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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
[X] Quarterly Report Pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934
For the Quarterly Period Ended June 30, 2002
[_] Transition Report Pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934
For the Transition Period from ______________ to _______________
Commission File Number 0-19119
---------------------
CEPHALON, INC.
----------------------------------------------------------------
(Exact Name of Registrant as Specified in its Charter)
Delaware 23-2484489
- -------------------------------------------- --------------------------------
(State Other Jurisdiction of Incorporation (I.R.S. Employer Identification
or Organization) Number)
145 Brandywine Parkway, West Chester, PA 19380-4245
- ------------------------------------------- -----------------
(Address of Principal Executive Offices) (Zip Code)
Registrant's Telephone Number, Including Area Code (610) 344-0200
--------------------
Not Applicable
- --------------------------------------------------------------------------------
Former Name, Former Address and Former Fiscal Year, If Changed Since Last Report
Indicate by check mark whether the Registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
Registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes X No _____
---
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date.
Class Outstanding as of August 9, 2002
---------------------------------- --------------------------------
Common Stock, par value $.01 55,101,389 Shares
This Report Includes a Total of 38 Pages
CEPHALON, INC. AND SUBSIDIARIES
INDEX
Page No.
--------
PART I - FINANCIAL INFORMATION
Item 1. Consolidated Financial Statements (Unaudited)
Consolidated Balance Sheets - 3
June 30, 2002 and December 31, 2001
Consolidated Statements of Operations - 4
Three and six months ended June 30, 2002 and 2001
Consolidated Statements of Stockholders' Equity - 5
June 30, 2002 and December 31, 2001
Consolidated Statements of Cash Flows - 6
Six months ended June 30, 2002 and 2001
Notes to Consolidated Financial Statements 7
Item 2. Management's Discussion and Analysis of 16
Financial Condition and Results of Operations
Item 3. Quantitative and Qualitative Disclosure about Market Risk 35
PART II - OTHER INFORMATION
Item 1. Legal Proceedings 36
Item 2. Changes in Securities and Use of Proceeds 36
Item 4. Submission of Matters to a Vote of Security Holders 36
Item 6. Exhibits and Reports on Form 8-K 37
SIGNATURES 38
2
CEPHALON, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(Unaudited)
June 30, December 31,
2002 2001
--------------- ---------------
ASSETS
------
CURRENT ASSETS:
Cash and cash equivalents $ 391,786,000 $ 548,727,000
Investments 202,914,000 55,157,000
Receivables, net 83,211,000 75,192,000
Inventory 49,173,000 47,513,000
Other current assets 11,574,000 7,872,000
--------------- ---------------
Total current assets 738,658,000 734,461,000
PROPERTY AND EQUIPMENT, net 70,872,000 64,706,000
GOODWILL 248,565,000 248,911,000
INTANGIBLE ASSETS, net 310,984,000 298,269,000
DEBT ISSUANCE COSTS 24,237,000 26,720,000
OTHER ASSETS 13,999,000 16,020,000
--------------- ---------------
$ 1,407,315,000 $ 1,389,087,000
=============== ===============
LIABILITIES AND STOCKHOLDERS' EQUITY
------------------------------------
CURRENT LIABILITIES:
Accounts payable $ 30,781,000 $ 24,536,000
Accrued expenses 40,181,000 49,370,000
Current portion of long-term debt 20,646,000 32,200,000
Current portion of deferred revenues 491,000 824,000
--------------- ---------------
Total current liabilities 92,099,000 106,930,000
LONG-TERM DEBT 871,422,000 866,589,000
DEFERRED REVENUES 5,773,000 6,042,000
OTHER LIABILITIES 11,192,000 10,795,000
--------------- ---------------
Total liabilities 980,486,000 990,356,000
--------------- ---------------
COMMITMENTS AND CONTINGENCIES (Note 8)
STOCKHOLDERS' EQUITY:
Preferred stock, $.01 par value, 5,000,000 shares authorized,
2,500,000 shares issued, and none outstanding -- --
Common stock, $.01 par value, 200,000,000 shares authorized,
55,096,552 and 54,909,533 shares issued,
and 54,867,674 and 54,685,792 shares outstanding 551,000 549,000
Additional paid-in capital 987,739,000 982,123,000
Treasury stock, 228,878 and 223,741 shares outstanding, at cost (9,803,000) (9,523,000)
Accumulated deficit (565,133,000) (576,691,000)
Accumulated other comprehensive income 13,475,000 2,273,000
--------------- ---------------
Total stockholders' equity 426,829,000 398,731,000
--------------- ---------------
$ 1,407,315,000 $ 1,389,087,000
=============== ===============
The accompanying notes are an integral part of these consolidated financial
statements.
3
CEPHALON, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
Three Months Ended Six Months Ended
June 30, June 30,
------------------------------ ---------------------------------
2002 2001 2002 2001
------------------------------ ---------------------------------
REVENUES:
Product sales $ 108,767,000 $ 44,286,000 $ 204,570,000 $ 85,108,000
Other revenues 11,960,000 11,913,000 27,658,000 18,163,000
------------- ------------ ------------- ------------
120,727,000 56,199,000 232,228,000 103,271,000
------------- ------------ ------------- ------------
COSTS AND EXPENSES:
Cost of product sales 15,472,000 9,273,000 29,317,000 17,571,000
Research and development 31,401,000 20,894,000 61,224,000 40,505,000
Selling, general and administrative 44,911,000 27,291,000 85,195,000 51,656,000
Depreciation and amortization 8,042,000 3,562,000 16,335,000 7,051,000
------------- ------------ ------------- ------------
99,826,000 61,020,000 $ 192,071,000 116,783,000
------------- ------------ ------------- ------------
INCOME (LOSS) FROM OPERATIONS 20,901,000 (4,821,000) 40,157,000 (13,512,000)
------------- ------------ ------------- ------------
OTHER INCOME AND EXPENSE
Interest income 3,770,000 3,039,000 6,640,000 4,546,000
Interest expense (9,782,000) (4,136,000) (21,280,000) (5,456,000)
Other expense (460,000) (72,000) (1,298,000) (1,110,000)
------------- ------------ ------------- ------------
(6,472,000) (1,169,000) (15,938,000) (2,020,000)
------------- ------------ ------------- ------------
INCOME (LOSS) BEFORE INCOME TAXES 14,429,000 (5,990,000) 24,219,000 (15,532,000)
INCOME TAXES -- -- (1,985,000) --
------------- ------------ ------------- ------------
INCOME (LOSS) BEFORE DIVIDENDS ON PREFERRED STOCK,
EXTRAORDINARY CHARGE AND CUMULATIVE
EFFECT OF CHANGING INVENTORY COSTING METHOD 14,429,000 (5,990,000) 22,234,000 (15,532,000)
DIVIDENDS ON CONVERTIBLE EXCHANGEABLE
PREFERRED STOCK -- (3,328,000) -- (5,594,000)
------------- ------------ ------------- ------------
INCOME (LOSS) BEFORE EXTRAORDINARY CHARGE AND
CUMULATIVE EFFECT OF CHANGING INVENTORY
COSTING METHOD 14,429,000 (9,318,000) 22,234,000 (21,126,000)
EXTRAORDINARY GAIN (CHARGE) ON EARLY
EXTINGUISHMENT OF DEBT -- 3,016,000 (7,142,000) 3,016,000
CUMULATIVE EFFECT OF CHANGING INVENTORY
COSTING METHOD FROM FIFO TO LIFO -- -- (3,534,000) --
------------- ------------ ------------- ------------
INCOME (LOSS) APPLICABLE TO COMMON SHARES $ 14,429,000 $ (6,302,000) $ 11,558,000 $(18,110,000)
============= ============ ============= ============
BASIC INCOME (LOSS) PER COMMON SHARE:
Income (loss) per common share before
extraordinary charge and
cumulative effect of changing inventory
costing method $ 0.26 $ (0.19) $ 0.40 $ (0.47)
Extraordinary charge on early
extinguishment of debt -- 0.06 (0.13) 0.07
Cumulative effect of changing inventory
costing method -- -- (0.06) --
------------- ------------ ------------- ------------
$ 0.26 $ (0.13) $ 0.21 $ (0.40)
============= ============ ============= ============
DILUTED INCOME (LOSS) PER COMMON SHARE:
Income (loss) per common share before
extraordinary charge and
cumulative effect of changing inventory
costing method $ 0.25 $ (0.19) $ 0.39 $ (0.47)
Extraordinary charge on early
extinguishment of debt -- 0.06 (0.13) 0.07
Cumulative effect of changing inventory
costing method -- -- (0.06) --
------------- ------------ ------------- ------------
$ 0.25 $ (0.13) $ 0.20 $ (0.40)
------------- ------------ ------------- ------------
WEIGHTED AVERAGE NUMBER
OF COMMON SHARES OUTSTANDING 55,071,000 47,725,000 55,017,000 45,229,000
============= ============ ============= ============
WEIGHTED AVERAGE NUMBER
OF COMMON SHARES OUTSTANDING-ASSUMING DILUTION 57,033,000 47,725,000 57,161,000 45,229,000
============= ============ ============= ============
The accompanying notes are an integral part of these consolidated
financial statements.
