SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
[X] Quarterly Report Pursuant to Section 13 or 15(d) of the
Securities Exchange Act of 1934
For the Quarterly Period Ended June 30, 1997
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[_] 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
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CEPHALON, INC.
---------------------------------
(Exact Name of Registrant as Specified in its Charter)
Delaware 23-2484489
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(State Other Jurisdiction of (I.R.S. Employer Identification Number)
Incorporation or Organization)
145 Brandywine Parkway, West Chester, PA 19380
- ------------------------------------------ -------------------------
(Address of Principal Executive Offices) (Zip Code)
Registrant's Telephone Number, Including Area Code (610) 344-0200
------------------
Not Applicable
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Former Name, Former Address and Former Fiscal
Year, If Changed Since Last Report
Indicate by check mark whether the Registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the Registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes X No
------- -------
Applicable only to corporate issuers:
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date.
Class Outstanding as of August 8, 1997
---------------------------- ----------------------------------
Common Stock, par value $.01 25,737,647 Shares
This Report Includes a Total of 19 Pages
CEPHALON, INC. and SUBSIDIARIES
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INDEX
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Page No.
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PART I - FINANCIAL INFORMATION
Item 1. Financial Statements
Consolidated Balance Sheets - 3
June 30, 1997 and December 31, 1996
Consolidated Statements of Operations - 4
Three and six months ended June 30, 1997 and 1996
Consolidated Statements of Cash Flows - 5
Six months ended June 30, 1997 and 1996
Notes to Consolidated Financial Statements 6 - 8
Item 2. Management's Discussion and Analysis of 9 - 17
Financial Condition and Results of Operations
PART II - OTHER INFORMATION
Item 4. Submission of Matters to a Vote of Security Holders 18
Item 6. Exhibits and Reports on Form 8-K 18
SIGNATURES 19
CEPHALON, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
---------------------------
(Unaudited)
June 30, December 31,
1997 1996
------------- -------------
ASSETS
------
CURRENT ASSETS:
Cash and cash equivalents $11,640,000 $5,671,000
Reverse repurchase agreements 22,962,000 5,207,000
Short-term investments 110,928,000 135,970,000
Other 9,589,000 7,696,000
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Total current assets 155,119,000 154,544,000
PROPERTY AND EQUIPMENT, net of accumulated
depreciation and amortization of $10,131,000 and $8,852,000 21,850,000 22,086,000
OTHER 3,329,000 1,261,000
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$180,298,000 $177,891,000
============= =============
LIABILITIES AND STOCKHOLDERS' EQUITY
------------------------------------
CURRENT LIABILITIES:
Accounts payable $4,428,000 $1,638,000
Accrued liabilities 17,432,000 14,786,000
Current portion of long-term debt 1,625,000 5,164,000
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Total current liabilities 23,485,000 21,588,000
LONG-TERM DEBT (Note 2) 46,760,000 16,974,000
OTHER 2,399,000 2,003,000
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Total liabilities 72,644,000 40,565,000
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COMMITMENTS AND CONTINGENCIES (Note 3)
STOCKHOLDERS' EQUITY: (Note 4)
Preferred stock, $.01 par value,
5,000,000 shares authorized, none issued -- --
Common stock, $.01 par value, 100,000,000 shares authorized,
25,395,073 and 24,618,223 shares issued and outstanding 254,000 246,000
Additional paid-in capital 299,569,000 295,047,000
Accumulated deficit (192,169,000) (157,967,000)
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Total stockholders' equity 107,654,000 137,326,000
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$180,298,000 $177,891,000
============= =============
The accompanying notes are an integral part of these financial statements.
CEPHALON, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
-------------------------------------
(Unaudited)
Three Months Ended June 30, Six Months Ended June 30,
----------------------------- -----------------------------
1997 1996 1997 1996
------------- ------------- ------------- -------------
CONTRACT REVENUES: $ 3,889,000 $ 4,060,000 $ 9,517,000 $ 7,788,000
OPERATING EXPENSES:
Research and development 14,569,000 16,247,000 27,746,000 30,540,000
Selling, general and administrative 9,833,000 6,268,000 18,530,000 11,763,000
------------- ------------- ------------- -------------
24,402,000 22,515,000 46,276,000 42,303,000
LOSS FROM OPERATIONS (20,513,000) (18,455,000) (36,759,000) (34,515,000)
INTEREST:
Income 2,443,000 2,123,000 4,060,000 3,864,000
Expense (1,002,000) (568,000) (1,503,000) (1,187,000)
------------- ------------- ------------- -------------
1,441,000 1,555,000 2,557,000 2,677,000
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LOSS $(19,072,000) $(16,900,000) $(34,202,000) $(31,838,000)
============= ============= ============= =============
LOSS PER SHARE $(0.76) $(0.70) $(1.37) $(1.32)
============= ============= ============= =============
WEIGHTED AVERAGE NUMBER
OF SHARES OUTSTANDING 25,103,831 24,301,003 24,909,222 24,164,919
============= ============= ============= =============
The accompanying notes are an integral part of these financial statements.
