SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
[X] Quarterly Report Pursuant to Section 13 or 15(d)
of the Securities Exchange Act of 1934
For the Quarterly Period Ended March 31, 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 (I.R.S. Employer Identification
Incorporation 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 May 10, 2002
- ---------------------------------- ------------------------------
Common Stock, par value $.01 55,073,424 Shares
This Report Includes a Total of 31 Pages
CEPHALON, INC. AND SUBSIDIARIES
-------------------------------
INDEX
-----
Page No.
--------
PART I - FINANCIAL INFORMATION
Item 1. Consolidated Financial Statements (Unaudited)
Consolidated Balance Sheets - 3
March 31, 2002 and December 31, 2001
Consolidated Statements of Operations - 4
Three months ended March 31, 2002 and 2001
Consolidated Statements of Stockholders' Equity - 5
March 31, 2002 and December 31, 2001
Consolidated Statements of Cash Flows - 6
Three months ended March 31, 2002 and 2001
Notes to Consolidated Financial Statements 7
Item 2. Management's Discussion and Analysis of 13
Financial Condition and Results of Operations
Item 3. Quantitative and Qualitative Disclosure about Market Risk 29
PART II - OTHER INFORMATION
Item 1. Legal Proceedings 30
Item 2. Changes in Securities and Use of Proceeds 30
Item 6. Exhibits and Reports on Form 8-K 30
SIGNATURES 31
2
CEPHALON, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(Unaudited)
March 31, December 31,
2002 2001
-------------------- ----------------------
ASSETS
------
CURRENT ASSETS:
Cash and cash equivalents $456,023,000 $548,727,000
Investments 138,028,000 55,157,000
Receivables, net 78,333,000 75,192,000
Inventory 44,765,000 47,513,000
Other current assets 9,253,000 7,872,000
-------------------- ----------------------
Total current assets 726,402,000 734,461,000
PROPERTY AND EQUIPMENT, net 66,561,000 64,706,000
GOODWILL 244,357,000 248,911,000
INTANGIBLE ASSETS, net 297,471,000 298,269,000
DEBT ISSUANCE COSTS 25,550,000 26,720,000
OTHER ASSETS 10,211,000 16,020,000
-------------------- ----------------------
$1,370,552,000 $1,389,087,000
==================== ======================
LIABILITIES AND STOCKHOLDERS' EQUITY
------------------------------------
CURRENT LIABILITIES:
Current portion of long-term debt $21,359,000 $32,200,000
Accounts payable 15,523,000 24,536,000
Accrued expenses 45,342,000 49,370,000
Current portion of deferred revenues 624,000 824,000
-------------------- ----------------------
Total current liabilities 82,848,000 106,930,000
LONG-TERM DEBT 872,112,000 866,589,000
DEFERRED REVENUES 6,238,000 6,042,000
OTHER LIABILITIES 10,832,000 10,795,000
-------------------- ----------------------
Total liabilities 972,030,000 990,356,000
-------------------- ----------------------
COMMITMENTS AND CONTINGENCIES (Note 5)
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, 100,000,000 shares authorized,
55,038,014 and 54,909,533 shares issued,
and 54,813,081 and 54,685,792 shares outstanding 550,000 549,000
Additional paid-in capital 985,624,000 982,123,000
Treasury stock, 224,933 and 223,741 shares outstanding, at cost (9,603,000) (9,523,000)
Accumulated deficit (579,562,000) (576,691,000)
Accumulated other comprehensive income 1,513,000 2,273,000
-------------------- ----------------------
Total stockholders' equity 398,522,000 398,731,000
-------------------- ----------------------
$1,370,552,000 $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
March 31,
----------------------------------
2002 2001
--------------- ---------------
REVENUES:
Product sales $ 95,803,000 $ 40,822,000
Other revenues 15,698,000 6,250,000
--------------- ---------------
111,501,000 47,072,000
--------------- ---------------
COSTS AND EXPENSES:
Cost of product sales 13,845,000 8,298,000
Research and development 29,823,000 19,611,000
Selling, general and administrative 40,284,000 24,365,000
Depreciation and amortization 8,293,000 3,489,000
--------------- ---------------
92,245,000 55,763,000
--------------- ---------------
INCOME (LOSS) FROM OPERATIONS 19,256,000 (8,691,000)
OTHER INCOME AND EXPENSE
Interest income 2,870,000 1,507,000
Interest expense (11,498,000) (1,320,000)
Other expense (838,000) (1,038,000)
--------------- ---------------
(9,466,000) (851,000)
--------------- ---------------
INCOME (LOSS) BEFORE INCOME TAXES 9,790,000 (9,542,000)
INCOME TAXES (1,985,000) --
--------------- ---------------
INCOME (LOSS) BEFORE DIVIDENDS ON PREFERRED STOCK,
EXTRAORDINARY CHARGE AND CUMULATIVE
EFFECT OF CHANGING INVENTORY COSTING METHOD 7,805,000 (9,542,000)
DIVIDENDS ON CONVERTIBLE EXCHANGEABLE
PREFERRED STOCK -- (2,266,000)
--------------- ---------------
INCOME (LOSS) BEFORE EXTRAORDINARY CHARGE AND
CUMULATIVE EFFECT OF CHANGING INVENTORY
COSTING METHOD 7,805,000 (11,808,000)
EXTRAORDINARY CHARGE ON EARLY
EXTINGUISHMENT OF DEBT (7,142,000) --
CUMULATIVE EFFECT OF CHANGING INVENTORY
COSTING METHOD FROM FIFO TO LIFO
(3,534,000) --
--------------- ---------------
LOSS APPLICABLE TO COMMON SHARES $(2,871,000) $(11,808,000)
=============== ===============
BASIC AND DILUTED LOSS PER COMMON SHARE:
Income (loss) per common share before extraordinary charge and
