... (147,000) (38,000)
Increase(decrease) in operating
liabilities:
Accounts payable......................... 1,230,000 (1,668,000)
Accrued expenses......................... (370,000) 685,000
Other long-term liabilities.............. 217,000 144,000
------------ ------------
Net cash used for operating
activities.............................. (16,662,000) (13,565,000)
------------ ------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of property and equipment......... (599,000) (512,000)
Sale leaseback of property and
equipment.................................. 333,000 --
Sales and maturities (purchases) of
investments, net........................... 16,648,000 9,740,000
------------ ------------
Net cash provided by investing
activities.............................. 16,382,000 9,228,000
------------ ------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from exercises of common
stock options and warrants................. 1,736,000 4,568,000
Principal payments on long-term debt........ (4,111,000) (970,000)
------------ ------------
Net cash (used for) provided by
financing activities.................... (2,375,000) 3,598,000
------------ ------------
NET DECREASE IN CASH AND CASH
EQUIVALENTS................................. (2,655,000) (739,000)
CASH AND CASH EQUIVALENTS, BEGINNING OF
PERIOD...................................... 5,671,000 6,565,000
------------ ------------
CASH AND CASH EQUIVALENTS, END OF PERIOD..... $ 3,016,000 $ 5,826,000
============ ============
</TABLE>
The accompanying notes are an integral part of these financial statements.
3
<PAGE>
CEPHALON, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
1. The Company and Summary of Significant Accounting Policies
----------------------------------------------------------
Business
Cephalon, Inc. ("Cephalon" or the "Company") seeks to discover and develop
pharmaceutical products primarily for the treatment of neurological disorders
such as amyotrophic lateral sclerosis ("ALS"), peripheral neuropathies,
narcolepsy, Alzheimer's disease and stroke. The Company also co-promotes, to
neurologists in the United States, two proprietary drugs of Bristol-Myers Squibb
Company ("BMS") and a product of Medtronic, Inc., for the treatment of
intractable spasticity. The Company has not received regulatory approval for
the commercial sale of any of its proprietary products under development. 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
the Food and Drug Administration ("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 for any indication by any
regulatory authority for marketing in any jurisdiction.
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, 1996. 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.
Accounting pronouncements
In February 1997, the Financial Accounting Standards Board issued FAS No. 128,
"Earnings per Share," which is effective for financial statements for fiscal
years ending after December 15, 1997. This statement simplifies the standards
for computing earnings per share previously found in APB Opinion No. 15 and
makes them comparable to international EPS standards. The Company intends to
adopt FAS No. 128 for its fiscal year ending December 31, 1997; early adoption
is not permitted. Pro forma calculations are not included hereto because the
Company does not expect that the effect of adopting FAS No. 128 will be
material.
4
<PAGE>
CEPHALON, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(Unaudited)
2. Cash, Cash Equivalents and Investments
--------------------------------------
As of the indicated dates, short-term investments were as follows:
<TABLE>
<CAPTION>
March 31, December 31,
1997 1996
------------ ------------
<S> <C> <C>
U.S. Treasury bills and notes............... 109,748,000 125,158,000
Commercial paper............................ 589,000 983,000
Other corporate obligations................. 5,841,000 9,829,000
------------ ------------
$116,178,000 $135,970,000
============ ============
</TABLE>
The Company considers all highly liquid instruments purchased with an original
maturity of three months or less to be cash equivalents. Investments in
overnight reverse repurchase agreements are collateralized 102% by U.S. Treasury
securities. These securities are held in a trust account with a commercial bank
on behalf of the Company. The Company believes that the quantity and quality of
the collateral are sufficient to secure its investment in these instruments. The
balance of the Company's short-term investments consisted primarily of U.S.
Treasury securities, high grade commercial paper and U.S. corporate obligations
and asset-backed securities having AAA ratings. All investments are valued at
market. Contractual maturities of the Company's investments in debt securities
are $80,646,000 in the remainder of 1997 and $46,899,000 in 1998.
Under the terms of an unsecured loan agreement with a commercial bank,
$3,750,000 was held in a custodial account as of December 31, 1996. In March
1997, the Company repaid in full the $3,750,000 balance due on the loan.
3. Accrued Expenses
----------------
Accrued expenses consisted of the following:
<TABLE>
<CAPTION>
March 31, December 31,
1997 1996
----------- ------------
<S> <C> <C>
Accrued compensation and benefits........................ $ 1,409,000 $ 1,569,000
Accrued professional and consulting fees................. 1,972,000 2,749,000
Accrued clinical trial fees and related expenses......... 3,114,000 3,177,000
Accrued license fees and royalties....................... 688,000 133,000
Accrued co-promotion expenses............................ 1,220,000 723,000
Other accrued expenses................................... 6,042,000 6,435,000
----------- -----------
$14,445,000 $14,786,000
=========== ===========
</TABLE>
4. Commitments and Contingencies
-----------------------------
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 has funding commitments under several other cancelable
agreements, including those entered into for the purpose of conducting clinical
trials. Pursuant to the BMS Agreement, the Company is obligated to fund
approximately $977,000 in the remainder of 1997 for promotional and support
activities of Stadol NS targeting neurologists. In addition, the Company has
obligations to make royalty, license and milestone payments under certain of its
licensing and research and development agreements, including
5
<PAGE>
CEPHALON, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(Unaudited)
milestone payments of $2,000,000 and $268,000 if PROVIGIL (modafinil) receives
regulatory approval in the United States and the United Kingdom, respectively.
Under the November 1996 purchase agreement, the purchaser of the Company's
former pilot-scale manufacturing facility in Beltsville, Maryland has the right
to seek indemnification from the Company, during the first year after the sale,
for certain types of claims.
