SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
[X] Quarterly Report Pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934
For the Quarterly Period Ended March 31, 1999
[ ] 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
- ---------------------------------------------- -----------------------
(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 May 10, 1999
---------------------------- ------------------------------
Common Stock, par value $.01 28,924,239 Shares
This Report Includes a Total of 20 Pages
CEPHALON, INC. AND SUBSIDIARIES
INDEX
Page No.
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PART I - FINANCIAL INFORMATION
Item 1. Financial Statements (Unaudited)
Consolidated Balance Sheets - 3
March 31, 1999 and December 31, 1998
Consolidated Statements of Operations - 4
Three months ended March 31, 1999 and 1998
Consolidated Statements of Cash Flows - 5
Three months ended March 31, 1999 and 1998
Notes to Consolidated Financial Statements 6
Item 2. Management's Discussion and Analysis of 10
Financial Condition and Results of Operations
PART II - OTHER INFORMATION
Item 6. Exhibits and Reports on Form 8-K 19
SIGNATURES 20
CEPHALON, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(Unaudited)
March 31, December 31,
1999 1998
------------- -------------
ASSETS
CURRENT ASSETS:
Cash and cash equivalents $ 5,118,000 $ 3,975,000
Reverse repurchase agreements 18,992,000 3,509,000
Short-term investments 54,397,000 59,862,000
Trade accounts receivable, net of reserves (Note 2) 1,351,000 --
Inventory (Note 3) 195,000 38,000
Other 4,780,000 5,210,000
------------- -------------
Total current assets 84,833,000 72,594,000
PROPERTY AND EQUIPMENT, net of accumulated
depreciation and amortization of $13,906,000 and $13,439,000 20,169,000 20,505,000
OTHER 3,405,000 1,574,000
------------- -------------
$ 108,407,000 $ 94,673,000
============= =============
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Accounts payable $ 2,677,000 $ 3,558,000
Accrued expenses (Note 5) 17,094,000 13,298,000
Current portion of long-term debt 1,640,000 1,624,000
------------- -------------
Total current liabilities 21,411,000 18,480,000
LONG-TERM DEBT (Note 4) 38,503,000 15,096,000
OTHER 3,701,000 3,495,000
------------- -------------
Total liabilities 63,615,000 37,071,000
------------- -------------
COMMITMENTS AND CONTINGENCIES (Note 6)
STOCKHOLDERS' EQUITY: (Note 7)
Preferred stock, $.01 par value,
5,000,000 shares authorized, none issued -- --
Common stock, $.01 par value, 100,000,000 shares authorized,
28,831,467 and 28,802,323 shares issued and outstanding 288,000 288,000
Additional paid-in capital 338,238,000 331,107,000
Accumulated deficit (293,734,000) (273,793,000)
------------- -------------
Total stockholders' equity 44,792,000 57,602,000
------------- -------------
$ 108,407,000 $ 94,673,000
============= =============
The accompanying notes are an integral part of these financial statements.
3
CEPHALON, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
Three Months Ended,
March 31,
----------------------------
1999 1998
------------ ------------
REVENUES:
Product sales (Note 2) $ 1,730,000 $ 59,000
Other revenues (Note 8) 2,500,000 3,509,000
------------ ------------
4,230,000 3,568,000
------------ ------------
COSTS AND EXPENSES:
Cost of product sales (Note 3) 188,000 --
Research and development (Note 8) 9,972,000 11,974,000
Selling, general and administrative (Note 5) 13,614,000 7,169,000
------------ ------------
23,774,000 19,143,000
------------ ------------
LOSS FROM OPERATIONS (19,544,000) (15,575,000)
------------ ------------
OTHER:
Interest income 878,000 1,471,000
Interest expense (Notes 4 and 6) (1,275,000) (555,000)
------------ ------------
(397,000) 916,000
------------ ------------
LOSS $(19,941,000) $(14,659,000)
============ ============
BASIC AND DILUTED LOSS PER SHARE $ (0.69) $ (0.53)
============ ============
WEIGHTED AVERAGE NUMBER
OF SHARES OUTSTANDING 28,819,187 27,870,715
============ ============
The accompanying notes are an integral part of these financial statements.