cumulative effect of changing inventory costing method $0.14 $(0.28)
Extraordinary charge on early extinguishment of debt (0.13) --
Cumulative effect of changing inventory costing method (0.06) --
--------------- ---------------
$(0.05) $(0.28)
=============== ===============
WEIGHTED AVERAGE NUMBER
OF COMMON SHARES OUTSTANDING 54,963,000 42,732,000
=============== ===============
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 Common
Loss Total Deficit Income Stock
--------------- ------------------------------ ----------------- -------------
BALANCE, JANUARY 1, 2001 $165,193,000 $(515,543,000) $1,401,000 $425,000
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 -- -- -- 70,000
Issuance of common stock upon conversion of
convertible notes 262,590,000 -- -- 37,000
Stock options exercised 25,542,000 -- -- 13,000
Stock purchase warrants exercised 2,679,000 -- -- 2,000
Restricted stock award plan 5,349,000 -- -- 2,000
Employee benefit plan 1,283,000 -- --
Dividends declared on convertible preferred stock (5,664,000) -- -- --
Treasury stock acquired (3,629,000) -- --
------------- -------------- ------------- ------------
BALANCE, DECEMBER 31, 2001 398,731,000 (576,691,000) 2,273,000 549,000
Loss $(2,871,000) (2,871,000) (2,871,000) -- --
---------------
Foreign currency translation loss (263,000)
Unrealized investment losses (497,000)
---------------
Other comprehensive income (760,000) (760,000) -- (760,000) --
---------------
Comprehensive loss $(3,631,000)
===============
Stock options exercised 2,057,000 -- -- 1,000
Restricted stock award plan 610,000 -- --
--
Employee benefit plan 795,000 -- --
--
Treasury stock acquired (40,000) -- -- --
------------- -------------- ------------ ------------
BALANCE, MARCH 31, 2002 $398,522,000 $(579,562,000) $1,513,000 $550,000
============= ============== ============ ============
Additional
Preferred Paid-in Treasury
Stock Capital Stock
------------- ------------ ------------
BALANCE, JANUARY 1, 2001 $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 (25,000) (45,000) --
Issuance of common stock upon conversion of
convertible notes -- 262,553,000 --
Stock options exercised -- 27,304,000 (1,775,000)
Stock purchase warrants exercised -- 2,677,000 --
Restricted stock award plan -- 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 -- 982,123,000 (9,523,000)
Loss -- -- --
Foreign currency translation loss
Unrealized investment losses
Other comprehensive income -- -- --
Comprehensive loss
Stock options exercised -- 2,096,000 (40,000)
Restricted stock award plan -- 610,000 --
Employee benefit plan -- 795,000 --
Treasury stock acquired -- -- (40,000)
----------- ------------ -------------
BALANCE, MARCH 31, 2002 $ -- $985,624,000 $(9,603,000)
=========== ============ =============
The accompanying notes are an integral part of these consolidated financial
statements
5
CEPHALON, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
---------------------------------------
(Unaudited)
Three Months Ended
March 31,
---------------------------------
2002 2001
-------------- ------------
CASH FLOWS FROM OPERATING ACTIVITIES:
Loss $(2,871,000) $(9,542,000)
Adjustments to reconcile loss to net cash
provided by (used for) operating activities:
Depreciation and amortization 8,293,000 3,489,000
Extraordinary charge on extinguishment of debt 7,142,000
Non-cash interest expense 5,055,000 1,073,000
Cumulative effect of changing inventory costing method from FIFO to LIFO 3,534,000 --
Stock-based compensation expense 1,405,000 1,711,000
Other -- (10,000)
(Increase) decrease in operating assets:
Receivables 1,597,000 (1,915,000)
Inventory (786,000) (6,570,000)
Other current assets (1,381,000) (1,604,000)
Other long-term assets (125,000) (12,000)
Increase (decrease) in operating liabilities:
Accounts payable (9,013,000) 239,000
Accrued expenses (4,212,000) (2,792,000)
Deferred revenues (4,000) 2,237,000
Other long-term liabilities 37,000 (16,000)
-------------- ------------
Net cash provided by (used for) operating activities 8,671,000 (13,712,000)
-------------- ------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of property and equipment (3,038,000) (1,389,000)
Acquistion of intangible assets (4,974,000) --
Sales and maturities (purchases) of investments, net (83,368,000) 22,972,000
-------------- ------------
Net cash (used for) provided by investing activities (91,380,000) 21,583,000
-------------- ------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from exercises of common stock options and warrants 2,057,000 13,883,000
Payments to acquire treasury stock (40,000) --
Preferred dividends paid -- (2,266,000)
Principal payments on and retirements of long-term debt (11,144,000) (669,000)
-------------- ------------
Net cash (used for) provided by financing activities (9,127,000) 10,948,000
-------------- ------------
EFFECT OF EXCHANGE RATE CHANGES ON CASH AND CASH EQUIVALENTS (868,000) 790,000
-------------- ------------
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS (92,704,000) 19,609,000
CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD 548,727,000 36,571,000
-------------- ------------