Related party
Late in 1995, Cephalon Clinical Partners, L.P. (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. If the Company elects not to
contribute such funds, the research and development agreement with the
Partnership will terminate and all development and marketing rights to
MYOTROPHIN (rhIGF-I) in the Territory will revert to the Partnership, which may
commercialize MYOTROPHIN (rhIGF-I) itself or license or assign its rights to a
third party. The Company would not receive any benefits from any such
commercialization.
The Partnership granted the Company an exclusive license (the "Interim
License") to manufacture and market MYOTROPHIN (rhIGF-I) within the United
States, Canada and Europe (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-I) 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 is 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-I) 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 Company
does not exercise the Purchase Option prior to its expiration, the Interim
License will terminate and all development and marketing rights to MYOTROPHIN
(rhIGF-I) in the Territory would revert to the Partnership, which may
commercialize MYOTROPHIN (rhIGF-I) itself or license or assign its rights to a
third party. The Company would not receive any benefits from such
commercialization.
The Company's collaboration with Chiron is subject to the rights of the
Partnership, which licensed to the Company the right to develop MYOTROPHIN
(rhIGF-I) in North America and Europe in return for receiving certain payments.
The Company is solely responsible for making any such royalty and milestone
payments owed to the Partnership and is responsible for funding the Purchase
Option if it exercises the option.
6
<PAGE>
CEPHALON, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(Unaudited)
Shareholder Litigation
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 have been designated by the Court, collectively, as the "lead
plaintiff" 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 as well as options to purchase or sell those securities during the
period between June 12, 1995 and June 7, 1996. The plaintiffs allege, based in
part on statements and opinions expressed at the June 7, 1996 meeting of an FDA
advisory committee to review the MYOTROPHIN treatment investigational new drug
application, that earlier statements by the Company about the North American and
European trial results were misleading. The plaintiffs seek unspecified damages
and other relief. The Company's motion to dismiss the case is pending, and
discovery related to the merits of the allegation in the complaint has been
postponed until the motion is decided, which is likely to occur in 1997. The
Company intends to vigorously defend the action. However, management believes
that it is too early in the proceedings to determine with any certainty the
outcome of this action or the potential liability of the Company, if any.
5. Stockholders' Equity
--------------------
At March 31, 1997, 3,245,723 options to purchase shares of common stock were
outstanding at exercise prices ranging from $0.15 per share to $31.00 per share,
of which 1,681,168 options were exercisable, including 584,000 options
exercisable at prices below $10.00 per share.
As of March 31, 1997, unvested restricted stock awards for 198,150 shares were
outstanding, including awards for 7,450 shares granted during the quarter ended
March 31, 1997. The restricted stock awards generally vest in equal annual
installments over four years. The Company recognized compensation expense of
$515,000 in the first quarter of 1997 related to these outstanding awards.
At March 31, 1997, warrants to purchase 2,820,437 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>
1,681,162 September 1, 1993--August 31, 1997 $11.32
September 1, 1997--August 31, 1999 $13.82
371,500 September 1, 1994--August 31, 1999 $13.70
17,775 September 1, 1993--August 31, 1999 $11.77
750,000 February 9, 1994--February 8, 2002 $18.50
</TABLE>
During the three months ended March 31, 1997, 77,667 warrants and 91,565 stock
options were exercised for an aggregate exercise price of $899,000 and $950,000,
respectively.
7
<PAGE>
CEPHALON, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(Unaudited)
6. Revenue
-------
Revenue--Contract
Contract revenues consisted primarily of the revenue recorded under the
Company's collaboration agreements as follows:
<TABLE>
<CAPTION>
Three months ended March 31,
----------------------------
1997 1996
------------- -------------
<S> <C> <C>
TAP Holdings......................... $1,800,000 $1,328,000
SmithKline Beecham................... 749,000 706,000
Kyowa Hakko Kogyo.................... 1,000,000 --
Schering-Plough...................... 588,000 750,000
Chiron (see Note 7).................. 1,491,000 944,000
</TABLE>
7. Research and Development
------------------------
Chiron Corporation
Since January 1994, the Company and Chiron have collaborated in the
development of MYOTROPHIN (rhIGF-I) in the neurological field, for
commercialization in all countries of the world other than Japan. Under the
agreement, Chiron contributed its intellectual property rights within the
neurology field related to certain compounds, including rhIGF-I. The Company
contributed certain patent rights related to MYOTROPHIN (rhIGF\\-\\I), subject
to the rights of the Partnership (see Note 4).
The Company and Chiron have established joint committees to develop and
oversee the clinical and marketing strategies and budgets for compounds to be
developed under the collaboration. The collaboration is currently developing
MYOTROPHIN (rhIGF-I) for the treatment of ALS and certain peripheral
neuropathies. The companies have agreed to fund equal amounts of these
MYOTROPHIN program costs.
For the quarter ended March 31, 1997, the equalization of estimated first
quarter program costs resulted in net revenue from Chiron of $1,491,000.
The January 1994 collaboration between the Company and Chiron is subject to
the rights of the Partnership (see Note 4).
8. Subsequent Events
-----------------
In April 1997, the Company completed a $30,000,000 private placement of senior
convertible notes. The convertible notes mature in April 1998 and bear interest,
payable quarterly in cash or common stock, at a rate of seven percent per annum.
The Company will record the notes at their face value and accrue interest on the
outstanding amount of the notes. The notes are convertible into common stock of
the Company, subject to certain limitations, at a six percent discount to a
market price formula at the time of conversion. The Company has registered
1,400,000 shares of its common stock for sale upon conversion of the notes. The
Company intends to register 1,600,000 additional shares to allow for full
conversion of the notes based upon the current market price of the Company's
common stock. If not converted into common stock at or prior to maturity, the
outstanding, unconverted notes plus accrued interest will be exchanged for an
equal dollar amount of 10 3/4% debentures which mature in 2013. The convertible
notes cannot be converted without the consent of the Company at a price less
than $25 per share until July 2, 1997. The Company may redeem the notes, at a
redemption price equal to 110 percent of the outstanding principal amount plus
interest, if the conversion price falls below approximately $21 per share.
