<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 June 30, 2000
-------------
[ ] 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 Incorporation or (I.R.S. Employer
Organization) Identification Number)
145 Brandywine Parkway, West Chester, PA 19380-4245
------------------------------------------ ----------
(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 August 7, 2000
----- --------------------------------
Common Stock, par value $.01 34,887,555 Shares
This Report Includes a Total of 27 Pages
<PAGE>
CEPHALON, INC. and SUBSIDIARIES
-------------------------------
INDEX
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Page No.
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PART I - FINANCIAL INFORMATION
Item 1. Financial Statements (Unaudited)
Consolidated Balance Sheets - 3
June 30, 2000 and December 31, 1999
Consolidated Statements of Operations - 4
Three and six months ended June 30, 2000 and 1999
Consolidated Statements of Cash Flows - 5
Six months ended June 30, 2000 and 1999
Notes to Consolidated Financial Statements 6
Item 2. Management's Discussion and Analysis of 10
Financial Condition and Results of Operations
PART II - OTHER INFORMATION
Item 1. Legal Proceedings 26
Item 4. Submission of Matters to a Vote of Security Holders 26
Item 6. Exhibits and Reports on Form 8-K 26
SIGNATURES 27
2
<PAGE>
CEPHALON, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(Unaudited)
<TABLE>
<CAPTION>
June 30, December 31,
2000 1999
---------------- ---------------
<S> <C>
ASSETS
CURRENT ASSETS:
Cash and cash equivalents $29,010,000 $13,152,000
Short-term investments 121,377,000 188,410,000
Receivables, net 11,017,000 5,578,000
Inventory (Note 2) 14,465,000 4,258,000
Other 1,026,000 988,000
---------------- ---------------
Total current assets 176,895,000 212,386,000
PROPERTY AND EQUIPMENT, net of accumulated
depreciation and amortization of $16,030,000 and $15,192,000 24,339,000 20,001,000
OTHER 2,453,000 1,666,000
---------------- ---------------
$203,687,000 $234,053,000
=============== ==============
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Accounts payable $7,365,000 $6,221,000
Accrued expenses 19,988,000 19,328,000
Current portion of long-term debt (Note 3) 1,977,000 31,906,000
---------------- ---------------
Total current liabilities 29,330,000 57,455,000
LONG-TERM DEBT 13,486,000 14,034,000
OTHER 198,000 4,207,000
---------------- ---------------
Total liabilities 43,014,000 75,696,000
---------------- ---------------
COMMITMENTS AND CONTINGENCIES (Note 5)
STOCKHOLDERS' EQUITY:
Preferred stock, $.01 par value, 5,000,000 shares authorized,
2,500,000 shares issued and outstanding 25,000 25,000
Common stock, $.01 par value, 100,000,000 shares authorized,
34,811,075 and 32,560,938 shares issued and outstanding 348,000 326,000
Additional paid-in capital 529,030,000 505,702,000
Treasury stock (1,480,000) (1,290,000)
Accumulated deficit (368,066,000) (347,135,000)
Accumulated other comprehensive income 816,000 729,000
---------------- ---------------
Total stockholders' equity 160,673,000 158,357,000
---------------- ---------------
$203,687,000 $234,053,000
=============== ==============
</TABLE>
The accompanying notes are an integral part of these financial statements.
3
<PAGE>
CEPHALON, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
<TABLE>
<CAPTION>
Three Months Ended Six Months Ended
June 30, June 30,
------------------------------------ ----------------------------------
2000 1999 2000 1999
--------------- --------------- --------------- ---------------
<S> <C> <C> <C> <C>
REVENUES: (Note 6)
Product sales - PROVIGIL $15,287,000 $ 5,522,000 $28,750,000 $ 7,252,000
Other revenues 4,423,000 5,227,000 9,256,000 7,727,000
-------------- --------------- -------------- --------------
19,710,000 10,749,000 38,006,000 14,979,000
-------------- --------------- -------------- --------------
COSTS AND EXPENSES:
Cost of product sales - PROVIGIL 3,282,000 651,000 5,074,000 839,000
Research and development 14,475,000 10,180,000 27,377,000 20,152,000
Selling, general and administrative 13,733,000 10,166,000 28,716,000 23,780,000
-------------- --------------- -------------- --------------
31,490,000 20,997,000 61,167,000 44,771,000
-------------- --------------- -------------- --------------
LOSS FROM OPERATIONS (11,780,000) (10,248,000) (23,161,000) (29,792,000)
-------------- --------------- -------------- --------------
INTEREST:
Income 6,688,000 862,000 9,710,000 1,740,000
Expense (1,737,000) (2,115,000) (2,949,000) (3,390,000)
-------------- --------------- -------------- --------------
4,951,000 (1,253,000) 6,761,000 (1,650,000)
-------------- --------------- -------------- --------------
LOSS (6,829,000) (11,501,000) (16,400,000) (31,442,000)
Dividends on preferred stock (2,265,000) -- (4,531,000) --
-------------- --------------- -------------- --------------
LOSS APPLICABLE TO COMMON SHARES $(9,094,000) $(11,501,000) $(20,931,000) $(31,442,000)
============== ============== ============== ==============
BASIC AND DILUTED LOSS
PER COMMON SHARE $(0.27) $(0.40) $(0.63) $(1.09)
============== ============== ============== ==============
WEIGHTED AVERAGE NUMBER
OF COMMON SHARES OUTSTANDING 34,048,553 28,998,290 33,164,431 28,879,804
============== ============== ============== ==============
</TABLE>
The accompanying notes are an integral part of these financial statements.
4
<PAGE>
<TABLE>
<CAPTION>
CEPHALON, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
Six Months Ended
June 30,
------------------------------------------------
2000 1999
---------------- ----------------
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Loss $(16,400,000) $(31,442,000)
Adjustments to reconcile loss to net cash
used for operating activities:
Depreciation and amortization 838,000 2,106,000
Non-cash compensation expense 3,053,000 595,000
Other (469,000) 743,000
(Increase) decrease in operating assets:
Receivables (4,301,000) (135,000)
Inventory (10,207,000) (3,642,000)
Other current assets (408,000) 201,000
Other long-term assets (787,000) (1,959,000)
Increase (decrease) in operating liabilities:
Accounts payable 1,144,000 2,826,000
Accrued expenses 660,000 4,505,000
Other long-term liabilities (4,009,000) 356,000
---------------- ----------------
Net cash used for operating activities (30,886,000) (25,846,000)
---------------- ----------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of property and equipment (4,558,000) (43,000)
Sales and maturities (purchases) of investments, net 66,318,000 (10,504,000)
---------------- ----------------
Net cash provided by (used for) investing activities 61,760,000 (10,547,000)
---------------- ----------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from sales of common stock and warrants -- 12,000,000
Proceeds from exercises of common stock options and warrants 20,030,000 2,906,000
Proceeds from issuance of long-term debt -- 30,000,000
Dividend payments on preferred stock (4,531,000) --
Principal payments on and retirements of long-term debt (31,318,000) (876,000)
---------------- ----------------
Net cash (used for) provided by financing activities (15,819,000) 44,030,000
---------------- ----------------
EFFECT OF EXCHANGE RATE CHANGES ON CASH AND CASH EQUIVALENTS 803,000 68,000
---------------- ----------------
NET INCREASE IN CASH AND CASH EQUIVALENTS 15,858,000 7,705,000
CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD 13,152,000 7,484,000
---------------- ----------------
CASH AND CASH EQUIVALENTS, END OF PERIOD $29,010,000 $15,189,000
================ ===============
</TABLE>
The accompanying notes are an integral part of these financial statements.
5
<PAGE>
CEPHALON, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
1. NATURE OF BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Business
Cephalon, Inc., headquartered in West Chester, PA, ("Cephalon") is a
biopharmaceutical company dedicated to the discovery, development and marketing
of products to treat neurological disorders and cancer. We have had negative
cash flow from operations since inception and have funded our operations
primarily from the proceeds of public and private placements of our securities.