CASH AND CASH EQUIVALENTS, END OF PERIOD $456,023,000 $56,180,000
============== ============
Supplemental disclosures of cash flow information:
Cash payments for interest $3,170,000 $2,140,000
Non-cash investing and financing activities:
Capital lease additions 325,000 259,000
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 products to treat sleep disorders,
neurological disorders, cancer and pain. In addition to conducting an active
research and development program, we market three products in the United States
and a number of products in various countries throughout Europe. We are
headquartered in West Chester, Pennsylvania and have offices in Salt Lake City,
Utah, 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 modafinil, which is the
active drug substance found in our PROVIGIL(R)(modafinil) tablets [C-IV] and
MODIODAL(R)(modafinil) products, and for which we have worldwide control of the
intellectual property, marketing and manufacturing rights. We operate
manufacturing facilities in Salt Lake City, Utah, for the production of
ACTIQ(R)(oral transmucosal fentanyl citrate) [C-II] 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 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.
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. 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 not
recognized a net deferred tax asset.
Group Lafon
On December 28, 2001, we completed our acquisition of the outstanding
shares of capital stock of Group Lafon. With this acquisition, we control
worldwide rights to our product PROVIGIL. The acquisition is expected to
increase our product sales, improve gross margins for PROVIGIL by eliminating
payments to Group Lafon, improve profitability and provide us with an important
research, commercial and manufacturing infrastructure in France.
The purchase price was approximately $452,446,000. The purchase price was
funded in part by the proceeds of our December 11, 2001 offering of $600,000,000
of our 2.50% convertible subordinated notes due December 2006. Of the purchase
price, $450,000,000 was paid in cash to the sellers and $2,446,000 represents
transaction costs of the acquisition and severance payments, partially offset by
an estimate of the amount expected to be refunded by the seller under the terms
of the acquisition agreement. All such amounts are expected to be paid or
received in 2002.
7
CEPHALON, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--CONTINUED
(Unaudited)
The following unaudited pro forma information shows the results of the our
operations for the three months ended March 31, 2001 as though the acquisition
had occurred as of January 1, 2001:
Three months
ended
March 31, 2001
--------------
Total revenues................................................$ 67,200,000
Net loss......................................................$(14,336,000)
Basic and diluted net loss per common share: $ (0.34)
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" (SFAS 142), 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 their estimated useful lives or
contractual lives as appropriate. The application of SFAS 142 did not have a
material impact on our 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 a liability, 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 4--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 during the
first quarter of 2002. The following table summarizes the calculation of the
$7,142,000 extraordinary charge:
8
CEPHALON, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--CONTINUED
(Unaudited)
Carrying value of the debt as of December 31, 2001........................... $ 50,000,000
Interest accreted during the first quarter 2002 @ 20%........................ 2,500,000
--------------
Carrying value of the debt as of March 29, 2002.............................. 52,500,000
Less: unamortized debt issuance 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)
==============
In addition, our statement of operations for the three months ended March
31, 2002 included certain charges related to the operations of the joint
venture, as follows:
Three months
ended
March 31, 2002
--------------
Selling, general and administrative expenses................ $3,508,000
Interest expense............................................ 3,163,000
Interest income............................................. (190,000)
-----------
$6,481,000
===========
3. INVENTORY
Inventory consisted of the following:
March 31, December 31,
2002 2001
---- ----
Raw material.............................. $24,494,000 $19,666,000
Work-in-process........................... 3,412,000 7,632,000
Finished goods............................ 16,859,000 20,215,000
------------- ------------
$44,765,000 $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 expansion of our internal
manufacturing capacity for ACTIQ has reduced our reliance on third party
manufacturers and sharpened management's focus on minimizing the cost of
manufacturing products. Consistent with this goal, the LIFO method reflects
current changes to manufacturing costs on the statement of operations on a more
timely basis, resulting in a better matching of currents costs of products sold
with product revenues.