8
<PAGE>
CEPHALON, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(Unaudited)
The terms of the convertible notes require the maintenance of a minimum cash
balance and certain other restrictions.
In May 1997, the Company purchased capped call options (the "Options") from
Swiss Bank Corporation, London Branch ("SBC") on 2,500,000 shares of common
stock. In payment of the purchase price of such Options, the Company issued to
SBC 490,000 shares of common stock (the "Shares"), which the Company registered
for resale by SBC under the Securities Act of 1933. The Options, which are
exercisable on the expiration date of October 31, 1997, have a strike price of
$21.50 per share (the "Strike Price") and a cap price of $39.50 per share (the
"Cap Price"). If upon expiration of the options the price of the Company's
common stock is above the Strike Price, the Company expects that the Options
would be settled in cash. However, the Company may elect to physically settle
the Options by requiring delivery by SBC to the Company of shares of the common
stock. If the Options are settled in cash, SBC or its affiliates would likely
sell shares of the common stock, which may include some or all of the Shares
then held by them as a hedge with respect to the Options. If the Options are
physically settled, SBC will deliver shares of the common stock to the Company,
which likely would include some or all of the Shares, upon payment by the
Company of the applicable exercise price.
9
<PAGE>
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
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 U.S. Food and Drug Administration (the "FDA") and foreign
regulatory approval to market products currently under development. Cephalon has
had only limited experience in filing and pursuing applications necessary to
gain regulatory approvals. There can be no assurance that the data from the
Company's clinical studies or the Company's interpretation of data will be
accepted by any regulatory authority. In addition, there can be no assurance
that any application by the Company to market a product will be reviewed in a
timely manner or that approval to market a product will be received from the
appropriate regulatory authority. Should approval be granted to market a
product, there can be no assurance that the Company will be able to successfully
market the product or achieve a profitable level of sales.
Uncertainties Related to MYOTROPHIN(R) (rhIGF-I)
In February 1997, the Company, in collaboration with Chiron Corporation
("Chiron"), filed a new drug application ("NDA") with the FDA requesting that
MYOTROPHIN (rhIGF-I) be approved for the treatment of amyotrophic lateral
sclerosis ("ALS") in the United States. At a public hearing on May 8, 1997, the
Peripheral and Central Nervous System Drugs Advisory Committee (the "Advisory
Committee") found, by a vote of 6 to 3, that the data presented to it for
review did not constitute "substantial" evidence that MYOTROPHIN (rhIGF-I) is
effective in the treatment of ALS. To support commercialization of a drug, the
FDA requires "substantial" evidence of the drug's safety and effectiveness. The
Advisory Committee's recommendation, although not binding, is usually followed
by the FDA. There can be no assurance that the FDA will grant authorization to
commercialize MYOTROPHIN (rhIGF-I) in the United States on the basis of the
results of the two completed studies.
The efficacy and safety data from the North American and European studies of
MYOTROPHIN (rhIGF-I) have not yet been formally reviewed by any regulatory
authority outside the United States. A marketing authorization application has
been accepted for review by the European Medicines Evaluation Agency under the
centralized procedures of the European Union. Under those procedures, a
regulatory decision with respect to the single application is binding on all 15
member states of the European Union, subject in some countries to subsequent
review by national authorities as to pricing and reimbursement matters.
During the double-blind portion of the MYOTROPHIN study conducted in Europe,
an imbalance in death rates was observed in the drug-treated group compared to
the placebo-treated group. The Company believes that mortalities observed in the
North American and European clinical studies are due to the normal progression
of the disease or other circumstances not attributable to MYOTROPHIN (rhIGF-I).
The Company is continuing to furnish MYOTROPHIN (rhIGF-I) to patients who
participated in the two Phase III ALS studies, to patients in its Phase II
program in peripheral neuropathies, and to patients under the ongoing treatment
investigational new drug ("T-IND") program. The reporting of patient deaths as
adverse events could result in regulatory action adverse to the interests of the
Company.
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-I) will
10
<PAGE>
receive marketing approval in any jurisdiction for any indication. A negative
decision by any regulatory authority could adversely influence the decision of
other regulatory authorities. If the FDA or any other regulatory authority were
to require additional data prior to approval of MYOTROPHIN (rhIGF-I) for
commercialization, there can be no assurance that the Company and Chiron would
be willing or able to conduct any study as a Phase III activity or that the
results of such study, if conducted, would be positive. A new study also would
be expensive and would take several years to complete. A delay in obtaining
approval or a failure to obtain any approval for MYOTROPHIN (rhIGF-I) would
materially adversely affect the Company's business and the price of its common
stock. The Company has indicated its willingness to conduct an additional study
of MYOTROPHIN (rhIGF-I) in ALS patients as a post-approval activity.
Chiron's U.S. manufacturing facility (the "Chiron Facility") will be the sole
source of supply for any potential future commercial or clinical needs of
MYOTROPHIN (rhIGF- I), including any material which Cephalon may have to supply
for use in Japan, as well as for use in the Company's ongoing clinical trials.
There can be no assurance that Chiron will be able to produce adequate
quantities of MYOTROPHIN (rhIGF-I) in a cost-effective manner or, in the case of
material purchased by Cephalon for use outside the collaboration, on terms
satisfactory to Cephalon.
The Company and Chiron will be required to demonstrate that the material
produced from the Chiron Facility is equivalent to the material used in the ALS
clinical trials, which was manufactured at the Company's pilot-scale
manufacturing facility in Beltsville, Maryland. Although, based on the results
of a bioequivalency study, the companies believe that the material is
equivalent, if regulatory authorities do not agree with that assessment,
regulatory approval of MYOTROPHIN (rhIGF-I) could be delayed.