4
CEPHALON, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
Three Months Ended,
March 31,
----------------------------
1999 1998
------------ ------------
CASH FLOWS FROM OPERATING ACTIVITIES:
Loss $(19,941,000) $(14,659,000)
Adjustments to reconcile loss to net cash
used for operating activities:
Depreciation and amortization 927,000 521,000
Non-cash compensation expense 424,000 403,000
Other 538,000 45,000
(Increase) decrease in operating assets:
Trade accounts receivable (1,460,000) --
Inventory (157,000) --
Other current assets 467,000 (29,000)
Other long-term assets (1,936,000) 131,000
Increase(decrease) in operating liabilities:
Accounts payable (881,000) 294,000
Accrued expenses 3,460,000 (2,557,000)
Other long-term liabilities 205,000 222,000
------------ ------------
Net cash used for operating activities (18,354,000) (15,629,000)
------------ ------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of property and equipment (23,000) (425,000)
Sales and maturities (purchases) of investments, net (10,018,000) 18,385,000
------------ ------------
Net cash (used for) provided by investing activities (10,041,000) 17,960,000
------------ ------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from exercises of common stock options and warrants 20,000 304,000
Proceeds from issuance of long-term debt 30,000,000 --
Principal payments on long-term debt (482,000) (326,000)
------------ ------------
Net cash provided by (used for) financing activities 29,538,000 (22,000)
------------ ------------
NET INCREASE IN CASH AND CASH EQUIVALENTS 1,143,000 2,309,000
CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD 3,975,000 10,271,000
------------ ------------
CASH AND CASH EQUIVALENTS, END OF PERIOD $ 5,118,000 $ 12,580,000
============ ============
The accompanying notes are an integral part of these financial statements.
5
CEPHALON, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
1. NATURE OF BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Business
Cephalon, Inc., headquartered in West Chester, PA, is an international
biopharmaceutical company dedicated to the discovery, development and marketing
of products to treat neurological disorders and cancer. The Company has had
negative cash flow from operations since inception and has funded its operations
primarily from the proceeds of public and private placements of its equity
securities. The Company initiated sales of its first approved product,
PROVIGIL(R) (modafinil) Tablets [C-IV] ("PROVIGIL"), in the United States and
the Republic of Ireland in February 1999, and has been marketing PROVIGIL in the
United Kingdom since March 1998. PROVIGIL is approved in those countries for use
by those suffering from excessive daytime sleepiness associated with narcolepsy.
The Company's business is subject to a number of significant risks,
including the risks inherent in pharmaceutical research and development
activities. The Company is highly dependent upon its successful
commercialization of PROVIGIL and there is no assurance that the Company will
achieve profitability solely on sales of PROVIGIL.
Basis of Presentation
The accompanying unaudited consolidated financial statements have been
prepared in accordance with generally accepted accounting principles for interim
financial information and with the instructions to Form 10-Q and Article 10 of
Regulation S-X. Accordingly, they do not include all of the information and
footnote disclosures required by generally accepted accounting principles for
complete financial statements. In the opinion of management, all adjustments
(consisting of normal recurring accruals) considered necessary for a fair
presentation have been included. These financial statements should be read in
conjunction with the consolidated financial statements and notes thereto
included in 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, 1998. 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.
2. TRADE ACCOUNTS RECEIVABLE AND PRODUCT SALES
Product sales are recognized upon shipment of finished goods and are
recorded net of reserves for returns and allowances. In February 1999, the
Company commenced sales of PROVIGIL in the United States. Shipments to
pharmaceutical wholesalers in the United States for the three months ended March
31, 1999 totaled $5,531,000. In accordance with standard industry practices, the
Company allows customers to return product which reaches its expiration date for
return and credit. Additionally, in connection with the commercial launch of
PROVIGIL, extended payment terms were provided to customers for initial
shipments of PROVIGIL. Given the uncertainty of market acceptance and the
Company's limited history of selling and payment collection related to sales of
PROVIGIL in the United States, along with the extended payment terms, the
Company established a reserve of $4,065,000 at March 31, 1999. Such reserve will
be continuously evaluated as the Company obtains additional information from
PROVIGIL sales, returns and collections.
For the period ended March 31, 1999, the Company's three largest customers
accounted for approximately 74% of trade receivables.
6
CEPHALON, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(Unaudited)
3. INVENTORY
Inventory related to PROVIGIL consisted of the following:
March 31, December 31,
1999 1998
--------- --------
Work-in-process...................... $ 125,000 $ --
Finished goods....................... 70,000 38,000
--------- --------
$ 195,000 $ 38,000
========= ========
Inventory is stated at the lower of cost or market value using the first-
in, first-out method. A significant portion of available PROVIGIL at March 31,
1999 and the PROVIGIL sold in the United States in the three months ended March
31, 1999 was produced prior to the December 1998 FDA approval and, in accordance
with SFAS No. 2 "Accounting for Research and Development Costs," its production
cost was recorded as research and development expense in those prior periods. As
a result, cost of product sales though March 31, 1999 consisted primarily of
royalties due to a third-party.
4. DEBT
In February 1999, the Company completed a private placement of $30,000,000
of revenue-sharing notes (the "Notes"). The Notes bear an annual interest rate
of 11%, payable on a quarterly basis in cash or common stock, at the option of
the Company. The Notes are repayable by the Company in March 2002 and are
secured by the Company's U.S. rights to PROVIGIL. Investors in the Notes also
will receive a payment of 6% of U.S. sales of PROVIGIL through March 1, 2004,
which will be recorded as interest expense. The Company has the right to redeem
the Notes at a premium prior to maturity, which would reduce the royalty period
by one year. Alternatively, the Company may also extend the maturity and the
royalty period by one year under certain circumstances. The Notes contain a
number of covenants including a requirement to maintain a minimum level of cash
and investments. Debt issuance costs of approximately $1,918,000 incurred by the
Company related to this offering were recorded in other assets and will be
amortized and charged to interest expense over the life of the Notes.
