Back to GetFilings.com
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, 2002
[_] 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 (I.R.S. Employer Identification
or Organization) 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 _____
---
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 9, 2002
---------------------------------- --------------------------------
Common Stock, par value $.01 55,101,389 Shares
This Report Includes a Total of 38 Pages
CEPHALON, INC. AND SUBSIDIARIES
INDEX
Page No.
--------
PART I - FINANCIAL INFORMATION
Item 1. Consolidated Financial Statements (Unaudited)
Consolidated Balance Sheets - 3
June 30, 2002 and December 31, 2001
Consolidated Statements of Operations - 4
Three and six months ended June 30, 2002 and 2001
Consolidated Statements of Stockholders' Equity - 5
June 30, 2002 and December 31, 2001
Consolidated Statements of Cash Flows - 6
Six months ended June 30, 2002 and 2001
Notes to Consolidated Financial Statements 7
Item 2. Management's Discussion and Analysis of 16
Financial Condition and Results of Operations
Item 3. Quantitative and Qualitative Disclosure about Market Risk 35
PART II - OTHER INFORMATION
Item 1. Legal Proceedings 36
Item 2. Changes in Securities and Use of Proceeds 36
Item 4. Submission of Matters to a Vote of Security Holders 36
Item 6. Exhibits and Reports on Form 8-K 37
SIGNATURES 38
2
CEPHALON, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(Unaudited)
June 30, December 31,
2002 2001
--------------- ---------------
ASSETS
------
CURRENT ASSETS:
Cash and cash equivalents $ 391,786,000 $ 548,727,000
Investments 202,914,000 55,157,000
Receivables, net 83,211,000 75,192,000
Inventory 49,173,000 47,513,000
Other current assets 11,574,000 7,872,000
--------------- ---------------
Total current assets 738,658,000 734,461,000
PROPERTY AND EQUIPMENT, net 70,872,000 64,706,000
GOODWILL 248,565,000 248,911,000
INTANGIBLE ASSETS, net 310,984,000 298,269,000
DEBT ISSUANCE COSTS 24,237,000 26,720,000
OTHER ASSETS 13,999,000 16,020,000
--------------- ---------------
$ 1,407,315,000 $ 1,389,087,000
=============== ===============
LIABILITIES AND STOCKHOLDERS' EQUITY
------------------------------------
CURRENT LIABILITIES:
Accounts payable $ 30,781,000 $ 24,536,000
Accrued expenses 40,181,000 49,370,000
Current portion of long-term debt 20,646,000 32,200,000
Current portion of deferred revenues 491,000 824,000
--------------- ---------------
Total current liabilities 92,099,000 106,930,000
LONG-TERM DEBT 871,422,000 866,589,000
DEFERRED REVENUES 5,773,000 6,042,000
OTHER LIABILITIES 11,192,000 10,795,000
--------------- ---------------
Total liabilities 980,486,000 990,356,000
--------------- ---------------
COMMITMENTS AND CONTINGENCIES (Note 8)
STOCKHOLDERS' EQUITY:
Preferred stock, $.01 par value, 5,000,000 shares authorized,
2,500,000 shares issued, and none outstanding -- --
Common stock, $.01 par value, 200,000,000 shares authorized,
55,096,552 and 54,909,533 shares issued,
and 54,867,674 and 54,685,792 shares outstanding 551,000 549,000
Additional paid-in capital 987,739,000 982,123,000
Treasury stock, 228,878 and 223,741 shares outstanding, at cost (9,803,000) (9,523,000)
Accumulated deficit (565,133,000) (576,691,000)
Accumulated other comprehensive income 13,475,000 2,273,000
--------------- ---------------
Total stockholders' equity 426,829,000 398,731,000
--------------- ---------------
$ 1,407,315,000 $ 1,389,087,000
=============== ===============
The accompanying notes are an integral part of these consolidated financial
statements.
3
CEPHALON, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
Three Months Ended Six Months Ended
June 30, June 30,
------------------------------ ---------------------------------
2002 2001 2002 2001
------------------------------ ---------------------------------
REVENUES:
Product sales $ 108,767,000 $ 44,286,000 $ 204,570,000 $ 85,108,000
Other revenues 11,960,000 11,913,000 27,658,000 18,163,000
------------- ------------ ------------- ------------
120,727,000 56,199,000 232,228,000 103,271,000
------------- ------------ ------------- ------------
COSTS AND EXPENSES:
Cost of product sales 15,472,000 9,273,000 29,317,000 17,571,000
Research and development 31,401,000 20,894,000 61,224,000 40,505,000
Selling, general and administrative 44,911,000 27,291,000 85,195,000 51,656,000
Depreciation and amortization 8,042,000 3,562,000 16,335,000 7,051,000
------------- ------------ ------------- ------------
99,826,000 61,020,000 $ 192,071,000 116,783,000
------------- ------------ ------------- ------------
INCOME (LOSS) FROM OPERATIONS 20,901,000 (4,821,000) 40,157,000 (13,512,000)
------------- ------------ ------------- ------------
OTHER INCOME AND EXPENSE
Interest income 3,770,000 3,039,000 6,640,000 4,546,000
Interest expense (9,782,000) (4,136,000) (21,280,000) (5,456,000)
Other expense (460,000) (72,000) (1,298,000) (1,110,000)
------------- ------------ ------------- ------------
(6,472,000) (1,169,000) (15,938,000) (2,020,000)
------------- ------------ ------------- ------------
INCOME (LOSS) BEFORE INCOME TAXES 14,429,000 (5,990,000) 24,219,000 (15,532,000)
INCOME TAXES -- -- (1,985,000) --
------------- ------------ ------------- ------------
INCOME (LOSS) BEFORE DIVIDENDS ON PREFERRED STOCK,
EXTRAORDINARY CHARGE AND CUMULATIVE
EFFECT OF CHANGING INVENTORY COSTING METHOD 14,429,000 (5,990,000) 22,234,000 (15,532,000)
DIVIDENDS ON CONVERTIBLE EXCHANGEABLE
PREFERRED STOCK -- (3,328,000) -- (5,594,000)
------------- ------------ ------------- ------------
INCOME (LOSS) BEFORE EXTRAORDINARY CHARGE AND
CUMULATIVE EFFECT OF CHANGING INVENTORY
COSTING METHOD 14,429,000 (9,318,000) 22,234,000 (21,126,000)
EXTRAORDINARY GAIN (CHARGE) ON EARLY
EXTINGUISHMENT OF DEBT -- 3,016,000 (7,142,000) 3,016,000
CUMULATIVE EFFECT OF CHANGING INVENTORY
COSTING METHOD FROM FIFO TO LIFO -- -- (3,534,000) --
------------- ------------ ------------- ------------
INCOME (LOSS) APPLICABLE TO COMMON SHARES $ 14,429,000 $ (6,302,000) $ 11,558,000 $(18,110,000)
============= ============ ============= ============
BASIC INCOME (LOSS) PER COMMON SHARE:
Income (loss) per common share before
extraordinary charge and
cumulative effect of changing inventory
costing method $ 0.26 $ (0.19) $ 0.40 $ (0.47)
Extraordinary charge on early
extinguishment of debt -- 0.06 (0.13) 0.07
Cumulative effect of changing inventory
costing method -- -- (0.06) --
------------- ------------ ------------- ------------
$ 0.26 $ (0.13) $ 0.21 $ (0.40)
============= ============ ============= ============
DILUTED INCOME (LOSS) PER COMMON SHARE:
Income (loss) per common share before
extraordinary charge and
cumulative effect of changing inventory
costing method $ 0.25 $ (0.19) $ 0.39 $ (0.47)
Extraordinary charge on early
extinguishment of debt -- 0.06 (0.13) 0.07
Cumulative effect of changing inventory
costing method -- -- (0.06) --
------------- ------------ ------------- ------------
$ 0.25 $ (0.13) $ 0.20 $ (0.40)
------------- ------------ ------------- ------------
WEIGHTED AVERAGE NUMBER
OF COMMON SHARES OUTSTANDING 55,071,000 47,725,000 55,017,000 45,229,000
============= ============ ============= ============
WEIGHTED AVERAGE NUMBER
OF COMMON SHARES OUTSTANDING-ASSUMING DILUTION 57,033,000 47,725,000 57,161,000 45,229,000
============= ============ ============= ============
The accompanying notes are an integral part of these consolidated
financial statements.
4
CEPHALON, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
(Unaudited)
Accumulated
Other
Comprehensive Accumulated Comprehensive
Income (Loss) Total Deficit Income
--------------- ----------------------------------------------
BALANCE, JANUARY 1, 2001 $165,193,000 $(515,543,000) $ 1,401,000
Loss $(55,484,000) (55,484,000) (55,484,000) --
------------
Foreign currency translation gain 368,000
Unrealized investment gains 504,000
------------
Other comprehensive income 872,000 872,000 -- 872,000
------------
Comprehensive loss $(54,612,000)
============
Conversion of preferred
stock into common stock -- -- --
Issuance of common stock -- --
upon conversion of convertible notes 262,590,000
Stock options exercised 25,542,000 -- --
Stock purchase warrants exercised 2,679,000 -- --
Restricted stock award plan 5,349,000 -- --
Employee benefit plan 1,283,000 -- --
Dividends declared on (5,664,000) (5,664,000) --
convertible preferred stock
Treasury stock acquired (3,629,000) -- --
------------ -------------- ------------
BALANCE, DECEMBER 31, 2001 398,731,000 (576,691,000) 2,273,000
Income $ 11,558,000 11,558,000 11,558,000 --
------------
Foreign currency translation gain 9,437,000
Unrealized investment gains 1,765,000
------------
Other comprehensive income 11,202,000 11,202,000 -- 11,202,000
------------
Comprehensive income $ 22,760,000
============
Stock options exercised 3,065,000 -- --
Restricted stock award plan 1,220,000 -- --
Employee benefit plan 1,224,000 -- --
Treasury stock acquired (171,000) -- --
------------ ------------- ------------
BALANCE, JUNE 30, 2002 $426,829,000 $(565,133,000) $ 13,475,000
============ ============= ============
Additional
Common Preferred Paid-in Treasury
Stock Stock Capital Stock
-------- ------- ------------ -----------
BALANCE, JANUARY 1, 2001 $425,000 $25,000 $683,004,000 $(4,119,000)
Loss -- -- -- --
Foreign currency translation gain
Unrealized investment gains
Other comprehensive income -- -- -- --
Comprehensive loss
Conversion of preferred
stock into common stock 70,000 (25,000) (45,000) --
Issuance of common stock 37,000 -- 262,553,000 --
upon conversion of convertible notes
Stock options exercised 13,000 -- 27,304,000 (1,775,000)
Stock purchase warrants exercised 2,000 2,677,000 --
Restricted stock award plan 2,000 -- 5,347,000 --
Employee benefit plan -- -- 1,283,000 --
Dividends declared on -- -- -- --
convertible preferred stock
Treasury stock acquired -- -- -- (3,629,000)
-------- -------- ------------- -----------
BALANCE, DECEMBER 31, 2001 549,000 -- 982,123,000 (9,523,000)
Income -- -- -- --
Foreign currency translation gain
Unrealized investment gains
Other comprehensive income -- -- -- --
Comprehensive income
Stock options exercised 2,000 -- 3,172,000 (109,000)
Restricted stock award plan -- -- 1,220,000 --
Employee benefit plan -- -- 1,224,000 --
Treasury stock acquired -- -- -- (171,000)
-------- ------- ------------ -----------
BALANCE, JUNE 30, 2002 $551,000 $ -- $987,739,000 $(9,803,000)
======== ======= ============ ===========
The accompaning notes are an integral part of these consolidated financial
statements.
