-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, RDBjyLBnz6ZXXZIKgtdlypqc86kjvjnebdsGdyo56yo02r/EdJZSdzigiB0frbNj 4j6dBQfvgcRfIJ4AsvaktQ== 0000950168-02-001455.txt : 20020515 0000950168-02-001455.hdr.sgml : 20020515 20020515155703 ACCESSION NUMBER: 0000950168-02-001455 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 4 CONFORMED PERIOD OF REPORT: 20020331 FILED AS OF DATE: 20020515 FILER: COMPANY DATA: COMPANY CONFORMED NAME: CEPHALON INC CENTRAL INDEX KEY: 0000873364 STANDARD INDUSTRIAL CLASSIFICATION: PHARMACEUTICAL PREPARATIONS [2834] IRS NUMBER: 232484489 STATE OF INCORPORATION: DE FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-Q SEC ACT: 1934 Act SEC FILE NUMBER: 000-19119 FILM NUMBER: 02652177 BUSINESS ADDRESS: STREET 1: 145 BRANDYWINE PKWY CITY: WEST CHESTER STATE: PA ZIP: 19380 BUSINESS PHONE: 6103440200 MAIL ADDRESS: STREET 1: 145 BRANDYWINE PARKWAY CITY: WEST CHESTER STATE: PA ZIP: 19380 10-Q 1 d10q.txt FORM 10-Q SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-Q [X] Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 For the Quarterly Period Ended March 31, 2002 ------------------- [ ] Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 For the Transition Period from _________ to __________ Commission File Number 0-19119 --------------------- CEPHALON, INC. ----------------------------------------------------------------- (Exact Name of Registrant as Specified in its Charter) Delaware 23-2484489 - --------------------- ----------------------- (State Other Jurisdiction of (I.R.S. Employer Identification Incorporation or Organization) Number) 145 Brandywine Parkway, West Chester, PA 19380-4245 - ------------------------------------------ -------------------------- (Address of Principal Executive Offices) (Zip Code) Registrant's Telephone Number, Including Area Code (610) 344-0200 -------------------------- Not Applicable ------------------------------------------------------------------------------ Former Name, Former Address and Former Fiscal Year, If Changed Since Last Report Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes X No _______ : Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date. Class Outstanding as of May 10, 2002 - ---------------------------------- ------------------------------ Common Stock, par value $.01 55,073,424 Shares This Report Includes a Total of 31 Pages CEPHALON, INC. AND SUBSIDIARIES ------------------------------- INDEX -----
Page No. -------- PART I - FINANCIAL INFORMATION Item 1. Consolidated Financial Statements (Unaudited) Consolidated Balance Sheets - 3 March 31, 2002 and December 31, 2001 Consolidated Statements of Operations - 4 Three months ended March 31, 2002 and 2001 Consolidated Statements of Stockholders' Equity - 5 March 31, 2002 and December 31, 2001 Consolidated Statements of Cash Flows - 6 Three months ended March 31, 2002 and 2001 Notes to Consolidated Financial Statements 7 Item 2. Management's Discussion and Analysis of 13 Financial Condition and Results of Operations Item 3. Quantitative and Qualitative Disclosure about Market Risk 29 PART II - OTHER INFORMATION Item 1. Legal Proceedings 30 Item 2. Changes in Securities and Use of Proceeds 30 Item 6. Exhibits and Reports on Form 8-K 30 SIGNATURES 31
2 CEPHALON, INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS (Unaudited)
March 31, December 31, 2002 2001 -------------------- ---------------------- ASSETS ------ CURRENT ASSETS: Cash and cash equivalents $456,023,000 $548,727,000 Investments 138,028,000 55,157,000 Receivables, net 78,333,000 75,192,000 Inventory 44,765,000 47,513,000 Other current assets 9,253,000 7,872,000 -------------------- ---------------------- Total current assets 726,402,000 734,461,000 PROPERTY AND EQUIPMENT, net 66,561,000 64,706,000 GOODWILL 244,357,000 248,911,000 INTANGIBLE ASSETS, net 297,471,000 298,269,000 DEBT ISSUANCE COSTS 25,550,000 26,720,000 OTHER ASSETS 10,211,000 16,020,000 -------------------- ---------------------- $1,370,552,000 $1,389,087,000 ==================== ====================== LIABILITIES AND STOCKHOLDERS' EQUITY ------------------------------------ CURRENT LIABILITIES: Current portion of long-term debt $21,359,000 $32,200,000 Accounts payable 15,523,000 24,536,000 Accrued expenses 45,342,000 49,370,000 Current portion of deferred revenues 624,000 824,000 -------------------- ---------------------- Total current liabilities 