5. LITIGATION
The Company, a current director and officer, and a former officer 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
into a single class action. The plaintiff class is comprised of those persons
and entities who purchased Cephalon common stock, or traded in options to buy or
sell Cephalon common stock, during the period June 12, 1995 through and
including June 7, 1996. Plaintiffs seek to hold defendants liable for stock
trading losses that stem from alleged violations of the U.S. securities laws and
alleged common law negligent misrepresentation. More specifically, plaintiffs
have alleged that statements by the Company and the named defendants relating to
the results of certain clinical studies of MYOTROPHIN were misleading. The
Company has vigorously defended this lawsuit and believes that there are valid
defenses against the claims, but the defense of the action is expensive, and the
costs of this defense will reduce the available insurance coverage that might
otherwise be available to satisfy the claims. In an effort to resolve this
dispute, in January 1999 the Company engaged a mediator to initiate a non-
binding mediation process and commenced discussions with counsel for the lead
plaintiffs. Although the Company cannot determine at this time the exact amount
of its potential liability in this matter, it has increased its accrual for
litigation by recording $4,300,000 in selling, general and administrative
expenses in the first quarter of 1999. An adverse judgment or definitive
settlement in this matter could materially exceed both the $9,500,000 accrued to
date and the coverage which may be available under its directors' and officers'
liability insurance and could therefore materially affect the Company's
financial position, cash flows or results of operations.
7
CEPHALON, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(Unaudited)
6. COMMITMENTS AND CONTINGENCIES
Related Party
In August 1992, Cephalon exclusively licensed rights to manufacture and
market MYOTROPHIN(R) (mecasermin) Injection ("MYOTROPHIN") for human therapeutic
use within the United States, Canada and Europe (the "Territory") to Cephalon
Clinical Partners, L.P. (the "Partnership").
The Company is performing the development and clinical testing of
MYOTROPHIN on behalf of the Partnership and the Company's costs incurred to
develop MYOTROPHIN in the Territory were reimbursed by the Partnership to the
extent of its available funds. Late in 1995, the Partnership depleted all of its
available funds and has not provided funding of MYOTROPHIN development costs to
the Company since that time. The amount of funding required for further
development is determined by the Partnership's general partner in advance of
each quarter, and each quarter, the Company has the right, but not the
obligation, to contribute such funds.
In exchange for the exclusive license to MYOTROPHIN, Cephalon is obligated
to make royalty payments equal to 10.1% of MYOTROPHIN sales and a payment of
approximately $16,000,000 (the "Milestone Payment") that is to be made if
MYOTROPHIN 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"). 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. The Purchase Option becomes exercisable upon certain events
subsequent to commercialization. If the Company does not exercise the Purchase
Option prior to its expiration date or if the Company ceases further development
of MYOTROPHIN, all development and marketing rights to MYOTROPHIN in the
Territory would revert to the Partnership, which may commercialize MYOTROPHIN
itself or license or assign its rights to a third party. The Company would not
receive any benefits from any such commercialization, license or assignment of
rights.
Legal Proceedings
Due to the Company's involvement in promoting STADOL NS(R) (butorphanol
tartrate) Nasal Spray, a product of Bristol-Myers Squibb Company ("BMS"), the
Company is a co-defendant in a product liability action brought against BMS.
Although the Company cannot predict with certainty the outcome of this
litigation, it believes that any expenses or damages that are incurred will be
paid by BMS under the indemnification provisions of the co-promotion agreement.
As such, the Company does not believe that these actions will have a negative
effect on the Company's financial condition or results of operations.
7. STOCKHOLDERS' EQUITY
The private placement of the Notes (see Note 4) includes the issuance of
warrants, expiring March 1, 2004, to purchase 1,920,000 shares of the Company's
common stock at an exercise price of $10.08. The investors will forfeit 480,000
warrants if specified aggregate PROVIGIL sales levels are achieved in the United
States through March 1, 2002. In addition, the Company may, with notice, call up
to 720,000 of the warrants for redemption at a nominal price after November 24,
2001 if the market value of the Company's common stock exceeds certain
thresholds. The investors can choose to exercise the warrants prior to
redemption. The estimated aggregate value of the warrants of $6,236,000 was
recorded as a discount to the Notes and is being amortized and charged to
interest expense over the term of the Notes.
8
CEPHALON, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(Unaudited)
8. OTHER REVENUES
Other revenues is derived from collaborative research and development
agreements and co-promotion agreements. The major source of other revenue in the
three months ended March 31, 1999 and March 31, 1998 was recognized under a
licensing and research and development collaboration with TAP Holdings Inc.
Under the terms of the agreement, the Company is to develop and commercialize
certain compounds for the treatment of human cancers and prostate disorders in
the United States. The Company is compensated quarterly by TAP, based on a
contract rate per individual assigned to the program for that quarter and
reimbursement of certain external costs, all subject to annual budgetary
maximums.