4
CEPHALON, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
(Unaudited)
Accumulated
Other
Comprehensive Accumulated Comprehensive
Income (Loss) Total Deficit Income
--------------- ----------------------------------------------
BALANCE, JANUARY 1, 2001 $165,193,000 $(515,543,000) $ 1,401,000
Loss $(55,484,000) (55,484,000) (55,484,000) --
------------
Foreign currency translation gain 368,000
Unrealized investment gains 504,000
------------
Other comprehensive income 872,000 872,000 -- 872,000
------------
Comprehensive loss $(54,612,000)
============
Conversion of preferred
stock into common stock -- -- --
Issuance of common stock -- --
upon conversion of convertible notes 262,590,000
Stock options exercised 25,542,000 -- --
Stock purchase warrants exercised 2,679,000 -- --
Restricted stock award plan 5,349,000 -- --
Employee benefit plan 1,283,000 -- --
Dividends declared on (5,664,000) (5,664,000) --
convertible preferred stock
Treasury stock acquired (3,629,000) -- --
------------ -------------- ------------
BALANCE, DECEMBER 31, 2001 398,731,000 (576,691,000) 2,273,000
Income $ 11,558,000 11,558,000 11,558,000 --
------------
Foreign currency translation gain 9,437,000
Unrealized investment gains 1,765,000
------------
Other comprehensive income 11,202,000 11,202,000 -- 11,202,000
------------
Comprehensive income $ 22,760,000
============
Stock options exercised 3,065,000 -- --
Restricted stock award plan 1,220,000 -- --
Employee benefit plan 1,224,000 -- --
Treasury stock acquired (171,000) -- --
------------ ------------- ------------
BALANCE, JUNE 30, 2002 $426,829,000 $(565,133,000) $ 13,475,000
============ ============= ============
Additional
Common Preferred Paid-in Treasury
Stock Stock Capital Stock
-------- ------- ------------ -----------
BALANCE, JANUARY 1, 2001 $425,000 $25,000 $683,004,000 $(4,119,000)
Loss -- -- -- --
Foreign currency translation gain
Unrealized investment gains
Other comprehensive income -- -- -- --
Comprehensive loss
Conversion of preferred
stock into common stock 70,000 (25,000) (45,000) --
Issuance of common stock 37,000 -- 262,553,000 --
upon conversion of convertible notes
Stock options exercised 13,000 -- 27,304,000 (1,775,000)
Stock purchase warrants exercised 2,000 2,677,000 --
Restricted stock award plan 2,000 -- 5,347,000 --
Employee benefit plan -- -- 1,283,000 --
Dividends declared on -- -- -- --
convertible preferred stock
Treasury stock acquired -- -- -- (3,629,000)
-------- -------- ------------- -----------
BALANCE, DECEMBER 31, 2001 549,000 -- 982,123,000 (9,523,000)
Income -- -- -- --
Foreign currency translation gain
Unrealized investment gains
Other comprehensive income -- -- -- --
Comprehensive income
Stock options exercised 2,000 -- 3,172,000 (109,000)
Restricted stock award plan -- -- 1,220,000 --
Employee benefit plan -- -- 1,224,000 --
Treasury stock acquired -- -- -- (171,000)
-------- ------- ------------ -----------
BALANCE, JUNE 30, 2002 $551,000 $ -- $987,739,000 $(9,803,000)
======== ======= ============ ===========
The accompaning notes are an integral part of these consolidated financial
statements.
5
CEPHALON, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
Six Months Ended
June 30,
-----------------------------------
2002 2001
-------------- --------------
CASH FLOWS FROM OPERATING ACTIVITIES:
Income (loss) before preferred dividends $ 11,558,000 $ (12,516,000)
Adjustments to reconcile income (loss) to net cash
provided by (used for) operating activities:
Depreciation and amortization 16,335,000 7,051,000
Extraordinary charge (gain) on extinguishment of debt 7,142,000 (3,016,000)
Non-cash interest expense 7,099,000 2,413,000
Cumulative effect of changing inventory costing method from FIFO to LIFO 3,534,000 --
Stock-based compensation expense 2,444,000 3,517,000
Other 3,266,000 216,000
(Increase) decrease in operating assets:
Receivables (3,927,000) (8,214,000)
Inventory (2,803,000) (11,331,000)
Other current assets (3,258,000) (2,762,000)
Other long-term assets (3,086,000) 5,000
Increase (decrease) in operating liabilities:
Accounts payable 3,781,000 (651,000)
Accrued expenses (10,261,000) 3,419,000
Deferred revenues 397,000 (467,000)
Other long-term liabilities (1,945,000) (74,000)
------------- -------------
Net cash provided by (used for) operating activities 30,276,000 (22,410,000)
------------- -------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of property and equipment (6,572,000) (4,745,000)
Acquistion of intangible assets (23,658,000) --
Sales and maturities (purchases) of investments, net (145,992,000) (239,239,000)
------------- -------------
Net cash used for investing activities (176,222,000) (243,984,000)
------------- -------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from exercises of common stock options and warrants 3,065,000 20,115,000
Payments to acquire treasury stock (171,000) --
Net proceeds from issuance of long-term debt -- 385,785,000
Preferred dividends paid -- (6,656,000)
Principal payments on and retirements of long-term debt (15,354,000) (49,576,000)
------------- -------------
Net cash (used for) provided by financing activities (12,460,000) 349,668,000
------------- -------------
EFFECT OF EXCHANGE RATE CHANGES ON CASH AND CASH EQUIVALENTS 1,465,000 787,000
------------- -------------
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS (156,941,000) 84,061,000
CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD 548,727,000 36,571,000
------------- -------------
CASH AND CASH EQUIVALENTS, END OF PERIOD $ 391,786,000 $ 120,632,000
============= =============
Supplemental disclosures of cash flow information:
Cash payments for interest $ 13,981,000 $ 1,870,000
Non-cash investing and financing activities:
Capital lease additions 663,000 360,000
The accompanying notes are an integral part of these consolidated financial
statements.
6
CEPHALON, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
1. NATURE OF BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Business
Cephalon is an international biopharmaceutical company dedicated to the
discovery, development and marketing of innovative products to treat sleep and
neurological disorders, cancer and pain. In addition to conducting an active
research and development program, we market three products in the United States,
PROVIGIL(R) (modafinil) tablets [C-IV], ACTIQ(R) (oral transmucosal fentanyl
citrate) [C-II], and GABITRIL(R) (tiagabine hydrochloride), as well as a number
of products in various countries throughout Europe. We are headquartered in West
Chester, Pennsylvania, and have offices in Salt Lake City, Utah, and
internationally in France, the United Kingdom, Germany and Switzerland. Our
research and development headquarters are located in the United States. We
operate manufacturing facilities in France for the production of bulk
pharmaceuticals, including modafinil, which is the active drug substance
contained in PROVIGIL. We also operate manufacturing facilities in Salt Lake
City, Utah, for the production of ACTIQ for distribution and sale in the
European Union.
Basis of Presentation
The accompanying unaudited consolidated financial statements have been
prepared in accordance with generally accepted accounting principles for interim
financial information and with the instructions to Form 10-Q and Article 10 of
Regulation S-X. Accordingly, they do not include all of the information and
footnote disclosures required by generally accepted accounting principles for
complete financial statements. In the opinion of management, all adjustments
(consisting only of normal recurring accruals) considered necessary for a fair
presentation have been included. These financial statements should be read in
conjunction with the consolidated financial statements and notes thereto
included in our annual report on Form 10-K, filed with the Securities and
Exchange Commission, which includes audited financial statements as of December
31, 2001 and 2000 and for each of the three years in the period ended December
31, 2001. The results of our operations for any interim period are not
necessarily indicative of the results of our operations for any other interim
period or for a full year.
Revenue Recognition
Product sales are recognized upon the transfer of ownership and risk of
loss for the product to the customer and are recorded net of estimated reserves
for contractual allowances, discounts and returns. The estimated reserves are
reviewed at each reporting period and adjusted to reflect data available at that
time. To the extent our estimates are inaccurate, we will adjust the reserves
which will impact the amount of product sales revenue recognized in the period
of the adjustment.
Income Taxes
We have provided for income taxes related to our foreign subsidiaries in
accordance with Statement of Financial Accounting Standards (SFAS) No. 109,
"Accounting for Income Taxes," which requires the recognition of deferred tax
assets and liabilities for the expected tax consequences of temporary
differences between the tax and financial reporting bases of assets and
liabilities. We have a history of losses in our U.S. operations, which has
generated significant federal and state tax net operating loss (NOL)
carryforwards of approximately $344,139,000 and $147,620,000, respectively, as
of December 31, 2001. United States generally accepted accounting principles
require us to record a valuation allowance against the deferred tax asset
associated with this NOL carryforward if it is more likely than not that we will
not be able to utilize the NOL carryforward to offset future taxes. Due to the
size of the NOL carryforward in relation to our history of unprofitable
operations, we have provided a full valuation allowance against this deferred
tax asset.
7
CEPHALON, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--CONTINUED
(Unaudited)
Group Lafon
On December 28, 2001, we completed our acquisition of the outstanding
shares of capital stock of Laboratoire L. Lafon and affiliated entities
(collectively "Group Lafon"). With this acquisition, we control worldwide rights
to modafinil, marketed under the trade name PROVIGIL in the United States. To
date, the acquisition has increased our product sales, improved gross margins
for PROVIGIL, improved profitability and provided us with important research and
development, commercial and manufacturing infrastructure in France.