CEPHALON, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
-------------------------------------
(Unaudited)
Six Months Ended June 30,
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1997 1996
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CASH FLOWS FROM OPERATING ACTIVITIES:
Loss $(34,202,000) $(31,838,000)
Adjustments to reconcile loss to net cash
used for operating activities:
Depreciation and amortization 1,279,000 1,918,000
Non-cash compensation expense 1,650,000 1,128,000
(Increase) decrease in operating assets:
Other current assets (1,962,000) 1,547,000
Other long-term assets (1,668,000) (75,000)
Increase(decrease) in operating liabilities:
Accounts payable 2,790,000 (2,519,000)
Other current liabilities 2,660,000 1,825,000
Other long-term liabilities 396,000 364,000
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Net cash used for operating activities (29,057,000) (27,650,000)
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CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of property and equipment (1,043,000) (1,074,000)
Sale leaseback of property and equipment 743,000 --
Sales and maturities of investments, net 7,287,000 22,429,000
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Net cash provided by investing activities 6,987,000 21,355,000
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CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from exercises of common stock options and warrants 2,535,000 7,402,000
Proceeds from issuance of long-term debt 30,000,000 400,000
Principal payments on long-term debt (4,496,000) (1,945,000)
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Net cash provided by financing activities 28,039,000 5,857,000
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NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS 5,969,000 (438,000)
CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD 5,671,000 6,565,000
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CASH AND CASH EQUIVALENTS, END OF PERIOD $11,640,000 $6,127,000
============= =============
The accompanying notes are an integral part of these financial statements.
CEPHALON, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
1. The Company and Summary of Significant Accounting Policies
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Business
Cephalon, Inc. ("Cephalon" or the "Company") seeks to discover and
develop pharmaceutical products primarily for the treatment of neurological
disorders such as amyotrophic lateral sclerosis ("ALS"), peripheral
neuropathies, narcolepsy, Alzheimer's disease and stroke. The Company also co-
promotes, to neurologists in the United States, two drugs of Bristol-Myers
Squibb Company ("BMS") and a product of Medtronic, Inc. The Company has not
received regulatory approval for the commercial sale of any of its proprietary
products under development. The Company has funded its operations primarily from
the proceeds of public and private placements of its equity securities and the
receipt of payments under research and development agreements.
The Company's business of developing and marketing pharmaceutical
products is subject to a number of significant risks, including risks inherent
in research and development activities and in conducting business in a highly
regulated environment. The success of the Company depends to a large degree upon
obtaining the U.S. Food and Drug Administration ("FDA") and foreign regulatory
approval to market products currently under development. There can be no
assurance that any of the Company's product candidates will be approved for any
indication by any regulatory authority for marketing in any jurisdiction.
Basis of presentation
These consolidated financial statements of Cephalon, Inc. are unaudited
and include all adjustments which, in the opinion of management, are necessary
to present fairly the financial condition and results of operations as of and
for the periods set forth in the Consolidated Balance Sheets, Consolidated
Statements of Operations and Consolidated Statements of Cash Flows. All such
adjustments are of a normal, recurring nature. The consolidated financial
statements do not include all of the information and footnote disclosures
normally included in financial statements prepared in accordance with generally
accepted accounting principles and should be read in conjunction with the
consolidated financial statements and notes thereto included in the Company's
annual report on Form 10-K, filed with the Securities and Exchange Commission,
which includes financial statements as of and for each of the three years in the
period ended December 31, 1996. The results of the Company's operations for any
interim period are not necessarily indicative of the results of the Company's
operations for any other interim period or for a full year.
Net loss per share
Net loss per share is computed using the weighted average number of
common shares outstanding during the period. Common stock equivalents relating
to stock options, warrants and convertible debt are excluded from the
computation as their effect is antidilutive.
Accounting pronouncements
In February 1997, the Financial Accounting Standards Board issued SFAS
No. 128, "Earnings per Share," which is effective for financial statements for
fiscal years ending after December 15, 1997. This statement intends to simplify
the standards for computing earnings per share ("EPS") previously found in APB
Opinion No. 15 and to make them comparable to international EPS standards. The
Company intends to adopt SFAS No. 128 for its fiscal year ending December 31,
1997; early adoption is not permitted. Pro forma calculations are not included
herein because the Company does not expect that the effect of adopting SFAS No.
128 will be materially different from results using the current practice under
APB Opinion No. 15.
6
CEPHALON, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(Unaudited)
2. Long-term Debt
--------------
In April 1997, the Company completed a $30,000,000 private placement of
senior convertible notes (the "Notes"), which mature in April 1998 and bear
interest, payable quarterly in cash or common stock, at a rate of seven percent
per annum. The Notes have been recorded at their face value and are convertible
into registered common shares of the Company, subject to certain limitations, at
a six percent discount to a market price formula at the time of conversion. The
Company has limited the number of shares authorized for conversion to 3,040,000.
If based upon the market price from time to time, a greater number of shares is
required to enable full conversion, the Company either must authorize a greater
number of shares or must redeem the inconvertible portion of the Notes for cash.
The Company has a right to redeem the Notes at a redemption price equal to 110
percent of the outstanding principal amount plus interest, if the conversion
price falls below approximately $21 per share. If not converted into common
stock or redeemed, the outstanding, unconverted notes plus accrued interest will
be exchanged at face value at maturity for an equal dollar amount of debentures
bearing interest at a rate of 10 3/4% per annum and maturing in 2013.
3. Commitments and Contingencies
-----------------------------
Related party
Cephalon Clinical Partners, L.P. (the "Partnership") granted the Company
an exclusive license (the "Interim License") to manufacture and market
MYOTROPHIN (rhIGF-I) within the United States, Canada and Europe (the
"Territory") in return for certain royalty payments and a payment of
approximately $16,000,000 (the "Milestone Payment") that is to be made if
MYOTROPHIN (rhIGF-I) receives regulatory approval in the United States or
certain other countries within the Territory. The Company has the option to pay
the Milestone Payment in cash, common stock, or a combination thereof.