The Company and Chiron are required to comply with all applicable FDA
requirements, including current Good Manufacturing Practice ("cGMP") regulations
in the manufacture of MYOTROPHIN. The facilities used by the Company and Chiron
for the manufacture of MYOTROPHIN are subject to FDA inspection at any time
during the conduct of clinical studies or commercial operations, to determine
compliance with cGMP requirements. The cGMP regulations are complex, and failure
to be in compliance could lead to the need for remedial action, penalties and
delays in production of material acceptable to the FDA. Should the Chiron
Facility not be able to produce sufficient quantities of MYOTROPHIN (rhIGF-I) in
accordance with applicable regulations, the collaboration would have to obtain
MYOTROPHIN (rhIGF-I) from another source. There can be no assurance that
Cephalon or the collaboration would be able to locate an alternative, cost-
effective source of supply of MYOTROPHIN (rhIGF-I).
Uncertainties Related to PROVIGIL(R) (modafinil)
In December 1996, the Company submitted an NDA to the FDA requesting that
PROVIGIL (modafinil) be approved for the treatment of the excessive daytime
sleepiness associated with narcolepsy, based on the results of two Phase III
studies conducted in the United States. There can be no assurance that the FDA
or other regulatory authorities will determine that the results generated from
the Company's clinical trials demonstrate sufficient safety and efficacy to
permit marketing approval.
The Company also is pursuing applications seeking authorization to market
PROVIGIL (modafinil) in the Republic of Ireland and the United Kingdom, which
are other territories licensed from Laboratoire L. Lafon ("Lafon"). The
regulatory authorities in both countries have requested and have been provided
additional information with respect to the applications which were originally
filed by Lafon under the multi-state procedures of the Committee for Proprietary
Medicinal Products ("CPMP"). There can be no assurance that the additional
information provided will be adequate in order to permit approval of the
applications. Even if those applications are approved, the Company must also
request permission to vary the applications with respect to certain
manufacturing procedures and other matters. There can be no assurance that any
regulatory approvals or variations will be obtained at all or in a timely
manner. The Company is in the process of establishing a sales force in the
United Kingdom to sell PROVIGIL (modafinil). Any delays in accomplishing these
activities could delay launch of the product, if it is approved. The Company is
required, under the terms of its license with Lafon, to launch the product no
later than three months after approval.
11
<PAGE>
Lafon is responsible for manufacturing the bulk modafinil compound for the
Company, and the Company has entered into an agreement with a third party to
manufacture tablets for commercial use from bulk modafinil provided by Lafon.
The facilities used for the manufacture of modafinil are required to comply with
all applicable FDA requirements, including cGMP regulations. The facilities for
the manufacture of modafinil are subject to inspection by the FDA and European
regulatory authorities at any time during the conduct of clinical studies or
commercial operations. The cGMP regulations are complex, and failure to be in
compliance could lead to the need for remedial action, penalties and delays in
production of material acceptable to the FDA or other regulatory authorities. If
Lafon is unable to supply the Company with modafinil, Cephalon is permitted to
make the compound itself or to purchase it from third parties. There can be no
assurance that Cephalon would be able to manufacture modafinil, that a third-
party manufacturer could be located or that either alternative would be cost-
effective. If the tablet manufacturer is unable to supply tablets for any
reason, there can be no assurance that the Company will be able to identify a
suitable alternative supplier at all or without delaying the launch of PROVIGIL
(modafinil).
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
adversely affect the Company's marketing of PROVIGIL (modafinil) in its
territories.
Shareholder Litigation
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 have been designated by the Court, collectively, as the "lead
plaintiff" 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 as well as options to purchase or sell those securities during the
period between June 12, 1995 and June 7, 1996. The plaintiffs allege, based in
part on statements and opinions expressed at the June 7, 1996 meeting of an FDA
advisory committee to review the MYOTROPHIN treatment investigation new drug
application, that earlier statements by the Company about the North American and
European trial results were misleading. The plaintiffs seek unspecified damages
and other relief. The Company's motion to dismiss the case is pending, and
discovery related to the merits of the allegation in the complaint has been
postponed until the motion is decided, which is likely to occur in 1997. The
Company intends to vigorously defend the action. However, management believes
that it is too early in the proceedings to determine with any certainty the
outcome of this action or the potential liability of the Company, if any.
Other Risks
The results of clinical studies of product candidates under development by the
Company which are conducted by collaborators of the Company, including studies
of rhIGF-I being conducted by the Company's licensee in Japan and clinical
studies of modafinil being conducted by Lafon and its licensees 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-I) and PROVIGIL (modafinil) are approved for
commercialization, the Company cannot predict at this time the potential
revenues to be received from sales of MYOTROPHIN (rhIGF-I) 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(R) (riluzole) has been commercialized in the United States
and Europe by Rhone-Poulenc Rorer, Inc. for use in treating ALS. It is not clear
whether ALS patients, given the
12
<PAGE>
constraints of drug reimbursement programs, would be able to support both
Rilutek and MYOTROPHIN (rhIGF-I) (as well as any other drugs which may be
approved in the future for use in treating ALS), especially if MYOTROPHIN
(rhIGF-I) 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.
TAP Holdings Inc. ("TAP") has begun a Phase I clinical study of a compound
being developed in collaboration with the Company 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 dependence on
collaborative partners and third-party suppliers, 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,
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, the outcome of any
current or potential litigation, and reliance by the Company on key personnel.
The market price for shares of the Company's common stock has historically
been highly volatile. Future negative announcements concerning the Company, its
competitors or other companies in the biopharmaceutical industry, including the
results of testing and clinical trials, regulatory hearings and decisions,
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 adverse effect on the market price of the Company's common stock.