The purchase price for Group Lafon was approximately $456,654,000, which
was funded in part by the proceeds of our December 11, 2001 offering of
$600,000,000 of 2.50% convertible subordinated notes due December 2006. Of the
purchase price, $450,000,000 was paid in cash to the sellers with the remainder
primarily representing transaction costs of the acquisition and severance
payments, partially offset by an estimate of the amount expected to be refunded
by the seller under the terms of the acquisition agreement. The purchase
accounting for the acquisition may be revised for up to one year from the
transaction date due to changes in assessments of contingencies and our
integration plans. All such amounts are expected to be paid or received in 2002.
The following unaudited pro forma information shows the results of our
operations for the three months and the six months ended June 30, 2001 as though
the acquisition had occurred as of January 1, 2001:
Three months ended Six months ended
June 30, 2001 June 30, 2001
------------- -------------
Total revenues ................................. $ 77,620,000 $ 144,820,000
Net loss ....................................... $ (9,870,000) $ (24,206,000)
Basic and diluted net loss per common share: $ (0.20) $ (0.54)
The pro forma results have been prepared for comparative purposes only and
are not necessarily indicative of the actual results of operations had the
acquisition taken place as of January 1, 2001, or the results that may occur in
the future. Furthermore, the pro forma results do not give effect to all cost
savings or incremental costs that may occur as a result of the integration and
consolidation of the acquisition.
Recent Accounting Pronouncements
In June 2001, the Financial Accounting Standards Board (FASB) finalized
SFAS No.142, "Goodwill and Other Intangible Assets," which is effective for
fiscal years beginning after December 15, 2001. SFAS 142 no longer requires the
amortization of goodwill; rather, goodwill will be subject to a periodic
assessment for impairment by applying a fair-value-based test. In addition, an
acquired intangible asset should be separately recognized if the benefit of the
intangible asset is obtained through contractual or other legal rights, or if
the intangible asset can be sold, transferred, licensed, rented, or exchanged,
regardless of the acquirer's intent to do so. Such acquired intangible assets
will be amortized over the period in which the economic benefits of the
intangible asset are consumed or otherwise used up. The new criteria for
recording intangible assets separate from goodwill did not require us to
reclassify any of our intangible assets. We have only recorded goodwill related
to our acquisition of Group Lafon effective December 28, 2001; therefore, our
transitional impairment test indicated that there was no impairment of goodwill
upon our adoption of SFAS 142 effective January 1, 2002.
In June 2001, the FASB issued SFAS No. 143, "Accounting for Asset
Retirement Obligations," which requires recognition of the fair value of
liabilities associated with the retirement of long-lived assets when a legal
obligation to incur such costs arises as a result of the acquisition,
construction, development and/or the normal operation of a long-lived asset.
SFAS 143 requires that the fair value of a liability for an asset retirement
obligation be recognized in the period in which it is incurred if a reasonable
estimate of fair value can be made. The associated asset retirement costs are
capitalized as part of the carrying amount of the long-lived asset and
subsequently allocated to expense over the asset's useful life. SFAS 143 is
effective for fiscal years beginning after December 15, 2002. The adoption of
this new standard will not have any impact on our current financial statements.
On January 1, 2002, we adopted SFAS No. 144, "Accounting for the Impairment
or Disposal of Long-Lived Assets." This Statement provides new guidance on the
recognition of impairment losses on long-lived assets to be held
8
CEPHALON, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--CONTINUED
(Unaudited)
and used or to be disposed of and also broadens the definition of what
constitutes a discontinued operation and how the results of a discontinued
operation are to be measured and presented. The adoption of this new standard
has not had any impact on our current financial statements.
In April 2002, the FASB issued SFAS No. 145 "Rescission of FASB Statements
No. 4, 44 and 64, Amendment of FASB Statement No. 13, and Technical
Corrections." This Statement amends or rescinds certain existing authoritative
pronouncements related to lease accounting in order to make various technical
corrections, clarify meanings, or describe applicability under changed
conditions. SFAS No. 145 is effective for fiscal years beginning after May 15,
2002. The adoption of this new standard will not have any impact on our current
financial statements.
In June 2002, the FASB issued SFAS No. 146, "Accounting for Exit or
Disposal Activities." This Statement addresses the recognition, measurement and
reporting of costs that are associated with exit and disposal activities,
including restructuring activities that are currently accounted for pursuant to
the guidance in EITF Issue No. 94-3, "Liability Recognition for Certain Employee
Termination Benefits and Other Costs to Exit an Activity (including Certain
Costs Incurred in a Restructuring)." The Statement requires that costs
associated with exit or disposal activities be recorded at their fair values
when a liability has been incurred. SFAS No. 146 is effective for disposal
activities initiated after December 31, 2002. The adoption of this new standard
will not have any impact on our current financial statements.
2. JOINT VENTURE
In December 2001, we formed a joint venture with an unaffiliated third
party investor to fund additional commercial activities in support of PROVIGIL
and GABITRIL in the United States. In exchange for our transfer to the joint
venture of certain intellectual property and other rights related to these two
products, we received a Class B interest, representing a 50% interest in the
joint venture. In exchange for its contribution of $50,000,000 in cash to the
joint venture, the investor received Class A interests, also representing a 50%
interest in the joint venture.
As of December 31, 2001, the $50,000,000 investor's Class A interest was
recorded on our balance sheet as debt, and the joint venture's cash balance of
$50,000,000 was included in our balance of cash and cash equivalents.
On March 29, 2002, we acquired the investor's Class A interests and ended
the joint venture by the issuance and sale in a private placement of $55,000,000
aggregate principal amount of 3.875% convertible subordinated notes due March
2007. The notes are convertible into our common stock, at the option of the
holder, at a price of $70.36 per share. See "Note 7--Long-Term Debt."
The purchase of the investor's Class A interests in the joint venture
resulted in the recognition of an extraordinary charge of $7,142,000 on the
early extinguishment of debt during the first quarter of 2002. The following
table summarizes the calculation of this extraordinary charge:
Carrying value of the debt as of December 31, 2001 ....................... $ 50,000,000
Interest accreted during the first quarter 2002 at 20% ................... 2,500,000
------------
Carrying value of the debt as of March 29, 2002 .......................... 52,500,000
Less: unamortized joint venture formation costs as of March 29, 2002 ..... (4,642,000)
------------
47,858,000
Fair value of subordinated notes issued on March 29, 2002 ................ (55,000,000)
------------
Extraordinary charge ..................................................... $ (7,142,000)
============
9
CEPHALON, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--CONTINUED
(Unaudited)
In addition, our statement of operations for the six months ended June 30,
2002 included certain charges related to the operations of the joint venture, as
follows:
Six months ended
June 30, 2002
-------------
Selling, general and administrative expenses ............. $3,508,000
Interest expense ......................................... 3,163,000
Interest income .......................................... (190,000)
----------
$6,481,000
==========
3. CASH, CASH EQUIVALENTS AND INVESTMENTS
Cash, cash equivalents and investments consisted of the following:
June 30, December 31,
2002 2001
---- ----
Cash and cash equivalents
Demand deposits and money market funds ................... $ 333,113,000 $ 4,364,000
Repurchase agreements .................................... -- 155,817,000
U.S. government agency obligations ....................... 586,000 79,985,000
Commercial paper ......................................... 4,993,000 245,158,000
Asset backed securities .................................. 1,114,000 4,636,000
Bonds .................................................... 51,980,000 58,767,000
------------- -------------
391,786,000 548,727,000
------------- -------------
Short-term investments (at market value):
U.S. government agency obligations ....................... 7,168,000 8,076,000
Commercial paper ......................................... 80,872,000 17,135,000
Asset backed securities .................................. 19,000 2,878,000
Bonds .................................................... 114,855,000 26,068,000
Certificates of deposit .................................. -- 1,000,000
------------- -------------
202,914,000 55,157,000
------------- -------------
$ 594,700,000 $ 603,884,000
------------- -------------
The contractual maturities of our investments in cash, cash equivalents,
and investments at June 30, 2002 are as follows:
Less than one year ..................................... $ 498,903,000
Greater than one year but less than two years .......... 14,900,000
Greater than two years ................................. 80,897,000
-------------
$ 594,700,000
-------------
10
CEPHALON, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--CONTINUED
(Unaudited)
4. RECEIVABLES
Receivables consisted of the following:
June 30, December 31,
2002 2001
---- ----
Trade receivables ...................................................... $ 47,645,000 $ 40,790,000
Receivables from collaborations ........................................ 12,102,000 16,438,000
Other receivables ...................................................... 33,212,000 24,790,000
Reserve for sales discounts, returns and allowances .................... (9,748,000) (6,826,000)
------------- -------------
$ 83,211,000 $ 75,192,000
============= =============
5. INVENTORY
Inventory consisted of the following:
June 30, December 31,
2002 2001
---- ----
Raw materials ...................................................... $25,664,000 $19,666,000
Work-in-process .................................................... 5,369,000 7,632,000
Finished goods ..................................................... 18,140,000 20,215,000
----------- -----------
$49,173,000 $47,513,000
=========== ===========
Effective January 1, 2002, we changed our method of valuing inventories from
the first-in, first-out, or FIFO method, to the last-in, first-out, or LIFO
method. We recognized a charge of $3,534,000 in the first quarter of 2002 as the
cumulative effect of adopting the LIFO inventory costing method. The acquisition
of Group Lafon's manufacturing operations and the planned expansion of our
internal manufacturing capacity for ACTIQ has reduced and is expected to further
reduce our reliance on third party manufacturers. The expansion of our internal
manufacturing capabilities should allow us to benefit from efficiencies of scale
and lead to lower per unit inventory costs. The LIFO method will reflect these
expected changes to manufacturing costs on the statement of operations on a more
timely basis, resulting in a better matching of current costs of products sold
with product revenues.