The Company has a contractual option to purchase all of the limited
partnership interests in the Partnership (the "Purchase Option") in specified
circumstances following the initiation of commercial sales, if any, of
MYOTROPHIN (rhIGF-I). To exercise the Purchase Option, Cephalon is required to
make an advance payment of $40,275,000 in cash or, at Cephalon's election,
$42,369,000 in shares of the Company's common stock, valued at the market price
at the time the Purchase Option is exercised. In addition to the advance
payment, the exercise of the Purchase Option requires the Company to make future
royalty payments to the former limited partners for a period of eleven years
after exercise at a royalty rate of 10.1% (subject to reduction under certain
circumstances) of MYOTROPHIN sales in the Territory. If the Company does not
exercise the Purchase Option prior to its expiration, the Interim License will
terminate and all development and marketing rights to MYOTROPHIN (rhIGF-I) in
the Territory would revert to the Partnership, which may commercialize
MYOTROPHIN (rhIGF-I) itself or license or assign its rights to a third party.
The Company would not receive any benefits from such commercialization.
The Company's collaboration with Chiron is subject to the rights of the
Partnership, which licensed to the Company the right to develop MYOTROPHIN
(rhIGF-I) in the Territory in return for receiving certain payments, described
above. The Company is solely responsible for making any such royalty and
milestone payments owed to the Partnership and is responsible for funding the
Purchase Option if it exercises the option.
Shareholder Litigation
The Company and certain of its officers have been named as defendants in
a number of civil actions filed in the U.S. District Court for the Eastern
District of Pennsylvania, which have been consolidated. Several of the
plaintiffs have been designated by the Court, collectively, as the "lead
plaintiff" for purposes of the Private Securities Litigation Reform Act of 1995.
The consolidated complaint, filed in October 1996 by the lead plaintiffs,
extended and expanded the class period to include purchasers of the Company's
securities as well as options to
7
CEPHALON, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(Unaudited)
purchase or sell those securities during the period between June 12, 1995 and
June 7, 1996. The plaintiffs allege, based in part on statements and opinions
expressed at a June 1996 meeting of an FDA advisory committee to review the
MYOTROPHIN treatment investigational new drug application, that earlier
statements by the Company about the North American and European trial results
were misleading. The plaintiffs seek unspecified damages and other relief. The
Company's motion to dismiss the case is pending, and discovery related to the
merits of the allegation in the complaint has been postponed until the motion is
decided, which may occur later in 1997. The Company intends to vigorously defend
the action. However, management believes that it is too early in the proceedings
to determine with any certainty the outcome of this action or the potential
liability of the Company, if any.
4. Stockholders' Equity
--------------------
In May 1997, the Company purchased options (the "Options") from Swiss
Bank Corporation, London Branch ("SBC") to acquire 2,500,000 shares of the
Company's common stock. In payment of the purchase price of the Options, the
Company issued to SBC 490,000 shares of common stock. The Options are
exercisable by the Company on the expiration date of October 31, 1997 at a price
of $21.50 per share (the "Strike Price"). The Company expects to receive in cash
the excess, if any, of the average price of the Company's common stock for the
fifteen trading days prior to the expiration date over the Strike Price, subject
to a maximum payment of $18.00 per share. Alternatively, the Company may elect
to exercise the Options and receive shares of the Company's stock in exchange
for payment of the Strike Price. If the average price of the common stock over
the fifteen trading days prior to the expiration date of the Options does not
exceed $21.50, the Options will expire unexercised. The Options have been, and
the ultimate settlement, if any, will be, recorded in stockholders' equity.
Warrants to purchase 84,000 shares of the Company's stock at an exercise
price of $24.77 per share were issued to the placement agent in connection with
the private placement of the Company's senior convertible notes (see Note 2).
8
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
Certain Risks Related to Cephalon's Business
The statements under this caption are intended to serve as cautionary
statements within the meaning of the Private Securities Litigation Reform Act of
1995 and should be read in conjunction with the forward-looking statements in
this Report as well as statements presented elsewhere by management of the
Company. The following information is not intended to limit in any way the
characterization of other statements or information in this Report as cautionary
statements for such purpose.
The Company's business of developing and marketing pharmaceutical
products is subject to a number of significant risks, including those inherent
in pharmaceutical research and development activities and in conducting business
in a regulated environment. The success of the Company depends to a large degree
upon obtaining U.S. Food and Drug Administration ("FDA") and foreign regulatory
approval to market products currently under development. Cephalon has had only
limited experience in pursuing the applications necessary to gain such
approvals. There can be no assurance that the data from any of the Company's
clinical studies or the Company's interpretation of such data will be accepted
by any regulatory authority. In addition, there can be no assurance that any
application by the Company to market a product will be reviewed in a timely
manner or that such application will be approved by the appropriate regulatory
authority. Should approval be granted to market a product, there can be no
assurance that the Company will be able to successfully market the product or
achieve a profitable level of sales.
Uncertainties Related to MYOTROPHIN(R) (rhIGF-I)
In February 1997, the Company, in collaboration with Chiron Corporation
("Chiron"), filed a new drug application ("NDA") with the FDA requesting that
MYOTROPHIN (rhIGF-I) be approved for the treatment of amyotrophic lateral
sclerosis ("ALS") in the United States. At a public hearing on May 8, 1997, the
Peripheral and Central Nervous System Drugs Advisory Committee (the "Advisory
Committee") found, by a vote of 6 to 3, that the data presented to it for review
did not meet the FDA's standard of "substantial" evidence of effectiveness.
Representatives of the FDA also expressed their concern at the May 8th hearing
that the data presented failed to meet that standard, although the agency as a
whole has not reached a decision. The Advisory Committee's recommendation,
although not binding, is usually followed by the FDA. The FDA has exercised its
right to extend the review period for the NDA by three months to November 1997,
to review additional information recently submitted by the Company and Chiron.
The due date represents the agency's target date, and the actual decision could
be sooner or later than the target date. There can be no assurance the
additional information will satisfy the concerns of the FDA and provide a basis
for NDA approval.