82,848,000 106,930,000 LONG-TERM DEBT 872,112,000 866,589,000 DEFERRED REVENUES 6,238,000 6,042,000 OTHER LIABILITIES 10,832,000 10,795,000 -------------------- ---------------------- Total liabilities 972,030,000 990,356,000 -------------------- ---------------------- COMMITMENTS AND CONTINGENCIES (Note 5) STOCKHOLDERS' EQUITY: Preferred stock, $.01 par value, 5,000,000 shares authorized, 2,500,000 shares issued, and none outstanding -- -- Common stock, $.01 par value, 100,000,000 shares authorized, 55,038,014 and 54,909,533 shares issued, and 54,813,081 and 54,685,792 shares outstanding 550,000 549,000 Additional paid-in capital 985,624,000 982,123,000 Treasury stock, 224,933 and 223,741 shares outstanding, at cost (9,603,000) (9,523,000) Accumulated deficit (579,562,000) (576,691,000) Accumulated other comprehensive income 1,513,000 2,273,000 -------------------- ---------------------- Total stockholders' equity 398,522,000 398,731,000 -------------------- ---------------------- $1,370,552,000 $1,389,087,000 ==================== ======================
The accompanying notes are an integral part of these consolidated financial statements 3 CEPHALON, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS (Unaudited)
Three Months Ended March 31, ---------------------------------- 2002 2001 --------------- --------------- REVENUES: Product sales $ 95,803,000 $ 40,822,000 Other revenues 15,698,000 6,250,000 --------------- --------------- 111,501,000 47,072,000 --------------- --------------- COSTS AND EXPENSES: Cost of product sales 13,845,000 8,298,000 Research and development 29,823,000 19,611,000 Selling, general and administrative 40,284,000 24,365,000 Depreciation and amortization 8,293,000 3,489,000 --------------- --------------- 92,245,000 55,763,000 --------------- --------------- INCOME (LOSS) FROM OPERATIONS 19,256,000 (8,691,000) OTHER INCOME AND EXPENSE Interest income 2,870,000 1,507,000 Interest expense (11,498,000) (1,320,000) Other expense (838,000) (1,038,000) --------------- --------------- (9,466,000) (851,000) --------------- --------------- INCOME (LOSS) BEFORE INCOME TAXES 9,790,000 (9,542,000) INCOME TAXES (1,985,000) -- --------------- --------------- INCOME (LOSS) BEFORE DIVIDENDS ON PREFERRED STOCK, EXTRAORDINARY CHARGE AND CUMULATIVE EFFECT OF CHANGING INVENTORY COSTING METHOD 7,805,000 (9,542,000) DIVIDENDS ON CONVERTIBLE EXCHANGEABLE PREFERRED STOCK -- (2,266,000) --------------- --------------- INCOME (LOSS) BEFORE EXTRAORDINARY CHARGE AND CUMULATIVE EFFECT OF CHANGING INVENTORY COSTING METHOD 7,805,000 (11,808,000) EXTRAORDINARY CHARGE ON EARLY EXTINGUISHMENT OF DEBT (7,142,000) -- CUMULATIVE EFFECT OF CHANGING INVENTORY COSTING METHOD FROM FIFO TO LIFO (3,534,000) -- --------------- --------------- LOSS APPLICABLE TO COMMON SHARES $(2,871,000) $(11,808,000) =============== =============== BASIC AND DILUTED LOSS PER COMMON SHARE: Income (loss) per common share before extraordinary charge and cumulative effect of changing inventory costing method $0.14 $(0.28) Extraordinary charge on early extinguishment of debt (0.13) -- Cumulative effect of changing inventory costing method (0.06) -- --------------- --------------- $(0.05) $(0.28) =============== =============== WEIGHTED AVERAGE NUMBER OF COMMON SHARES OUTSTANDING 54,963,000 42,732,000 =============== ===============
The accompanying notes are an integral part of these consolidated financial statements 4 CEPHALON, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (Unaudited)
Accumulated Other Comprehensive Accumulated Comprehensive Common Loss Total Deficit Income Stock --------------- ------------------------------ ----------------- ------------- BALANCE, JANUARY 1, 2001 $165,193,000 $(515,543,000) $1,401,000 $425,000 Loss $(55,484,000) (55,484,000) (55,484,000) -- -- --------------- Foreign currency translation gain 368,000 Unrealized investment gains 504,000 --------------- Other comprehensive income 872,000 872,000 -- 872,000 -- --------------- Comprehensive loss $(54,612,000) =============== Conversion of preferred stock into common stock -- -- -- 70,000 Issuance of common stock upon conversion of convertible notes 262,590,000 -- -- 37,000 Stock options exercised 25,542,000 -- -- 13,000 Stock purchase warrants exercised 2,679,000 -- -- 2,000 Restricted stock award plan 5,349,000 -- -- 2,000 Employee benefit plan 1,283,000 -- -- Dividends