Cost of product sales under the LIFO inventory costing method was $4,545,000
lower for the three months ended June 30, 2002 and $9,033,000 lower for the six
months ended June 30, 2002 than it would have been under the FIFO method. If we
had adopted LIFO effective January 1, 2001, the effect on our statement of
operations for the three and six months ended June 30, 2001 would have been
immaterial.
11
CEPHALON, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--CONTINUED
(Unaudited)
6. INTANGIBLE ASSETS
Intangible assets consisted of the following:
June 30, December 31,
2002 2001
----- ----
Developed technology acquired from Lafon ..................... $ 132,000,000 $ 132,000,000
Trademarks/tradenames acquired from Lafon .................... 16,000,000 16,000,000
GABITRIL product rights ...................................... 109,553,000 92,648,000
Novartis CNS product rights .................................. 41,641,000 41,641,000
ACTIQ marketing rights ....................................... 29,114,000 29,114,000
Other product rights ......................................... 11,265,000 --
-------------- --------------
339,573,000 311,403,000
Less accumulated amortization ................................ (28,589,000) (13,134,000)
-------------- --------------
$ 310,984,000 $ 298,269,000
============== ==============
GABITRIL product rights increased by $16,905,000 since December 31, 2001 as
a result of a $10,000,000 payment to Abbott stemming from the extension of the
composition of matter patent and additional payments for expanded rights in
Europe and other countries worldwide. Other product rights increased as a result
of payments for the acquisition of additional product rights in Europe and other
countries worldwide.
Amortization of intangible assets was $12,758,000 for the six months ended
June 30, 2002. Estimated amortizaion of intangible assets for each of the next
five fiscal years are as follows: 2003 -- $27,582,000; 2004 -- $27,461,000; 2005
- --$27,310,000; 2006-- $27,310,000; and 2007-- $26,224,000.
7. LONG-TERM DEBT
Long-term debt consisted of the following:
June 30, December 31,
2002 2001
---- ----
Capital lease obligations .................................... $ 3,024,000 $ 2,852,000
Mortgage and building improvement loans ...................... 11,491,000 12,085,000
Joint venture ................................................ -- 50,000,000
Convertible subordinated notes ............................... 838,000,000 783,000,000
Notes payable/Other .......................................... 8,092,000 13,460,000
Due to Abbott Laboratories ................................... 31,461,000 37,392,000
-------------- --------------
Total debt ................................................... 892,068,000 898,789,000
Less current portion ......................................... (20,646,000) (32,200,000)
-------------- --------------
Total long-term debt ......................................... $ 871,422,000 $ 866,589,000
============== ==============
Convertible Subordinated Notes
On March 29, 2002, we issued and sold $55,000,000 of aggregate principal in
a private placement of 3.875% Convertible Notes due March 29, 2007. The notes
were issued and sold to the purchaser in a transaction exempt from registration
requirements of the Securities Act of 1933, as amended, because the offer and
sale of the notes did not involve a public offering.
12
CEPHALON, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--CONTINUED
(Unaudited)
We are obligated to pay interest on the notes at a rate of 3.875% per year
on each of April 15 and October 15, beginning October 15, 2002. The notes also
are convertible into our common stock, at the option of the holders, at a price
of $70.36 per share, subject to adjustment upon certain events.
The holders of the notes may elect to require us to redeem the notes on
March 28, 2005 at a redemption price equal to 100% of the principal amount of
notes submitted for redemption, plus accrued and unpaid interest. In certain
other circumstances, at the option of the holders, we may be required to
repurchase the notes at 100% of the principal amount of the notes submitted for
repurchase, plus accrued and unpaid interest.
We issued these notes in connection with our acquisition of the Class A
interest held by our joint venture partner. See "Note 2--Joint Venture."
8. COMMITMENTS AND CONTINGENCIES
Legal Proceedings
In February 2001, a complaint was filed in Utah state court by Zars, Inc.
and one of its research scientists, against us and our subsidiary Anesta Corp.
The plaintiffs are seeking a declaratory judgment to establish their right to
develop transdermal or other products containing fentanyl and other
pharmaceutically active agents under a royalty and release agreement between
Zars and Anesta. The complaint also asks for unspecified damages for breach of
contract, interference with economic relations, defamation and slander. We
believe that we have valid defenses to all claims raised in this action. In any
event, we do not believe any judgment against us will have a material adverse
effect on our financial condition or results of operations.
We are a party to certain other litigation in the ordinary course of our
business, including matters alleging employment discrimination, product
liability and breach of commercial contract. However, we are vigorously
defending ourselves in all of these actions and do not believe these matters,
even if adversely adjudicated or settled, would have a material adverse effect
on our financial condition or results of operations.
Related party
In August 1992, we exclusively licensed our rights to MYOTROPHIN(R) for
human therapeutic use within the United States, Canada and Europe to Cephalon
Clinical Partners, L.P., or CCP. We developed MYOTROPHIN on behalf of CCP under
a research and development agreement. Under this agreement, CCP granted an
exclusive license to manufacture and market MYOTROPHIN for human therapeutic use
within the United States, Canada and Europe, and we agreed to make royalty
payments equal to a percentage of product sales and a milestone payment of
approximately $16,000,000 upon regulatory approval. We have a contractual
option, but not an obligation, to purchase all of the limited partnership
interests of CCP, which is exercisable upon the occurrence of certain events
following the first commercial sale of MYOTROPHIN. If, and only if, we decide to
exercise this purchase option, we would make an advance payment of approximately
$40,275,000 in cash or, at our election, approximately $42,369,000 in shares of
common stock or a combination thereof. If we discontinue development of
MYOTROPHIN, or if we do not exercise this purchase option, our license will
terminate and all rights to manufacture or market MYOTROPHIN in the United
States, Canada and Europe will revert to CCP, which may then commercialize
MYOTROPHIN itself or license or assign its rights to a third party. In that
event, we would not receive any benefits from such commercialization, license or
assignment of rights.
9. OTHER COMPREHENSIVE INCOME
SFAS No. 130, "Reporting Comprehensive Income," requires presentation of
the components of comprehensive income (loss). Our comprehensive income (loss)
includes net income and loss, unrealized gains and losses from
13
CEPHALON, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--CONTINUED
(Unaudited)
foreign currency translation adjustments, and unrealized investment gains. Our
total comprehensive income (loss) is as follows:
Three months ended Six months ended
June 30, June 30,
------- -------
2002 2001 2002 2001
---- ---- ---- ----
Income (loss) before preferred dividends ........ $ 14,429,000 $ (2,974,000) $ 11,558,000 $(12,516,000)
Other comprehensive income (loss):
Foreign currency translation adjustment ....... 9,700,000 (3,000) 9,437,000 787,000
Unrealized investment gains ................... 2,262,000 2,000 1,765,000 107,000
------------ ------------ ------------ ------------
Other comprehensive income (loss) ............... $ 26,391,000 $ (2,975,000) $ 22,760,000 $(11,622,000)
============ ============ ============ ============
10. EARNINGS PER SHARE
We compute income (loss) per common share in accordance with SFAS No. 128,
"Earnings Per Share." Basic income (loss) per common share is computed based on
the weighted average number of common shares outstanding during the period.
Diluted income (loss) per common share is computed based on the weighted average
shares outstanding and the dilutive impact of common stock equivalents
outstanding during the period. The dilutive effect of employee stock options and
restricted stock awards is measured using the treasury stock method. Common
stock equivalents are not included in periods where there is a loss, as they are
anti-dilutive. The following is a reconciliation of net income (loss) and
weighted average common shares outstanding for purposes of calculating basic and
diluted income (loss) per common share:
Three months Six months
ended June 30, ended June 30,
-------------- --------------
2002 2001 2002 2001
---- ---- ---- ----
Numerator:
Net income (loss) used for basic and diluted
income (loss) per common share ................... $ 14,429,000 $ (6,302,000) $ 11,558,000 $(18,110,000)
============ ============ ============ ============
Denominator:
Weighted average shares used for basic
income (loss) per common share ................... 55,071,000 47,725,000 55,017,000 45,229,000
Effect of dilutive securities:
Employee stock options and restricted
stock awards ..................................... 1,962,000 -- 2,144,000 --
------------ ------------ ------------ ------------
Weighted average shares used for diluted
income (loss) per common share ................... 57,033,000 47,725,000 57,161,000 45,229,000
============ ============ ============ ============
The weighted average shares used in the calculation of diluted income per
common share for the three months ended June 30, 2002 excludes 2,327,000 shares
relating to employee stock options and 10,662,000 shares relating to convertible
notes as the inclusion of such shares would be anti-dilutive. The weighted
average shares used in the calculation of diluted income per common share for
the six months ended June 30, 2002 excludes 2,038,000 shares relating to
employee stock options and 10,662,000 shares relating to convertible notes as
the inclusion of such shares would be anti-dilutive.
14
CEPHALON, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--CONTINUED
(Unaudited)
11. SEGMENT AND SUBSIDIARY INFORMATION
On December 28, 2001, we completed our acquisition of Group Lafon. As a
result, we now have significant sales, manufacturing, and research operations in
Europe. Prior to 2002, our European operations accounted for 2%, 3% and 6% of
total product sales for the years ended December 31, 2001, 2000 and 1999,
respectively. For the six months ended June 30, 2002, our European operations
accounted for approximately 24% of total product sales.