Sales of PROVIGIL(R) (modafinil) Tablets [C-IV] were initiated in the United
Kingdom in March 1998 and in the United States and the Republic of Ireland in
February 1999. In June 1999, we began promoting and marketing PROVIGIL in
Austria. In July 2000, our partner, Dompe S.p.A. began promoting and marketing
PROVIGIL in Italy. PROVIGIL is approved in those countries for use by those
suffering from excessive daytime sleepiness associated with narcolepsy. In
addition to the territories mentioned above, we also have the rights to market
PROVIGIL in Latin America, Japan, South Korea, Taiwan and Switzerland. We
entered into a collaborative agreement with Abbott Laboratories in June 1999 to
market and further develop GABITRIL(R) (tiagabine hydrochloride), an adjunctive
treatment for partial seizures associated with epilepsy, in the United States.
Our business is subject to a number of significant risks, including the risks
inherent in pharmaceutical research and development activities. We are highly
dependent upon the commercial success of PROVIGIL but there is no assurance that
we will achieve profitability solely on sales of PROVIGIL.
Basis of Presentation
The accompanying unaudited consolidated financial statements have been
prepared in accordance with generally accepted accounting principles for interim
financial information and with the instructions to Form 10-Q and Article 10 of
Regulation S-X. Accordingly, they do not include all of the information and
footnote disclosures required by generally accepted accounting principles for
complete financial statements. In the opinion of management, all adjustments
(consisting of normal recurring accruals) considered necessary for a fair
presentation have been included. These financial statements should be read in
conjunction with the consolidated financial statements and notes thereto
included in our annual report on Form 10-K, filed with the Securities and
Exchange Commission, which includes financial statements as of December 31, 1999
and 1998 and for each of the three years in the period ended December 31, 1999.
The results of our operations for any interim period are not necessarily
indicative of the results of our operations for any other interim period or for
a full year.
Concentrations of Credit Risk
At June 30, 2000, four pharmaceutical wholesalers represented 85% of our U.S.
trade accounts receivable. We control credit risk through credit approvals,
credit limits and by performing ongoing credit evaluations of our customers.
Recent Accounting Pronouncements
In December 1999, the Securities and Exchange Commission, or SEC, issued Staff
Accounting Bulletin No. 101, "Revenue Recognition in Financial Statements" , or
SAB 101, which is effective for fiscal years beginning after December 15, 1999.
The bulletin draws on existing accounting rules and provides specific guidance
on how those accounting rules should be applied, and specifically addresses
revenue recognition for non-refundable technology access fees in the
biotechnology industry. We expect that we will be required to defer non-
refundable technology fees recorded in 1999 and recognize the related revenue
over future periods. The SEC has extended the implementation date of SAB 101
until the fourth quarter of fiscal years beginning after December 15, 1999. In
accordance with SAB 101, we expect to report a change in accounting principle
and to record the impact of this change as a cumulative effect in our statement
of operations.
6
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CEPHALON, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(Unaudited)
2. INVENTORY
Inventory consists solely of PROVIGIL and is stated at the lower of cost or
market value using the first-in, first-out method:
<TABLE>
<S> <C> <C>
June 30, December 31,
2000 1999
----------- ----------
Raw material........................ $ 5,489,000 $1,570,000
Work-in-process..................... 3,278,000 1,616,000
Finished goods...................... 5,698,000 1,072,000
----------- ----------
$14,465,000 $4,258,000
=========== ==========
</TABLE>
3. DEBT
Revenue Sharing Notes
In February 1999, we completed a private placement of $30,000,000 of revenue-
sharing notes. The notes were retired in the first quarter of 2000 for an
aggregate cash payment of $35,500,000. The former holders of the notes will
continue to receive a payment of 6% of net sales of PROVIGIL in the United
States through December 31, 2001.
4. LEGAL PROCEEDINGS
In November 1999, we received a federal grand jury subpoena in connection with
an investigation under the supervision of the Office of Consumer Litigation of
the U.S. Department of Justice. The grand jury also issued subpoenas to certain
of our former and current employees. We believe that the investigation relates
to the release of certain lots of MYOTROPHIN(R) (mecasermin) Injection used in
clinical trials and related reports filed with the FDA during the period 1994-
96. We have not been identified as a target of the investigation, and we are
cooperating with the inquiry. We cannot predict the outcome of the
investigation.
In August 1999, the U.S. District Court for the Eastern District of
Pennsylvania entered a final order approving the settlement of a class action
alleging that statements made about the results of certain clinical studies of
MYOTROPHIN were misleading. A related complaint has been filed with the Court by
a small number of plaintiffs who decided not to participate in the settlement.
This related complaint alleges that we are liable under common law for
misrepresentations concerning the results of the MYOTROPHIN clinical trials, and
that we and certain of our current and former officers and directors are liable
for the actions of persons who allegedly traded in our common stock on the basis
of material inside information. We believe that we have valid defenses to all
claims raised in this action and we have filed a motion to dismiss these claims,
which is pending with the Court. Moreover, even if there is a judgment against
us, we do not believe it will have a material negative effect on our financial
condition or results of operations.
5. COMMITMENTS AND CONTINGENCIES
Related Party
In August 1992, we exclusively licensed our rights to MYOTROPHIN for human
therapeutic use within the United States, Canada and Europe to Cephalon Clinical
Partners, L.P., or CCP. We perform development and clinical testing of
MYOTROPHIN on behalf of CCP under a research and development agreement with CCP.
7
<PAGE>
CEPHALON, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(Unaudited)
CCP has granted us an exclusive license to manufacture and market MYOTROPHIN
for human therapeutic use within the United States, Canada and Europe in return
for royalty payments equal to a percentage of product sales and a milestone
payment of approximately $16,000,000 that will be made if MYOTROPHIN receives
regulatory approval.
We have a contractual option to purchase all of the limited partnership
interests of CCP. To exercise this purchase option, we are required to make an
advance payment of $40,275,000 in cash or, at our election, $42,369,000 in
shares of common stock or a combination thereof. The purchase option will become
exercisable upon the occurrence of certain events once sales activity commences.
Should we discontinue development of MYOTROPHIN or if we do not exercise the
purchase option, our license will terminate and all rights to manufacture or
market MYOTROPHIN in the United States, Canada and Europe will revert to CCP,
which may then commercialize MYOTROPHIN itself or license or assign its rights
to a third party. In that event, we would not receive any benefits from such
commercialization, license or assignment of rights.
6. REVENUES
Product sales
Product sales of PROVIGIL were accounted for as follows:
<TABLE>
<CAPTION>
For the three months For the six months ended
ended June 30, June 30,
2000 1999 2000 1999
----------- ---------- ----------- -----------
<S> <C> <C> <C> <C>
Gross product sales of PROVIGIL $13,266,000 $6,494,000 $27,318,000 $12,282,000
Adjustment to the reserve for returns and allowances 2,021,000 (972,000) 1,432,000 (5,030,000)
----------- ---------- ----------- -----------
Net product sales of PROVIGIL $15,287,000 $5,522,000 $28,750,000 $ 7,252,000
=========== ========== =========== ===========
</TABLE>
Four pharmaceutical wholesalers accounted for 84% of U.S. gross product sales
in the first half of 2000.
At June 30, 2000, the balance in the reserve for returns and allowances was
$3,284,000 of which $2,706,000 was for product returns. Our return reserve
calculation is based upon inventory levels at the wholesalers and at the retail
pharmacies, as well as product reorder history as measured at each reporting
period. The reserve balance is directly affected by product movement through
the supply chain or changes in wholesaler and retailer inventory levels.
Other Revenues
The major sources of other revenues include reimbursement of research and
development costs under our collaborative agreements with Lundbeck and TAP, and
reimbursement under our copromotion agreement with Abbott for sales of GABITRIL.