9
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
Certain Risks Related to Cephalon's Business
During the next several years we will be very dependent on the commercial
success of PROVIGIL(R) (modafinil) Tablets [C-IV].
At our present level of operations, we will not be able to attain profitability
if physicians prescribe PROVIGIL only for those who are diagnosed narcoleptics
and we may not promote PROVIGIL outside of this approved use.In December 1998,
the FDA approved PROVIGIL for use by those suffering from excessive daytime
sleepiness associated with narcolepsy. The market for use of PROVIGIL in
narcolepsy patients is relatively small; it is limited to approximately 125,000
persons in the United States, of which we estimate between 30,000 and 45,000
currently are seeking treatment from a physician. We have initiated clinical
studies to examine whether or not PROVIGIL is effective and safe when used in
connection with disorders other than narcolepsy, but we do not know whether
these studies will, in fact, demonstrate safety and efficacy, or if they do,
whether we will succeed in receiving regulatory approval to market PROVIGIL for
additional disorders. If the results of these studies are negative, or if
adverse experiences are reported in these clinical studies or otherwise in
connection with the use of PROVIGIL by patients, this could undermine physician
and patient comfort with the product and limit the commercial success of the
product. Even if the results of these studies are positive, the impact on
PROVIGIL may be negligible until we are able to obtain FDA approval to expand
the authorized use of PROVIGIL to include treatment for conditions other than
excessive daytime sleepiness associated with narcolepsy. FDA regulations
restrict our ability to communicate the results of additional clinical studies
to patients and physicians without first obtaining from the FDA approval to
expand the authorized uses for the product. As a result, it may be several
years, if ever, before we have sales revenue from PROVIGIL beyond that
attributable to prescriptions for diagnosed narcoleptics.
In addition, the following factors could limit the rate and level of market
acceptance of PROVIGIL:
o the effectiveness of our sales and marketing efforts relative to those
of our competitors;
o the availability and level of reimbursement for PROVIGIL by third-party
payors, including the Federal, state and foreign government agencies;
o the occurrence of any side effects or adverse reactions (or unfavorable
publicity relating thereto) stemming from the use of PROVIGIL;
o we have little experience selling pharmaceuticals and we face
significant competition; o health care reform may limit the commercial
success of PROVIGIL;
o we may not be able to maintain market exclusivity of PROVIGIL; o and
manufacturing, supply and distribution problems could significantly
impact us.
Holders of our revenue sharing notes have certain rights to PROVIGIL and our
revenues from PROVIGIL.
The notes contain a number of covenants including a requirement to maintain
cash and cash equivalent balances of $40,000,000 through December 31, 1999 and
$30,000,000 during the remainder of the term of the notes. This requirement to
maintain cash and cash equivalent balances may limit our flexibility to use our
cash resources for other corporate purposes. The notes are secured by our
licenses, patents and FDA rights relating to PROVIGIL. If we fail to maintain
the required cash balances, the holders of the notes can declare a default and
increase the royalty percentage to 25% of U.S. PROVIGIL sales and, if the
default is not cured within one year, can accelerate the due date of the notes
and foreclose on the security if we fail to pay principal and interest when due
or violate certain other covenants.
10
We will need substantial additional funds to continue operations.
Since our inception we have had negative cash flow from operations. Based
on our use of funds for the quarter ended March 31, 1999, we had sufficient cash
resources to fund our operations at their current level for at least twelve
months. However, we will need to raise substantial additional funds to continue
our operations at their current level, continue to meet all of our minimum cash
balance requirements during the period prior to repayment of the notes and pay
the notes at maturity. We expect that it will be at least several years, if
ever, before our level of commercial sales and other revenue will provide enough
funds to generate positive cash flow from operations. Therefore, if we cannot
raise additional funds, we will have to reduce our present level of spending
which may involve curtailing or restructuring our operations, including the sale
of certain assets. Even after taking these steps, we would not be able to
eliminate all of our existing fixed costs, such as occupancy expenses and debt
service.
Most of the funds we have raised to date have been through the sale of
equity in our company; our ability to raise money through the sale of additional
equity in our company, as well as the price at which such equity may be sold,
are difficult to predict. If we issue common stock or securities convertible
into common stock in order to raise such funds, the existing shareholders'
percentage ownership of our company necessarily would be reduced.
We are involved in a number of legal proceedings that could impact our financial
condition.
