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 September 30, 1997
--------------------
[_] Transition Report Pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934
For the Transition Period from ______________ to _______________
Commission File Number 0-19119
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CEPHALON, INC.
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(Exact Name of Registrant as Specified in its Charter)
Delaware 23-2484489
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(State Other Jurisdiction of Incorporation or (I.R.S. Employer
Organization) Identification Number)
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
- --------------------------------------------------------------------------------
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 November 10, 1997
---------------------------- -----------------------------------
Common Stock, par value $.01 27,032,081 Shares
This Report Includes a Total of 20 Pages
CEPHALON, INC. and SUBSIDIARIES
-------------------------------
INDEX
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Page No.
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PART I - FINANCIAL INFORMATION
Item 1. Financial Statements
Consolidated Balance Sheets - 3
September 30, 1997 and December 31, 1996
Consolidated Statements of Operations - 4
Three and nine months ended September 30, 1997 and 1996
Consolidated Statements of Cash Flows - 5
Nine months ended September 30, 1997 and 1996
Notes to Consolidated Financial Statements 6 - 8
Item 2. Management's Discussion and Analysis of 9 - 18
Financial Condition and Results of Operations
PART II - OTHER INFORMATION
Item 6. Exhibits and Reports on Form 8-K 19
SIGNATURES 20
CEPHALON, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
---------------------------
(Unaudited)
September 30, December 31,
1997 1996
---------------- ----------------
ASSETS
------
CURRENT ASSETS:
Cash and cash equivalents $ 15,003,000 $ 5,671,000
Reverse repurchase agreements 30,636,000 5,207,000
Short-term investments 86,995,000 135,970,000
Other 7,353,000 7,696,000
------------ ------------
Total current assets 139,987,000 154,544,000
PROPERTY AND EQUIPMENT, net of accumulated
depreciation and amortization of $10,560,000 and $8,852,000 22,010,000 22,086,000
OTHER 2,973,000 1,261,000
------------ ------------
$164,970,000 $177,891,000
============ ============
LIABILITIES AND STOCKHOLDERS' EQUITY
------------------------------------
CURRENT LIABILITIES:
Accounts payable $ 1,561,000 $ 1,638,000
Accrued liabilities 16,760,000 14,786,000
Current portion of long-term debt 1,730,000 5,164,000
------------- -------------
Total current liabilities 20,051,000 21,588,000
LONG-TERM DEBT (Note 2) 41,626,000 16,974,000
OTHER 2,363,000 2,003,000
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Total liabilities 64,040,000 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, $.01 par value, 100,000,000 shares authorized,
25,878,605 and 24,618,223 shares issued and outstanding 259,000 246,000
Additional paid-in capital 304,999,000 295,047,000
Accumulated deficit (204,328,000) (157,967,000)
------------- -------------
Total stockholders' equity 100,930,000 137,326,000
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$ 164,970,000 $ 177,891,000
============= =============
The accompanying notes are an integral part of these financial statements.
3
CEPHALON, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
-------------------------------------
(Unaudited)
Three Months Ended, Nine Months Ended
September 30, September 30,
--------------------------------- ----------------------------------
1997 1996 1997 1996
--------------- ------------- --------------- --------------
CONTRACT REVENUES: $ 4,599,000 $ 3,619,000 $ 14,116,000 $ 11,407,000
OPERATING EXPENSES:
Research and development 10,111,000 15,161,000 37,857,000 45,701,000
Selling, general and administrative 7,607,000 6,765,000 26,137,000 18,528,000
------------ ------------ ------------ ------------
17,718,000 21,926,000 63,994,000 64,229,000
LOSS FROM OPERATIONS (13,119,000) (18,307,000) (49,878,000) (52,822,000)
INTEREST:
Income 1,932,000 2,304,000 5,992,000 6,168,000
Expense (972,000) (558,000) (2,475,000) (1,745,000)
------------ ------------ ------------ ------------
960,000 1,746,000 3,517,000 4,423,000
------------ ------------ ------------ ------------
LOSS $(12,159,000) $(16,561,000) $(46,361,000) $(48,399,000)
============ ============ ============ ============
LOSS PER SHARE (Note 1) $(0.47) $(0.68) $(1.84) $(2.00)
============ ============ ============ ============
WEIGHTED AVERAGE NUMBER
OF SHARES OUTSTANDING 25,742,380 24,437,777 25,193,900 24,248,996
============ ============ ============ ============
The accompanying notes are an integral part of these financial statements.