7. SUBSEQUENT EVENT
Cephalon and Anesta Corp. announced on July 17, 2000 that the two companies
have agreed to a merger under which Cephalon will acquire all of the outstanding
shares of Anesta in a tax-free, stock-for-stock transaction
8
<PAGE>
CEPHALON, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(Unaudited)
intended to be accounted for as a pooling of interests. The merger agreement
provides that each stockholder of Anesta will receive 0.4765 shares of Cephalon
stock for each share of Anesta stock. The merger, which is subject to regulatory
approval and the approval of Anesta shareholders, is expected to be completed
during the fourth quarter of 2000. Under the terms of the merger agreement,
Anesta will become a wholly-owned subsidiary of Cephalon.
9
<PAGE>
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
Certain Risks Related to Cephalon's Business
During the next several years we will be very dependent on the commercial
success of PROVIGIL, and we may be unable to attain profitability on sales of
PROVIGIL.
In December 1998, the FDA approved PROVIGIL for use by those suffering from
excessive daytime sleepiness associated with narcolepsy and, in February 1999,
we commenced selling PROVIGIL in the United States. At our present level of
operations, we may not be able to attain profitability if physicians prescribe
PROVIGIL only for those who are diagnosed with narcolepsy. Under current FDA
regulations, we are limited in our ability to promote PROVIGIL outside this
approved use. The market for use of PROVIGIL in narcolepsy patients is
relatively small; it is limited to approximately 125,000 persons in the United
States, of which we estimate approximately 50,000 currently are seeking
treatment from a physician.
We have initiated clinical studies to examine whether or not PROVIGIL is
effective and safe when used to treat disorders other than narcolepsy. Although
some study data has been positive, additional studies in these disorders will be
necessary before we can apply to expand the authorized uses of PROVIGIL. We do
not know whether all of these studies will demonstrate safety and efficacy, or
if they do, whether we will succeed in receiving regulatory approval to market
PROVIGIL for additional disorders. If the results of some of these studies are
negative, or if adverse experiences are reported in these clinical studies or
otherwise in connection with the use of PROVIGIL by patients, this could
undermine physician and patient comfort with the product, limit the commercial
success of the product and impact the acceptance of PROVIGIL in the narcolepsy
market. Even if the results of these studies are positive, the impact on sales
of PROVIGIL may be minimal unless we are able to obtain FDA approval to expand
the authorized use of PROVIGIL. FDA regulations restrict our ability to
communicate the results of additional clinical studies to patients and
physicians without first obtaining approval from the FDA to expand the
authorized uses for this product.
In addition, the following factors could limit the rate and level of market
acceptance of PROVIGIL:
. the effectiveness of our sales and marketing efforts relative to those
of our competitors;
. the availability and level of reimbursement for PROVIGIL by third-party
payors, including federal, state and foreign government agencies; and
. the occurrence of any side effects, adverse reactions or misuse (or
unfavorable publicity relating thereto) stemming from the use of
PROVIGIL.
We have described these and other factors in more detail below.
. Our lack of experience selling our own pharmaceutical products, together
with significant competition, may impact our ability to effectively
market and sell PROVIGIL in the United States.
In the United States and elsewhere, PROVIGIL faces significant competition in
the marketplace. Narcolepsy, and some of the other disorders for which we are
conducting additional studies, are currently treated with several drugs, many of
which have been available for a number of years or are available in inexpensive
generic forms. Thus, we will need to demonstrate to physicians, patients and
third party payors that the cost of PROVIGIL is reasonable and appropriate in
light of the safety and efficacy of the product, the price of competing products
and the related health care benefits to the patient.
10
<PAGE>
. As PROVIGIL is used commercially, unintended side effects, adverse
reactions or incidents of misuse may occur which could result in
additional regulatory controls, and reduce sales of PROVIGIL.
Prior to 1999, the use of PROVIGIL had been limited principally to clinical
trial patients under controlled conditions and under the care of expert
physicians. We cannot predict whether the widespread commercial use of PROVIGIL
will produce undesirable or unintended side effects that have not been evident
in our clinical trials or the relatively limited broader use to date. As
PROVIGIL becomes more widely utilized by significant numbers of patients who
could take multiple medications, adverse drug interactions could occur that are
difficult to predict. Additionally, incidents of product misuse may occur. These
events, among others, could result in additional regulatory controls, including
withdrawal of the product from the market.
. The efforts of government entities and third party payors to contain or
reduce the costs of health care may adversely affect our sales and limit
the commercial success of PROVIGIL.
In certain foreign markets, pricing or profitability of pharmaceutical
products is subject to various forms of direct and indirect governmental
control. In the United States, there have been, and we expect there will
continue to be, various federal and state proposals to implement similar
government controls. The commercial success of PROVIGIL could be limited if
federal or state governments adopt any such proposals. In addition, in the
United States and elsewhere, sales of pharmaceutical products depend in part on
the availability of reimbursement to the consumer from third party payors, such
as government and private insurance plans. Third party payors increasingly
challenge the prices charged for products, and limit reimbursement levels
offered to consumers for such products. If third party payors focus their cost
control efforts on PROVIGIL, this could limit the commercial success of the
product.
. We may not be able to maintain market exclusivity for PROVIGIL, and
therefore potential competitors may develop competing products, which
could result in a decrease in sales and market share, cause us to reduce
prices to compete successfully, and prevent PROVIGIL from being a
commercial success.
We hold exclusive license rights to a composition-of-matter patent covering
modafinil as the active drug substance in PROVIGIL; this patent was to have
expired in 1998 in the United States, but we have applied for a patent extension
that, if granted, would extend the term of this patent until November 18, 2001.
In addition, we own a U.S. patent covering the particle size of modafinil that
was issued in 1997 and expires on October 6, 2014. However, we may not succeed
in obtaining any extension for the composition-of-matter patent, and we cannot
guarantee that any of our patents will be found to be valid if their validity is
challenged by a third party, or that these patents (or any other patent owned or
licensed by us) would prevent a potential competitor from developing competing
products or product formulations that avoid infringement.
In the United States, the Orphan Drug Act provides incentives to drug
manufacturers to develop and manufacture drugs for the treatment of rare
disorders. The FDA has granted orphan drug status to PROVIGIL for its use in the
treatment of excessive daytime sleepiness associated with narcolepsy. The grant
of orphan drug status to PROVIGIL allows us a seven-year period of marketing
exclusivity for the product in that indication. While the marketing exclusivity
provided by the orphan drug law should prevent other sponsors from obtaining
approval of the same compound for the same indication (unless the other sponsor
can demonstrate clinical superiority or we are unable to provide or obtain
adequate supplies of PROVIGIL), it would not prevent approval of the compound
for other indications that otherwise are non-exclusive, or approval of other
kinds of compounds for the same indication.
. Manufacturing, supply and distribution problems could create supply
disruptions that would damage commercial prospects for PROVIGIL.
We depend upon Laboratoire L. Lafon as our sole supplier of bulk modafinil
compound, the active drug substance contained in PROVIGIL. Moreover, we depend
upon a single manufacturer that is qualified to
11
<PAGE>
manufacture finished PROVIGIL for commercial purposes. We maintain an inventory
of modafinil compound to protect against supply disruptions and are qualifying
an additional manufacturer of finished product.
We must comply with all applicable regulatory requirements of the FDA and
foreign authorities, including current Good Manufacturing Practice, or cGMP,
regulations. The facilities used to manufacture, store and distribute our
products are subject to inspection by regulatory authorities at any time to
determine compliance with regulations. The cGMP regulations are complex, and
failure to be in compliance could lead to remedial action, civil and criminal
penalties and delays in production of material.
A non-active ingredient used in PROVIGIL is no longer manufactured or
commercially available. At anticipated levels of demand, we have several years
supply of this ingredient. We have prepared a new formulation of PROVIGIL that
does not include the now unavailable ingredient; however, the introduction of
any such new formulation requires regulatory approval. If we are unable to
obtain approval for a new formulation, or if demand for the product were to
significantly exceed expectations, we could face supply disruptions that would
result in significant costs and delays, undermine goodwill established with
physicians and patients, and damage commercial prospects for PROVIGIL.