The following summarized information presents our revenues and long-lived
assets by geographic segment. We have determined that all of our European
operations have similar economic characteristics and may be aggregated into a
single segment for reporting purposes. Information concerning our geographic
operations is provided below.
Revenues:
Three months ended Six months ended
June 30, 2002 June 30, 2002
------------- -------------
United States ........................ $ 92,081,000 $175,549,000
Europe ............................... 28,646,000 56,679,000
------------ ------------
Total ................................ $120,727,000 $232,228,000
============ ============
Long-lived assets at June 30, 2002:
United States ........................ $213,579,000
Europe ............................... 455,078,000
------------
Total ................................ $668,657,000
============
15
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
RESULTS OF OPERATIONS
Three months ended June 30, 2002 compared to three months ended June 30, 2001
Three months ended
June 30,
2002 2001
---- ----
Product sales:
PROVIGIL ........................ $ 47,035,000 $29,848,000
ACTIQ ........................... 28,511,000 9,764,000
GABITRIL ........................ 10,112,000 4,674,000
Group Lafon products ............ 23,109,000 --
------------ -----------
Total product sales .................. 108,767,000 44,286,000
------------ -----------
Other revenues:
H. Lundbeck A/S ................. 1,966,000 2,211,000
Novartis Pharma AG .............. 2,611,000 2,005,000
Sanofi-Synthelabo ............... 5,772,000 --
Schwarz Pharma AG ............... -- 2,727,000
Other ........................... 1,611,000 4,970,000
------------ -----------
Total other revenues ................. 11,960,000 11,913,000
------------ -----------
Total revenues ....................... $120,727,000 $56,199,000
============ ===========
Revenues-- Product sales in the second quarter of 2002 increased 146%
over the second quarter of 2001. The increase is attributable to a number of
factors including:
. Sales of PROVIGIL increased 58% due to increased market
acceptance. A domestic price increase of 5% was effective June 1,
2002.
. Sales of ACTIQ increased 192%. After our merger with Anesta in
October 2000, we established a dedicated sales force for ACTIQ and
have made ongoing changes to our marketing approach that have
contributed to higher sales. A domestic price increase of 4.9%
effective March 1, 2002 also contributed to higher sales.
. Sales of GABITRIL increased 116% as a result of both increased
demand in the U.S. market and the initiation of sales efforts in
Europe in the first quarter of 2002 following our December 2001
acquisition of European rights to GABITRIL. Additionally, an
average increase in domestic prices of 9.8% effective March 1,
2002 contributed to the sales increase.
. Product sales generated by Group Lafon, which we acquired on
December 28, 2001, were $23,109,000 during the second quarter of
2002. The most significant product sales during the period were
$10,988,000 of SPASFON(R), used for biliary/urinary tract spasm
and irritable bowel syndrome, and $6,612,000 of FONZYLANE(R), used
for the treatment of insufficient arterial circulation in the
lower limbs. Additionally, sales include $2,644,000 of MODIODAL,
the trade name for modafinil in France.
Total other revenues were essentially unchanged from period to period.
Revenue recognized in the second quarter of 2002 under our licensing,
development and marketing collaboration with Sanofi-Synthelabo, which began in
October 2001, was partially offset by $3,500,000 of milestone revenues
recognized in the second quarter of 2001 upon receiving ACTIQ marketing
authorization in certain European countries and by a decrease in revenue
recognized
16
under the former research and development collaboration with Schwarz Pharma AG
which terminated as of June 30, 2001.
Cost of Product Sales-- The cost of product sales in the second quarter
of 2002 decreased to approximately 14% of product sales from approximately 21%
in the second quarter of 2001 due principally to the fact that PROVIGIL related
manufacturing profit and royalties paid by Cephalon to Group Lafon, following
our acquisition of Lafon, represent intercompany profits which are eliminated in
consolidation.
Research and Development Expenses--Research and development expenses
increased 50% to $31,401,000 in the second quarter of 2002 from $20,894,000 in
the second quarter of 2001. An increase of $6,494,000 is attributable to higher
expenditures on drug development costs in the United States for our compounds
that have progressed into later stages of development and also for
infrastructure costs to support the growing number of ongoing clinical trials,
including Phase II/III clinical studies for CEP-1347 and studies related to our
efforts to expand the label for PROVIGIL beyond its current indication. In
addition, we incurred $5,308,000 of research and development expenses at Group
Lafon in the second quarter of 2002.
Selling, General and Administrative Expenses--Selling, general and
administrative expenses increased 65% to $44,911,000 for the quarter ended June
30, 2002 from $27,291,000 for the second quarter of 2001. Group Lafon
represented $7,808,000 of this increase. In addition, we incurred an increase of
$4,250,000 in U.S. sales and marketing costs as a result of the expansion of our
field sales forces.
Depreciation and Amortization Expenses--Depreciation and amortization
expenses increased to $8,042,000 in the second quarter of 2002 from $3,562,000
in the second quarter of 2001 due primarily to amortization expense of
$2,733,000 for intangible assets acquired in our acquisition of Group Lafon.
Other Income and Expense--Interest income increased by $731,000 from the
second quarter of 2001 due to higher average investment balances, partially
offset by lower average rates of return. Interest expense increased by
$5,646,000 from the second quarter of 2001 due primarily to interest recorded on
the increase in outstanding convertible subordinated notes.
Dividends on Convertible Exchangeable Preferred Stock-- In May 2001, the
holders of 2,344,586 shares of the 2,500,000 shares outstanding of our
convertible exchangeable preferred stock converted their preferred shares into
an aggregate of 6,541,394 shares of our common stock, in accordance with the
terms of the preferred stock. As an inducement to the holders to convert their
preferred stock prior to August 2001, when we were initially permitted to redeem
the preferred stock, we agreed to pay immediately all dividends accrued through
the date of conversion as well as all dividends that would have accrued on the
converted shares through the August 2001 redemption date. In the second quarter
of 2001, we recognized a regular quarterly dividend of $2,265,000 and an
additional $1,063,000 of dividend expense associated with the early conversion.
The remaining 155,414 shares of preferred stock outstanding at June 30, 2001
were converted into 433,604 shares of common stock in the third quarter of 2001.
Extraordinary Gain on Early Extinguishment of Debt-- In May 2001, we paid
$24,438,000 to Novartis Pharma AG for deferred obligations due to them under our
continuing November 2000 collaboration agreement. In connection with this
payment, we recorded an extraordinary gain on the early extinguishment of debt
of $3,016,000.
17
Six months ended June 30, 2002 compared to six months ended June 30, 2001
Six months ended
June 30,
2002 2001
---- ----
Product sales:
PROVIGIL .......................... $ 91,210,000 $ 56,872,000
ACTIQ ............................. 47,778,000 16,346,000
GABITRIL .......................... 20,276,000 11,890,000
Group Lafon products .............. 45,306,000 --
------------ ------------
Total product sales .................... 204,570,000 85,108,000
------------ ------------
Other revenues:
H. Lundbeck A/S ................... 4,165,000 3,511,000
Novartis Pharma AG ................ 4,939,000 4,329,000
Sanofi-Synthelabo ................. 15,507,000 --
Schwarz Pharma AG ................. -- 2,805,000
TAP Pharmaceuticals, Inc. ......... -- 1,189,000
Other ............................. 3,047,000 6,329,000
------------ ------------
Total other revenues ................... 27,658,000 18,163,000
------------ ------------
Total revenues ......................... $232,228,000 $103,271,000
============ ============
Revenues-- Product sales in the first half of 2002 increased 140% over
the first half of 2001. The increase is attributable to a number of factors
including:
. Sales of PROVIGIL increased 60% due to increased market
acceptance. A domestic price increase of 5% was effective June 1,
2002.
. Sales of ACTIQ increased 192%. After our merger with Anesta in
October 2000, we established a dedicated sales force for ACTIQ and
have made ongoing changes to our marketing approach that have
contributed to higher sales. A domestic price increase of 4.9%
effective March 1, 2002 also contributed to higher sales.
. Sales of GABITRIL increased 71% as a result of both increased
demand in the U.S. market and the initiation of sales efforts in
Europe during the first quarter of 2002 following our December
2001 acquisition of European rights to GABITRIL. Additionally, an
average increase in domestic prices of 9.8% effective March 1,
2002 contributed to the sales increase.
. Product sales generated by Group Lafon, which we acquired on
December 28, 2001, were $45,306,000 during the first half of 2002.
The most significant product sales during the period were
$22,100,000 of SPASFON, used for biliary/urinary tract spasm and
irritable bowel syndrome, and $12,828,000 of FONZYLANE, used for
the treatment of insufficient arterial circulation in the lower
limbs. Additionally, sales include $5,258,000 of MODIODAL, the
trade name for modafinil in France.
Total other revenues increased by $9,495,000 or 52%. Revenue recognized
in the first half of 2002 under our licensing, development and marketing
collaboration with Sanofi-Synthelabo, which began in October 2001, was partially
offset by $3,500,000 in milestone revenues recognized in the second quarter of
2001 upon receiving ACTIQ marketing authorization in certain European countries
and by a decrease in revenue recognized under the former research and
development collaborations with Schwarz Pharma AG and TAP Pharmaceuticals, Inc.
which terminated as of June 30, 2001 and March 31, 2001, respectively.
Cost of Product Sales-- The cost of product sales in the first half of
2002 decreased to approximately 14% of product sales from approximately 21% in
the first half of 2001 due principally to the fact that PROVIGIL related
18
manufacturing profit and royalties paid by Cephalon to Group Lafon, following
our acquisition of Lafon, now represent intercompany profits which are
eliminated in consolidation.