5
CEPHALON, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
Six Months Ended
June 30,
-----------------------------------
2002 2001
-------------- --------------
CASH FLOWS FROM OPERATING ACTIVITIES:
Income (loss) before preferred dividends $ 11,558,000 $ (12,516,000)
Adjustments to reconcile income (loss) to net cash
provided by (used for) operating activities:
Depreciation and amortization 16,335,000 7,051,000
Extraordinary charge (gain) on extinguishment of debt 7,142,000 (3,016,000)
Non-cash interest expense 7,099,000 2,413,000
Cumulative effect of changing inventory costing method from FIFO to LIFO 3,534,000 --
Stock-based compensation expense 2,444,000 3,517,000
Other 3,266,000 216,000
(Increase) decrease in operating assets:
Receivables (3,927,000) (8,214,000)
Inventory (2,803,000) (11,331,000)
Other current assets (3,258,000) (2,762,000)
Other long-term assets (3,086,000) 5,000
Increase (decrease) in operating liabilities:
Accounts payable 3,781,000 (651,000)
Accrued expenses (10,261,000) 3,419,000
Deferred revenues 397,000 (467,000)
Other long-term liabilities (1,945,000) (74,000)
------------- -------------
Net cash provided by (used for) operating activities 30,276,000 (22,410,000)
------------- -------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of property and equipment (6,572,000) (4,745,000)
Acquistion of intangible assets (23,658,000) --
Sales and maturities (purchases) of investments, net (145,992,000) (239,239,000)
------------- -------------
Net cash used for investing activities (176,222,000) (243,984,000)
------------- -------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from exercises of common stock options and warrants 3,065,000 20,115,000
Payments to acquire treasury stock (171,000) --
Net proceeds from issuance of long-term debt -- 385,785,000
Preferred dividends paid -- (6,656,000)
Principal payments on and retirements of long-term debt (15,354,000) (49,576,000)
------------- -------------
Net cash (used for) provided by financing activities (12,460,000) 349,668,000
------------- -------------
EFFECT OF EXCHANGE RATE CHANGES ON CASH AND CASH EQUIVALENTS 1,465,000 787,000
------------- -------------
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS (156,941,000) 84,061,000
CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD 548,727,000 36,571,000
------------- -------------
CASH AND CASH EQUIVALENTS, END OF PERIOD $ 391,786,000 $ 120,632,000
============= =============
Supplemental disclosures of cash flow information:
Cash payments for interest $ 13,981,000 $ 1,870,000
Non-cash investing and financing activities:
Capital lease additions 663,000 360,000
The accompanying notes are an integral part of these consolidated financial
statements.
6
CEPHALON, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
1. NATURE OF BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Business
Cephalon is an international biopharmaceutical company dedicated to the
discovery, development and marketing of innovative products to treat sleep and
neurological disorders, cancer and pain. In addition to conducting an active
research and development program, we market three products in the United States,
PROVIGIL(R) (modafinil) tablets [C-IV], ACTIQ(R) (oral transmucosal fentanyl
citrate) [C-II], and GABITRIL(R) (tiagabine hydrochloride), as well as a number
of products in various countries throughout Europe. We are headquartered in West
Chester, Pennsylvania, and have offices in Salt Lake City, Utah, and
internationally in France, the United Kingdom, Germany and Switzerland. Our
research and development headquarters are located in the United States. We
operate manufacturing facilities in France for the production of bulk
pharmaceuticals, including modafinil, which is the active drug substance
contained in PROVIGIL. We also operate manufacturing facilities in Salt Lake
City, Utah, for the production of ACTIQ for distribution and sale in the
European Union.
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 only 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 audited financial statements as of December
31, 2001 and 2000 and for each of the three years in the period ended December
31, 2001. 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.
Revenue Recognition
Product sales are recognized upon the transfer of ownership and risk of
loss for the product to the customer and are recorded net of estimated reserves
for contractual allowances, discounts and returns. The estimated reserves are
reviewed at each reporting period and adjusted to reflect data available at that
time. To the extent our estimates are inaccurate, we will adjust the reserves
which will impact the amount of product sales revenue recognized in the period
of the adjustment.
Income Taxes
We have provided for income taxes related to our foreign subsidiaries in
accordance with Statement of Financial Accounting Standards (SFAS) No. 109,
"Accounting for Income Taxes," which requires the recognition of deferred tax
assets and liabilities for the expected tax consequences of temporary
differences between the tax and financial reporting bases of assets and
liabilities. We have a history of losses in our U.S. operations, which has
generated significant federal and state tax net operating loss (NOL)
carryforwards of approximately $344,139,000 and $147,620,000, respectively, as
of December 31, 2001. United States generally accepted accounting principles
require us to record a valuation allowance against the deferred tax asset
associated with this NOL carryforward if it is more likely than not that we will
not be able to utilize the NOL carryforward to offset future taxes. Due to the
size of the NOL carryforward in relation to our history of unprofitable
operations, we have provided a full valuation allowance against this deferred
tax asset.
7
CEPHALON, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--CONTINUED
(Unaudited)
Group Lafon
On December 28, 2001, we completed our acquisition of the outstanding
shares of capital stock of Laboratoire L. Lafon and affiliated entities
(collectively "Group Lafon"). With this acquisition, we control worldwide rights
to modafinil, marketed under the trade name PROVIGIL in the United States. To
date, the acquisition has increased our product sales, improved gross margins
for PROVIGIL, improved profitability and provided us with important research and
development, commercial and manufacturing infrastructure in France.
The purchase price for Group Lafon was approximately $456,654,000, which
was funded in part by the proceeds of our December 11, 2001 offering of
$600,000,000 of 2.50% convertible subordinated notes due December 2006. Of the
purchase price, $450,000,000 was paid in cash to the sellers with the remainder
primarily representing transaction costs of the acquisition and severance
payments, partially offset by an estimate of the amount expected to be refunded
by the seller under the terms of the acquisition agreement. The purchase
accounting for the acquisition may be revised for up to one year from the
transaction date due to changes in assessments of contingencies and our
integration plans. All such amounts are expected to be paid or received in 2002.
The following unaudited pro forma information shows the results of our
operations for the three months and the six months ended June 30, 2001 as though
the acquisition had occurred as of January 1, 2001:
Three months ended Six months ended
June 30, 2001 June 30, 2001
------------- -------------
Total revenues ................................. $ 77,620,000 $ 144,820,000
Net loss ....................................... $ (9,870,000) $ (24,206,000)
Basic and diluted net loss per common share: $ (0.20) $ (0.54)
The pro forma results have been prepared for comparative purposes only and
are not necessarily indicative of the actual results of operations had the
acquisition taken place as of January 1, 2001, or the results that may occur in
the future. Furthermore, the pro forma results do not give effect to all cost
savings or incremental costs that may occur as a result of the integration and
consolidation of the acquisition.
Recent Accounting Pronouncements
In June 2001, the Financial Accounting Standards Board (FASB) finalized
SFAS No.142, "Goodwill and Other Intangible Assets," which is effective for
fiscal years beginning after December 15, 2001. SFAS 142 no longer requires the
amortization of goodwill; rather, goodwill will be subject to a periodic
assessment for impairment by applying a fair-value-based test. In addition, an
acquired intangible asset should be separately recognized if the benefit of the
intangible asset is obtained through contractual or other legal rights, or if
the intangible asset can be sold, transferred, licensed, rented, or exchanged,
regardless of the acquirer's intent to do so. Such acquired intangible assets
will be amortized over the period in which the economic benefits of the
intangible asset are consumed or otherwise used up. The new criteria for
recording intangible assets separate from goodwill did not require us to
reclassify any of our intangible assets. We have only recorded goodwill related
to our acquisition of Group Lafon effective December 28, 2001; therefore, our
transitional impairment test indicated that there was no impairment of goodwill
upon our adoption of SFAS 142 effective January 1, 2002.
In June 2001, the FASB issued SFAS No. 143, "Accounting for Asset
Retirement Obligations," which requires recognition of the fair value of
liabilities associated with the retirement of long-lived assets when a legal
obligation to incur such costs arises as a result of the acquisition,
construction, development and/or the normal operation of a long-lived asset.
SFAS 143 requires that the fair value of a liability for an asset retirement
obligation be recognized in the period in which it is incurred if a reasonable
estimate of fair value can be made. The associated asset retirement costs are
capitalized as part of the carrying amount of the long-lived asset and
subsequently allocated to expense over the asset's useful life. SFAS 143 is
effective for fiscal years beginning after December 15, 2002. The adoption of
this new standard will not have any impact on our current financial statements.
On January 1, 2002, we adopted SFAS No. 144, "Accounting for the Impairment
or Disposal of Long-Lived Assets." This Statement provides new guidance on the
recognition of impairment losses on long-lived assets to be held
8
CEPHALON, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--CONTINUED
(Unaudited)
and used or to be disposed of and also broadens the definition of what
constitutes a discontinued operation and how the results of a discontinued
operation are to be measured and presented. The adoption of this new standard
has not had any impact on our current financial statements.
In April 2002, the FASB issued SFAS No. 145 "Rescission of FASB Statements
No. 4, 44 and 64, Amendment of FASB Statement No. 13, and Technical
Corrections." This Statement amends or rescinds certain existing authoritative
pronouncements related to lease accounting in order to make various technical
corrections, clarify meanings, or describe applicability under changed
conditions. SFAS No. 145 is effective for fiscal years beginning after May 15,
2002. The adoption of this new standard will not have any impact on our current
financial statements.
In June 2002, the FASB issued SFAS No. 146, "Accounting for Exit or
Disposal Activities." This Statement addresses the recognition, measurement and
reporting of costs that are associated with exit and disposal activities,
including restructuring activities that are currently accounted for pursuant to
the guidance in EITF Issue No. 94-3, "Liability Recognition for Certain Employee
Termination Benefits and Other Costs to Exit an Activity (including Certain
Costs Incurred in a Restructuring)." The Statement requires that costs
associated with exit or disposal activities be recorded at their fair values
when a liability has been incurred. SFAS No. 146 is effective for disposal
activities initiated after December 31, 2002. The adoption of this new standard
will not have any impact on our current financial statements.
2. JOINT VENTURE
In December 2001, we formed a joint venture with an unaffiliated third
party investor to fund additional commercial activities in support of PROVIGIL
and GABITRIL in the United States. In exchange for our transfer to the joint
venture of certain intellectual property and other rights related to these two
products, we received a Class B interest, representing a 50% interest in the
joint venture. In exchange for its contribution of $50,000,000 in cash to the
joint venture, the investor received Class A interests, also representing a 50%
interest in the joint venture.
As of December 31, 2001, the $50,000,000 investor's Class A interest was
recorded on our balance sheet as debt, and the joint venture's cash balance of
$50,000,000 was included in our balance of cash and cash equivalents.
On March 29, 2002, we acquired the investor's Class A interests and ended
the joint venture by the issuance and sale in a private placement of $55,000,000
aggregate principal amount of 3.875% convertible subordinated notes due March
2007. The notes are convertible into our common stock, at the option of the
holder, at a price of $70.36 per share. See "Note 7--Long-Term Debt."