We rely on several third parties in the United States to distribute, provide
customer service activities and accept and process returns. Although we employ a
small number of persons to coordinate and manage the activities undertaken by
these third parties, we have relatively limited experience in this regard. Any
disruption in these activities could impede our ability to sell PROVIGIL and
could reduce sales revenue.
Our sales of PROVIGIL and related financial results will fluctuate and these
fluctuations may adversely affect our stock price.
A number of analysts and investors who follow our stock have developed models
to attempt to forecast future PROVIGIL sales and have established earnings
expectations based upon those models. Forecasting revenue growth is difficult;
especially when there is little commercial history and when the level of market
acceptance of the product is uncertain. Forecasting is further complicated by
the difficulties in estimating stocking levels at pharmaceutical wholesalers and
at retail pharmacies and in estimating potential product returns. As a result it
is likely that there will be significant fluctuations in revenues, which may not
meet with market expectations and which may adversely affect our stock price.
Other factors which may cause our financial results to fluctuate include the
cost of PROVIGIL sales, achievement and timing of research and development
milestones, co-promotion and other collaboration revenues, cost and timing of
clinical trials, marketing and other expenses and manufacturing or supply
disruption.
We anticipate that we will incur additional losses.
To date, we have not been profitable and our accumulated deficit was
approximately $368 million at June 30, 2000. Our losses have resulted
principally from costs incurred in research and development, including clinical
trials, and from selling, general and administrative costs associated with our
operations. We expect to continue to incur losses until such time as product
revenue from PROVIGIL or other products and product candidates exceed expenses
of operating our business. While we seek to attain profitability, we cannot be
sure that we will ever achieve product revenues from PROVIGIL or from any of our
other product candidates sufficient for us to attain this objective. We cannot
be sure that we or our collaborators will obtain required regulatory approvals,
or successfully develop, commercialize, manufacture and market any other product
candidates.
12
<PAGE>
The results and timing of future clinical trials cannot be predicted and future
setbacks may materially affect our business.
We must demonstrate through preclinical testing and clinical trials that a
product candidate is safe and efficacious. The results from preclinical testing
and early clinical trials may not be predictive of results obtained in
subsequent clinical trials, and we cannot be sure that these clinical trials
will demonstrate the safety and efficacy necessary to obtain regulatory approval
for any product candidates.
A number of companies in the biotechnology and pharmaceutical industries have
suffered significant setbacks in advanced clinical trials, even after obtaining
promising results in earlier trials. In addition, certain clinical trials are
conducted with patients having the most advanced stages of disease. During the
course of treatment, these patients often die or suffer other adverse medical
effects for reasons that may not be related to the pharmaceutical agent being
tested. Such events can have a negative impact on the statistical analysis of
clinical trial results.
The completion of clinical trials of our product candidates may be delayed by
many factors. One such factor is the rate of enrollment of patients. Neither we
nor our collaborators can control the rate at which patients present themselves
for enrollment, and we cannot be sure that the rate of patient enrollment will
be consistent with our expectations or be sufficient to enable clinical trials
of our product candidates to be completed in a timely manner or at all. Any
significant delays in, or termination of, clinical trials of our product
candidates may have a material adverse effect on our business.
We cannot be sure that we will be permitted by regulatory authorities to
undertake additional clinical trials for any of our product candidates, or that
if such trials are conducted, any of our product candidates will prove to be
safe and efficacious or will receive regulatory approvals. Any delays in or
termination of these clinical trial efforts may have a material adverse effect
on our business.
Our research and development activities may not result in any additional
pharmaceutical products, which may adversely affect our business.
We are highly focused on the research and development of potential
pharmaceutical products. These activities include engaging in discovery research
and process development, conducting preclinical and clinical studies, and
seeking regulatory approval in the United States and abroad. In all of these
areas, we have relatively limited resources and compete against larger
multinational pharmaceutical companies. Moreover, even if we undertake these
activities in an effective and efficient manner, regulatory approval for the
sale of new pharmaceutical products remains highly uncertain since, in our
industry, the majority of compounds fail to enter clinical studies and the
majority of therapeutic candidates entering clinical studies fail to be
commercialized.
Our research and development and marketing efforts are highly dependent on
corporate collaborators and other third parties who may not devote sufficient
time, resources and attention to our programs, which may adversely impact our
efforts to develop and market potential products.
Because we have limited resources, we have entered into a number of agreements
with other pharmaceutical companies. These agreements may call for our partner
to control:
. the supply of bulk or formulated drugs for commercial use or for use in
clinical trials;
. the design and execution of clinical studies;
. the process of obtaining regulatory approval to market the product; and
. the marketing and selling of any approved product.
13
<PAGE>
In each of these areas, our partners may not support fully our research and
commercial interests since our program may compete for time, attention and
resources with the internal programs of our corporate collaborators. As such, we
cannot be sure that our corporate collaborators will share our perspectives on
the relative importance of our program, that they will commit sufficient
resources to our program to move it forward effectively, or that the program
will advance as rapidly as it might if we had retained complete control of all
research, development, regulatory and commercialization decisions.
We also rely on several of these collaborators and other third parties for the
production of compounds and the manufacture and supply of pharmaceutical
products. One of our collaborators, Kyowa Hakko, has agreed with us to modify
the related supply agreement so that we will be responsible for supplying the
compounds under development. We have selected another manufacturer to produce
these compounds, transferred the applicable manufacturing technology to this
third party and are working to improve and scale-up the production process. We
cannot be certain that this new manufacturer will be able to manufacture such
compounds or products in sufficient quantities, at reasonable prices, and in
accordance with cGMP requirements established by the FDA and other regulatory
authorities.
We experience intense competition in our fields of interest, which may adversely
affect our business.
Large and small companies, academic institutions, governmental agencies, and
other public and private research organizations conduct research, seek patent
protection, and establish collaborative arrangements for product development in
competition with us. Products developed by any of these entities may compete
directly with those we develop or sell. Many of these companies and institutions
have substantially greater capital resources, research and development staffs
and facilities than us, and substantially greater experience in conducting
clinical trials, obtaining regulatory approvals and manufacturing and marketing
pharmaceutical products. These entities represent significant competition for
us. In addition, competitors who are developing products for the treatment of
neurological or oncological disorders might succeed in developing technologies
and products that are more effective than any that we develop or sell or that
would render our technology and products obsolete or noncompetitive. Competition
and innovation from these or other sources potentially could materially
adversely affect any sales of products that might be developed or are currently
being sold by us or make them obsolete. Advances in current treatment methods
also may adversely affect the market for such products.
We may not be able to obtain adequate patent protection either in the United
States or abroad, which could impact our ability to compete effectively.
We place considerable importance on obtaining patent and trade secret
protection for new technologies, products and processes. We file applications
for patents covering the composition of matter or uses of our drug candidates or
our proprietary processes. We also rely on trade secrets, know-how and
continuing technological advancements to support our competitive position.
Although we have entered into confidentiality and invention rights agreements
with our employees, consultants, advisors and collaborators, we cannot be sure
that such agreements will be honored or that we will be able to effectively
protect our rights to our unpatented trade secrets and know-how. Moreover, we
cannot be sure that others will not independently develop substantially
equivalent proprietary information and techniques or otherwise gain access to
our trade secrets and know-how. In addition, many of our scientific and
management personnel have been recruited from other biotechnology and
pharmaceutical companies where they were conducting research in areas similar to
those that we now pursue. As a result, we could be subject to allegations of
trade secret violations and other claims.