Cephalon, a current director and officer, and a former officer, have been
named as defendants in a number of civil actions filed in the U.S. District
Court for the Eastern District of Pennsylvania, all of which have been
consolidated into a single class action. The plaintiff class is comprised of
those persons and entities who purchased Cephalon common stock, or traded in
options to buy or sell Cephalon common stock, during the period June 12, 1995
through and including June 7, 1996. Plaintiffs seek to hold defendants liable
for stock trading losses that stem from alleged violations of the U.S.
securities laws and alleged common law negligent misrepresentation. More
specifically, plaintiffs have alleged that statements made by Cephalon and the
named defendants relating to the results of certain clinical studies of
MYOTROPHIN were misleading. We have vigorously defended this lawsuit and believe
that there are valid defenses against the claims, but the defense of the action
is expensive, and the costs of this defense will reduce the amount of insurance
coverage that might otherwise be available to satisfy the claims. In an effort
to resolve this dispute, in January 1999 we engaged a mediator to initiate a
non-binding mediation process and commenced discussions with counsels for the
lead plaintiffs. Although we cannot determine at this time the exact amount of
the potential liability in this matter, we have increased our accrual for
litigation by recording $4,300,000 in selling, general and administrative
expenses in the first quarter of 1999. An adverse judgment or definitive
settlement in this matter could materially exceed both the $9,500,000 accrued to
date and the coverage which may be available under our directors' and officers'
liability insurance and could therefore materially affect the Company's
financial position, cash flows or results of operations.
Due to our involvement in promoting STADOL NS(R), generically called
butorphanol tartrate, Nasal Spray, a product of Bristol-Myers Squibb Company
("BMS"), we are a co-defendant in a product liability action brought against
BMS. Although we cannot predict with certainty the outcome of this litigation,
we believe that any expenses or damages that we may incur will be paid by BMS
under the indemnification provisions of our co-promotion agreement. As such, we
do not believe that these actions will have a negative effect on our financial
condition or results of operations.
11
We face other risks in our business.
The following other risks are characteristic of a company operating in the
biotechnology and pharmaceutical industries, including:
o the volatility of our common stock price;
o the potential for product liability claims;
o the risks inherent in research and development activities;
o our ability to protect our patents and other proprietary technology and
information;
o our dependence on key executives and scientists;
o uncertainties related to MYOTROPHIN(R) (mecasermin) injection;
o our dependence on corporate collaborators;
o environmental risks associated with the materials used in research and
development activities;
o and our failure or the failure of third-party vendors and suppliers to be
Year 2000 compliant in a timely manner.
In addition to historical facts or statements of current condition,
this report contains forward-looking statements. Forward-looking statements
provide our current expectations or forecasts of future events. These may
include statements regarding anticipated scientific progress in our
research programs, development of potential pharmaceutical products,
prospects for regulatory approval, manufacturing capabilities, market
prospects for our products, sales and earnings projections, and other
statements regarding matters that are not historical facts. Some of these
forward-looking statements may be identified by the use of words in the
statements such as "anticipate," "estimate," "expect," "project," "intend,"
"plan," "believe" or other words and terms of similar meaning. Our
performance and financial results could differ materially from those
reflected in these forward-looking statements due to general financial,
economic, regulatory and political conditions affecting the biotechnology
and pharmaceutical industries as well as more specific risks and
uncertainties such as those set forth above and in our reports to the SEC
on forms 8-K and 10-K. Given these risks and uncertainties, any or all of
these forward-looking statements may prove to be incorrect. Therefore, you
are cautioned not to place too much reliance on any such forward-looking
statements. Furthermore, we do not intend (and we are not obligated) to
update publicly any forward-looking statements, whether as a result of new
information, future events or otherwise. This discussion is permitted by
the Private Securities Litigation Reform Act of 1995.
12
Liquidity and Capital Resources
Cash, cash equivalents, reverse repurchase agreements and investments at
March 31, 1999 were $78,507,000, representing 72% of total assets, and at
December 31, 1998 were $67,346,000, representing 71% of total assets. Cash
equivalents, reverse repurchase agreements and investments consisted primarily
of short to intermediate-term corporate obligations, overnight investments that
are backed by collateral in the form of government securities with a value equal
to at least 102% of such investments and short to intermediate-term obligations
of the United States government.
The following is a summary of selected cash flow information for each of
the three months ended March 31:
1999 1998
------------ ------------
Net cash used for operating activities ................... $(18,354,000) $(15,629,000)
Net cash (used for) provided by investing activities ..... (10,041,000) 17,960,000
Net cash provided by (used for) financing activities ..... 29,538,000 (22,000)
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 three months ended March 31 is as follows:
1999 1998
--------- -----------
PROVIGIL sales.................................... $ 402,000 $ --
TAP Holdings...................................... 2,179,000 2,465,000
Bristol-Myers Squibb.............................. 683,000 --
Chiron............................................ -- 630,000
Medtronic......................................... 543,000 453,000
Interest.......................................... 1,006,000 1,740,000
Sales of PROVIGIL commenced in the United Kingdom in March 1998 and in the
United States and in the Republic of Ireland in February 1999. In connection
with the commercial launch in the United States, extended payment terms were
provided to customers, principally pharmaceutical wholesalers. As a result, only
a minimal amount of cash was received from U.S. sales in the three months ended
March 31, 1999. At March 31, 1999, $1,351,000, net of reserves of $4,065,000,
was receivable from the sale of PROVIGIL in the United States.