The purchase of the investor's Class A interests in the joint venture
resulted in the recognition of an extraordinary charge of $7,142,000 on the
early extinguishment of debt during the first quarter of 2002. The following
table summarizes the calculation of this extraordinary charge:
Carrying value of the debt as of December 31, 2001 ....................... $ 50,000,000
Interest accreted during the first quarter 2002 at 20% ................... 2,500,000
------------
Carrying value of the debt as of March 29, 2002 .......................... 52,500,000
Less: unamortized joint venture formation costs as of March 29, 2002 ..... (4,642,000)
------------
47,858,000
Fair value of subordinated notes issued on March 29, 2002 ................ (55,000,000)
------------
Extraordinary charge ..................................................... $ (7,142,000)
============
9
CEPHALON, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--CONTINUED
(Unaudited)
In addition, our statement of operations for the six months ended June 30,
2002 included certain charges related to the operations of the joint venture, as
follows:
Six months ended
June 30, 2002
-------------
Selling, general and administrative expenses ............. $3,508,000
Interest expense ......................................... 3,163,000
Interest income .......................................... (190,000)
----------
$6,481,000
==========
3. CASH, CASH EQUIVALENTS AND INVESTMENTS
Cash, cash equivalents and investments consisted of the following:
June 30, December 31,
2002 2001
---- ----
Cash and cash equivalents
Demand deposits and money market funds ................... $ 333,113,000 $ 4,364,000
Repurchase agreements .................................... -- 155,817,000
U.S. government agency obligations ....................... 586,000 79,985,000
Commercial paper ......................................... 4,993,000 245,158,000
Asset backed securities .................................. 1,114,000 4,636,000
Bonds .................................................... 51,980,000 58,767,000
------------- -------------
391,786,000 548,727,000
------------- -------------
Short-term investments (at market value):
U.S. government agency obligations ....................... 7,168,000 8,076,000
Commercial paper ......................................... 80,872,000 17,135,000
Asset backed securities .................................. 19,000 2,878,000
Bonds .................................................... 114,855,000 26,068,000
Certificates of deposit .................................. -- 1,000,000
------------- -------------
202,914,000 55,157,000
------------- -------------
$ 594,700,000 $ 603,884,000
------------- -------------
The contractual maturities of our investments in cash, cash equivalents,
and investments at June 30, 2002 are as follows:
Less than one year ..................................... $ 498,903,000
Greater than one year but less than two years .......... 14,900,000
Greater than two years ................................. 80,897,000
-------------
$ 594,700,000
-------------
10
CEPHALON, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--CONTINUED
(Unaudited)
4. RECEIVABLES
Receivables consisted of the following:
June 30, December 31,
2002 2001
---- ----
Trade receivables ...................................................... $ 47,645,000 $ 40,790,000
Receivables from collaborations ........................................ 12,102,000 16,438,000
Other receivables ...................................................... 33,212,000 24,790,000
Reserve for sales discounts, returns and allowances .................... (9,748,000) (6,826,000)
------------- -------------
$ 83,211,000 $ 75,192,000
============= =============
5. INVENTORY
Inventory consisted of the following:
June 30, December 31,
2002 2001
---- ----
Raw materials ...................................................... $25,664,000 $19,666,000
Work-in-process .................................................... 5,369,000 7,632,000
Finished goods ..................................................... 18,140,000 20,215,000
----------- -----------
$49,173,000 $47,513,000
=========== ===========
Effective January 1, 2002, we changed our method of valuing inventories from
the first-in, first-out, or FIFO method, to the last-in, first-out, or LIFO
method. We recognized a charge of $3,534,000 in the first quarter of 2002 as the
cumulative effect of adopting the LIFO inventory costing method. The acquisition
of Group Lafon's manufacturing operations and the planned expansion of our
internal manufacturing capacity for ACTIQ has reduced and is expected to further
reduce our reliance on third party manufacturers. The expansion of our internal
manufacturing capabilities should allow us to benefit from efficiencies of scale
and lead to lower per unit inventory costs. The LIFO method will reflect these
expected changes to manufacturing costs on the statement of operations on a more
timely basis, resulting in a better matching of current costs of products sold
with product revenues.
Cost of product sales under the LIFO inventory costing method was $4,545,000
lower for the three months ended June 30, 2002 and $9,033,000 lower for the six
months ended June 30, 2002 than it would have been under the FIFO method. If we
had adopted LIFO effective January 1, 2001, the effect on our statement of
operations for the three and six months ended June 30, 2001 would have been
immaterial.
11
CEPHALON, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--CONTINUED
(Unaudited)
6. INTANGIBLE ASSETS
Intangible assets consisted of the following:
June 30, December 31,
2002 2001
----- ----
Developed technology acquired from Lafon ..................... $ 132,000,000 $ 132,000,000
Trademarks/tradenames acquired from Lafon .................... 16,000,000 16,000,000
GABITRIL product rights ...................................... 109,553,000 92,648,000
Novartis CNS product rights .................................. 41,641,000 41,641,000
ACTIQ marketing rights ....................................... 29,114,000 29,114,000
Other product rights ......................................... 11,265,000 --
-------------- --------------
339,573,000 311,403,000
Less accumulated amortization ................................ (28,589,000) (13,134,000)
-------------- --------------
$ 310,984,000 $ 298,269,000
============== ==============
GABITRIL product rights increased by $16,905,000 since December 31, 2001 as
a result of a $10,000,000 payment to Abbott stemming from the extension of the
composition of matter patent and additional payments for expanded rights in
Europe and other countries worldwide. Other product rights increased as a result
of payments for the acquisition of additional product rights in Europe and other
countries worldwide.
Amortization of intangible assets was $12,758,000 for the six months ended
June 30, 2002. Estimated amortizaion of intangible assets for each of the next
five fiscal years are as follows: 2003 -- $27,582,000; 2004 -- $27,461,000; 2005
- --$27,310,000; 2006-- $27,310,000; and 2007-- $26,224,000.
7. LONG-TERM DEBT
Long-term debt consisted of the following:
June 30, December 31,
2002 2001
---- ----
Capital lease obligations .................................... $ 3,024,000 $ 2,852,000
Mortgage and building improvement loans ...................... 11,491,000 12,085,000
Joint venture ................................................ -- 50,000,000
Convertible subordinated notes ............................... 838,000,000 783,000,000
Notes payable/Other .......................................... 8,092,000 13,460,000
Due to Abbott Laboratories ................................... 31,461,000 37,392,000
-------------- --------------
Total debt ................................................... 892,068,000 898,789,000
Less current portion ......................................... (20,646,000) (32,200,000)
-------------- --------------
Total long-term debt ......................................... $ 871,422,000 $ 866,589,000
============== ==============
Convertible Subordinated Notes
On March 29, 2002, we issued and sold $55,000,000 of aggregate principal in
a private placement of 3.875% Convertible Notes due March 29, 2007. The notes
were issued and sold to the purchaser in a transaction exempt from registration
requirements of the Securities Act of 1933, as amended, because the offer and
sale of the notes did not involve a public offering.
12
CEPHALON, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--CONTINUED
(Unaudited)
We are obligated to pay interest on the notes at a rate of 3.875% per year
on each of April 15 and October 15, beginning October 15, 2002. The notes also
are convertible into our common stock, at the option of the holders, at a price
of $70.36 per share, subject to adjustment upon certain events.
The holders of the notes may elect to require us to redeem the notes on
March 28, 2005 at a redemption price equal to 100% of the principal amount of
notes submitted for redemption, plus accrued and unpaid interest. In certain
other circumstances, at the option of the holders, we may be required to
repurchase the notes at 100% of the principal amount of the notes submitted for
repurchase, plus accrued and unpaid interest.
We issued these notes in connection with our acquisition of the Class A
interest held by our joint venture partner. See "Note 2--Joint Venture."
8. COMMITMENTS AND CONTINGENCIES
Legal Proceedings
In February 2001, a complaint was filed in Utah state court by Zars, Inc.
and one of its research scientists, against us and our subsidiary Anesta Corp.
The plaintiffs are seeking a declaratory judgment to establish their right to
develop transdermal or other products containing fentanyl and other
pharmaceutically active agents under a royalty and release agreement between
Zars and Anesta. The complaint also asks for unspecified damages for breach of
contract, interference with economic relations, defamation and slander. We
believe that we have valid defenses to all claims raised in this action. In any
event, we do not believe any judgment against us will have a material adverse
effect on our financial condition or results of operations.
We are a party to certain other litigation in the ordinary course of our
business, including matters alleging employment discrimination, product
liability and breach of commercial contract. However, we are vigorously
defending ourselves in all of these actions and do not believe these matters,
even if adversely adjudicated or settled, would have a material adverse effect
on our financial condition or results of operations.
Related party
In August 1992, we exclusively licensed our rights to MYOTROPHIN(R) for
human therapeutic use within the United States, Canada and Europe to Cephalon
Clinical Partners, L.P., or CCP. We developed MYOTROPHIN on behalf of CCP under
a research and development agreement. Under this agreement, CCP granted an
exclusive license to manufacture and market MYOTROPHIN for human therapeutic use
within the United States, Canada and Europe, and we agreed to make royalty
payments equal to a percentage of product sales and a milestone payment of
approximately $16,000,000 upon regulatory approval. We have a contractual
option, but not an obligation, to purchase all of the limited partnership
interests of CCP, which is exercisable upon the occurrence of certain events
following the first commercial sale of MYOTROPHIN. If, and only if, we decide to
exercise this purchase option, we would make an advance payment of approximately
$40,275,000 in cash or, at our election, approximately $42,369,000 in shares of
common stock or a combination thereof. If we discontinue development of
MYOTROPHIN, or if we do not exercise this 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.
9. OTHER COMPREHENSIVE INCOME
SFAS No. 130, "Reporting Comprehensive Income," requires presentation of
the components of comprehensive income (loss). Our comprehensive income (loss)
includes net income and loss, unrealized gains and losses from
13
CEPHALON, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--CONTINUED
(Unaudited)
foreign currency translation adjustments, and unrealized investment gains. Our
total comprehensive income (loss) is as follows:
Three months ended Six months ended
June 30, June 30,
------- -------
2002 2001 2002 2001
---- ---- ---- ----
Income (loss) before preferred dividends ........ $ 14,429,000 $ (2,974,000) $ 11,558,000 $(12,516,000)
Other comprehensive income (loss):
Foreign currency translation adjustment ....... 9,700,000 (3,000) 9,437,000 787,000
Unrealized investment gains ................... 2,262,000 2,000 1,765,000 107,000
------------ ------------ ------------ ------------
Other comprehensive income (loss) ............... $ 26,391,000 $ (2,975,000) $ 22,760,000 $(11,622,000)
============ ============ ============ ============
10. EARNINGS PER SHARE
We compute income (loss) per common share in accordance with SFAS No. 128,
"Earnings Per Share." Basic income (loss) per common share is computed based on
the weighted average number of common shares outstanding during the period.
Diluted income (loss) per common share is computed based on the weighted average
shares outstanding and the dilutive impact of common stock equivalents
outstanding during the period. The dilutive effect of employee stock options and
restricted stock awards is measured using the treasury stock method. Common
stock equivalents are not included in periods where there is a loss, as they are
anti-dilutive. The following is a reconciliation of net income (loss) and
weighted average common shares outstanding for purposes of calculating basic and
diluted income (loss) per common share:
Three months Six months
ended June 30, ended June 30,
-------------- --------------
2002 2001 2002 2001
---- ---- ---- ----
Numerator:
Net income (loss) used for basic and diluted
income (loss) per common share ................... $ 14,429,000 $ (6,302,000) $ 11,558,000 $(18,110,000)
============ ============ ============ ============
Denominator:
Weighted average shares used for basic
income (loss) per common share ................... 55,071,000 47,725,000 55,017,000 45,229,000
Effect of dilutive securities:
Employee stock options and restricted
stock awards ..................................... 1,962,000 -- 2,144,000 --
------------ ------------ ------------ ------------
Weighted average shares used for diluted
income (loss) per common share ................... 57,033,000 47,725,000 57,161,000 45,229,000
============ ============ ============ ============
The weighted average shares used in the calculation of diluted income per
common share for the three months ended June 30, 2002 excludes 2,327,000 shares
relating to employee stock options and 10,662,000 shares relating to convertible
notes as the inclusion of such shares would be anti-dilutive. The weighted
average shares used in the calculation of diluted income per common share for
the six months ended June 30, 2002 excludes 2,038,000 shares relating to
employee stock options and 10,662,000 shares relating to convertible notes as
the inclusion of such shares would be anti-dilutive.