We also could incur substantial costs in defending any patent infringement
suits or in asserting any patent rights, including those licensed to us by third
parties, and in defending suits against us or our employees relating to
ownership of or rights to intellectual property. Such disputes could
substantially delay our drug development or commercialization. The U.S. Patent
and Trademark Office, or PTO, or a private party could institute an interference
proceeding involving us in connection with one or more of our patents or patent
applications. Such
14
<PAGE>
proceedings could result in an adverse decision as to priority of invention, in
which case we would not be entitled to a patent on the invention at issue in the
interference proceeding. The PTO or a private party could also institute
reexamination proceedings involving us in connection with one or more of our
patents, and such proceedings could result in an adverse decision as to the
validity or scope of the patents.
Anesta shareholders may not approve the merger between Cephalon and Anesta which
could negatively affect our future level of profitability.
The recently announced merger between Cephalon and Anesta is subject to
approval of regulatory authorities and Anesta shareholders. Shareholder approval
is not likely to take place until the fourth quarter of 2000. The merger has a
fixed exchange ratio of 0.4765 shares of newly-issued Cephalon common stock for
each share of Anesta common stock and is subject to the approval of Anesta
shareholders. Should Anesta shareholders vote against the merger, Cephalon's
level of future profitability and the price of Cephalon's common stock may be
negatively affected.
We are involved in legal proceedings that, if adversely adjudicated or settled,
could materially impact our financial condition.
In November 1999, we received a federal grand jury subpoena in connection with
an investigation under the supervision of the Office of Consumer Litigation of
the U.S. Department of Justice. The grand jury also issued subpoenas to certain
of our former and current employees. We believe that the investigation relates
to the release of certain lots of MYOTROPHIN used in clinical trials and related
reports filed with the FDA during the period 1994-96. We have not been
identified as a target of the investigation, and we are cooperating with this
inquiry. We cannot predict the outcome of the investigation.
In August 1999, the U.S. District Court for the Eastern District of
Pennsylvania entered a final order approving the settlement of a class action in
which plaintiffs alleged that statements made about the results of certain
clinical studies of MYOTROPHIN were misleading. A related complaint has been
filed with the Court by a small number of plaintiffs who decided not to
participate in the settlement. This related complaint alleges that we are liable
under common law for misrepresentations concerning the results of the MYOTROPHIN
clinical trials, and that we and certain of our current and former officers and
directors are liable for the actions of persons who allegedly traded in our
common stock on the basis of material inside information. We believe that we
have valid defenses to all claims raised in this action, and we have filed a
motion to dismiss these claims which is pending with the Court. Moreover, even
if there is a judgment against us, we do not believe it will have a material
negative effect on our financial condition or results of operations.
We face significant product liability risks, which may have a negative effect on
our financial performance.
The administration of drugs to humans, whether in clinical trials or
commercially, can result in product liability claims even if our drugs or a
collaborator's drugs are not actually at fault for causing an injury.
Furthermore, our products may cause, or may appear to have caused, adverse side
effects or potentially dangerous drug interactions that we may not learn about
or understand fully until the drug has been administered to patients for some
time. As the product is used more widely and in patients with varying medical
conditions, the likelihood of an adverse drug reaction may increase. Product
liability claims can be expensive to defend and may result in large judgments or
settlements against us, which could have a negative effect on our financial
performance. We maintain product liability insurance in amounts we believe to be
commercially reasonable, but claims could exceed our coverage limits.
Furthermore, we cannot be certain that we will always be able to purchase
sufficient insurance at an affordable price. Even if a product liability claim
is not successful, the adverse publicity and time and expense of defending such
a claim may interfere with our business.
15
<PAGE>
We may never obtain approval to market MYOTROPHIN, it may not be cost-effective
to pursue MYOTROPHIN for other indications, and therefore we may never derive
revenue from MYOTROPHIN.
We do not believe that the conditions for regulatory approval imposed by the
FDA can be met without conducting an additional Phase III study, and we have no
current plans to conduct such a study. Even if we chose to conduct an additional
study, the results of a new study may not be sufficient to obtain regulatory
approval. We have discussed with Kyowa Hakko the preliminary results of the
clinical study being conducted in Japan and, based upon these discussions, do
not believe that the final results of the study will support FDA approval of our
pending NDA. If MYOTROPHIN is not approved for the treatment of ALS, then it is
unlikely that we would pursue approval for the use of MYOTROPHIN to treat other
indications. Additionally, if we do not obtain approval of MYOTROPHIN for ALS or
pursue approval for other indications, rights to the product may revert back to
CCP.
The price of our common stock has been and may continue to be highly volatile.
The market price of our common stock is volatile, and we expect it to continue
to be volatile for the foreseeable future. For example, during the period
January 1, 1999 through August 7, 2000, our common stock traded at a high price
of $83.63 and a low price of $7.25. Negative announcements (such as adverse
regulatory decisions, disputes concerning patent or other proprietary rights, or
operating results that fall below the market's expectations) could trigger
significant declines in the price of our common stock. In addition, external
events, such as news concerning our competitors, changes in government
regulations that may impact the biotechnology or pharmaceutical industries or
flows of investor funds into or out of our industry, also are likely to affect
the price of our common stock.
Our dependence on key executives and scientists could impact the development and
management of our business.
We are highly dependent upon our ability to attract and retain qualified
scientific, technical and managerial personnel. There is intense competition for
qualified personnel in the pharmaceutical and biotechnology industries, and we
cannot be sure that we will be able to continue to attract and retain the
qualified personnel necessary for the development and management of our
business. Our research and development programs and our business might be harmed
by the loss of the services of existing personnel, as well as the failure to
recruit additional key scientific, technical and managerial personnel in a
timely manner. Much of the know-how we have developed resides in our scientific
and technical personnel and is not readily transferable to other personnel. We
do not maintain "key man" life insurance on any of our employees.
We may be required to incur significant costs to comply with environmental laws
and regulations and our compliance may limit any future profitability.
Our research and development activities involve the controlled use of
hazardous, infectious and radioactive materials that could be hazardous to human
health, safety or the environment. We store these materials and various wastes
resulting from their use at our facility pending ultimate use and disposal. We
are subject to a variety of federal, state and local laws and regulations
governing the use, generation, manufacture, storage, handling and disposal of
these materials and wastes resulting from their use, and we may be required to
incur significant costs to comply with both existing and future environmental
laws and regulations.
We believe that our safety procedures for handling and disposing of these
materials comply with federal, state and local laws and regulations, but the
risk of accidental injury or contamination from these materials cannot be
eliminated. In the event of an accident, we could be held liable for any
resulting damages.
16
<PAGE>
Anti-takeover provisions may deter a third party from acquiring us, limiting our
stockholders' ability to profit from such a transaction.
Our Board of Directors has the authority to issue up to 5,000,000 shares of
preferred stock, $0.01 par value, of which 1,000,000 have been reserved for
issuance in connection with our stockholder rights plan, and to determine the
price, rights, preferences and privileges of those shares without any further
vote or action by our stockholders. Our stockholder rights plan could have the
effect of making it more difficult for a third party to acquire a majority of
our outstanding voting stock.
We are subject to the anti-takeover provisions of Section 203 of the Delaware
Corporation Law, which prohibits us from engaging in a "business combination"
with an "interested stockholder" for a period of three years after the date of
the transaction in which the person becomes an interested stockholder, unless
the business combination is approved in a prescribed manner. The application of
Section 203 could have the effect of delaying or preventing a change of control
of Cephalon. We also have adopted a "poison pill" rights plan that will dilute
the stock ownership of an acquirer of our stock upon the occurrence of certain
events. Section 203, the rights plan, and the provisions of our certificate of
incorporation, our bylaws and Delaware corporate law, may have the effect of
deterring hostile takeovers or delaying or preventing changes in control of our
management, including transactions in which stockholders might otherwise receive
a premium for their shares over then current market prices.