4
CEPHALON, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
-------------------------------------
(Unaudited)
Nine Months Ended
September 30,
-----------------------------------------------
1997 1996
------------------ -----------------
CASH FLOWS FROM OPERATING ACTIVITIES:
Loss $(46,361,000) $(48,399,000)
Adjustments to reconcile loss to net cash
used for operating activities:
Depreciation and amortization 1,708,000 2,889,000
Non-cash compensation expense 2,311,000 1,693,000
(Increase) decrease in operating assets:
Other current assets 330,000 3,639,000
Other long-term assets (1,627,000) (102,000)
Increase(decrease) in operating liabilities:
Accounts payable (77,000) (2,321,000)
Accrued liabilities 1,926,000 2,773,000
Other long-term liabilities 360,000 565,000
------------ ------------
Net cash used for operating activities (41,430,000) (39,263,000)
------------ ------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of property and equipment (507,000) (1,588,000)
Sales and maturities of investments, net 23,545,000 34,811,000
------------ ------------
Net cash provided by investing activities 23,038,000 33,223,000
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CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from exercises of common stock options and warrants 2,631,000 8,231,000
Proceeds from issuance of long-term debt 30,000,000 2,079,000
Principal payments on long-term debt (4,907,000) (2,829,000)
------------ ------------
Net cash provided by financing activities 27,724,000 7,481,000
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NET INCREASE IN CASH AND CASH EQUIVALENTS 9,332,000 1,441,000
CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD 5,671,000 6,565,000
------------ ------------
CASH AND CASH EQUIVALENTS, END OF PERIOD $ 15,003,000 $ 8,006,000
============ ============
The accompanying notes are an integral part of these financial statements.
5
CEPHALON, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
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 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, particularly MYOTROPHIN
(rhIGF-I) and PROVIGIL (modafinil). There can be no assurance that any such
approvals will be obtained.
Basis of presentation
These consolidated financial statements of Cephalon are unaudited and
include all adjustments which, in the opinion of management, are necessary to
present fairly the financial condition and results of operations of the Company
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.
Loss per share
Loss per share is computed using the weighted average number of common
shares outstanding during the period. Common stock equivalents including 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 is intended 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 full fiscal year
ending December 31, 1997; earlier 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
currently calculated under APB Opinion No. 15.
6
CEPHALON, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (Continued)
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 were 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 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.
As of September 30, 1997, $5,000,000 in principal of the Notes had been
converted into 557,000 shares of common stock. The Company has limited the
number of shares authorized which remain available for conversion to 2,483,000.
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.
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
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 (rhIGF-I) 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 the payments described above.
The Company is solely responsible for making any royalty and milestone payments
owed to the Partnership and for funding the Purchase Option, if it elects to
exercise the option.
7
CEPHALON, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
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 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. A judgement adverse to the Company could, under some theories
of damages, result in an assessment which materially exceeds the coverage
provided by the Company's directors' and officers' liability insurance. The
Company's motion to dismiss the case was denied, and discovery has commenced and
is expected to continue through 1998. Based on presently available information,
management believes that is has meritorious defenses to the claims and intends
to vigorously defend the action. 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, which were
exercisable by the Company on the expiration date of October 31, 1997 at a price
of $21.50 per share, expired unexercised.
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 April 1997 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, particularly MYOTROPHIN
(rhIGF-I) and Provigil (modafinil). Cephalon has had only limited experience in
pursuing the applications necessary to gain such approvals. There can be no
assurance that applications by the Company to market products will be reviewed
in a timely manner or that such applications will be approved by the appropriate
regulatory authorities on the basis of the data contained in the applications.
Should approval be granted to market a product, there can be no assurance that
the Company will be able to successfully commercialize the product or achieve a
profitable level of sales.