We have a licensing and research and development collaboration with TAP
Holdings Inc. to develop and commercialize certain compounds for the treatment
of human cancers and prostate disorders in the United States. Under the terms of
the agreement, we perform research and preclinical development of these
compounds for which we are compensated quarterly by TAP, based on a contract
rate per individual assigned to the program for that quarter and reimbursement
of certain external costs, all subject to annual budgetary maximums. At March
31, 1999, $1,578,000 was receivable from TAP.
We market STADOL NS(R) (butorphanol tartrate) Nasal Spray for Bristol-Myers
Squibb to neurologists in the United States. Pursuant to our agreement, we
receive quarterly payments equal to a percentage of total STADOL NS sales
attributed to prescriptions written by neurologists which exceeds a
predetermined base amount. The payment received from BMS in the three months
ended March 31, 1999, represents payment earned for fourth quarter 1998 co-
promotion activity. There was no payment recorded from BMS in the corresponding
1998 period, since all payments earned for 1997 co-promotion activity were
received in 1997. At March 31, 1999, $500,000 was receivable from BMS.
13
Cephalon has been developing MYOTROPHIN in collaboration with Chiron
Corporation for the treatment of ALS and other neurological disorders. The
amounts we received in 1998 generally represented reimbursement from Chiron for
MYOTROPHIN program costs incurred in excess of our fifty percent share of
program costs. Since June 30, 1998, the companies have been bearing their own
MYOTROPHIN costs and we have not received reimbursement of MYOTROPHIN
expenditures since that time.
Under an April 1997 agreement with Medtronic, Inc., we were co-promoting
Intrathecal Baclofen Therapy (ITB(TM)) to neurologists and physiatrists in the
United States for the treatment of intractable spasticity. The agreement with
Medtronic terminated pursuant to its terms on April 29, 1999. At March 31, 1999,
$290,000 was receivable from Medtronic.
The decrease in interest received in 1999 compared to 1998 was primarily
due to lower investment balances.
--Operating Cash Outflows
Cash used in operating activities in the three months ended March 31, 1999
increased as a result of increased expenditures associated with the commercial
launch of PROVIGIL in the United States, clinical studies of PROVIGIL and debt
issuance costs associated with the $30 million private placement of revenue-
sharing notes.
--Cash and Funding Requirements Outlook
We believe that our cash and investment balance as of March 31, 1999 is
adequate to fund the then-current level of operations for at least twelve
months. We expect cash flow from operating activities to continue to be negative
for the next several years. The major source of our cash inflows in the three
months ended March 31, 1999 was derived from our collaborative research and
development agreement with TAP and from co-promotion agreements. The
continuation of funding under the agreement with TAP is subject to the
achievement of certain development milestones and periodic review by TAP and may
be terminated without cause with prior notice. The level of potential payments
to be received from BMS is subject to a number of uncertainties related to
product sales, including competition from new and existing products. The level
of payments to be received under our co-promotion agreement with Medtronic will
be less than received in 1998 due to the termination of the Medtronic agreement
in April 1999.
Although we initiated sales of PROVIGIL in the United States in February
1999, we expect it will be at least several years, if ever, before sales from
PROVIGIL will provide enough funds to generate cash inflows in excess of the
present level of cash outflows from operations. In addition to the uncertainty
surrounding the degree of market acceptance for a recently introduced product,
factors such as competition, the effectiveness of our sales and marketing
efforts and the ability to demonstrate the utility of PROVIGIL in disorders
other than narcolepsy will all have an impact on PROVIGIL sales that are not
predictable at this point in time.
The Company expects its cash requirements for PROVIGIL to increase
significantly for the next several years due to efforts associated with the
commercial launch of PROVIGIL in the United States, including building PROVIGIL
inventory and conducting clinical studies of PROVIGIL in disorders other than
narcolepsy. Additionally, we expect to continue to expend substantial funds on
research and development activities for our other products in development. We
intend to seek sources of funding for these research programs through
collaborative arrangements with third parties. If additional funds are
unavailable, we may have to reduce our present level of spend which may involve
curtailing or restructuring some of our programs. Additionally, if the
securities litigation results in an adverse judgment or definitive settlement
which exceeds the coverage available under our directors' and officers'
liability insurance, it would require a significant use of funds, the issuance
of shares of our common stock or a combination thereof.
We will require substantial additional funds to continue our operations at
their current level, continue to meet all of our minimum cash balance
requirements pursuant to our debt agreements and pay the Notes at maturity. We
will need to obtain additional funding through debt and/or equity financings,
collaborative arrangements or through other financing vehicles. The amount of
capital needed to fund operations will depend upon many factors,
14
including the scope of our research and development programs and the extent of
any funding under collaborative research arrangements, the cost of conducting
clinical studies, the cost of defending and enforcing patent claims and other
legal proceedings, and the level of sales of PROVIGIL in the United States. We
can not be sure that additional funds can be obtained on acceptable terms, if at
all. If additional funds cannot be obtained, we will have to reduce our present
level of spending which may involve curtailing or restructuring operations,
including the sale of certain assets of the company. Even with such curtailment,
we would not be able to eliminate fixed costs, such as occupancy expenses and
debt service.