14
CEPHALON, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--CONTINUED
(Unaudited)
11. SEGMENT AND SUBSIDIARY INFORMATION
On December 28, 2001, we completed our acquisition of Group Lafon. As a
result, we now have significant sales, manufacturing, and research operations in
Europe. Prior to 2002, our European operations accounted for 2%, 3% and 6% of
total product sales for the years ended December 31, 2001, 2000 and 1999,
respectively. For the six months ended June 30, 2002, our European operations
accounted for approximately 24% of total product sales.
The following summarized information presents our revenues and long-lived
assets by geographic segment. We have determined that all of our European
operations have similar economic characteristics and may be aggregated into a
single segment for reporting purposes. Information concerning our geographic
operations is provided below.
Revenues:
Three months ended Six months ended
June 30, 2002 June 30, 2002
------------- -------------
United States ........................ $ 92,081,000 $175,549,000
Europe ............................... 28,646,000 56,679,000
------------ ------------
Total ................................ $120,727,000 $232,228,000
============ ============
Long-lived assets at June 30, 2002:
United States ........................ $213,579,000
Europe ............................... 455,078,000
------------
Total ................................ $668,657,000
============
15
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
RESULTS OF OPERATIONS
Three months ended June 30, 2002 compared to three months ended June 30, 2001
Three months ended
June 30,
2002 2001
---- ----
Product sales:
PROVIGIL ........................ $ 47,035,000 $29,848,000
ACTIQ ........................... 28,511,000 9,764,000
GABITRIL ........................ 10,112,000 4,674,000
Group Lafon products ............ 23,109,000 --
------------ -----------
Total product sales .................. 108,767,000 44,286,000
------------ -----------
Other revenues:
H. Lundbeck A/S ................. 1,966,000 2,211,000
Novartis Pharma AG .............. 2,611,000 2,005,000
Sanofi-Synthelabo ............... 5,772,000 --
Schwarz Pharma AG ............... -- 2,727,000
Other ........................... 1,611,000 4,970,000
------------ -----------
Total other revenues ................. 11,960,000 11,913,000
------------ -----------
Total revenues ....................... $120,727,000 $56,199,000
============ ===========
Revenues-- Product sales in the second quarter of 2002 increased 146%
over the second quarter of 2001. The increase is attributable to a number of
factors including:
. Sales of PROVIGIL increased 58% due to increased market
acceptance. A domestic price increase of 5% was effective June 1,
2002.
. Sales of ACTIQ increased 192%. After our merger with Anesta in
October 2000, we established a dedicated sales force for ACTIQ and
have made ongoing changes to our marketing approach that have
contributed to higher sales. A domestic price increase of 4.9%
effective March 1, 2002 also contributed to higher sales.
. Sales of GABITRIL increased 116% as a result of both increased
demand in the U.S. market and the initiation of sales efforts in
Europe in the first quarter of 2002 following our December 2001
acquisition of European rights to GABITRIL. Additionally, an
average increase in domestic prices of 9.8% effective March 1,
2002 contributed to the sales increase.
. Product sales generated by Group Lafon, which we acquired on
December 28, 2001, were $23,109,000 during the second quarter of
2002. The most significant product sales during the period were
$10,988,000 of SPASFON(R), used for biliary/urinary tract spasm
and irritable bowel syndrome, and $6,612,000 of FONZYLANE(R), used
for the treatment of insufficient arterial circulation in the
lower limbs. Additionally, sales include $2,644,000 of MODIODAL,
the trade name for modafinil in France.
Total other revenues were essentially unchanged from period to period.
Revenue recognized in the second quarter of 2002 under our licensing,
development and marketing collaboration with Sanofi-Synthelabo, which began in
October 2001, was partially offset by $3,500,000 of milestone revenues
recognized in the second quarter of 2001 upon receiving ACTIQ marketing
authorization in certain European countries and by a decrease in revenue
recognized
16
under the former research and development collaboration with Schwarz Pharma AG
which terminated as of June 30, 2001.
Cost of Product Sales-- The cost of product sales in the second quarter
of 2002 decreased to approximately 14% of product sales from approximately 21%
in the second quarter of 2001 due principally to the fact that PROVIGIL related
manufacturing profit and royalties paid by Cephalon to Group Lafon, following
our acquisition of Lafon, represent intercompany profits which are eliminated in
consolidation.
Research and Development Expenses--Research and development expenses
increased 50% to $31,401,000 in the second quarter of 2002 from $20,894,000 in
the second quarter of 2001. An increase of $6,494,000 is attributable to higher
expenditures on drug development costs in the United States for our compounds
that have progressed into later stages of development and also for
infrastructure costs to support the growing number of ongoing clinical trials,
including Phase II/III clinical studies for CEP-1347 and studies related to our
efforts to expand the label for PROVIGIL beyond its current indication. In
addition, we incurred $5,308,000 of research and development expenses at Group
Lafon in the second quarter of 2002.
Selling, General and Administrative Expenses--Selling, general and
administrative expenses increased 65% to $44,911,000 for the quarter ended June
30, 2002 from $27,291,000 for the second quarter of 2001. Group Lafon
represented $7,808,000 of this increase. In addition, we incurred an increase of
$4,250,000 in U.S. sales and marketing costs as a result of the expansion of our
field sales forces.
Depreciation and Amortization Expenses--Depreciation and amortization
expenses increased to $8,042,000 in the second quarter of 2002 from $3,562,000
in the second quarter of 2001 due primarily to amortization expense of
$2,733,000 for intangible assets acquired in our acquisition of Group Lafon.
Other Income and Expense--Interest income increased by $731,000 from the
second quarter of 2001 due to higher average investment balances, partially
offset by lower average rates of return. Interest expense increased by
$5,646,000 from the second quarter of 2001 due primarily to interest recorded on
the increase in outstanding convertible subordinated notes.
Dividends on Convertible Exchangeable Preferred Stock-- In May 2001, the
holders of 2,344,586 shares of the 2,500,000 shares outstanding of our
convertible exchangeable preferred stock converted their preferred shares into
an aggregate of 6,541,394 shares of our common stock, in accordance with the
terms of the preferred stock. As an inducement to the holders to convert their
preferred stock prior to August 2001, when we were initially permitted to redeem
the preferred stock, we agreed to pay immediately all dividends accrued through
the date of conversion as well as all dividends that would have accrued on the
converted shares through the August 2001 redemption date. In the second quarter
of 2001, we recognized a regular quarterly dividend of $2,265,000 and an
additional $1,063,000 of dividend expense associated with the early conversion.
The remaining 155,414 shares of preferred stock outstanding at June 30, 2001
were converted into 433,604 shares of common stock in the third quarter of 2001.
Extraordinary Gain on Early Extinguishment of Debt-- In May 2001, we paid
$24,438,000 to Novartis Pharma AG for deferred obligations due to them under our
continuing November 2000 collaboration agreement. In connection with this
payment, we recorded an extraordinary gain on the early extinguishment of debt
of $3,016,000.
17
Six months ended June 30, 2002 compared to six months ended June 30, 2001
Six months ended
June 30,
2002 2001
---- ----
Product sales:
PROVIGIL .......................... $ 91,210,000 $ 56,872,000
ACTIQ ............................. 47,778,000 16,346,000
GABITRIL .......................... 20,276,000 11,890,000
Group Lafon products .............. 45,306,000 --
------------ ------------
Total product sales .................... 204,570,000 85,108,000
------------ ------------
Other revenues:
H. Lundbeck A/S ................... 4,165,000 3,511,000
Novartis Pharma AG ................ 4,939,000 4,329,000
Sanofi-Synthelabo ................. 15,507,000 --
Schwarz Pharma AG ................. -- 2,805,000
TAP Pharmaceuticals, Inc. ......... -- 1,189,000
Other ............................. 3,047,000 6,329,000
------------ ------------
Total other revenues ................... 27,658,000 18,163,000
------------ ------------
Total revenues ......................... $232,228,000 $103,271,000
============ ============
Revenues-- Product sales in the first half of 2002 increased 140% over
the first half of 2001. The increase is attributable to a number of factors
including:
. Sales of PROVIGIL increased 60% due to increased market
acceptance. A domestic price increase of 5% was effective June 1,
2002.
. Sales of ACTIQ increased 192%. After our merger with Anesta in
October 2000, we established a dedicated sales force for ACTIQ and
have made ongoing changes to our marketing approach that have
contributed to higher sales. A domestic price increase of 4.9%
effective March 1, 2002 also contributed to higher sales.
. Sales of GABITRIL increased 71% as a result of both increased
demand in the U.S. market and the initiation of sales efforts in
Europe during the first quarter of 2002 following our December
2001 acquisition of European rights to GABITRIL. Additionally, an
average increase in domestic prices of 9.8% effective March 1,
2002 contributed to the sales increase.
. Product sales generated by Group Lafon, which we acquired on
December 28, 2001, were $45,306,000 during the first half of 2002.
The most significant product sales during the period were
$22,100,000 of SPASFON, used for biliary/urinary tract spasm and
irritable bowel syndrome, and $12,828,000 of FONZYLANE, used for
the treatment of insufficient arterial circulation in the lower
limbs. Additionally, sales include $5,258,000 of MODIODAL, the
trade name for modafinil in France.
Total other revenues increased by $9,495,000 or 52%. Revenue recognized
in the first half of 2002 under our licensing, development and marketing
collaboration with Sanofi-Synthelabo, which began in October 2001, was partially
offset by $3,500,000 in milestone revenues recognized in the second quarter of
2001 upon receiving ACTIQ marketing authorization in certain European countries
and by a decrease in revenue recognized under the former research and
development collaborations with Schwarz Pharma AG and TAP Pharmaceuticals, Inc.
which terminated as of June 30, 2001 and March 31, 2001, respectively.
Cost of Product Sales-- The cost of product sales in the first half of
2002 decreased to approximately 14% of product sales from approximately 21% in
the first half of 2001 due principally to the fact that PROVIGIL related
18
manufacturing profit and royalties paid by Cephalon to Group Lafon, following
our acquisition of Lafon, now represent intercompany profits which are
eliminated in consolidation.
Research and Development Expenses--Research and development expenses
increased 51% to $61,224,000 in the first half of 2002 from $40,505,000 in the
first half of 2001. An increase of $11,198,000 is attributable to higher
expenditures on drug development costs in the United States for our compounds
that have progressed into later stages of development and also for
infrastructure costs to support the growing number of ongoing clinical trials,
including Phase II/III clinical studies for CEP-1347 and studies related to our
efforts to expand the label for PROVIGIL beyond its current indication. In
addition, we incurred $10,346,000 of research and development expenses at Group
Lafon in the first half of 2002.
Selling, General and Administrative Expenses--Selling, general and
administrative expenses increased 65% to $85,195,000 for the six months ended
June 30, 2002 from $51,656,000 for the first half of 2001. Group Lafon
represented $16,227,000 of this increase. In addition, we incurred an increase
of $9,847,000 in U. S. sales and marketing costs as a result of the expansion of
our field sales forces.
Depreciation and Amortization Expenses--Depreciation and amortization
expenses increased to $16,335,000 in the first half of 2002 from $7,051,000 in
the first half of 2001 due primarily to amortization expense of $5,466,000 for
intangible assets acquired in our acquisition of Group Lafon.
Other Income and Expense--Interest income increased by $2,094,000 from the
first half of 2001 due to higher average investment balances, partially offset
by lower average rates of return. Interest expense increased by $15,824,000 from
the first half of 2001 due primarily to interest recorded on the increase in
outstanding convertible subordinated notes.
Income Taxes--Income taxes of $1,985,000 recorded in the first half of 2002
represent foreign income tax expense associated with our Group Lafon operations.