Cost of product sales under the LIFO inventory costing method was
$4,488,000 lower in the first quarter of 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 first quarter of 2001 would have been
immaterial.
9
CEPHALON, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--CONTINUED
(Unaudited)
4. LONG-TERM DEBT
Long-term debt consisted of the following:
March 31, December 31,
2002 2001
---- ----
Capital lease obligations......................................... $ 2,826,000 $ 2,852,000
Mortgage and building improvement loans........................... 11,691,000 12,085,000
Joint venture..................................................... -- 50,000,000
Convertible subordinated notes.................................... 838,000,000 783,000,000
Notes Payable/Other............................................... 9,000,000 13,460,000
Due to Abbott Laboratories........................................ 31,954,000 37,792,000
-------------- --------------
Total debt........................................................ 893,471,000 898,789,000
Less current portion..............................................
(21,359,000) (32,200,000)
-------------- --------------
Total long-term debt.............................................. $872,112,000 $866,589,000
============== ==============
Convertible Subordinated Notes
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.
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."
5. COMMITMENTS AND CONTINGENCIES
Legal Proceedings
In August 1999, the U.S. District Court for the Eastern District of
Pennsylvania entered a final order approving the settlement of a class action
alleging that statements made about the results of certain clinical studies of
MYOTROPHIN(R) (mecasermin) Injection were misleading. A related complaint has
been filed with the Court by a small number of plaintiffs who decided not to
participate in the settlement. This related complaint alleges that we are liable
under common law for misrepresentations concerning the results of the MYOTROPHIN
clinical trials, and that we and certain of our current and former officers and
directors are liable for the actions of persons who allegedly traded in our
common stock on the basis of material inside information. We believe that we
have valid defenses to all claims raised in this action. Moreover, even if there
is a judgment against us in this case, we do not believe it will have a material
adverse effect on our financial condition or results of operations.
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
10
CEPHALON, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--CONTINUED
(Unaudited)
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 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. Should 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.
6. OTHER COMPREHENSIVE INCOME
SFAS No. 130, "Reporting Comprehensive Income," requires presentation of the
components of comprehensive income (loss). Our comprehensive loss includes net
loss, unrealized gains and losses from foreign currency translation adjustments,
and unrealized investment gains and losses. Our total comprehensive loss is as
follows:
Three months
ended March 31,
2002 2001
---- ----
Loss before preferred dividends............. $(2,871,000) $(11,808,000)
Other comprehensive income (loss):
Foreign currency translation adjustment... (263,000) 790,000
Unrealized investment gains (losses)...... (497,000) 105,000
---------- -----------
Other comprehensive loss.................... $(3,631,000) $(10,913,000)
============ =============
7. 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
conducted by several subsidiaries located in Europe. In 2001 and prior years,
European operations were immaterial. United States product sales accounted for
98%, 97% and 98% of total product sales for the years ended December 31, 2001,
2000 and 1999, respectively.
11
CEPHALON, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--CONTINUED
(Unaudited)
The following summarized information presents our revenues and long-lived
assets by geographic segment. The summarized information of the European
subsidiaries has been prepared from the books and records maintained by each
subsidiary.