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 decisions, particularly
regulatory decisions concerning MYOTROPHIN (rhIGF-I) and Provigil (modafinil),
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.
Uncertainties Related to MYOTROPHIN(R) (rhIGF-I)
In February 1997, the Company, in collaboration with Chiron Corporation
("Chiron"), filed a new drug application ("NDA") containing data from two Phase
III studies, one conducted in North America and one in Europe, 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. Under the Presription Drug User Fee Act, which establishes
performance goals for FDA reviews of new product applications, the FDA's review
of the NDA was expected to be completed by November 11, 1997. On November 11,
1997, the Company and Chiron withdrew and resubmitted the NDA to the FDA to
enable the FDA to continue its review of additional information previously
submitted by the companies. The Company has been advised that the FDA will
complete its review of the data and reach a decision on the NDA promptly. There
can be no assurance that 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 in the
process of responding to
9
questions from member states on the MAA, including questions related to the
safety and efficacy data from the two Phase III studies. The questions need to
be answered to the satisfaction of the regulatory authorities in order for the
application to be approved. 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 Phase II
studies in other indications, and to patients under the ongoing treatment
investigational new drug ("T-IND") program. The reporting of patient deaths as
adverse events could result in regulatory action adverse to the interests of the
Company.
There can be no assurance that 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 data could be obtained from any ongoing
studies. Even if the Company and Chiron would be willing or able to conduct any
additional study as a pre-approval activity, there can be no assurance that the
results of any such study would be positive. A new study would be expensive and
would take several years to complete.
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). 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.
The Company is evaluating MYOTROPHIN (rhIGF-I) for use in treating
disorders other than ALS. Preliminary clinical studies have been completed in
diabetic neuropathy and post-polio syndrome, and studies are underway evaluating
the use of MYOTROPHIN (rhIGF-I) in small fiber neuropathy and multiple
sclerosis. The results of these studies and studies conducted by others will be
considered in determining whether any of these indications should be further
evaluated in Phase III studies. A study intended to evaluate the use of
MYOTROPHIN (rhIGF-I) in chemotherapy-induced neuropathy is being re-assessed to
determine if challenges in enrolling patients can be resolved to allow the study
to resume. There can be no assurance that MYOTROPHIN (rhIGF-I) will demonstrate
efficacy or prove to be commercially viable in any other indication.
10
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.
In addition to the United States, the Company has licensed from Laboratoire L.
Lafon ("Lafon") the exclusive rights to develop, market, and sell PROVIGIL
(modafinil) in the United Kingdom, the Republic of Ireland and certain other
territories. On October 20, 1997, the Company's U.K. subsidiary received
approval to market PROVIGIL (modafinil) in the United Kingdom from the Medicines
Control Agency ("MCA"). Cephalon intends to manufacture PROVIGIL (modafinil)
tablets in the United States and launch the drug in the United Kingdom upon MCA
approval of the variations pertaining to these manufacturing arrangements. The
Company also is pursuing a marketing application in the Republic of Ireland.
There can be no assurance that regulatory approvals or variations to the
approvals received 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. There can be no assurance that the
product can be launched within the contractually specified time limit.
The FDA and the Drug Enforcement Administration ("DEA") will review data
related to the actual or potential abuse profile of PROVIGIL (modafinil), for
classification of PROVIGIL (modafinil) as a controlled substance under the
Controlled Substances Act (the "CSA"). The Company expects that PROVIGIL
(modafinil) will be classified as a controlled substance under 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 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. The DEA process must be
completed before commercialization could begin. Classification of PROVIGIL
(modafinil) as a controlled substance in the United States may affect regulatory
decisions with respect to similar classifications in other territories licensed
by the Company from Lafon.