Net Cash (Used for) Provided by Investing Activities
A summary of net cash (used for) provided by investing activities for the
three ended March 31 is as follows:
1999 1998
------------- -----------
Purchases of property and equipment......................... $ (23,000) $ (425,000)
Sales and maturities (purchases) of investments, net........ (10,018,000) 18,385,000
------------- -----------
Net cash (used for) provided by investing activities... $ (10,041,000) $17,960,000
============= ===========
Net sales and maturities (purchases) of investments represent the
liquidation or accumulation of investments.
Net Cash Provided by (Used for) Financing Activities
A summary of net cash (used for) provided by financing activities for the
three months ended March 31 is as follows:
1999 1998
----------- ---------
Proceeds from exercises of common stock options and warrants..... $ 20,000 $ 304,000
Proceeds from issuance of long-term debt......................... 30,000,000 --
Principal payments on long-term debt............................. (482,000) (326,000)
----------- ---------
Net cash provided by (used for) financing activities........ $29,538,000 $ (22,000)
=========== =========
The extent and timing of future warrant and option exercises, if any, are
primarily dependent upon the market price of Cephalon's common stock and general
financial market conditions, as well as the exercise prices and expiration dates
of the warrants and options.
Proceeds from the issuance of long-term debt in the three months ended
March 31, 1999 consists of a private placement of $30,000,000 of revenue-sharing
notes.
For all periods presented, principal payments on long-term debt include
payments on mortgage loans and payments on capital lease obligations.
15
Commitments and Contingencies
--Related Party
In August 1992, Cephalon exclusively licensed rights to manufacture and
market MYOTROPHIN(R) (mecasermin) Injection ("MYOTROPHIN") for human therapeutic
use within the United States, Canada and Europe (the "Territory") to Cephalon
Clinical Partners, L.P. (the "Partnership").
We are performing the development and clinical testing of MYOTROPHIN on
behalf of the Partnership and our costs incurred to develop MYOTROPHIN in the
Territory were reimbursed by the Partnership to the extent of its available
funds. Late in 1995, the Partnership depleted all of its available funds and has
not provided funding of MYOTROPHIN development costs to us since that time. The
amount of additional funding required for further development is determined by
the Partnership's general partner in advance of each quarter, and each quarter,
we have the right, but not the obligation, to contribute such funds.
In exchange for the exclusive license to MYOTROPHIN, we are obligated to
make royalty payments equal to 10.1% of MYOTROPHIN sales and a payment of
approximately $16,000,000 (the "Milestone Payment") that is to be made if
MYOTROPHIN receives regulatory approval in the United States or certain other
countries within the Territory. We have the option to pay the Milestone Payment
in cash, common stock, or a combination thereof.
We have a contractual option to purchase all of the limited partnership
interests in the Partnership (the "Purchase Option"). To exercise the Purchase
Option, we are required to make an advance payment of $40,275,000 in cash or, at
our election, $42,369,000 in shares of the Company's Common Stock, valued at the
market price at the time the Purchase Option is exercised. The Purchase Option
becomes exercisable upon certain events subsequent to commercialization. If we
do not exercise the Purchase Option prior to its expiration date or if the
Company ceases further development of MYOTROPHIN, all development and marketing
rights to MYOTROPHIN in the Territory would revert to the Partnership, which may
commercialize MYOTROPHIN itself or license or assign its rights to a third
party. We would not receive any benefits from any such commercialization,
license or assignment of rights.
The January 1994 collaboration between Cephalon and Chiron is subject to
the rights of the Partnership. We are solely responsible for making any royalty
and milestone payments owed to the Partnership and for funding any exercises of
the Purchase Option.
The general partner of the Partnership is a wholly-owned subsidiary of
Cephalon, which owns 1% of the Partnership.
--Litigation
Cephalon, a current director and officer, and a former officer have been
named as defendants in a number of civil actions, which have been consolidated
into a single class action, alleging that statements made about the results of
certain clinical studies of MYOTROPHIN were misleading. In a separate matter,
due to our involvement in promoting STADOL NS, a product of Bristol-Myers Squibb
Company, we are a co-defendant in a product liability action brought against
BMS. See "Certain Risks Related to Cephalon's Business."