The Company expects to satisfy its need for additional operating funds through
public or private placements of its securities. Any such financings using either
equity securities or options or warrants to acquire equity securities of the
Company would result in the issuance of additional shares and in the reduction
of the percentage ownership of the Company by existing shareholders. The
exercise of outstanding options and warrants also would result in such a
reduction. If the currently-outstanding options and warrants were to be
exercised in accordance with their terms, the outstanding number of shares of
common stock would increase by approximately 25%. See "Results of Operations."
In May 1997, the Company purchased capped call options (the "Options") from
Swiss Bank Corporation, London Branch ("SBC") on 2,500,000 shares of common
stock. In payment of the purchase price of such Options, the Company issued to
SBC 490,000 shares of common stock (the "Shares"), which the Company registered
for resale by SBC under the Securities Act of 1933. The Options, which are
exercisable on the expiration date of October 31, 1997, have a strike price of
$21.50 per share (the "Strike Price") and a cap price of $39.50 per share (the
"Cap Price"). The Company purchased the Options to allow the Company to benefit,
subject to the terms of the Options, from any appreciation in the market value
of the Company's common stock on expiration of the Options. Purchase of the
Options by the Company involves certain risks. The purchase of the Options will
benefit the Company only if the market price of the common stock appreciates to
a level above $21.50 at the expiration of the Options. If the market price of
the common stock at expiration of the Options does not exceed $21.50, the
Company will have issued the Shares for no value. Even if the market price of
the common stock at expiration of the Options exceeds $21.50, the benefit to the
Company may be less than the market value of the Shares when they were sold.
13
<PAGE>
Liquidity and Capital Resources
Cash, cash equivalents and investments at March 31, 1997 and December 31, 1996
were $127,545,000 and $146,848,000, respectively, representing 78% and 83%,
respectively, of total assets.
Cash equivalents and investments consisted primarily of short- to
intermediate-term obligations of the United States government, overnight reverse
repurchase agreements that are collateralized 102% by such government
obligations, and short- to intermediate-term corporate obligations. Certain of
the Company's lease agreements contain covenants that obligate the Company to
maintain certain minimum cash and investment balances.
The following is a summary of selected cash flow information for the three
months ended March 31:
<TABLE>
<CAPTION>
1997 1996
---- ----
<S> <C> <C>
Net cash used for operating activities.................. $(16,662,000) $(13,565,000)
Net cash provided by investing activities............... 16,382,000 9,228,000
Net cash (used for) provided by financing activities.... (2,375,000) 3,598,000
</TABLE>
Net cash used for operating activities
--Operating cash inflows
A summary of the major sources of cash receipts reflected in net cash used for
operating activities for the quarter ended March 31 is as follows:
<TABLE>
<CAPTION>
1997 1996
---- ----
<S> <C> <C>
TAP Holdings......................................... $1,548,000 $1,415,000
Bristol-Myers Squibb................................. 453,000 --
Chiron............................................... -- 2,803,000
Schering-Plough...................................... 88,000 750,000
SmithKline Beecham................................... 729,000 707,000
Kyowa Hakko.......................................... 587,000 407,000
Interest............................................. 1,617,000 1,741,000
</TABLE>
In May 1994, the Company and TAP entered into a research and development and
license agreement (the "TAP Agreement") to develop and commercialize certain
compounds in the United States for the treatment of cancer. Under the terms of
the 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 March 31, 1997,
$1,800,000 was receivable from TAP.
The Company and Bristol-Myers Squibb Company ("BMS") entered into two co-
promotion agreements (the "BMS Agreement"), under which Cephalon markets two BMS
proprietary products, Stadol NS(R) (butorphanol tartrate) Nasal Spray ("Stadol
NS") and Serzone(R) (nefazodone hydrochoride) to neurologists in the United
States. Pursuant to the BMS Agreement, BMS makes quarterly payments to the
Company based primarily on the percentage of certain prescriptions written by
neurologists in excess of a predetermined base amount. The payment received
from BMS in 1997 represents fourth quarter 1996 payments earned under the co-
promotion agreement. In 1996, the payment related to the fourth quarter of 1995
was received in the second quarter of 1996. At March 31, 1997, $1,125,000 was
receivable from BMS.
The Company and Chiron are jointly developing MYOTROPHIN (rhIGF-I) for the
treatment of ALS and certain peripheral neuropathies. Under the collaboration,
as amended, the companies fund equal amounts of MYOTROPHIN program costs. The
payment received from Chiron in the first quarter of 1996 represents
14
<PAGE>
equalization of fourth quarter 1995 program costs incurred. The payment related
to equalization of fourth quarter 1996 program costs was received in the second
quarter of 1997. At March 31, 1997, $3,956,000 was receivable from Chiron.
In January 1997 the Company announced that Schering-Plough Corporation ("SP")
had decided to conclude its funding of the research program with the Company.
The last payment of $88,000 was received in March 1997.
Under the terms of a June 1993 agreement with SmithKline Beecham ("SB"), 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 March 31,
1997, $198,000 was receivable from SB.
In July 1993, the Company entered into an agreement (the "Kyowa Hakko
Myotrophin Agreement") with Kyowa Hakko Kogyo Co., Ltd. ("Kyowa Hakko") to
develop and market MYOTROPHIN (rhIGF-I) in Japan. The Company is reimbursed for
supplying MYOTROPHIN (rhIGF-I) for the clinical trials conducted in Japan by
Kyowa Hakko. At March 31, 1997, a non-recurring $1,000,000 milestone payment was
receivable from Kyowa Hakko upon the Company's filing of the MYOTROPHIN (rhIGF-
I) NDA in the United States.