We have determined that all of our 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 for the three months ended March 31, 2002:
United States................................... $ 83,469,000
Europe.......................................... 28,032,000
--------------
Total........................................... $ 111,501,000
==============
Long-lived assets at March 31, 2002:
United States.................................. $ 200,691,000
Europe......................................... 443,459,000
--------------
Total.......................................... $ 644,150,000
==============
12
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
RESULTS OF OPERATIONS
Three months ended March 31, 2002 compared to three months ended March 31,
2001
Three months
ended March 31,
2002 2001
----- ----
Product sales:
PROVIGIL..................................................... $ 44,175,000 $27,024,000
ACTIQ........................................................ 19,267,000 6,582,000
GABITRIL..................................................... 10,164,000 7,216,000
Group Lafon products......................................... 22,197,000 --
------------- ------------
Total product sales............................................... 95,803,000 40,822,000
------------- ------------
Other revenues:
H. Lundbeck A/S.............................................. 2,200,000 1,300,000
Novartis Pharma AG........................................... 2,328,000 2,325,000
Sanofi-Synthelabo............................................ 9,735,000 --
Takeda Abbott Pharmaceuticals................................ -- 1,200,000
Other........................................................ 1,435,000 1,425,000
------------- ------------
Total other revenues.............................................. 15,698,000 6,250,000
------------- ------------
Total revenues.................................................... $111,501,000 $47,072,000
============ ===========
Revenues-- Product sales in the first quarter of 2002 increased 135% over
the first quarter of 2001. The increase is attributable to a number of factors
including:
. Sales of PROVIGIL increased 63% due to increased market acceptance,
as well as a 5% domestic price increase that took effect in the second
quarter of 2001.
. Sales of ACTIQ increased 193%. 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 resulted in higher
sales. A 6.6% average domestic price increase in the second quarter of
2001 also contributed to higher sales.
. Sales of GABITRIL increased 41%. This increase is the result of
increased demand in the U.S. market and the expansion of our sales
efforts into Europe in the first quarter of 2002 as a result of the
acquisition of European rights to GABITRIL. Additionally, an average
increase in domestic prices of 10% in the second quarter of 2001
contributed to the sales increase.
. Sales of Group Lafon products, acquired on December 28, 2001, were
$22,197,000 during the first quarter of 2002. The most significant
product sales during the period were $11,077,000 of SPASFON, used for
biliary/urinary tract spasm and irritable bowel syndrome. Additionally,
sales include $2,607,000 of MODIODAL, the French trade name for
PROVIGIL.
Total other revenues increased by $9,448,000, or 151%. This increase was
due primarily to revenues recognized under our licensing, development and
marketing collaborations with Sanofi-Synthelabo, which began in October 2001,
and H. Lundbeck A/S, partially offset by a decrease in revenue due to the March
31, 2001 termination of our collaboration with Takeda Abbott Pharmaceuticals.
13
Cost of Product Sales-- The cost of product sales in the first quarter of
2002 decreased to 14% of product sales from 20% in the first quarter of 2001 due
principally to the positive effects of the Group Lafon acquisition.
Research and Development Expenses--Research and development expenses
increased 52% to $29,823,000 in the first quarter of 2002 from $19,611,000 in
the first quarter of 2001. An increase of $3,900,000 is attributable to higher
expenditures on drug development and manufacturing costs for our compounds that
have progressed into later stages of development and infrastructure costs to
support the growing number of ongoing clinical trials including Phase 2 clinical
studies for CEP-1347 and studies of PROVIGIL related to our efforts to expand
the label for PROVIGIL beyond its current indication. In addition, we incurred
$5,038,000 of research and development expenses in the first quarter of 2002 at
Group Lafon.
Selling, General and Administrative Expenses--Selling, general and
administrative expenses increased 65% to $40,284,000 for the quarter ended March
31, 2002 from $24,365,000 for the first quarter of 2001 primarily due to an
increase of $3,300,000 in external sales and marketing expenses and an increase
of $2,400,000 in the size of our internal sales force to promote and support
PROVIGIL, ACTIQ and GABITRIL. In addition, we incurred $8,419,000 of selling,
general and administrative expenses in the first quarter of 2002 at Group Lafon.
Depreciation and Amortization Expenses--Depreciation and amortization
expenses increased to $8,293,000 in the first quarter of 2002 from $3,489,000 in
the first quarter of 2001 due primarily to amortization expense of $2,733,000
for intangible assets acquired in our acquisition of Group Lafon. In addition,
we incurred $1,216,000 of depreciation expense associated with assets acquired
from Group Lafon.
Other Income and Expense--Interest income increased by $1,363,000 from the
first quarter of 2001 due to higher average investment balances, partially
offset by lower average rates of return. Interest expense increased by
$10,178,000 from the first quarter of 2001 due primarily to interest recorded on
the $783,000,000 of outstanding convertible subordinated notes and the
$50,000,000 of debt related to the joint venture restructuring. Other expenses
decreased by $212,000 due to the fluctuation in the currency exchange value of
the pound Sterling (GBP) relative to the U.S. dollar.
Income Taxes--Income taxes of $1,985,000 recorded in the first quarter of
2002 represent foreign income tax expense associated with activities in France.