In addition to historical facts or statements of current condition, this
report contains forward-looking statements. Forward-looking statements provide
our current expectations or forecasts of future events. These may include
statements regarding anticipated scientific progress in our research programs,
development of potential pharmaceutical products, prospects for regulatory
approval, manufacturing capabilities, market prospects for our products, sales
and earnings projections, and other statements regarding matters that are not
historical facts. Some of these forward-looking statements may be identified by
the use of words in the statements such as "anticipate," "estimate," "expect,"
"project," "intend," "plan," "believe" or other words and terms of similar
meaning. Our performance and financial results could differ materially from
those reflected in these forward-looking statements due to general financial,
economic, regulatory and political conditions affecting the biotechnology and
pharmaceutical industries as well as more specific risks and uncertainties such
as those set forth above and in our reports to the SEC on Forms 8-K and 10-K.
Given these risks and uncertainties, any or all of these forward-looking
statements may prove to be incorrect. Therefore, you should not rely on any
such forward-looking statements. Furthermore, we do not intend (and we are not
obligated) to update publicly any forward-looking statements. This discussion
is permitted by the Private Securities Litigation Reform Act of 1995.
17
<PAGE>
Liquidity and Capital Resources
Cash, cash equivalents, and investments at June 30, 2000 were $150,387,000,
representing 74% of total assets.
The following is a summary of selected cash flow information:
<TABLE>
<CAPTION>
Six months
Ended June 30,
------------
2000 1999
------------ ------------
<S> <C> <C>
Net cash used for operating activities................ $(30,886,000) $(25,846,000)
Net cash provided by (used for) investing activities.. 61,760,000 (10,547,000)
Net cash (used for) provided by financing activities.. (15,819,000) 44,030,000
</TABLE>
Net Cash Used for Operating Activities
--Operating Cash Inflows
The following is a summary of the major sources of cash receipts reflected in
net cash used for operating activities:
<TABLE>
<CAPTION>
Six Months
Ended June 30,
---------------
2000 1999
----------- ----------
<S> <C> <C>
PROVIGIL sales............................................... $24,560,000 $9,002,000
TAP Holdings Inc............................................. 3,608,000 3,727,000
Abbott Laboratories, Inc..................................... 2,734,000 --
H. Lundbeck A/S.............................................. 3,682,000 2,400,000
Bristol-Myers Squibb Company................................. 607,000 683,000
Medtronic, Inc............................................... -- 543,000
Interest..................................................... 5,567,000 1,998,000
</TABLE>
Sales of PROVIGIL commenced in the United Kingdom in March 1998 and in the
United States and the Republic of Ireland in February 1999. In June 1999, we
began promoting and marketing PROVIGIL in Austria. In July 2000, our partner,
Dompe S.p.A. began promoting and marketing PROVIGIL in Italy. At June 30, 2000,
$7,031,000 was receivable from U.S. sales of PROVIGIL.
We have a research and development collaboration with TAP Holdings Inc. to
develop and commercialize certain compounds for the treatment of human cancers
and prostate disorders in the United States. Under the terms of the agreement,
we perform research and preclinical development of these compounds for which we
are 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 June 30, 2000, $1,082,000
was receivable from TAP.
The $1,840,000 received from Abbott in the first quarter of 2000 represents
compensation for our GABITRIL sales and marketing efforts from the commencement
of the agreement in June 1999 to December 1999. At June 30, 2000, $1,354,000 was
receivable from Abbott.
In May 1999, we entered into a collaborative agreement with H. Lundbeck A/S to
discover, develop and market products to treat neurodegenerative diseases. The
payment received from Lundbeck in the six months ended June 30, 1999 represents
a license fee. The payment of $3,464,000 received from Lundbeck in the six
months ended June 30, 2000 includes $2,464,000 for reimbursement of our research
and development efforts in the fourth
18
<PAGE>
quarter of 1999 and in the first quarter of 2000 and $1,000,000 for a license
fee. At June 30, 2000, $1,859,000 was receivable from Lundbeck.
The decrease in amounts received from Bristol-Myers in 2000 as compared to
1999 is due to a reduction in STADOL NS sales. At June 30, 2000, there was no
receivable due from Bristol-Myers. Our agreement with Bristol-Myers will
terminate in September, 2000. We expect to receive a final payment from
Bristol-Myers in the first quarter of 2001.
Under an April 1997 agreement with Medtronic, Inc., we co-promoted Intrathecal
Baclofen Therapy (ITB(TM)) to neurologists and physiatrists in the United States
for the treatment of intractable spasticity. This agreement terminated in April
1999. Under a separate March 2000 agreement with Medtronic Europe S.A., Cephalon
(UK) Limited is copromoting ITB(TM) to neurologists and certain other
rehabilitation specialists in the United Kingdom, France and Austria for the
treatment of intractable spasticity.
The increase in interest received in 2000 compared to 1999 was due to higher
average investment balances and higher average rates of return on investments.
--Operating Cash Outflows
Operating cash outflows increased in the six months ended June 30, 2000 as
compared to the corresponding period in 1999 as a result of expenditures
associated with PROVIGIL, including the commercialization of PROVIGIL in the
United States, clinical studies of PROVIGIL in disorders other than narcolepsy,
and the purchase of PROVIGIL inventories. Additionally, cash outflows increased
over the prior year due to expenditures related to a 37% increase in headcount
from period to period primarily as a result of increases in our sales and
marketing groups and as a result of a premium of $5,500,000 associated with the
prepayment of the revenue-sharing notes.
Net Cash Provided by (Used for) Investing Activities
The following is a summary of net cash provided by (used for) investing
activities:
<TABLE>
<CAPTION>
Six Months
Ended June 30,
--------------
2000 1999
----------- ------------
<S> <C> <C>
Purchases of property and equipment .................... $(4,558,000) $ (43,000)
Sales and maturities (purchases) of investments, net ... 66,318,000 (10,504,000)
----------- ------------
Net cash provided by (used for) investing activities .. $61,760,000 $(10,547,000)
=========== ============
</TABLE>
Purchases of property and equipment has increased in 2000 due to the expansion
and renovation of our West Chester facility.
Sales and maturities of investments represent the liquidation of investments.
Purchases of investments represent the accumulation of investments.
19
<PAGE>
Net Cash (Used for) Provided by Financing Activities
The following is a summary of net cash (used for) provided by financing
activities:
<TABLE>
<CAPTION>
Six Months
Ended June 30,
--------------
2000 1999
------------ -----------
<S> <C> <C>
Proceeds from sales of common stock and warrants...................... $ -- $12,000,000
Proceeds from exercises of common stock options and warrants.......... 20,030,000 2,906,000
Proceeds from issuance of long-term debt.............................. -- 30,000,000
Dividend payments on preferred stock.................................. (4,531,000) --
Principal payments on and retirements of long-term debt ............. (31,318,000) (876,000)
------------ -----------
Net cash (used for) provided by financing activities................ $(15,819,000) $44,030,000
============ ===========
</TABLE>
In connection with the May 1999 collaborative agreement, Lundbeck purchased
1,000,000 shares of Cephalon's common stock at a price of $12.00 per share,
which was the average market price for the five trading days prior to the
closing of the agreement.
During the six months ended June 30, 2000, we received proceeds of $20,030,000
for the exercise of approximately 2,229,000 common stock options and warrants.
At June 30, 2000, 4,317,148 common stock options and warrants remained
outstanding. The extent and timing of future warrant and option exercises, if
any, are primarily dependent upon the market price of Cephalon's common stock,
as well as the exercise prices and expiration dates of the warrants and options.
Proceeds from the issuance of long-term debt in the six months ended June 30,
1999 consist of a private placement of $30,000,000 of revenue-sharing notes.
These notes were repaid in the first quarter of 2000.
During 1999, we completed a sale of 2,500,000 shares of convertible
exchangeable preferred stock at $50 per share. Dividends are cumulative at the
annual rate of $3.625 per share of preferred stock.
Principal payments on and retirements of long-term debt include payments on
mortgage loans and payments on capital lease obligations.
--Cash and Funding Requirements Outlook
We believe that our cash and investment balance as of June 30, 2000 will be
adequate to fund our expected level of operations for at least several years.