--Outlook
In future periods, receipt of payments from Chiron or payments by the Company
to Chiron will depend on the relative costs incurred in the MYOTROPHIN program
by the two companies. The continuation of the research funding under the
agreements with TAP and SB, during 1997 and thereafter, are subject to the
achievement of certain development milestones and periodic review by those
companies and may be terminated without cause with prior notice. The Company
expects to receive annual payments from BMS in 1997 comparable to the annual
amount received in 1996. The ability to maintain the current level of product
sales related to the payments from BMS is subject to a number of uncertainties,
including competition from new and existing products and the impact of any
regulatory actions. The milestone payment from Kyowa Hakko, mentioned above, is
a one-time payment. Additional receipts from Kyowa Hakko will depend upon the
level of sales of MYOTROPHIN clinical supplies to Kyowa Hakko.
--Operating cash outflows
Net cash used for selling, general and administrative activities increased in
the first quarter of 1997 as compared to the same 1996 period due to funding
increases in costs associated with the Company's sales and marketing activities,
including increases in pre-marketing efforts in support of the products in
development, a 37% increase in sales and marketing staffing levels and increases
in administrative external costs. The funding of research and development
expenses decreased in the 1997 period as compared to the 1996 period primarily
due to the cessation of manufacturing operations as a result of the November
1996 sale of the Company's Beltsville, Maryland pilot-scale manufacturing
facility.
- --Outlook
Pending a decision by the FDA on the MYOTROPHIN (rhIGF-I) NDA, the Company
expects to continue funding development costs during the remainder of 1997,
including the cost of preparations for filings with other regulatory
authorities, continuation of a Phase II clinical program to test the potential
utility of MYOTROPHIN (rhIGF-I) in the treatment of other neurological
indications, including peripheral neuropathies, continuing the T-IND expanded
access program in ALS patients in the United States, and a planned early access
program in ALS patients in Europe. Even if MYOTROPHIN is not approved in the
United States, the costs of developing MYOTROPHIN are expected to continue to be
significant because many of the activities would be needed to support possible
commercialization of MYOTROPHIN in Europe.
The Partnership granted the Company an exclusive license (the "Interim
License") to manufacture and market MYOTROPHIN (rhIGF-I) within the United
States, Canada and Europe (the "Territory") in return for certain
15
<PAGE>
royalty payments and a payment of approximately $16,000,000 (the "Milestone
Payment") that is to be made if MYOTROPHIN (rhIGF-I) 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").
If the Company is required to make the Milestone Payment and elects to do so in
cash, or if it elects to exercise the Purchase Option for cash, the Company will
be required to make a substantial cash payment, as further described under
"Commitments and contingencies."
The costs to develop PROVIGIL (modafinil) are expected to continue to be
significant during the remainder of 1997 due to open label extensions of the
double-blind portions of clinical studies, potential Phase II studies in other
neurological disorders and pre-launch activities for potential commercialization
of PROVIGIL (modafinil).
Pursuant to the BMS Agreement, the Company is obligated to fund approximately
$977,000 in the remainder of 1997 for promotional and support activities of
Stadol NS targeting neurologists. The Company also expects to incur significant
expenses under the collaborations with SB and TAP, which may exceed payments
received under the related agreements, as well as significant costs in its other
development programs.
Selling, general and administrative activities in the United States and Europe
may be expanded or decreased, as appropriate, as the Company evaluates the
potential for obtaining regulatory approvals of MYOTROPHIN (rhIGF-I) and
PROVIGIL (modafinil). The Company may also build inventories of MYOTROPHIN
(rhIGF-I) and PROVIGIL (modafinil), which also would require substantial
funding.
--Operating cash requirements outlook
The Company expects its negative operating cash flow to continue due to
funding of research, development, clinical trial, regulatory filing, sales and
marketing and other costs. The capital required to fund the Company's
operations for 1997 may be greater than that of the prior year. The amount
needed to fund operations will depend upon many factors, including the success
of the Company's research and development programs, the extent of any
collaborative research or other funding arrangements, the costs and timing of
seeking regulatory approvals, if any, of its products, technological changes,
competition and the expansion of the Company's sales and marketing activities.
See "Certain Risks Related to Cephalon's Business."
Net cash provided by investing activities
A summary of net cash provided by investing activities for the quarter ended
March 31 is as follows:
<TABLE>
<CAPTION>
1997 1996
---- ----
<S> <C> <C>
Purchases of property and equipment................. $ (599,000) $ (512,000)
Sale leaseback of property and equipment............ 333,000 --
Sales and maturities of investments, net............ 16,648,000 9,740,000
----------- ----------
Net cash provided by investing activities......... $16,382,000 $9,228,000
=========== ==========
</TABLE>
The Company may continue to incur significant capital expenditures as it
assesses its facility and equipment requirements.
Sales and maturities of investments, net represent the liquidation of a
portion of the Company's portfolio of investments of which the proceeds are used
to fund operations and other investing activities.
16
<PAGE>
Net cash (used for) provided by financing activities
A summary of cash (used for) provided by financing activities for the quarter
ended March 31 is as follows:
<TABLE>
<CAPTION>
1997 1996
---- ----
<S> <C> <C>
Proceeds from exercises of common stock options and warrants................... $ 1,736,000 $4,568,000
Principal payments on long-term debt........................................... (4,111,000) (970,000)
---------- ---------
Net cash (used for) provided by financing activities......................... $(2,375,000) $3,598,000
=========== ==========
</TABLE>
For the quarter ended March 31, 1997, the Company received cash from the
exercise of 69,246 warrants and 87,412 stock options in the amount of $807,000
and $929,000, 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.
In March 1997, the Company repaid in full the $3,750,000 balance due on the
unsecured bank loan.