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. The tablets and one of the raw
materials used as an excipient in the finished product are obtained through
companies who are believed to be the only available source of the materials. It
is unlikely that the Company will be able to identify a suitable alternative
supplier for the tablets or the excipient without changing the formulation of
the tablets, which would require regulatory approval and could delay or
interrupt 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
11
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 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. A judgment adverse to the Company could, under some theories
of damages, result in an assessment which materially exceeds the coverage
provided by the Company's directors' and officers' liability insurance. The
Company's motion to dismiss the case was denied, and discovery has commenced and
is expected to continue through 1998. Based on presently available information,
management believes that is has meritorious defenses to the claims and intends
to vigorously defend the action. 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 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 still being evaluated. There can be no assurance
that the compound ultimately 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
12
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 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. The Company's research funding agreement with SmithKline Beecham
plc ("SB") is currently being reviewed by SB and there can be no assurance that
SB will continue the funding arrangement beyond 1997. There can be no assurance
that any of the other collaborations will continue in the future.
To meet its capital requirements, the Company may from time to time seek to
access public or private financing markets by issuing debt, common or preferred
stock, warrants or other securities, either separately or in combination. The
Company may also seek additional funding through corporate collaborations or
other financing vehicles, potentially including "off-balance sheet" financing
through limited partnerships or corporations. There can be no assurance that
such financings will be available at all or on terms acceptable to the Company.
Any financings using either common stock or securities convertible into common
stock would result in the issuance of additional shares and in the reduction of
the percentage ownership of the Company by existing shareholders. At September
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 33%. Of this
amount, 21%, or approximately 5,400,000 shares, which includes the 2,483,000
shares reserved for conversion of the convertible notes, are exercisable at
prices at or below $11.75, the closing market price of the Company's common
stock at September 30, 1997.
Liquidity and Capital Resources
Cash, cash equivalents, reverse repurchase agreements and investments at
September 30, 1997 and December 31, 1996 were $132,634,000 and $146,848,000,
respectively, representing 80% 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 nine
months ended September 30:
1997 1996
---- ----
Net cash used for operating activities................ $(41,430,000) $(39,263,000)
Net cash provided by investing activities............. 23,038,000 33,223,000
Net cash provided by financing activities............. 27,724,000 7,481,000
13
Net cash used for operating activities
--Operating cash inflows
The major source of the Company's current cash inflows is derived from
collaborative research and development agreements. A summary of the major
sources of cash receipts reflected in net cash used for operating activities for
the nine months ended September 30 is as follows:
1997 1996
---- ----
TAP Holdings..................... $5,068,000 $4,365,000
Bristol-Myers Squibb............. 3,352,000 3,557,000
Chiron........................... 5,242,000 3,747,000
Schering-Plough.................. 88,000 2,250,000
SmithKline Beecham............... 2,297,000 2,138,000
Kyowa Hakko...................... 1,631,000 1,668,000
Interest......................... 6,307,000 6,719,000
The Company and Chiron are jointly developing MYOTROPHIN (rhIGF-I) for the
treatment of ALS and certain peripheral neuropathies. Under the collaboration,
the companies equally fund MYOTROPHIN (rhIGF-I) program costs. The payments
received from Chiron in 1997 represent equalization of fourth quarter 1996,
first quarter 1997 and second quarter 1997 program costs. The payments received
from Chiron in 1996 represent equalization of fourth quarter 1995 and first
quarter 1996 program costs.
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 payments received from
Kyowa Hakko primarily represent reimbursement of MYOTROPHIN (rhIGF-I) supplies
for the clinical trials conducted in Japan by Kyowa Hakko. Also included in the
payments received from Kyowa Hakko in 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
Cash used for selling, general and administrative activities increased in
the first nine 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 products in development 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. The decrease was partially
offset by the cost of purchasing bulk modafinil compound.
--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 agreement with TAP, during 1997
and thereafter, is subject to the achievement of certain development milestones
and periodic review by TAP and may be terminated without cause
14
with prior notice. SB is currently reviewing the research funding agreement with
the Company and there can be no assurance that SB will continue the funding
arrangement beyond 1997. The level of potential co-promotion payments from
Bristol-Myers Squibb Company ("BMS") during the remainder of 1997 and into 1998
is subject to a number of uncertainties related to product sales, including
competition from new and existing products and the introduction of 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 nine months
ended September 30 is as follows:
1997 1996
---- ----
Purchases of property and equipment............................ $ (507,000) $(1,588,000)
Sales and maturities of investments, net....................... 23,545,000 34,811,000
----------- -----------
Net cash provided by investing activities.................... $23,038,000 $33,223,000
=========== ===========
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 nine months ended
September 30 is as follows:
1997 1996
---- ----
Proceeds from exercises of common stock options and warrants............ $ 2,631,000 $ 8,231,000
Proceeds from the issuance of long-term debt............................ 30,000,000 2,079,000
Principal payments on long-term debt.................................... (4,907,000) (2,829,000)
----------- -----------
Net cash provided by financing activities............................. $27,724,000 $ 7,481,000
=========== ===========
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.