In May 1997, the Company and Chiron filed a joint marketing
authorization application ("MAA") with the European Medicines Evaluation Agency
("EMEA") for approval to market MYOTROPHIN (rhIGF-I) in Europe for the treatment
of ALS. The MAA has been accepted for review by the EMEA under the centralized
procedures of the European Union. Under those procedures, a regulatory decision
with respect to the single application is binding on all 15 member states of the
European Union, subject in some countries to subsequent decisions by national
authorities as to pricing and reimbursement matters. The companies are beginning
the process of responding to preliminary questions on the MAA, and there can be
no assurance that the questions can be answered satisfactorily or that the MAA
will be approved.
During the double-blind portion of the MYOTROPHIN study conducted in
Europe, an imbalance in death rates was observed in the drug-treated group
compared to the placebo-treated group. The Company believes that mortalities
observed in the clinical studies conducted to date are due to the normal
progression of the disease or other circumstances not attributable to MYOTROPHIN
(rhIGF-I). The Company is continuing to furnish MYOTROPHIN (rhIGF-I) to patients
who participated in the two Phase III ALS studies, to patients in its Phase II
program in peripheral neuropathies, and to patients under the ongoing treatment
investigational new drug ("T-IND") program. The reporting of patient deaths as
adverse events could result in regulatory action adverse to the interests of the
Company.
9
There can be no assurance that the FDA or any regulatory authority will
determine that the studies conducted to date demonstrate sufficient evidence of
safety and efficacy to support marketing approval of MYOTROPHIN (rhIGF-I) for
the treatment of ALS in any jurisdiction. A negative decision by any regulatory
authority could adversely influence the decision of other regulatory
authorities. If the FDA or any other regulatory authority were to require
additional data prior to approval of MYOTROPHIN (rhIGF-I) for the treatment of
ALS, there can be no assurance that the Company and Chiron would be willing or
able to conduct any study as a pre-approval activity or that the results of any
such study, if conducted, would be positive. A new study would be expensive and
would take several years to complete. A negative decision by a regulatory
authority would materially adversely affect the Company's business and the price
of its common stock.
Chiron's U.S. manufacturing facility (the "Chiron Facility") will be the
sole source of supply for any potential future commercial or clinical needs of
MYOTROPHIN (rhIGF- I), including any material which Cephalon may have to supply
for use in Japan, as well as for use in the Company's ongoing clinical trials.
In the manufacture of MYOTROPHIN (rhIGF-I), the Company and Chiron are required
to comply with all applicable regulatory requirements of the FDA and foreign
authorities, including current Good Manufacturing Practice ("cGMP") regulations.
The facilities used by the Company and Chiron for the manufacture of MYOTROPHIN
are subject to inspection by the FDA and other regulatory authorities at any
time during the conduct of clinical studies or commercial operations, to
determine compliance with cGMP requirements. The cGMP regulations are complex,
and failure to be in compliance could lead to remedial action, penalties and
delays in production of material. If the Chiron Facility is not able to produce
sufficient quantities of MYOTROPHIN (rhIGF-I) in accordance with applicable
regulations, the collaboration would have to obtain MYOTROPHIN (rhIGF-I) from
another source. There can be no assurance that Cephalon or the collaboration
would be able to locate an alternative, cost-effective source of supply of
MYOTROPHIN (rhIGF-I).
The Company and Chiron will be required to demonstrate that the material
produced at the Chiron Facility is equivalent to the material used in the ALS
clinical trials, which was manufactured at the Company's former pilot-scale
manufacturing facility in Beltsville, Maryland. Although, based on the results
of a bioequivalency study, the companies believe that the material is
equivalent, if regulatory authorities do not agree with that assessment,
regulatory approval of MYOTROPHIN (rhIGF-I) could be delayed.
Uncertainties Related to PROVIGIL(R) (modafinil)
In December 1996, the Company submitted an NDA to the FDA requesting
that PROVIGIL (modafinil) be approved for the treatment of the excessive daytime
sleepiness associated with narcolepsy, based primarily on the results of two
Phase III studies conducted in the United States. There can be no assurance that
the FDA will determine that the results generated from the Company's clinical
trials demonstrate sufficient safety and efficacy to support marketing approval.
The Company also is pursuing applications seeking authorization to
market PROVIGIL (modafinil) in the Republic of Ireland and the United Kingdom,
which are other territories licensed from Laboratoire L. Lafon ("Lafon"). There
can be no assurance that the information in the applications will be adequate to
permit approval. Even if those applications are approved, the Company must
subsequently request permission to vary the applications with respect to certain
manufacturing procedures and other matters before launch of the product. There
can be no assurance that any regulatory approvals or variations will be obtained
at all or in a timely manner. The Company is required, under the terms of its
license with Lafon, to launch the product no later than three months after
approval. Although the Company has established a sales force in the United
Kingdom to sell PROVIGIL (modafinil), there can be no assurance that the
product, if approved, can be launched in a timely manner.
The FDA and the Drug Enforcement Administration ("DEA") will review data
related to the actual or potential abuse profile of PROVIGIL (modafinil), for
possible classification of PROVIGIL (modafinil) as a controlled substance under
the Controlled Substances Act (the "CSA"). The CSA imposes various registration,
record-keeping and reporting requirements, procurement and manufacturing quotas,
labeling and packaging requirements, security controls and restrictions on
prescription refills on controlled substances, which vary
10
depending on a drug's classification into one of five "schedules," ranging from
drugs of high abuse to drugs with low abuse potential. Most states either adopt
the federal requirements or impose special requirements on the registration,
handling and distribution of controlled substances. If PROVIGIL (modafinil) is
classified as a controlled substance, the cost to the Company of distributing
PROVIGIL (modafinil) could increase, and the number of prescriptions for
PROVIGIL (modafinil) could decrease, depending on the schedule in which PROVIGIL
(modafinil) would be listed. The DEA's formal process of reviewing PROVIGIL
(modafinil) for its abuse potential is expected to begin only if the FDA makes a
determination of approvability, and must be completed before commercialization
begins.