Dividends on Convertible Exchangeable Preferred Stock--In May 2001, the
holders of 2,344,586 shares of the 2,500,000 shares outstanding of our
convertible exchangeable preferred stock converted their preferred shares into
an aggregate of 6,541,394 shares of our common stock, in accordance with the
terms of the preferred stock. As an inducement to the holders to convert their
preferred stock prior to August 2001, when we were initially permitted to redeem
the preferred stock, we agreed to pay immediately all dividends accrued through
the date of conversion as well as all dividends that would have accrued on the
converted shares through the August 2001 redemption date. In the second quarter
of 2001, we recognized a regular quarterly dividend of $2,265,000 and an
additional $1,063,000 of dividend expense associated with the early conversion.
The remaining 155,414 shares of preferred stock outstanding at June 30, 2001
were converted into 433,604 shares of common stock in the third quarter of 2001.
Extraordinary Gain (Charge) on Early Extinguishment of Debt--The purchase
of the investor's Class A interests in the joint venture resulted in the
recognition of an extraordinary charge of $7,142,000 during the first quarter of
2002.
In May 2001, we paid $24,438,000 to Novartis Pharma AG for deferred
obligations due to them under our continuing November 2000 collaboration
agreement. In connection with this payment, we recorded an extraordinary gain on
the early extinguishment of debt of $3,016,000.
Cumulative Effect of Changing Inventory Costing Method from FIFO to LIFO--
Effective January 1, 2002, we changed our method of valuing inventories from the
first-in, first-out, or FIFO method, to the last-in, first-out, or LIFO method.
We recognized a charge of $3,534,000 in the first quarter of 2002 as the
cumulative effect of adopting the LIFO inventory costing method. The acquisition
of Group Lafon's manufacturing operations and the planned expansion of our
internal manufacturing capacity for ACTIQ has reduced and is expected to further
reduce our reliance on third party manufacturers. The expansion of our internal
manufacturing capabilities should allow us to benefit from efficiencies of scale
and lead to lower per unit inventory cost. The LIFO method will reflect these
19
expected changes to manufacturing costs on the statement of operations on a more
timely basis, resulting in a better matching of current costs of products sold
with product revenues.
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
Management's Discussion and Analysis of Financial Condition and Results of
Operations discusses our consolidated financial statements, which have been
prepared in accordance with accounting principles generally accepted in the
United States. The preparation of financial statements requires management to
make estimates and assumptions that affect the carrying amounts of assets and
liabilities, and the reported amounts of revenues and expenses during the
reporting period. These estimates and assumptions are developed and adjusted
periodically by management based on historical experience and on various other
factors that are believed to be reasonable under the circumstances. Actual
results may differ from these estimates.
Our significant accounting policies are described in Note 1 to the
consolidated financial statements included in Item 1 of this Form 10-Q and Note
1 to the consolidated financial statements included in Item 8 of our Form 10-K
for the year ended December 31, 2001. Management considers the following
policies to be the most critical in understanding the more complex judgments
that are involved in preparing our consolidated financial statements and the
uncertainties that could impact its results of operations, financial position
and cash flows.
Revenue recognition--Product sales are recognized upon the transfer of
ownership and risk of loss for the product to the customer and are recorded net
of estimated reserves for contractual allowances, discounts and returns.
Contractual allowances result from sales under contracts with managed care
organizations and government agencies. The reserve for contractual allowances is
based on an estimate of prescriptions to be filled for individuals covered by
government agencies and managed care organizations with whom we have contracts.
Product returns are permitted with respect to unused pharmaceuticals based on
expiration dating of our product. The reserve for product returns is determined
by reviewing the history of each product's returns and by utilizing reports
purchased from external, independent sources which produce prescription data and
estimates of wholesale stocking levels and wholesale sales to retail pharmacies.
This data is reviewed to monitor product movement through the supply chain to
identify remaining inventory in the supply chain that may result in reserves for
contractual allowances or returns. To date, product returns have not been
material. The reserves are reviewed at each reporting period and adjusted to
reflect data available at that time. To the extent our estimates prove
inaccurate, we will adjust the reserves, which will impact the amount of product
sales revenue recognized in the period of the adjustments.
Other revenue, which includes revenues from collaborative agreements,
consists of up-front fees, ongoing research and development funding, milestone
payments and payments under co-promotional or managed services agreements.
Effective January 1, 2000, we adopted the SEC's Staff Accounting Bulletin No.
101, "Revenue Recognition in Financial Statements" (SAB 101). In accordance with
SAB 101, non-refundable up-front fees are deferred and amortized to revenue over
the related performance period. We estimate our performance period based on the
specific terms of each collaborative agreement, but actual performance may vary.
We adjust the performance periods based upon available facts and circumstances.
Periodic payments for research and development activities are recognized over
the period that we perform the related activities under the terms of the
agreements. Revenue resulting from the achievement of milestone events
stipulated in the agreements is recognized when the milestone is achieved.
Milestones are based upon the occurrence of a substantive element specified in
the contract or as measure of substantive progress towards completion under the
contract. Payments under co-promotional or managed services agreements are
recognized over the period when the products are sold or the promotional
activities are performed under the terms of the agreement.
Allowance for uncollectable accounts receivable--Accounts receivable are
reduced by an allowance for amounts that may become uncollectable in the future.
On an ongoing basis, management performs credit evaluations of our customers and
adjusts credit limits based upon the customer's payment history and
creditworthiness, as determined by a review of their current credit information.
We continuously monitor collections and payments from our customers. Based upon
our historical experience and any specific customer collection issues that are
identified, management uses its judgment to establish and evaluate the adequacy
of our allowance for estimated credit losses. While such credit losses have been
within our expectations and the allowance provided, we cannot be sure that we
will continue to
20
experience the same credit loss rates as we have in the past. As of June 30,
2002, approximately 91% of our U.S. trade accounts receivable were due from
three pharmaceutical wholesalers. A significant change in the liquidity or
financial position of any one of these wholesalers could have a material adverse
impact on the collectability of our accounts receivable and our future operating
results.
Inventories--Our inventories are valued at the lower of cost or market, and
include the cost of raw materials, labor and overhead. We changed our method of
valuing inventories from the first-in, first-out, or FIFO method, to the
last-in, first-out, or LIFO method, effective January 1, 2002. The acquisition
of Group Lafon's manufacturing operations and the planned expansion of our
internal manufacturing capacity for ACTIQ has reduced and is expected to further
reduce our reliance on third party manufacturers. The expansion of our internal
manufacturing capabilities should allow us to benefit from efficiencies of scale
and lead to lower per unit inventory costs. The LIFO method will reflect the
expected changes to manufacturing costs on the statement of operations on a more
timely basis, resulting in a better matching of current costs of products sold
with product revenues. The majority of our inventories are subject to expiration
dating. We regularly evaluate the carrying value of our inventories and when, in
the opinion of management, factors indicate that impairment has occurred, either
a reserve is established against the inventories' carrying value or the
inventories are completely written off. Management bases these decisions on the
level of inventories on hand in relation to our estimated forecast of product
demand, production requirements over the next twelve months and the expiration
dates of raw materials and finished goods. Although we make every effort to
ensure the accuracy of forecasts of future product demand, any significant
unanticipated decreases in demand could have a material impact on the carrying
value of our inventories and our reported operating results. To date, inventory
adjustments have not been material.
Valuation of Fixed Assets, Goodwill and Intangible Assets--Our fixed assets
and intangible assets (which consist primarily of developed technology,
trademarks, and product and marketing rights) have been recorded at cost and are
being amortized on a straight-line basis over the estimated useful life of those
assets. In conjunction with acquisitions of businesses or product rights, we
allocate the purchase price based upon the relative fair values of the assets
acquired and liabilities assumed. In certain circumstances, fair value may be
assigned to purchased in-process technology and immediately expensed. The
valuation of goodwill and intangible assets and the estimation of appropriate
useful lives to apply to intangibles requires us to use our judgment. We
regularly assess the impairment of intangibles, long-lived assets and goodwill
and will adjust the balance whenever events or changes in circumstances indicate
that the carrying value of the assets may not be recoverable. Our judgments
regarding the existence of impairment indicators are based on legal factors,
market conditions and operating performance of our fixed assets and acquired
businesses and products. Future events could cause us to conclude that
impairment indicators exist and the carrying values of our fixed assets,
intangible assets or goodwill are impaired. Any resulting impairment loss could
have a material adverse impact on our financial position and results of
operations. To date, such impairments have not been material.
In June 2001, the FASB finalized SFAS No. 142, "Goodwill and Other
Intangible Assets." The provisions of SFAS 142 are summarized in Note 1 to the
interim consolidated financial statements. The new criteria for recording
intangible assets separate from goodwill did not require us to reclassify any of
our intangible assets. We have only recorded goodwill related to our acquisition
of Group Lafon effective December 28, 2001; therefore, our transitional
impairment test indicated that there was no impairment of goodwill upon our
adoption of SFAS 142 effective January 1, 2002.
We evaluate the recoverability and measure the possible impairment of our
goodwill under SFAS 142. The impairment test is a two-step process that begins
with the estimation of the fair value of the reporting unit. The first step
screens for potential impairment, and the second step measures the amount of the
impairment, if any. Our estimate of fair value considers publicly available
information regarding the market capitalization of our company, as well as (i)
publicly available information regarding comparable publicly-traded companies in
the pharmaceutical industry, (ii) the financial projections and future prospects
of our business, including its growth opportunities and likely operational
improvements, and (iii) comparable sales prices, if available. As part of the
first step to assess potential impairment, we compare our estimate of fair value
for the company to the book value of our consolidated net assets. If the book
value of our consolidated net assets is greater than our estimate of fair value,
we would then proceed to the second step to measure the impairment, if any. The
second step compares the implied fair value of goodwill with its carrying value.
The implied fair value is determined by allocating the fair value of the
reporting unit to all of the assets and liabilities of that unit as if the
reporting unit had been acquired in a business combination, and
21
the fair value of the reporting unit was the purchase price paid to acquire the
reporting unit. The excess of the fair value of the reporting unit over the
amounts assigned to its assets and liabilities is the implied fair value of
goodwill. If the carrying amount of the reporting unit goodwill is greater than
its implied fair value, an impairment loss will be recognized in the amount of
the excess. We do not currently anticipate recognition of any impairment losses.
On a quarterly basis, we perform a review of our business to determine if
events or changes in circumstances have occurred which could have a material
adverse effect on the fair value of the company and its goodwill. If such events
or changes in circumstances were deemed to have occurred, we would consult with
one or more valuation specialists in estimating the impact on our estimate of
fair value. We believe the estimation methods are reasonable and reflective of
common valuation practices.
Income taxes--We have provided for income taxes related to our foreign
subsidiaries in accordance with SFAS No. 109, "Accounting for Income Taxes,"
which requires the recognition of deferred tax assets and liabilities for the
expected tax consequences of temporary differences between the tax and financial
reporting bases of assets and liabilities. We have a history of losses from our
U.S. operations, which has generated significant federal and state tax net
operating loss (NOL) carryforwards of approximately $344,139,000 and
$147,620,000, respectively, as of December 31, 2001. United States generally
accepted accounting principles require us to record a valuation allowance
against the deferred tax asset associated with this NOL carryforward if it is
more likely than not that we will not be able to utilize the NOL carryforward to
offset future taxes. Due to the size of the NOL carryforward in relation to our
history of unprofitable operations, we have provided a full valuation allowance
against this deferred tax asset.
The third quarter of 2001 was our first profitable quarter from commercial
operations since inception. Profitability in future periods could cause
management to conclude that it is more likely than not that we will realize all
or a portion of the NOL carryforward. Upon reaching such a conclusion, which is
subject to management's judgment, we would immediately record the estimated net
realizable value of the deferred tax asset at that time and would then begin to
provide for income taxes at a rate equal to our combined federal and state
effective rates. Subsequent revisions to the estimated net realizable value of
the deferred tax asset could cause our provision for income taxes to vary
significantly from period to period.
22
LIQUIDITY AND CAPITAL RESOURCES
Cash, cash equivalents and investments at June 30, 2002 were $594,700,000,
representing 42% of total assets.