Research and Development Expenses--Research and development expenses
increased 51% to $61,224,000 in the first half of 2002 from $40,505,000 in the
first half of 2001. An increase of $11,198,000 is attributable to higher
expenditures on drug development costs in the United States for our compounds
that have progressed into later stages of development and also for
infrastructure costs to support the growing number of ongoing clinical trials,
including Phase II/III clinical studies for CEP-1347 and studies related to our
efforts to expand the label for PROVIGIL beyond its current indication. In
addition, we incurred $10,346,000 of research and development expenses at Group
Lafon in the first half of 2002.
Selling, General and Administrative Expenses--Selling, general and
administrative expenses increased 65% to $85,195,000 for the six months ended
June 30, 2002 from $51,656,000 for the first half of 2001. Group Lafon
represented $16,227,000 of this increase. In addition, we incurred an increase
of $9,847,000 in U. S. sales and marketing costs as a result of the expansion of
our field sales forces.
Depreciation and Amortization Expenses--Depreciation and amortization
expenses increased to $16,335,000 in the first half of 2002 from $7,051,000 in
the first half of 2001 due primarily to amortization expense of $5,466,000 for
intangible assets acquired in our acquisition of Group Lafon.
Other Income and Expense--Interest income increased by $2,094,000 from the
first half of 2001 due to higher average investment balances, partially offset
by lower average rates of return. Interest expense increased by $15,824,000 from
the first half of 2001 due primarily to interest recorded on the increase in
outstanding convertible subordinated notes.
Income Taxes--Income taxes of $1,985,000 recorded in the first half of 2002
represent foreign income tax expense associated with our Group Lafon operations.
Dividends on Convertible Exchangeable Preferred Stock--In May 2001, the
holders of 2,344,586 shares of the 2,500,000 shares outstanding of our
convertible exchangeable preferred stock converted their preferred shares into
an aggregate of 6,541,394 shares of our common stock, in accordance with the
terms of the preferred stock. As an inducement to the holders to convert their
preferred stock prior to August 2001, when we were initially permitted to redeem
the preferred stock, we agreed to pay immediately all dividends accrued through
the date of conversion as well as all dividends that would have accrued on the
converted shares through the August 2001 redemption date. In the second quarter
of 2001, we recognized a regular quarterly dividend of $2,265,000 and an
additional $1,063,000 of dividend expense associated with the early conversion.
The remaining 155,414 shares of preferred stock outstanding at June 30, 2001
were converted into 433,604 shares of common stock in the third quarter of 2001.
Extraordinary Gain (Charge) on Early Extinguishment of Debt--The purchase
of the investor's Class A interests in the joint venture resulted in the
recognition of an extraordinary charge of $7,142,000 during the first quarter of
2002.
In May 2001, we paid $24,438,000 to Novartis Pharma AG for deferred
obligations due to them under our continuing November 2000 collaboration
agreement. In connection with this payment, we recorded an extraordinary gain on
the early extinguishment of debt of $3,016,000.
Cumulative Effect of Changing Inventory Costing Method from FIFO to LIFO--
Effective January 1, 2002, we changed our method of valuing inventories from the
first-in, first-out, or FIFO method, to the last-in, first-out, or LIFO method.
We recognized a charge of $3,534,000 in the first quarter of 2002 as the
cumulative effect of adopting the LIFO inventory costing method. The acquisition
of Group Lafon's manufacturing operations and the planned expansion of our
internal manufacturing capacity for ACTIQ has reduced and is expected to further
reduce our reliance on third party manufacturers. The expansion of our internal
manufacturing capabilities should allow us to benefit from efficiencies of scale
and lead to lower per unit inventory cost. The LIFO method will reflect these
19
expected changes to manufacturing costs on the statement of operations on a more
timely basis, resulting in a better matching of current costs of products sold
with product revenues.
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
Management's Discussion and Analysis of Financial Condition and Results of
Operations discusses our consolidated financial statements, which have been
prepared in accordance with accounting principles generally accepted in the
United States. The preparation of financial statements requires management to
make estimates and assumptions that affect the carrying amounts of assets and
liabilities, and the reported amounts of revenues and expenses during the
reporting period. These estimates and assumptions are developed and adjusted
periodically by management based on historical experience and on various other
factors that are believed to be reasonable under the circumstances. Actual
results may differ from these estimates.
Our significant accounting policies are described in Note 1 to the
consolidated financial statements included in Item 1 of this Form 10-Q and Note
1 to the consolidated financial statements included in Item 8 of our Form 10-K
for the year ended December 31, 2001. Management considers the following
policies to be the most critical in understanding the more complex judgments
that are involved in preparing our consolidated financial statements and the
uncertainties that could impact its results of operations, financial position
and cash flows.
Revenue recognition--Product sales are recognized upon the transfer of
ownership and risk of loss for the product to the customer and are recorded net
of estimated reserves for contractual allowances, discounts and returns.
Contractual allowances result from sales under contracts with managed care
organizations and government agencies. The reserve for contractual allowances is
based on an estimate of prescriptions to be filled for individuals covered by
government agencies and managed care organizations with whom we have contracts.
Product returns are permitted with respect to unused pharmaceuticals based on
expiration dating of our product. The reserve for product returns is determined
by reviewing the history of each product's returns and by utilizing reports
purchased from external, independent sources which produce prescription data and
estimates of wholesale stocking levels and wholesale sales to retail pharmacies.
This data is reviewed to monitor product movement through the supply chain to
identify remaining inventory in the supply chain that may result in reserves for
contractual allowances or returns. To date, product returns have not been
material. The reserves are reviewed at each reporting period and adjusted to
reflect data available at that time. To the extent our estimates prove
inaccurate, we will adjust the reserves, which will impact the amount of product
sales revenue recognized in the period of the adjustments.
Other revenue, which includes revenues from collaborative agreements,
consists of up-front fees, ongoing research and development funding, milestone
payments and payments under co-promotional or managed services agreements.
Effective January 1, 2000, we adopted the SEC's Staff Accounting Bulletin No.
101, "Revenue Recognition in Financial Statements" (SAB 101). In accordance with
SAB 101, non-refundable up-front fees are deferred and amortized to revenue over
the related performance period. We estimate our performance period based on the
specific terms of each collaborative agreement, but actual performance may vary.
We adjust the performance periods based upon available facts and circumstances.
Periodic payments for research and development activities are recognized over
the period that we perform the related activities under the terms of the
agreements. Revenue resulting from the achievement of milestone events
stipulated in the agreements is recognized when the milestone is achieved.
Milestones are based upon the occurrence of a substantive element specified in
the contract or as measure of substantive progress towards completion under the
contract. Payments under co-promotional or managed services agreements are
recognized over the period when the products are sold or the promotional
activities are performed under the terms of the agreement.
Allowance for uncollectable accounts receivable--Accounts receivable are
reduced by an allowance for amounts that may become uncollectable in the future.
On an ongoing basis, management performs credit evaluations of our customers and
adjusts credit limits based upon the customer's payment history and
creditworthiness, as determined by a review of their current credit information.
We continuously monitor collections and payments from our customers. Based upon
our historical experience and any specific customer collection issues that are
identified, management uses its judgment to establish and evaluate the adequacy
of our allowance for estimated credit losses. While such credit losses have been
within our expectations and the allowance provided, we cannot be sure that we
will continue to
20
experience the same credit loss rates as we have in the past. As of June 30,
2002, approximately 91% of our U.S. trade accounts receivable were due from
three pharmaceutical wholesalers. A significant change in the liquidity or
financial position of any one of these wholesalers could have a material adverse
impact on the collectability of our accounts receivable and our future operating
results.
Inventories--Our inventories are valued at the lower of cost or market, and
include the cost of raw materials, labor and overhead. We changed our method of
valuing inventories from the first-in, first-out, or FIFO method, to the
last-in, first-out, or LIFO method, effective January 1, 2002. The acquisition
of Group Lafon's manufacturing operations and the planned expansion of our
internal manufacturing capacity for ACTIQ has reduced and is expected to further
reduce our reliance on third party manufacturers. The expansion of our internal
manufacturing capabilities should allow us to benefit from efficiencies of scale
and lead to lower per unit inventory costs. The LIFO method will reflect the
expected changes to manufacturing costs on the statement of operations on a more
timely basis, resulting in a better matching of current costs of products sold
with product revenues. The majority of our inventories are subject to expiration
dating. We regularly evaluate the carrying value of our inventories and when, in
the opinion of management, factors indicate that impairment has occurred, either
a reserve is established against the inventories' carrying value or the
inventories are completely written off. Management bases these decisions on the
level of inventories on hand in relation to our estimated forecast of product
demand, production requirements over the next twelve months and the expiration
dates of raw materials and finished goods. Although we make every effort to
ensure the accuracy of forecasts of future product demand, any significant
unanticipated decreases in demand could have a material impact on the carrying
value of our inventories and our reported operating results. To date, inventory
adjustments have not been material.