Lafon is responsible for manufacturing the bulk modafinil compound for
the Company, and the Company has entered into an agreement with a third party to
manufacture tablets for commercial use from bulk modafinil provided by Lafon.
The facilities used for the manufacture of modafinil and PROVIGIL (modafinil)
tablets are required to comply with all applicable regulatory requirements of
the FDA and foreign authorities, including cGMP regulations. The facilities for
the manufacture of modafinil and the finished tablets are subject to inspection
by the FDA and other regulatory authorities at any time during the conduct of
clinical studies or commercial operations. The cGMP regulations are complex, and
failure to be in compliance could lead to remedial action, penalties and delays
in production of material. If Lafon is unable to supply the Company with bulk
modafinil, Cephalon is permitted to make the compound itself or to purchase it
from third parties. There can be no assurance that Cephalon would be able to
manufacture modafinil, that a third-party manufacturer could be located or that
either alternative would be cost-effective. If the tablet manufacturer is unable
to supply tablets for any reason, there can be no assurance that the Company
will be able to identify a suitable alternative supplier at all or without
delaying the commercialization of PROVIGIL (modafinil).
Lafon has licensed rights to modafinil to third parties in Canada as
well as certain countries in Europe, and may license other territories to other
third parties in the future. There is no contractual requirement that the
licensees and Lafon coordinate their marketing activities related to modafinil.
Furthermore, individual reimbursement policies in each country and applicable
antitrust laws prohibit the coordination of the pricing of modafinil in various
jurisdictions. The marketing activities of the other licensees therefore may
adversely affect the Company's marketing of PROVIGIL (modafinil) in its
territories.
Shareholder Litigation
The Company and certain of its officers have been named as defendants in
a number of civil actions filed in the U.S. District Court for the Eastern
District of Pennsylvania, which have been consolidated. Several of the
plaintiffs have been designated by the Court, collectively, as the "lead
plaintiff" for purposes of the Private Securities Litigation Reform Act of 1995.
The consolidated complaint, filed in October 1996 by the lead plaintiffs,
extended and expanded the class period to include purchasers of the Company's
securities as well as options to purchase or sell those securities during the
period between June 12, 1995 and June 7, 1996. The plaintiffs allege, based in
part on statements and opinions expressed at a June 1996 meeting of an FDA
advisory committee to review the MYOTROPHIN treatment investigation new drug
application, that earlier statements by the Company about the North American and
European trial results were misleading. The plaintiffs seek unspecified damages
and other relief. The Company's motion to dismiss the case is pending, and
discovery related to the merits of the allegation in the complaint has been
postponed until the motion is decided, which may occur later in 1997. The
Company intends to vigorously defend the action. However, management believes
that it is too early in the proceedings to determine with any certainty the
outcome of this action or the potential liability of the Company, if any.
Other Risks
The results of clinical studies of product candidates under development
by the Company which are conducted by collaborators of the Company, including
studies of rhIGF-I being conducted by the Company's licensee in Japan and
clinical studies of modafinil being conducted by Lafon and its licensees in
other countries, are required to be reported by the Company to the FDA and other
regulatory authorities. The reporting of the results of these other studies, if
negative, could adversely affect the regulatory review of the Company's product
approval applications
11
for the same product candidates. Negative results from trials by third parties
or negative assessments from regulatory authorities would materially adversely
affect the Company's business and the price of its common stock.
Even if MYOTROPHIN (rhIGF-I) and PROVIGIL (modafinil) are approved for
commercialization, the Company cannot predict at this time the potential
revenues to be received from sales of MYOTROPHIN (rhIGF-I) for use in treating
ALS or from sales of PROVIGIL (modafinil) for use in connection with narcolepsy.
ALS and narcolepsy each qualify as orphan diseases under the Orphan Drug Law,
which generally means that the potential patient population for each indication
is limited. Rilutek(R) (riluzole) has been commercialized in the United States
and Europe by Rhone-Poulenc Rorer, Inc. for use in treating ALS. It is not clear
whether ALS patients, given the constraints of drug reimbursement programs,
would be able to support both Rilutek and MYOTROPHIN (rhIGF-I) (as well as any
other drugs which may be approved in the future for use in treating ALS),
especially if MYOTROPHIN (rhIGF-I) has a higher price than competitive drugs.
Competition for PROVIGIL (modafinil) also is likely, because narcolepsy is
currently treated with several drugs, all of which are available generically and
have been available for a number of years.
TAP Holdings Inc. ("TAP") has begun a Phase I clinical study of a
compound being developed in collaboration with the Company for the treatment of
various cancers, including prostate cancer. The objective of the multi-center
study is to examine the drug's pharmacokinetic and safety profile in patients
with advanced cancer. Because the compound has not been extensively tested in
humans, the risk of safety problems is unknown. There can be no assurance that
the compound will prove to be safe in humans, or that it will show any
therapeutic benefit.
The Company's business is subject to additional significant risks
including, but not limited to, the need to obtain additional funds to support
its research, development and commercialization efforts, the Company's
dependence on collaborative partners and third-party suppliers, the Company's
relative inexperience in marketing and distributing commercial products,
uncertainties associated with obtaining and enforcing its patents and
uncertainties associated with the patent rights of others, uncertainties
regarding government reforms, product pricing and reimbursement levels,
technological change and competition from companies and institutions developing
products for the same indications as the Company's product candidates, the
product liability risks associated with being the manufacturer or seller of
pharmaceutical products, the outcome of any current or potential litigation, and
reliance by the Company on key personnel.