Dividends on Convertible Exchangeable Preferred Stock--In the first quarter
of 2001, we recognized $2,266,000 of dividend expense associated with the
previously outstanding shares of 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.
Extraordinary 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.
14
This amount consists of the write-off of $4,642,000 of the remaining costs
associated with the formation of the joint venture which were capitalized, and
a $2,500,000 loss on the early extinguishment of debt.
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 valuation method. The
acquisition of Group Lafon's manufacturing operations and the expansion of our
internal manufacturing capacity for ACTIQ has reduced our reliance on third
party manufacturers and sharpened management's focus on minimizing the cost of
manufacturing products. Consistent with this goal, the LIFO method reflects
current changes to manufacturing costs on the statement of operations on a more
timely basis, resulting in a better matching of currents 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 these financial statements requires management
to make estimates and assumptions that affect the reported amounts of assets and
liabilities, the disclosure of contingent assets and liabilities at the date of
the financial statements, and the reported amounts of revenues and expenses
during the reporting period. These estimates and assumptions are developed, and
challenged 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 under different
assumptions or conditions.
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 shipment of product
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. 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, 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. The reserves are reviewed at each reporting period and
adjusted to reflect data available at that time. To the extent our estimate of
allowances is inaccurate, we will adjust the reserve which will impact the
amount of product sales revenue recognized in the period of the adjustment.
Product returns are permitted with respect to unused pharmaceuticals based on
expiration dating of our product. To date, product returns have not been
material.
Revenue from collaborative agreements may consist of up-front fees, ongoing
research and development funding and milestone payments. 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.
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.
15
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 guarantee that it will continue to experience the same credit loss rates
as it has in the past. Also, as of March 31, 2002, approximately 91% of our
U.S. trade accounts receivable were due from three pharmaceutical wholesalers.
Any significant changes in the liquidity or financial position 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 expansion of our internal
manufacturing capacity for ACTIQ has reduced our reliance on third party
manufacturers and sharpened management's focus on minimizing the cost of
manufacturing products. Consistent with this goal, the LIFO method reflects
current changes to manufacturing costs on the statement of operations on a more
timely basis, resulting in a better matching of currents costs of products sold
with product revenues. The majority of our inventories are subject to expiration
dating. We continually 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.
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 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 them requires us to use our judgment. We continually
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.
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 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. 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 not recognized a net deferred tax asset.
The third quarter of 2001 was our first profitable quarter from commercial
operations since inception. Continued 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.
LIQUIDITY AND CAPITAL RESOURCES
Cash, cash equivalents and investments at March 31, 2002 were $594,051,000,
representing 43% of total assets.
16
Net Cash Provided by (Used for) Operating Activities
Net cash provided by operating activities was $8,671,000 for the three
months ended March 31, 2002 as compared to net cash used for operating
activities of $13,712,000 for the same period in 2001. The main factors that
contributed to the net cash provided by operating activities in 2002 are as
follows:
. The net loss before preferred dividends was $2,871,000 in 2002, as
compared to $9,542,000 in 2001, as a result of the increase in product
sales. In addition, we recognized the following non-cash transactions
in the first quarter of 2002: $8,293,000 of depreciation and
amortization expense, $5,055,000 of non-cash interest expense on our
convertible subordinated notes, $1,405,000 of non-cash compensation
expense, and $3,534,000 associated with changing our inventory costing
method from FIFO to LIFO.
. Accounts payable decreased $9,013,000 and accrued expenses decreased
$4,212,000. The decrease in accrued expenses is due primarily to
payments of $4,251,000 for bonuses related to 2001 and payments of
$4,641,000 related to the Group Lafon acquisition, partially offset by
an increase of $5,986,000 in accrued interest payable for the
outstanding convertible subordinated notes.
Net Cash (Used for) Provided by Investing Activities
A summary of net cash (used for) provided by investing activities is as
follows:
Three months ended
March 31,
2002 2001
----- ----
Purchases of property and equipment.......................... $ (3,038,000) $(1,389,000)
Acquisition of intangible assets............................. (4,974,000) --
Sales and maturities (purchases) of investments, net......... (83,368,000) 22,972,000
------------- ------------
Net cash (used for) provided by investing activities......... $(91,380,000) $ 21,583,000
============= ============
--Acquisition of intangible assets
The acquisition of intangible assets during the three months ended March
31, 2002 represents payments in connection with our December, 2001 acquisition
of expanded rights to GABITRIL 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:
Three months ended
March 31,
2002 2001
----- ----
Proceeds from exercises of common stock options and warrants........ $2,057,000 $13,883,000
Payments to acquire treasury stock.................................. (40,000) --
Preferred dividends paid............................................ -- (2,266,000)
Principal payments on and retirement of long-term debt.............. (11,144,000) (669,000)
------------ -----------
Net cash (used for) provided by financing activities................ $(9,127,000) $10,948,000
============ ===========
17
--Proceeds from exercises of common stock options and warrants
During the three months ended March 31, 2002, we received proceeds of
approximately $2,057,000 from the exercise of approximately 117,000 common stock
options compared to proceeds of $13,883,000 from the exercise of approximately
643,000 common stock options during the same period in 2001. At March 31, 2002,
options to purchase approximately 5,541,000 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 Plan, 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 corresponding dollar
value of payroll-related taxes.