Valuation of Fixed Assets, Goodwill and Intangible Assets--Our fixed assets
and intangible assets (which consist primarily of developed technology,
trademarks, and product and marketing rights) have been recorded at cost and are
being amortized on a straight-line basis over the estimated useful life of those
assets. In conjunction with acquisitions of businesses or product rights, we
allocate the purchase price based upon the relative fair values of the assets
acquired and liabilities assumed. In certain circumstances, fair value may be
assigned to purchased in-process technology and immediately expensed. The
valuation of goodwill and intangible assets and the estimation of appropriate
useful lives to apply to intangibles requires us to use our judgment. We
regularly assess the impairment of intangibles, long-lived assets and goodwill
and will adjust the balance whenever events or changes in circumstances indicate
that the carrying value of the assets may not be recoverable. Our judgments
regarding the existence of impairment indicators are based on legal factors,
market conditions and operating performance of our fixed assets and acquired
businesses and products. Future events could cause us to conclude that
impairment indicators exist and the carrying values of our fixed assets,
intangible assets or goodwill are impaired. Any resulting impairment loss could
have a material adverse impact on our financial position and results of
operations. To date, such impairments have not been material.
In June 2001, the FASB finalized SFAS No. 142, "Goodwill and Other
Intangible Assets." The provisions of SFAS 142 are summarized in Note 1 to the
interim consolidated financial statements. The new criteria for recording
intangible assets separate from goodwill did not require us to reclassify any of
our intangible assets. We have only recorded goodwill related to our acquisition
of Group Lafon effective December 28, 2001; therefore, our transitional
impairment test indicated that there was no impairment of goodwill upon our
adoption of SFAS 142 effective January 1, 2002.
We evaluate the recoverability and measure the possible impairment of our
goodwill under SFAS 142. The impairment test is a two-step process that begins
with the estimation of the fair value of the reporting unit. The first step
screens for potential impairment, and the second step measures the amount of the
impairment, if any. Our estimate of fair value considers publicly available
information regarding the market capitalization of our company, as well as (i)
publicly available information regarding comparable publicly-traded companies in
the pharmaceutical industry, (ii) the financial projections and future prospects
of our business, including its growth opportunities and likely operational
improvements, and (iii) comparable sales prices, if available. As part of the
first step to assess potential impairment, we compare our estimate of fair value
for the company to the book value of our consolidated net assets. If the book
value of our consolidated net assets is greater than our estimate of fair value,
we would then proceed to the second step to measure the impairment, if any. The
second step compares the implied fair value of goodwill with its carrying value.
The implied fair value is determined by allocating the fair value of the
reporting unit to all of the assets and liabilities of that unit as if the
reporting unit had been acquired in a business combination, and
21
the fair value of the reporting unit was the purchase price paid to acquire the
reporting unit. The excess of the fair value of the reporting unit over the
amounts assigned to its assets and liabilities is the implied fair value of
goodwill. If the carrying amount of the reporting unit goodwill is greater than
its implied fair value, an impairment loss will be recognized in the amount of
the excess. We do not currently anticipate recognition of any impairment losses.
On a quarterly basis, we perform a review of our business to determine if
events or changes in circumstances have occurred which could have a material
adverse effect on the fair value of the company and its goodwill. If such events
or changes in circumstances were deemed to have occurred, we would consult with
one or more valuation specialists in estimating the impact on our estimate of
fair value. We believe the estimation methods are reasonable and reflective of
common valuation practices.
Income taxes--We have provided for income taxes related to our foreign
subsidiaries in accordance with SFAS No. 109, "Accounting for Income Taxes,"
which requires the recognition of deferred tax assets and liabilities for the
expected tax consequences of temporary differences between the tax and financial
reporting bases of assets and liabilities. We have a history of losses from our
U.S. operations, which has generated significant federal and state tax net
operating loss (NOL) carryforwards of approximately $344,139,000 and
$147,620,000, respectively, as of December 31, 2001. United States generally
accepted accounting principles require us to record a valuation allowance
against the deferred tax asset associated with this NOL carryforward if it is
more likely than not that we will not be able to utilize the NOL carryforward to
offset future taxes. Due to the size of the NOL carryforward in relation to our
history of unprofitable operations, we have provided a full valuation allowance
against this deferred tax asset.
The third quarter of 2001 was our first profitable quarter from commercial
operations since inception. Profitability in future periods could cause
management to conclude that it is more likely than not that we will realize all
or a portion of the NOL carryforward. Upon reaching such a conclusion, which is
subject to management's judgment, we would immediately record the estimated net
realizable value of the deferred tax asset at that time and would then begin to
provide for income taxes at a rate equal to our combined federal and state
effective rates. Subsequent revisions to the estimated net realizable value of
the deferred tax asset could cause our provision for income taxes to vary
significantly from period to period.
22
LIQUIDITY AND CAPITAL RESOURCES
Cash, cash equivalents and investments at June 30, 2002 were $594,700,000,
representing 42% of total assets.
Net Cash Provided by (Used for) Operating Activities
Net cash provided by operating activities was $30,276,000 for the six
months ended June 30, 2002 as compared to net cash used for operating activities
of $22,410,000 for the same period in 2001. Net income was $11,558,000 in 2002,
as compared to a loss before preferred dividends of $12,516,000 in 2001, as a
result of the increase in product sales. In addition, we recognized the
following non-cash transactions in the first half of 2002: $16,335,000 of
depreciation and amortization expense, $7,099,000 of non-cash interest expense
on our convertible subordinated notes, $2,444,000 of non-cash compensation
expense, and $3,534,000 associated with changing our inventory costing method
from FIFO to LIFO. Receivables and inventories increased in 2002 by $3,927,000
and $2,803,000, respectively, as a result of the increase in product sales.
Accrued expenses decreased in 2002 by $10,261,000 primarily due to the payment
of costs associated with the acquisition of Group Lafon.
Net Cash Used for Investing Activities
A summary of net cash used for investing activities is as follows:
Six months ended
June 30,
2002 2001
----- ----
Purchases of property and equipment ....................................... $ (6,572,000) $ (4,745,000)
Acquisition of intangible assets .......................................... (23,658,000) --
Sales and maturities (purchases) of investments, net ...................... (145,992,000) (239,239,000)
------------- -------------
Net cash used for investing activities .................................... $(176,222,000) $(243,984,000)
============== ==============
--Acquisition of intangible assets
GABITRIL product rights increased by $16,905,000 since December 31, 2001 as
a result of a $10,000,000 payment to Abbott stemming from the extension of the
composition of matter patent and additional payments for expanded rights in
Europe and other countries worldwide. Other product rights increased as a result
of payments of $6,753,000 for the acquisition of additional product rights in
Europe and other countries worldwide.
Net Cash (Used for) Provided by Financing Activities
A summary of net cash provided by (used for) financing activities is as
follows:
Six months ended
June 30,
2002 2001
---- ----
Proceeds from exercises of common stock options and warrants .............. $ 3,065,000 $ 20,115,000
Payments to acquire treasury stock ........................................ (171,000) --
Net proceeds from the issuance of long-term debt .......................... -- 385,785,000
Preferred dividends paid .................................................. -- (6,656,000)
Principal payments on and retirement of long-term debt .................... (15,354,000) (49,576,000)
------------ ------------
Net cash (used for) provided by financing activities ...................... $(12,460,000) $349,668,000
============= ============
23
--Proceeds from exercises of common stock options and warrants
During the six months ended June 30, 2002, we received proceeds of
$3,065,000 from the exercise of 161,000 common stock options compared to
proceeds of $20,115,000 from the exercise of 1,021,000 common stock options
during the same period in 2001. At June 30, 2002, options to purchase 5,651,000
shares of our common stock at various exercise prices were outstanding. The
extent and timing of future option exercises, if any, are primarily dependent
upon the market price of our common stock and general financial market
conditions, as well as the exercise prices and expiration dates of the options.
--Payments to acquire treasury stock
Under our equity compensation plans, we may grant restricted stock awards
to employees. Upon vesting, shares of Cephalon common stock are withheld from
the employee's stock award and returned to the treasury for the dollar value of
payroll taxes withheld.
--Preferred dividends paid
The dividend payments of $6,656,000 during the first half of 2001 relate to
the previously outstanding shares of convertible, exchangeable preferred stock.
These outstanding preferred shares were converted during the second and third
quarters of 2001 into an aggregate of 6,974,998 shares of our common stock.
--Principal payments on long-term debt
In January 2002, we made a payment of $6,000,000 to Abbott Laboratories due
under our licensing agreement for U.S. product rights to GABITRIL. Payments of
$5,339,000 also were made during the first half of 2002 on the notes payable,
bank debt and other lines of credit of Group Lafon. In addition, for all periods
presented, principal payments on long-term debt include payments on mortgage and
building improvements loans and payments on capital lease obligations.
Commitments and Contingencies
--Legal Proceedings
In February 2001, a complaint was filed in Utah state court by Zars, Inc.
and one of its research scientists, against us and our subsidiary Anesta Corp.
The plaintiffs are seeking a declaratory judgment to establish their right to
develop transdermal or other products containing fentanyl and other
pharmaceutically active agents under a royalty and release agreement between
Zars and Anesta. The complaint also asks for unspecified damages for breach of
contract, interference with economic relations, defamation and slander. We
believe that we have valid defenses to all claims raised in this action. In any
event, we do not believe any judgment against us on any settlement of this claim
will have a material adverse effect on our financial condition or results of
operations.
We are a party to certain other litigation in the ordinary course of our
business, including matters alleging employment discrimination, product
liability and breach of commercial contract. However, we are vigorously
defending ourselves in all of the actions against us and do not believe these
matters, even if adversely adjudicated or settled, would have a material adverse
effect on our financial condition or results of operations.