The market price for shares of the Company's common stock has
historically been highly volatile. Future negative announcements concerning the
Company, its competitors or other companies in the biopharmaceutical industry,
including the results of testing and clinical trials, regulatory hearings and
decisions, technological innovations or commercial products, patents, government
regulations, developments concerning proprietary rights, litigation or public
concern as to the safety or commercial value of the Company's products may have
a material adverse effect on the market price of the Company's common stock.
The major source of the Company's current revenue is derived from
collaborative research and development agreements that are subject to periodic
review by the respective third parties and achievement of certain milestones by
the Company. There can be no assurance that any of the collaborations will
continue in the future.
The Company expects to satisfy its need for additional operating funds
through public or private placements of its securities. Any such financings
using either equity securities or options, warrants or convertible debt to
acquire equity securities of the Company would result in the issuance of
additional shares and in the reduction of the percentage ownership of the
Company by existing shareholders. The exercise of outstanding options, warrants,
or conversion of the convertible notes into shares would also result in such a
reduction. At June 30, 1997, the exercise of the outstanding options, warrants
and conversion of the convertible notes into shares in accordance with their
terms would increase the outstanding number of shares of common stock by
approximately 37%. Of this amount, 23%, or approximately 5,900,000 shares, which
includes the 3,040,000 shares reserved for conversion of the convertible
notes, are exercisable at prices at or below $11.50, the closing market price of
the Company's common stock at June 30, 1997.
12
Liquidity and Capital Resources
Cash, cash equivalents, reverse repurchase agreements and investments at
June 30, 1997 and December 31, 1996 were $145,530,000 and $146,848,000,
respectively, representing 81% and 83%, respectively, of total assets.
Cash equivalents, reverse repurchase agreements and investments
consisted primarily of short- to intermediate-term obligations of the United
States government, overnight reverse repurchase agreements that are
collateralized 102% by such government obligations, and short- to intermediate-
term corporate obligations. Certain of the Company's lease agreements contain
covenants that obligate the Company to maintain certain minimum cash and
investment balances.
The following is a summary of selected cash flow information for the six
months ended June 30:
1997 1996
---- ----
Net cash used for operating activities........... $(29,057,000) $(27,650,000)
Net cash provided by investing activities........ 6,987,000 21,355,000
Net cash provided by financing activities........ 28,039,000 5,857,000
Net cash used for operating activities
--Operating cash inflows
A summary of the major sources of cash receipts reflected in net cash
used for operating activities for the six months ended June 30 is as follows:
1997 1996
---- ----
TAP Holdings........................... $3,382,000 $2,742,000
Bristol-Myers Squibb................... 1,560,000 2,032,000
Chiron................................. 2,614,000 3,747,000
Schering-Plough........................ 88,000 1,500,000
SmithKline Beecham..................... 1,513,000 1,423,000
Kyowa Hakko............................ 1,487,000 442,000
Interest............................... 4,005,000 3,797,000
In January 1997, the Company announced that Schering-Plough Corporation
("SP") had decided to conclude its funding of the research program with the
Company. The last payment of $88,000 was received in March 1997.
In July 1993, the Company entered into an agreement (the "Kyowa Hakko
Myotrophin Agreement") with Kyowa Hakko Kogyo Co., Ltd. ("Kyowa Hakko") to
develop and market MYOTROPHIN (rhIGF-I) in Japan. The Company is reimbursed for
supplying MYOTROPHIN (rhIGF-I) for the clinical trials conducted in Japan by
Kyowa Hakko. Included in the payments received from Kyowa Hakko in the first
half of 1997 is a non-recurring $900,000 milestone payment that was paid upon
the Company's filing of the MYOTROPHIN (rhIGF-I) NDA in the United States.
--Operating cash outflows
Net cash used for selling, general and administrative activities
increased in the first six months of 1997 as compared to the 1996 period due to
increased funding of the Company's sales and marketing activities, including
increases in pre-marketing efforts in support of the products in development, a
53% increase in sales and marketing staffing levels and increases in
administrative external costs. The funding of research and development decreased
in the 1997 period as compared to the 1996 period primarily due to the reduction
in clinical trial expenses, including cost reductions due to the November 1996
sale of the Company's Beltsville, Maryland pilot-scale manufacturing facility
and the completion of certain clinical studies.
13
--Operating cash outlook
The Company expects its cash flow from operating activities to continue
to be negative until such time as product approvals, if any, are obtained and
revenue received from product sales exceeds funding of operating costs.
The major source of the Company's current cash inflows is derived from
collaborative research and development agreements. In future periods, receipt
of payments from Chiron or payments by the Company to Chiron will depend on the
relative costs incurred in the MYOTROPHIN program by the two companies. The
continuation of the research funding under the agreements with TAP and SB,
during 1997 and thereafter, are subject to the achievement of certain
development milestones and periodic review by those companies and may be
terminated without cause with prior notice. The Company expects to receive
annual payments from BMS in 1997 comparable to the annual amount received in
1996. However, the level of payments is subject to a number of uncertainties
related to product sales including competition from new and existing products
and a pending proposal for controlled substance classification of one of the
products being co-promoted by the Company.
The Company expects to continue to expend significant funds on both
MYOTROPHIN (rhIGF-I) and PROVIGIL (modafinil) to prepare for possible
commercialization of those products, including to build inventories, and to
investigate the utility of those products in other indications. The level of
expenditures will depend, in part, upon the Company's assessment of the
likelihood of obtaining approval to market those products. The Company intends
to continue to provide funding for its other research and development programs.
The amount of capital needed to fund operations will depend upon many factors,
including the success of the Company's research and development programs, the
availability of funding, the extent of any collaborative research arrangements,
the costs and timing of seeking regulatory approvals of its products,
technological changes, competition and the success of the Company's sales and
marketing activities.