Net Cash Provided by (Used for) Operating Activities
Net cash provided by operating activities was $30,276,000 for the six
months ended June 30, 2002 as compared to net cash used for operating activities
of $22,410,000 for the same period in 2001. Net income was $11,558,000 in 2002,
as compared to a loss before preferred dividends of $12,516,000 in 2001, as a
result of the increase in product sales. In addition, we recognized the
following non-cash transactions in the first half of 2002: $16,335,000 of
depreciation and amortization expense, $7,099,000 of non-cash interest expense
on our convertible subordinated notes, $2,444,000 of non-cash compensation
expense, and $3,534,000 associated with changing our inventory costing method
from FIFO to LIFO. Receivables and inventories increased in 2002 by $3,927,000
and $2,803,000, respectively, as a result of the increase in product sales.
Accrued expenses decreased in 2002 by $10,261,000 primarily due to the payment
of costs associated with the acquisition of Group Lafon.
Net Cash Used for Investing Activities
A summary of net cash used for investing activities is as follows:
Six months ended
June 30,
2002 2001
----- ----
Purchases of property and equipment ....................................... $ (6,572,000) $ (4,745,000)
Acquisition of intangible assets .......................................... (23,658,000) --
Sales and maturities (purchases) of investments, net ...................... (145,992,000) (239,239,000)
------------- -------------
Net cash used for investing activities .................................... $(176,222,000) $(243,984,000)
============== ==============
--Acquisition of intangible assets
GABITRIL product rights increased by $16,905,000 since December 31, 2001 as
a result of a $10,000,000 payment to Abbott stemming from the extension of the
composition of matter patent and additional payments for expanded rights in
Europe and other countries worldwide. Other product rights increased as a result
of payments of $6,753,000 for the acquisition of additional product rights in
Europe and other countries worldwide.
Net Cash (Used for) Provided by Financing Activities
A summary of net cash provided by (used for) financing activities is as
follows:
Six months ended
June 30,
2002 2001
---- ----
Proceeds from exercises of common stock options and warrants .............. $ 3,065,000 $ 20,115,000
Payments to acquire treasury stock ........................................ (171,000) --
Net proceeds from the issuance of long-term debt .......................... -- 385,785,000
Preferred dividends paid .................................................. -- (6,656,000)
Principal payments on and retirement of long-term debt .................... (15,354,000) (49,576,000)
------------ ------------
Net cash (used for) provided by financing activities ...................... $(12,460,000) $349,668,000
============= ============
23
--Proceeds from exercises of common stock options and warrants
During the six months ended June 30, 2002, we received proceeds of
$3,065,000 from the exercise of 161,000 common stock options compared to
proceeds of $20,115,000 from the exercise of 1,021,000 common stock options
during the same period in 2001. At June 30, 2002, options to purchase 5,651,000
shares of our common stock at various exercise prices were outstanding. The
extent and timing of future option exercises, if any, are primarily dependent
upon the market price of our common stock and general financial market
conditions, as well as the exercise prices and expiration dates of the options.
--Payments to acquire treasury stock
Under our equity compensation plans, we may grant restricted stock awards
to employees. Upon vesting, shares of Cephalon common stock are withheld from
the employee's stock award and returned to the treasury for the dollar value of
payroll taxes withheld.
--Preferred dividends paid
The dividend payments of $6,656,000 during the first half of 2001 relate to
the previously outstanding shares of convertible, exchangeable preferred stock.
These outstanding preferred shares were converted during the second and third
quarters of 2001 into an aggregate of 6,974,998 shares of our common stock.
--Principal payments on long-term debt
In January 2002, we made a payment of $6,000,000 to Abbott Laboratories due
under our licensing agreement for U.S. product rights to GABITRIL. Payments of
$5,339,000 also were made during the first half of 2002 on the notes payable,
bank debt and other lines of credit of Group Lafon. In addition, for all periods
presented, principal payments on long-term debt include payments on mortgage and
building improvements loans and payments on capital lease obligations.
Commitments and Contingencies
--Legal Proceedings
In February 2001, a complaint was filed in Utah state court by Zars, Inc.
and one of its research scientists, against us and our subsidiary Anesta Corp.
The plaintiffs are seeking a declaratory judgment to establish their right to
develop transdermal or other products containing fentanyl and other
pharmaceutically active agents under a royalty and release agreement between
Zars and Anesta. The complaint also asks for unspecified damages for breach of
contract, interference with economic relations, defamation and slander. We
believe that we have valid defenses to all claims raised in this action. In any
event, we do not believe any judgment against us on any settlement of this claim
will have a material adverse effect on our financial condition or results of
operations.
We are a party to certain other litigation in the ordinary course of our
business, including matters alleging employment discrimination, product
liability and breach of commercial contract. However, we are vigorously
defending ourselves in all of the actions against us and do not believe these
matters, even if adversely adjudicated or settled, would have a material adverse
effect on our financial condition or results of operations.
--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 developed MYOTROPHIN on behalf of CCP under a
research and development agreement. Under this agreement, CCP granted an
exclusive license to manufacture and market MYOTROPHIN for human therapeutic use
within the United States, Canada and Europe, and we agreed to make royalty
payments equal to a percentage of product sales and a milestone payment of
approximately $16,000,000 upon regulatory approval. We have a contractual
option, but not an obligation, to purchase all of the limited partnership
interests of CCP, which is exercisable upon the occurrence of certain events
24
following the first commercial sale of MYOTROPHIN. If, and only if, we decide to
exercise this purchase option, we would make an advance payment of approximately
$40,275,000 in cash or, at our election, approximately $42,369,000 in shares of
common stock or a combination thereof. If we discontinue development of
MYOTROPHIN, or if we do not exercise this 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.
Outlook
Cash, cash equivalents and investments at June 30, 2002 were $594,700,000.
Prior to 2001, we historically have had negative cash flows from operations and
have used the proceeds of public and private placements of our equity and debt
securities to fund operations. We currently believe that projected increases in
sales of our three U.S. marketed products, PROVIGIL, ACTIQ and GABITRIL, in
combination with other revenues, will allow us to achieve continued
profitability and positive cash flows from operations in 2002. At this time,
however, we cannot accurately predict the effect of certain developments on
future product sales such as the degree of market acceptance of our products,
competition, the effectiveness of our sales and marketing efforts and the
outcome of our research to demonstrate the utility of our products in
indications beyond those already included in the FDA approved labels. Other
revenues include receipts from 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 to periodic review by the
parties involved.
We expect to continue to incur significant expenditures associated with
manufacturing, selling and marketing our products and conducting additional
clinical studies to explore the utility of these products in treating disorders
beyond those currently approved in their respective labels. We also expect to
continue to incur significant expenditures to fund research and development
activities, including clinical trials, for our other product candidates. We may
seek sources of funding for a portion of these programs through collaborative
arrangements with third parties. However, we intend to retain a portion of the
commercial rights to these programs and, as a result, 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.
We may have significant fluctuations in quarterly results based primarily
on the level and timing of:
. product sales and cost of product 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 disruptions.
In December 2001, we acquired Group Lafon, which gave us worldwide control
of the intellectual property, marketing, and manufacturing rights related to
modafinil, the active drug substance in PROVIGIL. PROVIGIL accounted for
approximately 45% of our total product sales for the six months ended June 30,
2002. By consolidating our financial results with those of Group Lafon, we have
reduced significantly our cost of product sales for PROVIGIL by eliminating the
effect of preexisting contractual arrangements between us and Group Lafon.
In the second quarter of 2001, we completed a private placement of
$400,000,000 of 5.25% convertible subordinated notes due May 2006. In December
2001, we completed a private placement of $600,000,000 of 2.50% convertible
subordinated notes due December 2006. In March 2002, we completed a private
placement of $55,000,000
25
of 3.875% convertible notes due March 2007 to acquire all of the joint venture
interests of an unaffiliated third party investor. The 5.25% notes, 2.50% notes
and 3.875% notes are convertible at the option of the holders into our common
stock at per share conversion prices of $74.00, $81.00 and $70.36, respectively.
On various dates during the fourth quarter of 2001, certain holders of our
5.25% convertible notes approached us, and we agreed, to exchange $217,000,000
of the outstanding 5.25% convertible notes due May 2006 into 3,691,705 shares of
our common stock. The exchange transactions were completed using common stock
prices that equalized the fair value of the debt instrument with the fair value
of our common stock on the dates of the transactions. Since the notes were then
trading at a premium, the notes were exchanged at equivalent common stock prices
that were less than the original conversion price of $74.00 per share. As a
result, we recognized non-cash debt exchange expense totaling $52,444,000 in the
fourth quarter of 2001 based on the reduction of the original conversion price
in accordance with SFAS No. 84, "Induced Conversion of Convertible Debt." We
agreed to these exchanges to improve our debt to equity ratio.
There are currently $838,000,000 of convertible notes outstanding. The
annual interest payment on the outstanding balance of convertible notes is
$26,739,000 payable semiannually.
Based on our current level of operations and projected sales of our
products combined with other revenues and interest income, we believe that we
will be able to service our existing debt and meet our capital expenditure and
working capital requirements for the next several years. However, we cannot be
sure that our anticipated revenue growth will be realized or that we will
continue to generate positive cash flow from operations. We may need to obtain
additional funding for our operational needs, or for future significant
strategic transactions, and we cannot be certain that funding will be available
on terms acceptable to us, or at all.
26
CERTAIN RISKS RELATED TO OUR BUSINESS
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 below 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 to update publicly any
forward-looking statements, except as required by law. This discussion is
permitted by the Private Securities Litigation Reform Act of 1995.
A significant portion of our revenues is derived from U.S. sales of our three
largest products and our future success will depend on the continued acceptance
and growth of these products.
For the six months ended June 30, 2002, approximately 69% of our total
revenues were derived from U.S. sales of PROVIGIL, GABITRIL and ACTIQ. We cannot
be certain that these products will continue to be accepted in their markets.
Specifically, the following factors, among others, could affect the level of
market acceptance of PROVIGIL, GABITRIL and ACTIQ, including:
. the perception of the healthcare community of their safety and
efficacy, both in an absolute sense and relative to that of
competing products;
. the effectiveness of our sales and marketing efforts; o
unfavorable publicity regarding these products or similar
products;
. product price relative to other competing drugs or treatments;
. changes in government and other third-party payor reimbursement
policies and practices; and
. regulatory developments affecting the manufacture, marketing or
use of these products.
Any material adverse developments with respect to the sale or use of
PROVIGIL, GABITRIL or ACTIQ could significantly reduce our product revenues and
have a material adverse effect on our ability to generate net income and
positive net cash flow from operations.
We may be unsuccessful in our efforts to expand the number and scope of
authorized uses of PROVIGIL or GABITRIL, which would hamper sales growth and
make it more difficult to sustain profitability.
The market for the approved indications of two of our three largest
products is relatively small. We believe that a portion of our product sales is
derived from the use of these products outside of their labeled indications. To
a large degree, our future success depends on the expansion of the approved
indications for PROVIGIL and GABITRIL and physicians prescribing our products
outside of the approved indications. Under current FDA and European medical
authority regulations, we are restricted from promoting the use of these
products outside their labeled use. Any label expansion requires regulatory
approval.
We have initiated clinical studies to examine whether or not PROVIGIL and
GABITRIL are effective and safe when used to treat disorders outside their
currently approved uses. Although some study data has been positive, additional
studies in these disorders will be necessary before we can apply to regulatory
authorities to expand the authorized uses of these products. We do not know
whether these studies will demonstrate safety and efficacy, or if they do,
whether we will succeed in receiving regulatory approval to market PROVIGIL and
GABITRIL 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 these products by patients, this could
undermine physician and patient comfort with the products, limit their
commercial success, and diminish their acceptance. Even if the
27
results of these studies are positive, the impact on sales of PROVIGIL and
GABITRIL may be minimal unless we are able to obtain FDA and foreign medical
authority approval to expand the authorized use of these products. FDA
regulations limit our ability to communicate the results of additional clinical
studies to patients and physicians without first obtaining approval for any
expanded uses.