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 were 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. As of September
30, 1997, $5,000,000 in principal of the Notes had been converted into 557,000
shares of common stock. Subsequent to September 30, 1997, $11,204,000 in
principal of the Notes was converted into 1,114,000 shares of common stock
resulting in 1,369,000 shares authorized for conversion at November 6, 1997. 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.
15
Proceeds from the issuance of 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 an
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
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 (rhIGF-I) 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 the payments,
described above. The Company is solely responsible for making any royalty and
milestone payments owed to the Partnership and for funding the Purchase Option,
if it elects to exercise 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 (rhIGF-I) were misleading. See "Certain Risks Related to the
Company's Business."
Funding Requirements Outlook
As described above, the Company expects to continue to use cash to fund
operations. 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.
To finance its continuing operations and other potential significant cash
outflows, the Company may from time to time seek to access public or private
financing markets by issuing debt, common or preferred stock, warrant or other
securities, either separately or in combination. The Company also may seek
additional funding through
16
corporate collaborations or other financing vehicles, potentially including
"off-balance sheet" financing through limited partnerships or corporations.
There can be no assurance that such funding will be available at all or on terms
acceptable to the Company.
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 nine months ended September 30 is
as follows:
% change
1997 1996 1997 vs. 1996
---- ---- --------------
Revenues........................................ $14,116,000 $11,407,000 24%
Research and development expenses............... 37,857,000 45,701,000 (17)
Selling, general and administrative expenses.... 26,137,000 18,528,000 41
Interest income, net............................ 3,517,000 4,423,000 (20)
The increase in revenues for the nine months ended September 30, 1997 as
compared to the corresponding 1996 period resulted primarily from increases in
revenue recognized under the Chiron collaboration, the Kyowa Hakko Myotrophin
Agreement and the TAP Agreement, and revenue recognized from the initiation of a
co-promotion agreement with Medtronic, Inc. The increases in revenues were
partially offset by a decrease in revenue from SP.
Research and development expenses decreased for the nine months ended
September 30, 1997 as compared to the corresponding 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 and an increase in expenditures in the Company's
research programs.
The increase in the selling, general and administrative area for the nine
months ended September 30, 1997 as compared to the corresponding 1996 period was
due primarily to increases in costs associated with the Company's U.S. and
European sales and marketing activities including increases in pre-marketing
efforts in support of the products in development and increases in external
administrative costs.
Results for the three months ended September 30, 1997 as compared to the
corresponding 1996 period were similarly affected by the items discussed above
in the nine months comparison.
17
Results of Operations Outlook
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.
The major source of the Company's current revenue is derived from
collaborative research and development agreements. In future periods, revenue
or expense to be recognized by the Company under the collaboration with Chiron
will depend on the relative costs incurred in the MYOTROPHIN program by the two
companies. A substantial portion of the Company's revenues are derived from
collaboration agreements with TAP and SB. The continuation of the research
funding under the agreement with TAP during 1997 and thereafter, is subject to
the achievement of certain development milestones and periodic review by TAP and
may be terminated without cause with prior notice. SB is currently reviewing the
research funding agreement with the Company and there can be no assurance that
SB will continue the funding arrangement beyond 1997. The level of revenue to
be recognized under the BMS Agreement during the remainder of 1997 and into 1998
is subject to a number of uncertainties related to product sales, including
competition from new and existing products and the introduction of controlled
substance classification of one of the products being co-promoted by the
Company.
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, and may incur quarterly operating losses in excess of
the loss recorded for the three months ended September 30, 1997. 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.
18
PART II - OTHER INFORMATION
- ---------------------------
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits:
None
(b) Reports on Form 8-K:
None
19
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)
November 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)
20