Net cash provided by investing activities
A summary of net cash provided by investing activities for the six
months ended June 30 is as follows:
1997 1996
---- ----
Purchases of property and equipment................ $(1,043,000) $(1,074,000)
Sale leaseback of property and equipment........... 743,000 --
Sales and maturities of investments, net........... 7,287,000 22,429,000
--------- ----------
Net cash provided by investing activities.. $6,987,000 $21,355,000
========== ===========
Sales and maturities of investments, net represent the liquidation of a
portion of the Company's portfolio of investments, the proceeds of which are
used primarily to fund operations.
Net cash provided by financing activities
A summary of cash provided by financing activities for the six months
ended June 30 is as follows:
1997 1996
---- ----
Proceeds from exercises of common
stock options and warrants.................................. $2,535,000 $7,402,000
Proceeds from the issuance of long-term debt.................. 30,000,000 400,000
Principal payments on long-term debt.......................... (4,496,000) (1,945,000)
---------- ---------
Net cash provided by financing activities............. $28,039,000 $5,857,000
=========== ==========
The extent and timing of future warrant and option exercises, if any,
are primarily dependent upon the market price of the Company's common stock and
general financial market conditions, as well as the exercise prices and
expiration dates of the warrants and options.
14
In April 1997, the Company completed a $30,000,000 private placement of
senior convertible notes (the "Notes"), which mature in April 1998 and bear
interest, payable quarterly in cash or common stock, at a rate of seven percent
per annum. The Notes have been recorded at their face value and are convertible
into registered common shares of the Company, subject to certain limitations, at
a six percent discount to a market price formula at the time of conversion. The
Company has limited the number of shares authorized for conversion to 3,040,000.
If based upon the market price from time to time, a greater number of shares is
required to enable full conversion, the Company either must authorize a greater
number of shares or must redeem the inconvertible portion of the Notes for cash.
The Company has a right to redeem the Notes at a redemption price equal to 110
percent of the outstanding principal amount plus interest, if the conversion
price falls below approximately $21 per share. If not converted into common
stock or redeemed, the outstanding, unconverted notes plus accrued interest will
be exchanged at face value at maturity for an equal dollar amount of debentures
bearing interest at a rate of 10 3/4% per annum and maturing in 2013.
Proceeds from long-term debt in 1996 represent additional borrowings
provided by the Commonwealth of Pennsylvania in connection with the 1995 West
Chester building purchase.
In March 1997, the Company repaid in full the $3,750,000 balance due on
the unsecured bank loan.
Commitments and contingencies
--Related Party
Cephalon Clinical Partners, L.P. (the "Partnership") granted the Company
an exclusive license (the "Interim License") to manufacture and market
MYOTROPHIN (rhIGF-I) within the United States, Canada and Europe (the
"Territory") in return for certain royalty payments and a payment of
approximately $16,000,000 (the "Milestone Payment") that is to be made if
MYOTROPHIN (rhIGF-I) receives regulatory approval in the United States or
certain other countries within the Territory. The Company has the option to pay
the Milestone Payment in cash, common stock, or a combination thereof.
The Company has a contractual option to purchase all of the limited
partnership interests in the Partnership (the "Purchase Option") in specified
circumstances following the initiation of commercial sales, if any, of
MYOTROPHIN (rhIGF-I). To exercise the Purchase Option, Cephalon is required to
make an advance payment of $40,275,000 in cash or, at Cephalon's election,
$42,369,000 in shares of the Company's common stock, valued at the market price
at the time the Purchase Option is exercised. In addition to the advance
payment, the exercise of the Purchase Option requires the Company to make future
royalty payments to the former limited partners for a period of eleven years
after exercise at a royalty rate of 10.1% (subject to reduction under certain
circumstances) of MYOTROPHIN sales in the Territory. If the Company does not
exercise the Purchase Option prior to its expiration date the Interim License
will terminate and all development and marketing rights to MYOTROPHIN (rhIGF-I)
in the Territory would revert to the Partnership, which may commercialize
MYOTROPHIN (rhIGF-I) itself or license or assign its rights to a third party.
The Company would not receive any benefits from any such commercialization.
The Company's collaboration with Chiron is subject to the rights of the
Partnership, which licensed to the Company the right to develop MYOTROPHIN
(rhIGF-I) in North America and Europe in return for receiving certain payments.
The Company is solely responsible for making any such royalty and milestone
payments owed to the Partnership and is responsible for funding the Purchase
Option if it exercises the option.
--Shareholder Litigation
The Company and certain of its officers have been named as defendants in
a number of civil actions, which have been consolidated, alleging that various
statements by the Company about the North American and European trial results of
MYOTROPHIN were misleading. See "Certain Risks Related to the Company's
Business."
15
Funding Requirements Outlook
As described above, the Company expects to continue to use cash to fund
operations. Although the Company has the option to pay the Milestone Payment and
the Purchase Option in common stock, a significant use of funds would be
required if the Company were to decide to fund these payments in cash. The
Company also requires cash for the funding of purchases of property and
equipment and to service its long-term debt. The Company expects to continue to
fund operations using its current cash balance and through the sale of
investments. The Company believes that its cash and investment balance is
adequate to fund its present level of operations for a period in excess of one
year.
The Company will be required to raise significant additional funds to
finance its continuing operations and other potential significant cash outflows.
The vehicles used to raise funds may take a variety of forms, including
public or private placement of its equity securities, forming corporate
collaborations, or "off-balance sheet" financings through limited partnerships
or corporations. There can be no assurance that the Company will be successful
in its attempts to raise additional funds. If the Company is unable to raise
sufficient additional funds, the Company will have to reduce costs.