We expect cash flow from operating activities to continue to be negative until
sales from PROVIGIL generate cash inflows in excess of the level of cash
outflows from operations. We cannot accurately predict the effect of certain
developments on PROVIGIL sales such as the degree of market acceptance of
PROVIGIL, competition, the effectiveness of our sales and marketing efforts and
our ability to demonstrate the utility of PROVIGIL in disorders other than
narcolepsy. Cash inflows also include receipts from our collaborative research
and development agreements and from co-promotion agreements. The continuation of
funding under any of these agreements is subject to the achievement of certain
milestones and periodic review by the parties involved.
We expect our cash requirements for PROVIGIL to increase for the next several
years due to efforts associated with the commercialization of PROVIGIL in the
United States, including sales and marketing activities, building PROVIGIL
inventory and conducting clinical studies of PROVIGIL in disorders other than
narcolepsy. Additionally, under our collaboration with Abbott, we are obligated
to fund marketing and clinical trial activities for GABITRIL.
20
<PAGE>
We expect to increase our expenditure of funds on research and development
activities for our other products in development. We may seek sources of funding
for a portion of these research programs through collaborative arrangements with
third parties but since we intend to retain a portion of the commercial rights
to these programs, we still expect to spend significant funds on our share of
the cost of these programs, including the costs of research, preclinical
development, clinical research and manufacturing.
Additionally, we also will require substantial funds to:
. expand and renovate our West Chester facility;
. pay quarterly preferred stock dividends and royalty payments on net
sales of PROVIGIL;
. obtain additional product rights through licensing or acquisition.
Commitments and Contingencies
--Related Party
In August 1992, we exclusively licensed our rights to MYOTROPHIN for human
therapeutic use within the United States, Canada and Europe to CCP. We perform
any development and clinical testing of MYOTROPHIN on behalf of CCP under a
research and development agreement with CCP.
CCP has granted us an exclusive license to manufacture and market MYOTROPHIN
for human therapeutic use within the United States, Canada and Europe in return
for royalty payments equal to a percentage of product sales and a milestone
payment of approximately $16,000,000 that will be made if MYOTROPHIN receives
regulatory approval.
We have a contractual option to purchase all of the limited partnership
interests of CCP. To exercise this purchase option, we are required to make an
advance payment of $40,275,000 in cash or, at our election, $42,369,000 in
shares of common stock or a combination thereof. The purchase option will become
exercisable upon the occurrence of certain events once sales activity commences.
Should we discontinue development of MYOTROPHIN or if we do not exercise the
purchase option, our license will terminate and all rights to manufacture or
market MYOTROPHIN in the United States, Canada and Europe will revert to CCP,
which may then commercialize MYOTROPHIN itself or license or assign its rights
to a third party. In that event, we would not receive any benefits from such
commercialization, license or assignment of rights.
--Legal Proceedings
In November 1999, we received a federal grand jury subpoena in connection with
an investigation which we believe relates to the release of certain lots of
MYOTROPHIN used in clinical trials and related reports filed with the FDA during
the period 1994-96. On August 30, 1999, an order issued by the U.S. District
Court for the Eastern District of Pennsylvania became final that approved the
settlement of an action stemming from allegations that statements made about the
results of certain clinical studies of MYOTROPHIN were misleading. A further
complaint has been filed with the Court alleging liability under common law for
misrepresentations relating to these same studies and for failing to prevent
certain non-employees from trading in Cephalon common stock on the basis of
material inside information. We have filed a motion to dismiss these claims
which is pending with the Court. See "Certain Risks Related to Cephalon's
Business."
21
<PAGE>
Results of Operations
This section should be read in conjunction with the more detailed discussion
under "Liquidity and Capital Resources."
The following is a summary of revenues and expenses:
<TABLE>
<CAPTION>
Three Months Six Months
Ended June 30, Ended June 30,
-------------- --------------
% %
2000 1999 change 2000 1999 change
----------- ----------- ------ ----------- ----------- ------
<S> <C> <C> <C> <C> <C> <C>
Product sales - PROVIGIL............................ $15,287,000 $ 5,522,000 177% $28,750,000 $ 7,252,000 296%
Other revenues...................................... 4,423,000 5,227,000 (15) 9,256,000 7,727,000 20
Cost of product sales - PROVIGIL.................... 3,282,000 651,000 404 5,074,000 839,000 505
Research and development expenses................... 14,475,000 10,180,000 42 27,377,000 20,152,000 36
Selling, general and administrative expenses........ 13,733,000 10,166,000 35 28,716,000 23,780,000 21
Interest income (expense), net...................... 4,951,000 (1,253,000) (495) 6,761,000 (1,650,000) (510)
Preferred stock dividends........................... 2,265,000 -- -- 4,531,000 -- --
</TABLE>
PROVIGIL
Product sales are recognized upon shipment of product and are recorded net of
reserves for returns and allowances. Sales of PROVIGIL were initiated in the
United Kingdom in March 1998 and in the United States and the Republic of
Ireland in February 1999. In June 1999, we began promoting and marketing
PROVIGIL in Austria. In July 2000, our partner Dompe S.p.A. began promoting and
marketing PROVIGIL in Italy.
Product sales of PROVIGIL were accounted for as follows:
<TABLE>
<CAPTION>
For the three months For the six months ended
ended June 30, June 30,
---------------------------- ----------------------------
2000 1999 2000 1999
----------- ---------- ----------- -----------
<S> <C> <C> <C> <C>
Gross product sales of PROVIGIL $13,266,000 $6,494,000 $27,318,000 $12,282,000
Adjustment to the reserve for returns and allowances 2,021,000 (972,000) 1,432,000 (5,030,000)
----------- ---------- ----------- -----------
Net product sales of PROVIGIL $15,287,000 $5,522,000 $28,750,000 $ 7,252,000
=========== ========== =========== ===========
</TABLE>
Four pharmaceutical wholesalers accounted for 84% of U.S. gross product sales
in the first half of 2000.
At June 30, 2000, the balance in the reserve for returns and allowances was
$3,284,000 of which $2,706,000 was for product returns. Our return reserve
calculation is based upon inventory levels at the wholesalers and at the retail
pharmacies, as well as product reorder history as measured at each reporting
period. The reserve balance is directly affected by product movement through
the supply chain or changes in wholesaler and retailer inventory levels.
For the three and six months ended June 30, 2000, cost of product sales was
21% and 18%, respectively. For both the three and six months ended June 30,
1999, cost of product sales was 12% of sales and consisted primarily of
royalties and supply payments due to Lafon. All of the PROVIGIL sold in the
United States during 1999 was produced prior to its December 1998 FDA approval
and, in accordance with Statement of Financial Accounting Standards No. 2
"Accounting for Research and Development Costs," the costs of producing that
material were recorded as research and development expense in those prior
periods.
22
<PAGE>
Three months ended June 30, 2000 compared to the three months ended June 30,
1999
Other revenues decreased in the three months ended June 30, 2000 from the 1999
period due primarily to a decrease in reimbursable expenses incurred under our
collaboration agreement with TAP and from a decrease in revenue recognized from
Kyowa Hakko as a result of the completion of the MYOTROPHIN clinical studies
being conducted by Kyowa Hakko in Japan.
For the three months ended June 30, 2000, research and development expenses
increased from the same 1999 period due primarily to expenditures associated
with an increase in headcount and other compensation costs and expenditures
associated primarily with the PROVIGIL studies in attention
deficit/hyperactivity disorder and obstructive sleep apnea.
The increase in the selling, general and administrative area for the three
months ended June 30, 2000 as compared to the corresponding 1999 period was due
primarily to marketing expenses associated with the commercialization of
PROVIGIL and our collaboration agreement with Abbott to market GABITRIL and an
increase in the size of our sales force to fully support both PROVIGIL and
GABITRIL.