We may not be able to maintain adequate protection for our intellectual
property or market exclusivity for certain of our products and therefore
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
limit our commercial success.
We place considerable importance on obtaining patent protection for new
technologies, products and processes. To that end, we file applications for
patents covering the composition of matter or uses of our drug candidates or our
proprietary processes. The patent positions of pharmaceutical and biotechnology
companies can be highly uncertain and involve complex legal, scientific and
factual questions. To date, there has emerged no consistent policy regarding
breadth of claims in such companies' patents. Accordingly, the patents and
patent applications relating to our products, product candidates and
technologies may be challenged, invalidated or circumvented by third parties and
might not protect us against competitors with similar products or technology.
Patent disputes are frequent and can preclude commercialization of products. If
we ultimately lose any disputes, we could be subject to competition or
significant liabilities, we could be required to enter into third party licenses
or we could be required to cease using the technology or product in dispute. In
addition, even if such licenses are available, the terms of the license
requested by the third party could be unacceptable to us.
The U.S. composition of matter patent for modafinil expired in 2001. We own
U.S. and foreign patent rights that expire between 2014 and 2015 covering
formulations and uses of modafinil having certain particle sizes. Ultimately,
these particle-sized patents might be found invalid if challenged by a third
party or a potential competitor could develop a competing product or product
formulation that avoids infringement of these patents. If a competitor developed
a competing product that avoided infringement, our revenues from our
modafinil-based products could be significantly and negatively impacted.
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, these parties could fail to honor such agreements or
we could be unable to effectively protect our rights to our unpatented trade
secrets and know-how. Moreover, others could 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.
As our products are used commercially, unintended side effects, adverse
reactions or incidents of misuse may occur that could result in additional
regulatory controls and reduced sales of our products.
Prior to 1999, the use of our products had been limited principally to
clinical trial patients under controlled conditions and under the care of expert
physicians. The widespread commercial use of our products could produce
undesirable or unintended side effects that have not been evident in our
clinical trials or the relatively limited commercial use to date. In addition,
in patients who take multiple medications, drug interactions could occur that
can be difficult to predict. Additionally, incidents of product misuse may
occur. These events, among others, could result in additional regulatory
controls that could limit the circumstances under which the product is
prescribed or even lead to the withdrawal of the product from the market. More
specifically, ACTIQ has been approved under regulations concerning drugs with
certain safety profiles, under which the FDA has established special
restrictions to ensure safe use. Any violation of these special restrictions
could lead to the imposition of further restrictions or withdrawal of the
product from the market.
28
We may incur additional losses.
The quarter ended September 30, 2001 was our first profitable quarter from
commercial operations since inception and at June 30, 2002 our accumulated
deficit was $565,133,000. Our historical losses resulted principally from costs
incurred in research and development, including clinical trials, and from
selling, general and administrative costs associated with our operations. For us
to sustain profitability from commercial operations, we must continue to achieve
product and other revenues at or above their current levels. Moreover, our
future growth depends, in part, on our ability to obtain regulatory approvals
for future products or for the expansion of the approved indications for our
existing products, and our ability to successfully develop, commercialize,
manufacture and market any other product candidates.
Manufacturing, supply and distribution problems may create supply disruptions
that could result in a reduction of product sales revenue, and damage commercial
prospects for our products.
At our two manufacturing facilities in France, we produce the active drug
substance modafinil and certain other commercial products. At our U.S. facility
in Salt Lake City, Utah, we manufacture ACTIQ for international markets. For the
remainder of our products, we rely on third parties for product manufacturing.
In all cases, we must comply with all applicable regulatory requirements of the
FDA and foreign authorities, including cGMP regulations. In addition, we must
comply with all applicable regulatory requirements of the Drug Enforcement
Administration, and analogous foreign authorities for certain products. The
facilities used by us and third parties to manufacture, store and distribute our
products are subject to inspection by regulatory authorities at any time to
determine compliance with regulations. These regulations are complex, and any
failure to comply with them could lead to remedial action, civil and criminal
penalties and delays in production or distribution of material.
We depend upon sole suppliers for active drug substances contained in our
products, including our own French plant that manufactures modafinil, and Abbott
Laboratories to manufacture finished commercial supplies of ACTIQ and GABITRIL
for the U.S. market. We have two qualified manufacturers, Watson Pharmaceuticals
(formerly Circa Pharmaceuticals, Inc.), Copiague, New York and DSM
Pharmaceuticals (formerly Catalytica Pharmaceuticals, Inc.), Greenville, North
Carolina, for finished commercial supplies of PROVIGIL. The process of changing
or adding a manufacturer or changing a formulation requires prior FDA and/or
European medical authority approval and is very time-consuming. If we are unable
to manage this process effectively, 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 our products. We
maintain inventories of active drug substances and finished products to protect
against supply disruptions. Nevertheless, any disruption in these activities
could impede our ability to sell our products and could reduce sales revenue. We
also rely on third parties to distribute our products, perform customer service
activities and accept and process product returns.
Our activities and products are subject to significant government regulations
and approvals, which are often costly and could result in adverse consequences
to our business if we fail to comply.
We currently have a number of products that have been approved for sale in
the United States, foreign countries or both. All of our approved products are
subject to extensive continuing regulations relating to, among other things,
testing, manufacturing, quality control, labeling, and promotion. The failure to
comply with any rules and regulations of the FDA or any foreign medical
authority, or the post-approval discovery of previously unknown problems
relating to our products could result in, among others:
. fines, recalls, or seizures of products;
. total or partial suspension of product sales;
. non-approval of product license applications;
. restrictions on our ability to enter into strategic
relationships; and
. criminal prosecution.
It is both costly and time-consuming for us to comply with these
regulations. Additionally, incidents of adverse drug reactions, unintended side
effects or misuse relating to our products could result in additional regulatory
controls or restrictions, or even lead to withdrawal of the product from the
market.
29
With respect to our product candidates and for new therapeutic indications
for our existing products, we conduct research, preclinical testing and clinical
trials. We cannot market these product candidates or these new indications in
the United States or other countries without receiving approval from the FDA or
the appropriate foreign medical authority. The approval process is highly
uncertain and requires substantial time, effort and financial resources.
Ultimately, we may never obtain approval in a timely manner, or at all. Without
these required approvals, our ability to substantially grow revenues in the
future could be adversely affected.
In addition, because PROVIGIL and ACTIQ contain active ingredients that are
controlled substances, we are subject to regulation by the DEA and analogous
foreign organizations relating to the manufacture, shipment, sale and use of the
applicable products. These regulations also are imposed on prescribing
physicians and other third parties, making the use of such products relatively
complicated and expensive. With the increased concern for safety by the FDA and
the DEA with respect to products containing controlled substances, it is
possible that these regulatory agencies could impose additional restrictions on
marketing or even withdrawal of regulatory approval for such products. In
addition, adverse publicity may bring about rejection of the product by the
medical community. If the DEA, FDA or a foreign medical authority withdrew the
approval of, or placed additional significant restrictions on the marketing of
any of our products, our product sales and ability to promote our products could
be substantially affected.
The failure to successfully operate Group Lafon could negatively impact our
results of operations.
The operation of Group Lafon following our December 2001 acquisition
involves a number of risks and presents financial, managerial and operational
challenges, including:
. diversion of management attention from our existing business and
operations;
. difficulty with integration of personnel, and financial and other
systems; and
. increased foreign operations that may be difficult to manage,
especially since we have limited experience operating in France.
In light of these challenges, we may not be able to successfully manage the
operations and personnel of Group Lafon. Customer dissatisfaction or
manufacturing, supply or distribution problems associated with Group Lafon's
products could cause our pharmaceutical business in France to underperform
relative to our expectations, which could have a material adverse effect on our
business. We also could experience financial or other setbacks if Group Lafon's
businesses have problems or liabilities of which we were not aware or are
substantially greater than we anticipated based on our evaluation of the
business prior to the acquisition.
We may not achieve the expected cost savings and other benefits of the Group
Lafon acquisition.
In acquiring Group Lafon, we secured worldwide rights related to modafinil,
the active drug substance in PROVIGIL. PROVIGIL accounted for approximately 45%
of our total product sales for the six months ended June 30, 2002. By
consolidating our financial results with those of Group Lafon, we expect to
reduce our cost of product sales related to PROVIGIL. During the first half of
2002, we experienced a significant reduction in the cost of product sales
related to PROVIGIL. While the bulk of these cost savings result from
eliminating the effect of manufacturing profit and royalties paid by us and
Group Lafon, in the future there could be unanticipated costs associated with
our operation and management of the Group Lafon business that could limit or
eliminate these cost savings or other anticipated benefits of the Group Lafon
acquisition. As a result, the future cost savings realized, if any, and other
anticipated benefits could differ from, or their impact could be delayed
compared to, our expectations as described herein.
30
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 our products.
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 proposals to implement similar government controls. The
commercial success of our products 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 and government payors increasingly
challenge the prices charged for products and limit reimbursement levels offered
to consumers for such products. Third party and government payors could focus
their cost control efforts on our products, especially with respect to prices of
and reimbursement levels for products prescribed outside their labeled
indications. In these cases, these efforts could negatively impact sales of and
profits on our products.
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.
The conditions that our products treat, 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. With respect to PROVIGIL, there are several other
products used for the treatment of narcolepsy in the United States, which are
marketed under a number of brand names, including RITALIN(R) by Novartis,
CONCERTA(R) tablets by Alza and METHYLIN(R) by Mallinckrodt, and in our other
licensed territories, all of which have been available for a number of years and
many of which are available in inexpensive generic forms. With respect to ACTIQ,
we face competition from inexpensive oral opioid tablets and more expensive but
quick-acting invasive (intravenous, intramuscular and subcutaneous) opioid
delivery systems. Other technologies for rapidly delivering opioids to treat
breakthrough pain are being developed, at least one of which is in clinical
trials. With respect to GABITRIL, there are several products, including
NEURONTIN(R) (gabapentin) by Pfizer, used as adjunctive therapy for the partial
seizure market. Some are well-established therapies that have been on the market
for several years while others have recently entered the partial seizure
marketplace. In addition, several treatments for partial seizures are available
in inexpensive generic forms. Thus, we need to demonstrate to physicians,
patients and third party payors that the cost of our products is reasonable and
appropriate in the light of their safety and efficacy, the price of competing
products and the related health care benefits to the patient.
In addition, many of our competitors have substantially greater capital
resources, research and development staffs and facilities than we have, 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, including advances in current treatment methods,
could potentially affect sales of our products negatively or make them obsolete.
In addition, we may be at a competitive marketing disadvantage against companies
that have broader product lines and whose sales personnel are able to offer more
complementary products than we can. Any failure to maintain our competitive
position could adversely affect our business and 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 whether or not the drugs
are actually at fault for causing an injury. Furthermore, our products may
cause, or may appear to have caused, serious adverse side effects (including
death) 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 our products are used more widely and in patients with varying medical
conditions, the likelihood of an adverse drug reaction, unintended side effect
or incidence of misuse may increase. Product liability claims can be expensive
to
31
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 or purchasing sufficient insurance could
be expensive. 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.
The results and timing of our research and development activities, including
future clinical trials are difficult to predict, subject to future setbacks and,
ultimately, may not result in any additional pharmaceutical products, which may
adversely affect our business.
In order to remain competitive, we are focused on the search for new
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 the majority
of compounds discovered do not enter clinical studies and the majority of
therapeutic candidates fail to show the human safety and efficacy necessary for
regulatory approval and successful commercialization.