Results of Operations
This section should be read in conjunction with the more detailed
discussion under "Liquidity and Capital Resources."
A summary of revenues and expenses for the six months ended June 30 is
as follows:
% change
1997 1996 1997 vs. 1996
---- ---- -------------
Revenues............................................ $9,517,000 $7,788,000 22%
Research and development expenses................... 27,746,000 30,540,000 (9)
Selling, general and administrative expenses........ 18,530,000 11,763,000 58
Interest income, net................................ 2,557,000 2,677,000 (4)
The increase in revenues in the 1997 period from the 1996 period
resulted primarily from revenue recognized under the Chiron collaboration and
the TAP Agreement, which was partially offset by a decrease in revenue from SP.
Research and development expenses decreased in the 1997 period as
compared to the 1996 period primarily due to the reduction in clinical trial
expenses, including cost reductions due to the November 1996 sale of the
Company's Beltsville, Maryland pilot-scale manufacturing facility and the
completion of certain clinical studies. The decrease was partially offset by an
increase in expenditures due to the purchase of bulk modafinil compound.
The increase in the selling, general and administrative area in the 1997
period as compared to the 1996 period was due to increases in costs associated
with the Company's sales and marketing activities, including increases in pre-
marketing efforts in support of the products in development and a 53% increase
in sales and marketing staffing levels and increases in administrative external
costs.
16
Results of Operations Outlook
The Company expects to incur a net operating loss in 1997. The Company
expects to continue to incur operating losses unless and until such time as
product approvals, if any, are obtained and product sales exceed operating
expenses.
Revenue or expense to be recognized by the Company under the
collaboration with Chiron will depend on the relative costs incurred by the two
companies. A substantial portion of the Company's revenues are expected to
continue to be derived from collaboration agreements with TAP and SB, the
continuation of which is subject to periodic review and achievement of certain
milestones. Revenues to be recognized in the remainder of 1997 under the
agreements with TAP and SB are currently expected to approximate 1996 levels for
the same period. The level of revenue to be recognized under the BMS Agreement
in 1997 is expected to approximate 1996 levels, but is dependent upon the
success of marketing the co-promotion products. The April 1997 milestone payment
from Kyowa Hakko is a non-recurring source of revenue.
The Company expects that it will continue to incur significant research,
development, clinical trial, regulatory filing and other costs. In addition,
selling, general and administrative activities in the United States and Europe
may be expanded as the Company evaluates the potential for obtaining regulatory
approvals of MYOTROPHIN (rhIGF-I) and PROVIGIL (modafinil). The Company may also
continue to incur substantial expenses to build inventories of MYOTROPHIN
(rhIGF-I) and PROVIGIL (modafinil).
The Company expects to have significant fluctuations in quarterly
results based on the level and timing of recognition of contract revenues and
the incurrence of expenses. Additionally, if the Company were to make the
Milestone Payment or exercise the Purchase Option, a material charge to earnings
could result, depending upon the development status of the underlying
technology.
The Company does not believe that inflation has had a material impact on
the results of its operations since inception.
17
PART II - OTHER INFORMATION
- ---------------------------
Item 4. Submission of Matters to a Vote of Security-Holders:
The following was voted upon at the annual meeting of stockholders of Cephalon,
Inc., held in Frazer, Pennsylvania on May 14, 1997:
I. On the election of the following persons as directors:
NUMBER OF VOTES
------------------------------
FOR WITHHELD
--- --------
Dr. Frank Baldino, Jr. 20,040,982 317,241
William P. Egan 20,046,725 311,498
Dr. Robert J. Feeney 20,046,225 311,998
Martyn D. Greenacre 20,045,485 312,738
Kevin E. Moley 20,046,695 311,528
Bruce A. Peacock 19,961,542 396,681
Dr. Horst Witzel 20,046,345 311,878
II. To approve the amendment of the Company's Equity Compensation Program to
increase the number of shares of common stock subject to the annual grants
awarded under the plan from 2,000,000 to 3,500,000:
NUMBER OF VOTES
-----------------------------------------
FOR AGAINST ABSTAIN
--- ------- -------
10,902,884 5,975,742 46,024
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits:
None
(b) Reports on Form 8-K:
During the quarter ended June 30, 1997, the Registrant
filed Current Reports on Form 8-K for the following events:
(i) April 8, 1997, Cephalon, Inc. announced that it
had completed its $30 million private placement of senior convertible notes,
under the terms of a previously-announced agreement.
(ii) April 9, 1997, Cephalon, Inc. announced that it
had entered into an arrangement with a financial institution under which
Cephalon intends to purchase call options representing the right to acquire up
to 2.5 million shares of its own common stock.
(iii) May 7, 1977, Cephalon, Inc. announced that it had
confirmed the terms of its previously-announced arrangement for the purchase of
capped call options with respect to shares of its common stock.
(iv) May 8, 1997, Cephalon, Inc. announced that the
Peripheral and Central Nervous System Drugs Advisory Committee of the U.S. Food
and Drug Administration had found, by a vote of 6 to 3, that there was not
substantial evidence that MYOTROPHIN(R) (rhIGF-I or mecasermin) Injection is
effective in the treatment of amyotrophic lateral sclerosis (ALS or Lou Gehrig's
disease).
18
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
CEPHALON, INC.
(Registrant)
August 14, 1997 By /s/ Frank Baldino, Jr., Ph.D.
---------------------------------
Frank Baldino, Jr., Ph.D.
President, Chief Executive Officer
and Director
(Principal executive officer)
By /s/ J. Kevin Buchi
---------------------------------
J. Kevin Buchi
Senior Vice President, Finance and Chief
Financial Officer
(Principal financial and accounting officer)
19