declared on convertible preferred stock (5,664,000) -- -- -- Treasury stock acquired (3,629,000) -- -- ------------- -------------- ------------- ------------ BALANCE, DECEMBER 31, 2001 398,731,000 (576,691,000) 2,273,000 549,000 Loss $(2,871,000) (2,871,000) (2,871,000) -- -- --------------- Foreign currency translation loss (263,000) Unrealized investment losses (497,000) --------------- Other comprehensive income (760,000) (760,000) -- (760,000) -- --------------- Comprehensive loss $(3,631,000) =============== Stock options exercised 2,057,000 -- -- 1,000 Restricted stock award plan 610,000 -- -- -- Employee benefit plan 795,000 -- -- -- Treasury stock acquired (40,000) -- -- -- ------------- -------------- ------------ ------------ BALANCE, MARCH 31, 2002 $398,522,000 $(579,562,000) $1,513,000 $550,000 ============= ============== ============ ============ Additional Preferred Paid-in Treasury Stock Capital Stock ------------- ------------ ------------ BALANCE, JANUARY 1, 2001 $25,000 $683,004,000 $(4,119,000) Loss -- -- -- Foreign currency translation gain Unrealized investment gains Other comprehensive income -- -- -- Comprehensive loss Conversion of preferred stock into common stock (25,000) (45,000) -- Issuance of common stock upon conversion of convertible notes -- 262,553,000 -- Stock options exercised -- 27,304,000 (1,775,000) Stock purchase warrants exercised -- 2,677,000 -- Restricted stock award plan -- 5,347,000 -- Employee benefit plan -- 1,283,000 -- Dividends declared on convertible preferred stock -- -- Treasury stock acquired -- -- (3,629,000) ----------- ------------- ------------ BALANCE, DECEMBER 31, 2001 -- 982,123,000 (9,523,000) Loss -- -- -- Foreign currency translation loss Unrealized investment losses Other comprehensive income -- -- -- Comprehensive loss Stock options exercised -- 2,096,000 (40,000) Restricted stock award plan -- 610,000 -- Employee benefit plan -- 795,000 -- Treasury stock acquired -- -- (40,000) ----------- ------------ ------------- BALANCE, MARCH 31, 2002 $ -- $985,624,000 $(9,603,000) =========== ============ =============
The accompanying notes are an integral part of these consolidated financial statements 5 CEPHALON, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS --------------------------------------- (Unaudited)
Three Months Ended March 31, --------------------------------- 2002 2001 -------------- ------------ CASH FLOWS FROM OPERATING ACTIVITIES: Loss $(2,871,000) $(9,542,000) Adjustments to reconcile loss to net cash provided by (used for) operating activities: Depreciation and amortization 8,293,000 3,489,000 Extraordinary charge on extinguishment of debt 7,142,000 Non-cash interest expense 5,055,000 1,073,000 Cumulative effect of changing inventory costing method from FIFO to LIFO 3,534,000 -- Stock-based compensation expense 1,405,000 1,711,000 Other -- (10,000) (Increase) decrease in operating assets: Receivables 1,597,000 (1,915,000) Inventory (786,000) (6,570,000) Other current assets (1,381,000) (1,604,000) Other long-term assets (125,000) (12,000) Increase (decrease) in operating liabilities: Accounts payable (9,013,000) 239,000 Accrued expenses (4,212,000) (2,792,000) Deferred revenues (4,000) 2,237,000 Other long-term liabilities 37,000 (16,000) -------------- ------------ Net cash provided by (used for) operating activities 8,671,000 (13,712,000) -------------- ------------ CASH FLOWS FROM INVESTING ACTIVITIES: Purchases of property and equipment (3,038,000) (1,389,000) Acquistion of intangible assets (4,974,000) -- Sales and maturities (purchases) of investments, net (83,368,000) 22,972,000 -------------- ------------ Net cash (used for) provided by investing activities (91,380,000) 21,583,000 -------------- ------------ CASH FLOWS FROM FINANCING ACTIVITIES: Proceeds from exercises of common stock options and warrants 2,057,000 13,883,000 Payments to acquire treasury stock (40,000) -- Preferred dividends paid -- (2,266,000) Principal payments on and retirements of long-term debt (11,144,000) (669,000) -------------- ------------ Net cash (used for) provided by financing activities (9,127,000) 10,948,000 -------------- ------------ EFFECT OF EXCHANGE RATE CHANGES ON CASH AND CASH EQUIVALENTS (868,000) 790,000 -------------- ------------ NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS (92,704,000) 19,609,000 CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD 548,727,000 36,571,000 -------------- ------------ CASH AND CASH EQUIVALENTS, END OF PERIOD $456,023,000 $56,180,000 ============== ============ Supplemental disclosures of cash flow information: Cash payments for interest $3,170,000 $2,140,000 Non-cash investing and financing activities: Capital lease additions 325,000 259,000