Commitments and contingencies
- --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 has funding commitments under several other cancelable
agreements, including those entered into for the purpose of conducting clinical
trials. Pursuant to the BMS Agreement, the Company is obligated to fund
approximately $977,000 in the remainder of 1997 for promotional and support
activities of Stadol NS targeting neurologists. In addition, the Company has
obligations to make royalty, license and milestone payments under certain of its
licensing and research and development agreements, including milestone payments
of $2,000,000 and $268,000 if PROVIGIL (modafinil) receives regulatory approval
in the United States and the United Kingdom, respectively.
Under the November 1996 purchase agreement, the purchaser of the Company's
former pilot-scale manufacturing facility in Beltsville, Maryland has the right
to seek indemnification from the Company, during the first year after the sale,
for certain types of claims.
--Related Party
Late in 1995, Cephalon Clinical Partners, L.P. (the "Partnership") depleted
all of its available funding and will not provide further funding of MYOTROPHIN
(rhIGF-I) 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 to such funds. If the Company
elects not to contribute such funds, the research and development agreement with
the Partnership will terminate and all development and marketing rights to
MYOTROPHIN (rhIGF-I) in the Territory will revert to the Partnership, which may
commercialize MYOTROPHIN (rhIGF-I) itself or license or assign its rights to a
third party. The Company would not receive any benefits from any such
commercialization.
The Partnership granted the Company an exclusive license (the "Interim
License") to manufacture and market MYOTROPHIN (rhIGF-I) within the United
States, Canada and Europe (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-I) 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.
17
<PAGE>
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 is 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-I) 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 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-I) in the Territory would revert to the Partnership, which may
commercialize MYOTROPHIN (rhIGF-I) itself or license or assign its rights to a
third party. The Company would not receive any benefits from any such
commercialization.
The Company's collaboration with Chiron is subject to the rights of the
Partnership, which licensed to the Company the right to develop MYOTROPHIN
(rhIGF-I) in North America and Europe in return for receiving certain payments.
The Company is solely responsible for making any such royalty and milestone
payments owed to the Partnership and is responsible for funding the Purchase
Option if it exercises the option.
--Shareholder Litigation
The Company and certain of its officers have been named as defendants in a
number of civil actions, which have been consolidated, alleging that various
statements by the Company about the North American and European trial results of
MYOTROPHIN were misleading. See "Certain Risks Related to the Company's
Business."
Funding Requirements Outlook
As described above, the Company expects to continue to use cash to fund
operations. The Company may also require the use of cash for a number of other
reasons including to fund possible purchases of property and equipment and to
service its long-term debt. The Company expects that the sale of investments
will continue to be required in order to provide cash to fund operations.
The Company believes that its cash and investment resources are adequate to
fund its anticipated level of operations 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 decisions of regulatory authorities
concerning the Company's various marketing applications, the results of the
Company's ongoing clinical trials and other research and development programs,
the ability to meet clinical and commercial supply requirements, the expansion
of research and development and administrative facilities, technological
advances and competition and regulatory requirements. See "Certain Risks Related
to Cephalon's Business." If MYOTROPHIN (rhIGF-I) receives regulatory approval in
the United States or certain other countries within the Territory, the Company
would be obligated to make the Milestone Payment of approximately $16,000,000,
all or a portion of which may be made in cash.
To satisfy its capital requirements, the Company may seek to access the public
or private equity markets whenever conditions are favorable. In April 1997, the
Company completed a $30,000,000 private placement of senior convertible notes.
The convertible notes mature in April 1998 and bear interest, payable quarterly
in cash or common stock, at a rate of seven percent per annum. The Company will
record the notes at their face value and accrue interest on the outstanding
amount of the notes. The notes are convertible into common stock of the
18
<PAGE>
Company, subject to certain limitations, at a six percent discount to a market
price formula at the time of conversion. The Company has registered 1,400,000
shares of its common stock for sale upon conversion of the notes. The Company
intends to register 1,600,000 additional shares to allow for full conversion of
the notes based upon the current market price of the Company's common stock. If
not converted into common stock at or prior to maturity, the outstanding,
unconverted notes plus accrued interest will be exchanged for an equal dollar
amount of 10 3/4% debentures which mature in 2013. The convertible notes cannot
be converted without the consent of the Company at a price less than $25 per
share until July 2, 1997. The Company may redeem the notes, at a redemption
price equal to 110 percent of the outstanding principal amount plus interest, if
the conversion price falls below approximately $21 per share. The terms of the
convertible notes require the maintenance of a minimum cash balance and certain
other restrictions.
The Company also intends to seek additional funding through corporate
collaborations and other financing vehicles, potentially including "off-balance
sheet" financings 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. If adequate funds are not available, the Company may be required to
significantly curtail one or more of its research or development programs or
obtain funds through arrangements with existing or future collaborative partners
or others that may require the Company to relinquish rights to certain of its
technologies, product candidates or products.
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 quarter ended March 31 is as
follows:
<TABLE>
<CAPTION>
% change
1997 1996 1997 vs. 1996
---- ---- -------------
<S> <C> <C> <C>
Revenues.................................................................. $ 5,628,000 $ 3,728,000 51%
Research and development expenses......................................... 13,177,000 14,293,000 (8)
Selling, general and administrative expenses.............................. 8,697,000 5,495,000 58
Interest income, net...................................................... 1,116,000 1,122,000 (1)
</TABLE>
The increase in revenues in the 1997 period from the 1996 period resulted from
the recording of a milestone payment from Kyowa Hakko for the filing of the
MYOTROPHIN (rhIGF-I) NDA in the United States. In addition, increases in
revenue were recognized under the Chiron collaboration and the TAP Agreement.
Research and development expenses decreased in the 1997 period as compared to
the 1996 period primarily due to the cessation of operations as a result of the
November 1996 sale of the Company's Beltsville, Maryland pilot-scale
manufacturing facility.