16
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 three months ended March 31,
1999 is as follows:
% CHANGE
1999 1998 1999 VS. 1998
----------- ----------- -------------
Product sales................................... $ 1,730,000 $ 59,000 2832%
Other revenues.................................. 2,500,000 3,509,000 (29)
Cost of product sales........................... 188,000 -- --
Research and development expenses............... 9,972,000 11,974,000 (17)
Selling, general and administrative expenses.... 13,614,000 7,169,000 90
Interest (expense) income, net.................. (397,000) 916,000 (143)
Product sales are recognized upon shipment of finished goods and are
recorded net of reserves for returns and allowances. Product revenues increased
in the 1999 period from the same 1998 period due primarily from the initiation
of sales of PROVIGIL in the United States in February 1999. Shipments to
pharmaceutical wholesalers in the United States for the three months ended March
31, 1999 totaled $5,531,000. Sales of PROVIGIL were initiated in the United
Kingdom in March 1998 and the Republic of Ireland in February 1999. In
accordance with standard industry practices, we allow customers to return
product which reaches its expiration date for return and credit. Additionally,
in connection with the commercial launch of PROVIGIL, extended payment terms
were provided to customers for initial shipments of PROVIGIL. Given the
uncertainty of market acceptance and our limited history selling and collecting
payments related to sales PROVIGIL in the United States, along with our extended
payment terms, we established a reserve of $4,065,000 at March 31, 1999. Such
reserve will be continuously evaluated as we obtain additional information from
PROVIGIL sales, returns and collections.
Other revenues includes revenue recognized under research and development
and co-promotion agreements. Other revenues decreased in the 1999 period from
the 1998 period due primarily to decreased revenue from TAP, Chiron, Kyowa Hakko
and Medtronic. The decreases from Chiron and Kyowa Hakko generally reflect
reductions in efforts corresponding to the MYOTROPHIN program.
For the quarter ended March 31, 1999, cost of product sales was 11% of
sales and consisted primarily of royalties due to a third-party licensee. This
is not indicative of future expectations. Prior to December 1998 FDA approval of
PROVIGIL, we recorded the costs of producing PROVIGIL as research and
development expense in accordance with Statement of Financial Accounting
Standards No. 2 "Accounting for Research and Development Costs." Once this
inventory has been sold, we expect cost of product sales to be between 21% and
26% of sales.
For the quarter ended March 31, 1999, research and development expenses
decreased from the same 1998 period primarily because 1998 included expenses for
purchases of bulk modafinil compound and license fees. These reductions were
partially offset by increased clinical study expenditures in 1999 associated
with the PROVIGIL program.
The increase in the selling, general and administrative area in 1999 as
compared to the corresponding 1998 period was due primarily to the recording of
a $4,300,000 provision related to our securities litigation. Additionally, the
increase was caused by activities associated with the launch of PROVIGIL and an
increase in sales and marketing staffing levels.
The decrease in net interest income is primarily due to lower average
investment balances and the recognition of interest expense related to the
Notes, consisting of 11% of the principal of the Notes, 6% of PROVIGIL sales
payable to the holders of the Notes and amortization of warrant valuation and
debt issuance costs.
17
Results of operations outlook
We expect to continue to incur operating losses unless and until product
sales exceed operating expenses. Shipments of PROVIGIL in the three months ended
March 31, 1999 may not be indicative of future periods because of the incentives
offered to wholesalers during the initial launch. We expect that sales of
PROVIGIL may be limited since we can only market the product to treat excessive
daytime sleepiness associated with narcolepsy. We may never be able to achieve
profitability solely through sales of PROVIGIL even if we obtain approval to
market the product to treat other disorders.
The major source of our current revenue is derived from collaborative
research and development agreements and co-promotion agreements. The
continuation of any of these agreements is subject to the achievement of certain
milestones and to periodic review by the parties involved. Revenue from Chiron
will be less in 1999 because Chiron and the Company have agreed to fund their
own MYOTROPHIN related expenses. The level of revenue to be recognized from BMS
is subject to a number of uncertainties related to product sales, including
competition from new and existing products. Revenue in 1999 from Medtronic will
be less than 1998 due to the termination of the Medtronic agreement in April
1999.
During the remainder of 1999, we expect to continue to incur significant
expenditures associated with marketing PROVIGIL and conducting clinical studies
of PROVIGIL in disorders other than narcolepsy. Additionally, we expect to
continue to incur substantial expenses on research and development activities
for our other products in development. We intend to seek sources of funding for
these research and development programs through collaborative arrangements with
third parties.
We expect to have significant fluctuations in quarterly results based
primarily on the level and timing of:
o PROVIGIL sales;
o cost of PROVIGIL sales;
o contract and co-promotion revenues;
o and the occurrence of expenses.
In addition, we are engaged in a non-binding mediation process with regards
to a class action suit, and if the suit results in a adverse judgment or
settlement in excess of the amounts recorded to date, we would expect to incur
an additional material charge to the statement of operations. We also expect
interest expense to be higher in 1999 due to the Notes.
We do 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:
Exhibit
No. Description of Exhibit
------- ----------------------
27.1 Financial Data Schedule
(b) Reports on Form 8-K:
During the quarter ended March 31, 1999, the
Registrant filed a Current Report on Form 8-K on March 1, 1999 for the following
events:
(i) On February 25, 1999, Cephalon, Inc. announced
the completion of a debt offering totaling $30 million, raised through the
private sale of revenue-sharing notes.
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)
May 14, 1999 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)