Preclinical testing and clinical trials must demonstrate 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, including the rate of enrollment of patients. Neither we nor
our collaborators can control the rate at which patients present themselves for
enrollment, and the rate of patient enrollment may not be consistent with our
expectations or sufficient to enable clinical trials of our product candidates
to be completed in a timely manner or at all. In addition, we may not be
permitted by regulatory authorities to undertake additional clinical trials for
any of our product candidates. Even if such trials are conducted, our product
candidates may not prove to be safe and efficacious or receive regulatory
approvals. Any significant delays in, or termination of, clinical trials of our
product candidates could impact our ability to substantially increase our
product sales in the future.
Our research and development and marketing efforts are often dependent on
corporate collaborators and other third parties who may not devote sufficient
time, resources and attention to our programs, and which may limit our efforts
to successfully develop and market potential products.
Because we have limited resources, we have entered into a number of
collaboration agreements with other pharmaceutical companies including Lundbeck
and Sanofi-Synthelabo related to our research efforts in Parkinson's and
Alzheimer's disease, and solid tumors, respectively. In some cases, our
collaboration agreements call for our partners 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/or
. marketing and selling of any approved product.
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,
our program may not move forward as effectively, or 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
32
collaborators and other third parties for the production of compounds and the
manufacture and supply of pharmaceutical products. Additionally, we may find it
necessary from time to time to seek new or additional partners to assist us in
commercializing our products, though we might not be successful in establishing
any such new or additional relationships.
Our product sales and related financial results will fluctuate and these
fluctuations may cause our stock price to fall, especially if they are not
anticipated by investors.
A number of analysts and investors who follow our stock have developed
models to attempt to forecast future product sales and have established earnings
expectations based upon those models. These models, in turn, are based in part
on estimates of projected revenue and earnings that we disclose publicly.
Forecasting revenue growth is difficult, especially when there is little
commercial history and when the level of market acceptance of our products is
uncertain or, in the case of Group Lafon, when we have just recently acquired a
portfolio of products. 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 also may adversely affect our stock
price. There are a number of other factors that could cause our financial
results to fluctuate unexpectedly, including:
. the cost of product 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 disruptions.
The price of our common stock has been and may continue to be highly volatile.
The market price of our common stock is highly volatile, and we expect it
to continue to be volatile for the foreseeable future. For example, from January
1, 2001 through August 9, 2002, our common stock traded at a high price of
$78.88 and a low price of $35.82. Negative announcements, including, among
others:
. adverse regulatory decisions;
. disappointing clinical trial results;
. 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 economic conditions, our
competitors, changes in government regulations impacting the biotechnology or
pharmaceutical industries or the movement of capital into or out of our
industry, also are likely to affect the price of our common stock.
A portion of our product sales and certain balance sheet items are subject to
exchange rate fluctuations in the normal course of business that could adversely
affect our reported results of operations.
Historically, a portion of our product sales has been earned in currencies
other than the U.S. dollar. As a result of our acquisition of Group Lafon, the
portion of our product sales denominated in the euro and other local currencies
has and may continue to increase. For the sixth months ended June 30, 2002,
approximately 24% of our product sales were denominated in currencies other than
the U.S. dollar. We translate revenue earned from product sales into U.S.
dollars at the average exchange rate applicable during the relevant period. A
strengthening of the dollar could, therefore, reduce our earnings. Consequently,
fluctuations in the rate of exchange between the U.S. dollar and the euro and
other local currencies may affect period-to-period comparisons of our operating
results. In addition, we may face exposure to the extent that exchange rate
fluctuations affect the repayment of certain intercompany indebtedness. Finally,
the balance sheet of our foreign operations will be translated into U.S. dollars
at the period-end exchange rate. This latter exposure will result in changes to
the translated value of assets and liabilities, with the impact of the
translation included as a component of stockholders' equity.
33
We are involved in or may become involved in the future in legal proceedings
that, if adversely adjudicated or settled, could materially impact our financial
condition.
As a biopharmaceutical company, we are or may become a party to litigation
in the ordinary course of our business, including matters alleging employment
discrimination, product liability, patent infringement, or breach of commercial
contract, among others. In general, litigation claims can be expensive and time
consuming to defend and could result in settlements or damages that could
significantly impact results of operations and financial condition. We currently
are vigorously defending ourselves against certain litigation matters. However,
even if these existing lawsuits were adversely adjudicated or settled, we do not
believe there would be a material impact on our results of operations or our
financial condition.
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. Although we do not believe the loss of one individual would materially
harm our business, our research and development programs and our business might
be harmed by the loss of the services of multiple 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. While we have employment agreements with our key executives, we do
not ordinarily enter into employment agreements with our other key scientific,
technical and managerial employees. We do not maintain "key man" life insurance
on any of our employees.
Our prior use of Arthur Andersen LLP as our independent public accountant could
impact our ability to access the capital markets.
Our consolidated financial statements as of and for each of the three years
in the period ended December 31, 2001 were audited by Arthur Andersen LLP. On
March 14, 2002, Andersen was indicted on federal obstruction of justice charges
arising from the government's investigation of Enron Corporation. Following this
event, our Audit Committee directed management to consider the need to appoint
new independent public accountants. On June 4, 2002, at the direction of the
Board of Directors, acting upon the recommendation of the Audit Committee, we
dismissed Andersen and appointed PricewaterhouseCoopers LLP as our new
independent public accountants for fiscal year 2002. On June 15, 2002, a jury
found Andersen guilty on the government's charges.
SEC rules require us to present our audited financial statements in various
SEC filings, along with Andersen's consent to our inclusion of its audit report
in those filings. However, Andersen is unable to provide a consent to us for
inclusion in our future SEC filings relating to its report on our consolidated
financial statements as of and for each of the three years in the period ended
December 31, 2001. Additionally, Andersen is unable to provide us with assurance
services, such as advice customarily given to underwriters of our securities
offerings and other similar market participants. The SEC recently has provided
regulatory relief designed to allow companies that file reports with the SEC to
dispense with the requirement to file a consent of Andersen in certain
circumstances. Notwithstanding this relief, the inability of Andersen to provide
its consent or to provide assurance services to us in the future could
negatively affect our ability to, among other things, access the public capital
markets. Any delay or inability to access the public markets as a result of this
situation could have a material adverse impact on our business. Also, an
investor's ability to seek potential recoveries from Andersen related to any
claims that an investor may assert as a result of the audit performed by
Andersen may be limited significantly both as a result of an absence of a
consent and the diminished amount of assets of Andersen that are or may in the
future be available to satisfy claims.
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 and 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
34
these materials and wastes, and we may be required to incur significant costs to
comply with both existing and future environmental laws and regulations.
While we believe that our safety procedures for handling and disposing of
these materials comply with foreign, federal, state and local laws and
regulations, we cannot completely eliminate the risk of accidental injury or
contamination from these materials. In the event of an accident, we could be
held liable for any resulting damages, which could include fines and remedial
costs. These damages could require payment by us of significant amounts over a
number of years, which would be reflected in our results of operations and
financial condition.
Anti-takeover provisions may delay or prevent changes in control of our
management or 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 General 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 certain 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.
We may be unable to service or repay our substantial indebtedness or other
contingencies.
As of June 30, 2002, we had significant levels of indebtedness that, among
other things, could make it difficult for us to make payments on our
indebtedness or obtain financing in the future, limit our future flexibility and
make us more vulnerable in the event of a downturn in our business. Unless we
are able to generate sufficient cash flow from operations to service our
indebtedness, we will be required to raise additional funds. Because the
financing markets may be unwilling to provide funding to us or may only be
willing to provide funding on terms that we would consider unacceptable, we may
not have cash available or be able to obtain funding to permit us to meet our
debt service obligations.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK
There have been no material changes in quantitative and qualitative market
risk from the disclosure included in the Annual Report on Form 10-K for the
fiscal year ended December 31, 2001.
35
PART II - OTHER INFORMATION
Item 1. Legal Proceedings
The information set forth in Footnote 8 to the Notes to
Consolidated Financial Statements included herein is hereby
incorporated by reference.
Item 2. Changes in Securities and Use of Proceeds
On March 29, 2002, we issued and sold in a private placement
$55,000,000 aggregate principal amount of 3.875% Convertible
Notes due March 29, 2007. The notes were issued and sold to the
purchaser in a transaction exempt from registration requirements
of the Securities Act of 1933, as amended, because the offer and
sale of the notes did not involve a public offering.
We are obligated to pay interest on the notes at a rate of
3.875% per year on each of April 15 and October 15, beginning
October 15, 2002. The notes also are convertible into our common
stock, at the option of the holders, at a price of $70.36 per
share, subject to adjustment upon certain events.
The holders of the notes may elect to require us to redeem
the notes on March 28, 2005 at a redemption price equal to 100%
of the principal amount of notes submitted for redemption, plus
accrued and unpaid interest. In certain other circumstances, at
the option of the holders, we may be required to repurchase the
notes at 100% of the principal amount of the notes submitted for
repurchase, plus accrued and unpaid interest.
In connection with our offer and sale of the notes, we filed
a registration statement on Form S-3 on May 28, 2002 to register
the resale of the shares of common stock issuable upon conversion
of the notes that was declared effective by the Securities and
Exchange Commission on July 3, 2002.
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 West Chester, Pennsylvania on
May 15, 2002:
I. On the election of the following persons as directors:
Number of Votes
---------------------------------
FOR WITHHELD
Dr. Frank Baldino, Jr. 45,549,346 219,852
William P. Egan 45,519,813 249,385
Dr. Robert J. Feeney 45,517,817 251,381
Martyn D. Greenacre 45,456,883 312,315
Dr. Charles A. Sanders 45,518,684 250,514
Dr. Horst Witzel 45,543,895 225,303
II. To approve the amendment to the Company's Certificate of
Incorporation increasing the number of shares of the
Company's common stock authorized for issuance:
NUMBER OF VOTES
---------------------------------------------
FOR AGAINST ABSTAIN
42,663,994 2,977,460 127,744
36
III. To approve an increase in the number of shares of common stock
authorized for issuance under the Company's 1995 Equity
Compensation Plan and the amendment and restatement of the 1995
Plan:
NUMBER OF VOTES
------------------------------------------------
FOR AGAINST ABSTAIN
--- ------- -------
44,086,323 1,627,250 55,625
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits:
Exhibit
No. Description
--- -----------
3.1 Certificate of Amendment to the Restated Certificate of
Incorporation as filed with the Secretary of State of
the State of Delaware on May 16, 2002
3.2 Amended and Restated Bylaws of Cephalon, Inc. (as
restated July 25, 2002)
10.1+ Executive Severance Agreement between Cephalon, Inc.
and Frank Baldino, Jr.
10.2+ Form of Executive Severance Agreement between certain
Cephalon executive officers and Cephalon, Inc.
99.1 Certification Pursuant to 18 U.S.C. Section 1350, as
Adopted Pursuant to Section 906 of the Sarbanes-Oxley
Act of 2002
99.2 Certification Pursuant to 18 U.S.C. Section 1350, as
Adopted Pursuant to Section 906 of the Sarbanes-Oxley
Act of 2002
---------------------------------------------------------------
+ Compensation plans and arrangements for executives and others
(b) Reports on Form 8-K:
During the second quarter of 2002, the Registrant filed the
following Current Reports on Form 8-K:
(i) On April 16, 2002, Cephalon, Inc. filed an amended Current
Report on Form 8-K/A to include the consolidated financial
statements of Group Lafon.
(ii) On May 30, 2002, Cephalon, Inc. filed a Form 8-K that
included the Press Release dated May 29, 2002 publicly announcing
the appointment of Dr. Gail Wilensky to the Board of Directors of
the Company.
(iii) On June 6, 2002, Cephalon, Inc. filed a Form 8-K announcing
the dismissal of Arthur Andersen LLP as the Company's independent
public accountant for the fiscal year 2002, and the appointment
of PricewaterhouseCoopers LLP.
37
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 13, 2002 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)
38