The increase in the selling, general and administrative area in the 1997
period as compared to the 1996 period was due to increases in costs associated
with the Company's sales and marketing activities, including increases in pre-
marketing efforts in support of the products in development and a 37% increase
in sales and marketing staffing levels and increases in administrative external
costs.
Results of Operations Outlook
The Company expects to continue to incur a net operating loss in the remainder
of 1997. The Company expects to continue to incur operating losses unless and
until such time as product approvals are obtained and product sales, if any,
exceed operating expenses. The revenues received and costs incurred by the
Company in the remainder of 1997 depend to a large degree on the results of
regulatory actions with respect to the two NDAs recently filed with the FDA with
respect to MYOTROPHIN (rhIGF-I) and PROVIGIL (modafinil), and other product
programs. See "Certain Risks Related to Cephalon's Business." The Company
expects to have significant
19
<PAGE>
fluctuations in quarterly results based on the level and timing of recognition
of contract revenues and the incurrence of expenses.
Revenue or expense to be recognized by the Company under the collaboration
with Chiron will depend on the relative costs incurred by the two companies. A
substantial portion of the Company's revenues are expected to continue to be
derived from collaboration agreements with TAP and SB, the continuation of which
is subject to periodic review and achievement of certain milestones. Revenues to
be recognized in the remainder of 1997 under the agreements with TAP and SB are
currently expected to approximate 1996 levels. The level of revenue to be
recognized under the BMS Agreement is based primarily on the percentage of
certain prescriptions written by neurologists in excess of a predetermined base
amount and, therefore, is dependent upon the success of marketing the co-
promotion products. The milestone payment from Kyowa Hakko, mentioned above, is
a non-recurring source of revenue. Additional revenue recognized from Kyowa
Hakko will depend upon the level of sales of MYOTROPHIN clinical supplies to
Kyowa Hakko.
The Company expects that it will continue to incur significant research,
development, clinical trial, regulatory filing and other costs. In addition,
selling, general and administrative activities in the United States and Europe
may be expanded as the Company evaluates the potential for obtaining regulatory
approvals of MYOTROPHIN (rhIGF-I) and PROVIGIL (modafinil). The Company may also
incur substantial expenses to build inventories of MYOTROPHIN (rhIGF-I) and
PROVIGIL (modafinil).
If the Company were to make the Milestone Payment or exercise the Purchase
Option, a material charge to earnings could result, depending upon the
development status of the underlying technology.
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 March 31, 1997, 198,150 restricted stock grants were outstanding. At March
31, 1997, the Company had approximately 3,245,723 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
March 31, 1997, warrants to purchase 2,820,437 shares of common stock were
exercisable with prices ranging from $11.32 to $18.50, with various exercise
periods through February 2002.
In February 1997, the Financial Accounting Standards Board issued FAS No. 128,
"Earnings per Share," which is effective for financial statements for fiscal
years ending after December 15, 1997. This statement simplifies the standards
for computing earnings per share previously found in APB Opinion No. 15 and
makes them comparable to international EPS standards. The Company intends to
adopt FAS No. 128 for its fiscal year ending December 31, 1997; early adoption
is not permitted. The Company does not expect that the effect of adopting FAS
No. 128 will be material.
20
<PAGE>
PART II - OTHER INFORMATION
- ----------------------------
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits:
None
(b) Reports on Form 8-K:
During the quarter ended March 31, 1997, the Registrant
filed Current Reports on Form 8-K for the following events:
(i) January 16, 1997, Cephalon, Inc. announced an
agreement to issue, in a private placement, $30 million of senior convertible
notes. Cephalon, Inc. also announced that Schering-Plough Corporation will
discontinue its funding of the companies' research collaboration to develop
compounds for the treatment of Alzheimer's disease.
21
<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)
May 15, 1997 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)
22
<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 MARCH 31, 1997 AND IS QUALIFIED
IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS.
</LEGEND>
<CIK> 0000873364
<NAME> CEPAHLON, INC.
<S> <C> <C>
<PERIOD-TYPE> 3-MOS 3-MOS
<FISCAL-YEAR-END> DEC-31-1997 DEC-31-1996
<PERIOD-START> JAN-01-1997 JAN-01-1996
<PERIOD-END> MAR-31-1997 MAR-31-1996
<CASH> 3,016,000 5,671,000
<SECURITIES> 124,529,000 141,177,000
<RECEIVABLES> 8,192,000 5,286,000
<ALLOWANCES> 0 0
<INVENTORY> 0 0
<CURRENT-ASSETS> 3,493,000 2,410,000
<PP&E> 22,044,000 22,086,000
<DEPRECIATION> 9,493,000 8,852,000
<TOTAL-ASSETS> 162,683,000 177,891,000
<CURRENT-LIABILITIES> 18,812,000 21,588,000
<BONDS> 0 0
0 0
0 0
<COMMON> 248,000 246,000
<OTHER-SE> 124,541,000 137,080,000
<TOTAL-LIABILITY-AND-EQUITY> 162,683,000 177,891,000
<SALES> 0 0
<TOTAL-REVENUES> 5,628,000 3,728,000
<CGS> 0 0
<TOTAL-COSTS> 21,874,000 19,788,000
<OTHER-EXPENSES> 0 0
<LOSS-PROVISION> 0 0
<INTEREST-EXPENSE> 501,000 619,000
<INCOME-PRETAX> 0 0
<INCOME-TAX> 0 0
<INCOME-CONTINUING> 0 0
<DISCONTINUED> 0 0
<EXTRAORDINARY> 0 0
<CHANGES> 0 0
<NET-INCOME> (15,130,000) (14,938,000)
<EPS-PRIMARY> (.61) (.62)
<EPS-DILUTED> 0 0
</TABLE>