--Related Party
In August 1992, we exclusively licensed our rights to MYOTROPHIN for human
therapeutic use within the United States, Canada and Europe to Cephalon Clinical
Partners, L.P., or CCP. We developed MYOTROPHIN on behalf of CCP under a
research and development agreement. Under this agreement, CCP granted an
exclusive license to manufacture and market MYOTROPHIN for human therapeutic use
within the United States, Canada and Europe, and we agreed to make royalty
payments equal to a percentage of product sales and a milestone payment of
approximately $16,000,000 upon regulatory approval. We have a contractual
option, but not an obligation, to purchase all of the limited partnership
interests of CCP, which is exercisable upon the occurrence of certain events
24
following the first commercial sale of MYOTROPHIN. If, and only if, we decide to
exercise this purchase option, we would make an advance payment of approximately
$40,275,000 in cash or, at our election, approximately $42,369,000 in shares of
common stock or a combination thereof. If we discontinue development of
MYOTROPHIN, or if we do not exercise this purchase option, our license will
terminate and all rights to manufacture or market MYOTROPHIN in the United
States, Canada and Europe will revert to CCP, which may then commercialize
MYOTROPHIN itself or license or assign its rights to a third party. In that
event, we would not receive any benefits from such commercialization, license or
assignment of rights.
Outlook
Cash, cash equivalents and investments at June 30, 2002 were $594,700,000.
Prior to 2001, we historically have had negative cash flows from operations and
have used the proceeds of public and private placements of our equity and debt
securities to fund operations. We currently believe that projected increases in
sales of our three U.S. marketed products, PROVIGIL, ACTIQ and GABITRIL, in
combination with other revenues, will allow us to achieve continued
profitability and positive cash flows from operations in 2002. At this time,
however, we cannot accurately predict the effect of certain developments on
future product sales such as the degree of market acceptance of our products,
competition, the effectiveness of our sales and marketing efforts and the
outcome of our research to demonstrate the utility of our products in
indications beyond those already included in the FDA approved labels. Other
revenues include receipts from collaborative research and development agreements
and co-promotion agreements. The continuation of any of these agreements is
subject to the achievement of certain milestones and to periodic review by the
parties involved.
We expect to continue to incur significant expenditures associated with
manufacturing, selling and marketing our products and conducting additional
clinical studies to explore the utility of these products in treating disorders
beyond those currently approved in their respective labels. We also expect to
continue to incur significant expenditures to fund research and development
activities, including clinical trials, for our other product candidates. We may
seek sources of funding for a portion of these programs through collaborative
arrangements with third parties. However, we intend to retain a portion of the
commercial rights to these programs and, as a result, we still expect to spend
significant funds on our share of the cost of these programs, including the
costs of research, preclinical development, clinical research and manufacturing.
We may have significant fluctuations in quarterly results based primarily
on the level and timing of:
. product sales and cost of product sales;
. achievement and timing of research and development milestones;
. co-promotion and other collaboration revenues;
. cost and timing of clinical trials;
. marketing and other expenses; and
. manufacturing or supply disruptions.
In December 2001, we acquired Group Lafon, which gave us worldwide control
of the intellectual property, marketing, and manufacturing rights related to
modafinil, the active drug substance in PROVIGIL. PROVIGIL accounted for
approximately 45% of our total product sales for the six months ended June 30,
2002. By consolidating our financial results with those of Group Lafon, we have
reduced significantly our cost of product sales for PROVIGIL by eliminating the
effect of preexisting contractual arrangements between us and Group Lafon.
In the second quarter of 2001, we completed a private placement of
$400,000,000 of 5.25% convertible subordinated notes due May 2006. In December
2001, we completed a private placement of $600,000,000 of 2.50% convertible
subordinated notes due December 2006. In March 2002, we completed a private
placement of $55,000,000
25
of 3.875% convertible notes due March 2007 to acquire all of the joint venture
interests of an unaffiliated third party investor. The 5.25% notes, 2.50% notes
and 3.875% notes are convertible at the option of the holders into our common
stock at per share conversion prices of $74.00, $81.00 and $70.36, respectively.
On various dates during the fourth quarter of 2001, certain holders of our
5.25% convertible notes approached us, and we agreed, to exchange $217,000,000
of the outstanding 5.25% convertible notes due May 2006 into 3,691,705 shares of
our common stock. The exchange transactions were completed using common stock
prices that equalized the fair value of the debt instrument with the fair value
of our common stock on the dates of the transactions. Since the notes were then
trading at a premium, the notes were exchanged at equivalent common stock prices
that were less than the original conversion price of $74.00 per share. As a
result, we recognized non-cash debt exchange expense totaling $52,444,000 in the
fourth quarter of 2001 based on the reduction of the original conversion price
in accordance with SFAS No. 84, "Induced Conversion of Convertible Debt." We
agreed to these exchanges to improve our debt to equity ratio.
There are currently $838,000,000 of convertible notes outstanding. The
annual interest payment on the outstanding balance of convertible notes is
$26,739,000 payable semiannually.
Based on our current level of operations and projected sales of our
products combined with other revenues and interest income, we believe that we
will be able to service our existing debt and meet our capital expenditure and
working capital requirements for the next several years. However, we cannot be
sure that our anticipated revenue growth will be realized or that we will
continue to generate positive cash flow from operations. We may need to obtain
additional funding for our operational needs, or for future significant
strategic transactions, and we cannot be certain that funding will be available
on terms acceptable to us, or at all.
26
CERTAIN RISKS RELATED TO OUR BUSINESS
In addition to historical facts or statements of current condition, this report
contains forward-looking statements. Forward-looking statements provide our
current expectations or forecasts of future events. These may include statements
regarding anticipated scientific progress in our research programs, development
of potential pharmaceutical products, prospects for regulatory approval,
manufacturing capabilities, market prospects for our products, sales and
earnings projections, and other statements regarding matters that are not
historical facts. Some of these forward-looking statements may be identified by
the use of words in the statements such as "anticipate," "estimate," "expect," "
project," "intend," "plan," "believe" or other words and terms of similar
meaning. Our performance and financial results could differ materially from
those reflected in these forward-looking statements due to general financial,
economic, regulatory and political conditions affecting the biotechnology and
pharmaceutical industries as well as more specific risks and uncertainties such
as those set forth below and in our reports to the SEC on Forms 8-K and 10-K.
Given these risks and uncertainties, any or all of these forward-looking
statements may prove to be incorrect. Therefore, you should not rely on any such
forward-looking statements. Furthermore, we do not intend to update publicly any
forward-looking statements, except as required by law. This discussion is
permitted by the Private Securities Litigation Reform Act of 1995.
A significant portion of our revenues is derived from U.S. sales of our three
largest products and our future success will depend on the continued acceptance
and growth of these products.
For the six months ended June 30, 2002, approximately 69% of our total
revenues were derived from U.S. sales of PROVIGIL, GABITRIL and ACTIQ. We cannot
be certain that these products will continue to be accepted in their markets.
Specifically, the following factors, among others, could affect the level of
market acceptance of PROVIGIL, GABITRIL and ACTIQ, including:
. the perception of the healthcare community of their safety and
efficacy, both in an absolute sense and relative to that of
competing products;
. the effectiveness of our sales and marketing efforts; o
unfavorable publicity regarding these products or similar
products;
. product price relative to other competing drugs or treatments;
. changes in government and other third-party payor reimbursement
policies and practices; and
. regulatory developments affecting the manufacture, marketing or
use of these products.
Any material adverse developments with respect to the sale or use of
PROVIGIL, GABITRIL or ACTIQ could significantly reduce our product revenues and
have a material adverse effect on our ability to generate net income and
positive net cash flow from operations.
We may be unsuccessful in our efforts to expand the number and scope of
authorized uses of PROVIGIL or GABITRIL, which would hamper sales growth and
make it more difficult to sustain profitability.
The market for the approved indications of two of our three largest
products is relatively small. We believe that a portion of our product sales is
derived from the use of these products outside of their labeled indications. To
a large degree, our future success depends on the expansion of the approved
indications for PROVIGIL and GABITRIL and physicians prescribing our products
outside of the approved indications. Under current FDA and European medical
authority regulations, we are restricted from promoting the use of these
products outside their labeled use. Any label expansion requires regulatory
approval.
We have initiated clinical studies to examine whether or not PROVIGIL and
GABITRIL are effective and safe when used to treat disorders outside their
currently approved uses. Although some study data has been positive, additional
studies in these disorders will be necessary before we can apply to regulatory
authorities to expand the authorized uses of these products. We do not know
whether these studies will demonstrate safety and efficacy, or if they do,
whether we will succeed in receiving regulatory approval to market PROVIGIL and
GABITRIL for additional disorders. If the results of some of these studies are
negative, or if adverse experiences are reported in these clinical studies or
otherwise in connection with the use of these products by patients, this could
undermine physician and patient comfort with the products, limit their
commercial success, and diminish their acceptance. Even if the
27
results of these studies are positive, the impact on sales of PROVIGIL and
GABITRIL may be minimal unless we are able to obtain FDA and foreign medical
authority approval to expand the authorized use of these products. FDA
regulations limit our ability to communicate the results of additional clinical
studies to patients and physicians without first obtaining approval for any
expanded uses.
We may not be able to maintain adequate protection for our intellectual
property or market exclusivity for certain of our products and therefore
competitors may develop competing products, which could result in a decrease in
sales and market share, cause us to reduce prices to compete successfully, and
limit our commercial success.
We place considerable importance on obtaining patent protection for new
technologies, products and processes. To that end, we file applications for
patent