--Preferred dividends paid
The dividend payment of $2,266,000 during the first quarter of 2001
relates 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
$4,481,000 were also made during the first quarter of 2002 on the notes payable,
bank debt and other lines of credit assumed with the acquisition 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 August 1999, the U.S. District Court for the Eastern District of
Pennsylvania entered a final order approving the settlement of a class action
alleging that statements made about the results of certain clinical studies of
MYOTROPHIN(R) (mecasermin) Injection were misleading. A related complaint has
been filed with the Court by a small number of plaintiffs who decided not to
participate in the settlement. This related complaint alleges that we are
liable under common law for misrepresentations concerning the results of the
MYOTROPHIN clinical trials, and that we and certain of our current and former
officers and directors are liable for the actions of persons who allegedly
traded in our common stock on the basis of material inside information. We
believe that we have valid defenses to all claims raised in this action.
Moreover, even if there is a judgment against us in this case, we do not
believe it will 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
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. Should 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.
18
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.
Outlook
Cash, cash equivalents and investments at March 31, 2002 were $594,051,000.
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 our
ability 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 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; and
. marketing and other expenses.
19
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 66% of our total product sales for the year ended December 31,
2001. By consolidating our financial results with those of Group Lafon, we
expect to reduce significantly our cost of goods sold related to PROVIGIL. The
bulk of these cost savings result from 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 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. There is currently $838,000,000 of convertible notes
outstanding. The annual interest payments on the outstanding balance of
convertible notes will be $26,739,000, payable semiannually.
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.
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.
20
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 three months ended March 31, 2002, approximately 63% 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;
. 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 materials adverse developments with respect to the sale or use of
PROVIGIL, GABITRIL or ACTIQ could significantly reduce our product revenue 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, GABITRIL or ACTIQ, which would hamper sales growth
and make it more difficult to sustain profitability.
The market for the approved indications 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 expansion of the approved indications for
our products and physicians prescribing our products outside of the approved
indications. Under current FDA and European medical authority regulations, we
are limited in our ability to promote the use of these products outside their
labeled use. Any label expansion will require FDA 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
current indications. Although some study data has been positive, additional
studies in these disorders will be necessary before we can apply 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 results of these
studies
21
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 do not expect to conduct studies for the purpose of requesting an
expansion of the authorized use of ACTIQ. Future sales growth, if any, of ACTIQ
outside of the treatment of breakthrough cancer pain could come only from
physician prescriptions outside this labeled use. Physicians may or may not
prescribe ACTIQ for off-label uses and, in any event, sales from such
prescriptions may not prove to be significant to our results of operations.
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.
We may not be able to maintain adequate protection for our intellectual property
or market exclusivity for our products and therefore potential competitors may
develop competing products, which could result in a decrease in sales and market
share, cause us to reduce prices to compete successfully, and 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 composition of matter patent for modafinil expired in 2001. We license
or own U.S. and foreign patent rights covering the particle size pharmaceutical
composition of modafinil that expire between 2014 and 2015. Ultimately, these
particle size patents might be found invalid if challenged by a third party or a
potential competitor could develop a competing product or product formulation
that would avoid 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.
22
We may incur additional losses.
The quarter ended September 30, 2001 was our first profitable quarter from
commercial operations since inception and our accumulated deficit was
$579,562,000 at March 31, 2002. Our losses have resulted principally from costs
incurred in research and development, including clinical trials, and from
selling, general and administrative costs associated with our operations. In
order for us to maintain profitability from commercial operations, we must
continue to achieve product and other revenue 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 existing products in new
indications, 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 product 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
and DSM Pharmaceuticals, 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, provide
customer service activities and accept and process 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
either 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 can be 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.
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
23
the United States or other countries without receiving approval from the FDA or
the appropriate foreign medical authority. The approval process requires
substantial time, effort and financial resources, and we may never obtain
approval in a timely manner, or at all. We cannot provide you with any assurance
that required approvals will be obtained timely or at all. In addition, if the
FDA or a foreign medical authority determines that we have not complied with
regulations in the research and development of a product candidate or a new
indication, they may not grant approval. 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. Future products may contain controlled substances.