In association with the purchase of our West Chester facilities in March 1995,
we obtained loans from the Commonwealth of Pennsylvania in the amount of
$12,000,000. These loans have a 15-year term with an annual interest rate of 2%
which was to increase to prime plus 2% if we failed to hire a specified number
of employees in Chester County, Pennsylvania by the end of 1999. We have been
paying interest at the 2% rate and accruing interest at the higher rate over the
life of the loan. Although we did not meet the hiring target, in April 2000
Cephalon and the Commonwealth reached an agreement under which the Commonwealth
waived the interest penalty. As a result, and as reflected in our statement of
operations for the second quarter of 2000, we recognized interest income for the
interest differential of $4,008,000 that was previously accrued. The increase in
net interest income in the second quarter of 2000 is also due to higher average
investment balances and higher average rates of return on investments and a
decrease in interest expense due to the retirement in the first quarter of 2000
of the revenue-sharing notes.
Preferred dividends of $2,265,000 were recognized in the second quarter of
2000 in connection with the August 1999 private offering of 2,500,000 shares of
convertible exchangeable preferred stock.
Six months ended June 30, 2000 compared to the six months ended June 30, 1999
Other revenues increased in the six months ended June 30, 2000 from the 1999
period due primarily to revenue recognized under our collaboration agreement
with H. Lundbeck A/S which was initiated in May 1999 and revenue recognized
under our collaboration agreement with Abbott Laboratories which was entered
into in June 1999. This increase was partially offset by a decrease in revenue
recognized under the U.S. Medtronic co-promotion agreement which terminated in
April 1999, a decrease in reimbursable expenses incurred under our collaboration
agreement with TAP and from a decrease in revenue recognized from Kyowa Hakko as
a result of the completion of the MYOTROPHIN clinical studies being conducted by
Kyowa Hakko in Japan.
For the six months ended June 30, 2000, research and development expenses
increased from the same 1999 period due primarily to expenditures associated
with an increase in headcount and other compensation costs and expenditures
associated primarily with the PROVIGIL studies in attention
deficit/hyperactivity disorder and obstructive sleep apnea.
The increase in the selling, general and administrative area for the six
months ended June 30, 2000 as compared to the corresponding 1999 period was due
primarily to marketing expenses associated with the commercialization of
PROVIGIL and our collaboration agreement with Abbott to market GABITRIL and an
increase in the size of our sales force to fully support both PROVIGIL and
GABITRIL. This increase was partially offset by the recording of a $4,300,000
provision in the first quarter of 1999 associated with the settlement of the
then-current securities litigation.
23
<PAGE>
The increase in net interest income in 2000 is primarily due to the
recognition of $4,008,000 in interest income associated with the Commonwealth of
Pennsylvania waiving the interest penalty on our West Chester facilities
funding. In addition, the increase is due to higher average investment balances
and higher average rates of return on investments and a decrease in interest
expense due to the retirement in the first quarter of 2000 of the revenue-
sharing notes.
Preferred dividends were recognized in 2000 in connection with the August 1999
private offering of 2,500,000 shares of convertible exchangeable preferred
stock.
Results of operations outlook
We expect to continue to incur operating losses unless and until sales of
PROVIGIL exceed operating expenses. We expect that sales of PROVIGIL may be
limited since we can only market the product to treat excessive daytime
sleepiness associated with narcolepsy. We may never be able to achieve
profitability solely through sales of PROVIGIL even if our market-base is
expanded to include other indications.
Other revenues include revenue recognized under collaborative research and
development agreements and co-promotion agreements. The continuation of any of
these agreements is subject to the achievement of certain milestones and
periodic review by the parties involved.
We expect to continue to incur significant expenditures associated with the
commercialization of PROVIGIL in the United States, including sales and
marketing activities, and conducting clinical studies of PROVIGIL in disorders
other than narcolepsy. Additionally, under our agreement with Abbott, we are
obligated to fund marketing and clinical trial activities for GABITRIL.
We expect to increase our expenditures on research and development activities
for our other products in development. We may seek sources of funding for these
research and development programs through collaborative arrangements with third
parties but we still expect to have significant expenditures for our share of
the costs of these programs, including the costs of research, preclinical
development, clinical research and manufacturing. As a result of our sale of
2,500,000 shares of convertible exchangeable preferred stock during the third
quarter of 1999, we will continue to recognize quarterly preferred stock
dividends unless the preferred stock is converted into convertible debentures or
shares of our common stock which is unlikely to occur before the third quarter
of 2001.
We expect to have significant fluctuations in quarterly results based
primarily on the level and timing of:
. PROVIGIL sales, including changes in the provision for product returns;
. the cost of PROVIGIL sales;
. achievement and timing of research and development milestones;
. co-promotion and other collaboration revenues;
. cost and timing of clinical trials; and
. marketing and other expenses.
In connection with the issuance in December 1999 of Staff Accounting Bulletin
No. 101 "Revenue Recognition in Financial Statements," or SAB 101, we expect
that we will be required to defer non-refundable license fees recorded in 1999
and recognize the related revenue over future periods. The SEC has extended the
implementation date of SAB 101 until the fourth quarter of fiscal years
beginning after December 15, 1999. In accordance with SAB 101, we expect to
report a change in accounting principles and to record the impact of this change
as a cumulative effect in our statement of operations.
24
<PAGE>
We do not believe that inflation has had a material impact on the results of
our operations since our inception.
Subsequent Event
Cephalon and Anesta Corp. announced on July 17, 2000 that the two companies
have agreed to a merger under which Cephalon will acquire all of the outstanding
shares of Anesta in a tax-free, stock-for-stock transaction intended to be
accounted for as a pooling of interests. The merger agreement provides that
each stockholder of Anesta will receive 0.4765 shares of Cephalon stock for each
share of Anesta stock. The merger, which is subject to regulatory approval and
the approval of Anesta shareholders, is expected to be completed during the
fourth quarter of 2000. Under the terms of the merger agreement, Anesta will
become a wholly-owned subsidiary of Cephalon.
25
<PAGE>
PART II - OTHER INFORMATION
----------------------------
Item 1. Legal Proceedings
The information set forth in Footnote 4 to the Notes to Consolidated
Financial Statements included herein is hereby incorporated by
reference.
Item 4. Submission of Matters to a Vote of Security Holders:
The following matters were considered at the annual meeting of
stockholders of Cephalon held in Malvern, Pennsylvania on May 16, 2000:
I. On the election of the following persons as directors:
<TABLE>
<CAPTION>
NUMBER OF VOTES
------------------------------------------------
FOR WITHHELD
----------------------- -----------------------
<S> <C> <C>
Dr. Frank Baldino, Jr. 28,678,192 248,200
William P. Egan 28,680,903 245,489
Dr. Robert J. Feeney 28,679,903 246,489
Martyn D. Greenacre 28,679,853 246,539
David R. King 28,672,403 253,539
Kevin E. Moley 28,679,713 246,679
Dr. Horst Witzel 28,678,913 247,479
</TABLE>
<TABLE>
<CAPTION>
<S> <C>
II. To approve an amendment to, and restatement of, Cephalon's Equity Compensation Plan:
</TABLE>
<TABLE>
<CAPTION>
NUMBER OF VOTES
-----------------------------------------------------------------------
FOR AGAINST ABSTAIN
-------------------------------- ------------- ----------------------
<S> <C> <C>
16,483,063 12,100,086 115,929
</TABLE>
Item 6. Exhibits and Reports on Form 8-K
<TABLE>
<CAPTION>
<S> <C> <C>
(a) Exhibits:
Exhibit
No. Description of Exhibit
---------- ----------------------
27.1 Financial Data Schedule
(b) Reports on Form 8-K:
No reports on Form 8-K were filed during the quarter ended June 30,
2000.
</TABLE>
26
<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)
August 14, 2000 By /s/ Frank Baldino, Jr.
--------------------------
Frank Baldino, Jr., Ph.D.
Chairman and Chief Executive Officer
(Principal executive officer)
By /s/ J. Kevin Buchi
-----------------------
J. Kevin Buchi
Senior Vice President and Chief Financial Officer
(Principal financial and accounting officer)
27