The increased concern for safety by the FDA and the DEA with respect to products
containing controlled substances can result in the imposition of restrictions on
marketing or even withdrawal of regulatory approval for such products. In
addition, negative 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 control of the intellectual
property, marketing, and manufacturing rights related to modafinil, the active
drug substance in PROVIGIL. PROVIGIL accounted for approximately 66% of our
total product sales for the year ended December 31, 2001. 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 quarter of 2002, we
experienced a reduction in the cost of product sales related to PROVIGIL from
approximately 22% of net sales to approximately 3% of net sales. While the bulk
of these cost savings result from eliminating the effect of preexisting
contractual arrangements between us and Group Lafon, 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 actually realized, if any, and other anticipated benefits could
differ from, or their impact could be delayed compared to, our expectations as
described herein.
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 federal and state 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
24
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, if any, 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 including methylphenidate, which is
marketed under a number of brand names, including RITALIN(R) by Novartis,
CONCERTA(R) tablets by Alva and METHYLIN(R) by Mallinckrodt, as well as
competitive products 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 will 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 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.
25
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, most importantly
with 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 partner to control:
. the supply of bulk or formulated drugs for commercial use or for use in
clinical trials;
. the design and execution of clinical studies;
. the process of obtaining regulatory approval to market the product;
and/or
. the 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
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.
26
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 may 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 disruption.
The price of our common stock has been and may continue to be highly volatile.
The market price of our common stock is volatile, and we expect it to
continue to be volatile for the foreseeable future. For example, from January 1,
2001 through May 10, 2002, our common stock traded at a high price of $78.880
and a low price of $36.375. 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 our competitors, changes in
government regulations that may impact the biotechnology or pharmaceutical
industries or the movement of capital into or out of our industry, are also
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, we
expect that the portion of our product sales denominated in the euro and other
local currencies will increase. 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 translations included as a component of
stockholders' equity.
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
27
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. We do not have employment agreements with any of our key scientific,
technical and managerial employees. We do not maintain "key man" life insurance
on any of our employees.
We may be required to incur significant costs to comply with environmental laws
and regulations and our compliance may limit any future profitability.
Our research and development activities involve the controlled use of
hazardous, infectious and radioactive materials that could be hazardous to human
health, safety or the environment. We store these materials and various wastes
resulting from their use at our facility pending ultimate use and disposal. We
are subject to a variety of federal, state and local laws and regulations
governing the use, generation, manufacture, storage, handling and disposal of
these materials and wastes, and we may be required to incur significant costs to
comply with both existing and future environmental laws and regulations.
We believe that our safety procedures for handling and disposing of these
materials comply with foreign, federal, state and local laws and regulations,
but 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 the provisions of our certificate of incorporation, our bylaws and Delaware
corporate law, may have the effect of deterring hostile takeovers or delaying or
preventing changes in control of our management, including transactions in which
stockholders might otherwise receive a premium for their shares over then
current market prices.
28
We may be unable to service or repay our substantial indebtedness or other
contingencies.
As of March 31, 2002, we had significant levels of indebtedness that, among
other things, could make it difficult for us to make payments on our
indebtedness or to 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 could consider unacceptable, we may
not have either 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.
29
PART II - OTHER INFORMATION
Item 1. Legal Proceedings
The information set forth in Footnote 4 to the Notes to
Consolidated Financial Statements included herein is hereby
incorporated by reference.
Item 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 have
agreed to file, on or prior to May 28, 2002, a registration
statement on Form S-3 to register the resale of the shares of
common stock issuable upon conversion of the notes.
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits:
Exhibit
No. Description
---- -----------
4.1 Form of 3.875% Convertible Promissory
Note due March 29, 2007.
4.2 Registration Rights Agreement dated
March 29, 200 between Cephalon, Inc. and
Anthem Investors, LLC.
10.1 Amendment to Consulting Agreement
between Cephalon, Inc. and Martyn D.
Greenacre dated April 1, 2002.
18.1 Preferability Letter from Arthur
Andersen LLP.
(b) Reports on Form 8-K:
During the first quarter of 2002, the Registrant
filed the following Current Reports on Form 8-K:
(i) On January 10, 2002, Cephalon, Inc. filed the
Press Release dated December 28, 2001 publicly
announcing the completion of the acquisition of Group
Lafon.
(ii) On February 13, 2002, Cephalon, Inc. filed an
amended Current Report on Form 8-K/A to include the
pro forma financial information and financial
statements of Group Lafon.
30
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
CEPHALON, INC.
(Registrant)
May 15, 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)
31