The accompanying notes are an integral part of these consolidated financial statements 6 CEPHALON, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) 1. NATURE OF BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES Business Cephalon is an international biopharmaceutical company dedicated to the discovery, development and marketing of products to treat sleep disorders, neurological disorders, cancer and pain. In addition to conducting an active research and development program, we market three products in the United States and a number of products in various countries throughout Europe. We are headquartered in West Chester, Pennsylvania and have offices in Salt Lake City, Utah, France, the United Kingdom, Germany and Switzerland. Our research and development headquarters are located in the United States. We operate manufacturing facilities in France for the production of modafinil, which is the active drug substance found in our PROVIGIL(R)(modafinil) tablets [C-IV] and MODIODAL(R)(modafinil) products, and for which we have worldwide control of the intellectual property, marketing and manufacturing rights. We operate manufacturing facilities in Salt Lake City, Utah, for the production of ACTIQ(R)(oral transmucosal fentanyl citrate) [C-II] for distribution and sale in the European Union. Basis of Presentation The accompanying unaudited consolidated financial statements have been prepared in accordance with generally accepted accounting principles for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnote disclosures required by generally accepted accounting principles for complete financial statements. In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation have been included. These financial statements should be read in conjunction with the consolidated financial statements and notes thereto included in our annual report on Form 10-K, filed with the Securities and Exchange Commission, which includes audited financial statements as of December 31, 2001 and 2000 and for each of the three years in the period ended December 31, 2001. The results of our operations for any interim period are not necessarily indicative of the results of our operations for any other interim period or for a full year. Income Taxes We have provided for income taxes related to our foreign subsidiaries in accordance with Statement of Financial Accounting Standards (SFAS) No. 109, "Accounting for Income Taxes," which requires the recognition of deferred tax assets and liabilities for the expected tax consequences of temporary differences between the tax and financial reporting bases of assets and liabilities. We have a history of losses in our U.S. operations, which has generated significant federal and state tax net operating loss (NOL) carryforwards of approximately $344,139,000 and $147,620,000, respectively, as of December 31, 2001. Generally accepted accounting principles require us to record a valuation allowance against the deferred tax asset associated with this NOL carryforward if it is more likely than not that we will not be able to utilize the NOL carryforward to offset future taxes. Due to the size of the NOL carryforward in relation to our history of unprofitable operations, we have not recognized a net deferred tax asset. Group Lafon On December 28, 2001, we completed our acquisition of the outstanding shares of capital stock of Group Lafon. With this acquisition, we control worldwide rights to our product PROVIGIL. The acquisition is expected to increase our product sales, improve gross margins for PROVIGIL by eliminating payments to Group Lafon, improve profitability and provide us with an important research, commercial and manufacturing infrastructure in France. The purchase price was approximately $452,446,000. The purchase price was funded in part by the proceeds of our December 11, 2001 offering of $600,000,000 of our 2.50% convertible subordinated notes due December 2006. Of the purchase price, $450,000,000 was paid in cash to the sellers and $2,446,000 represents transaction costs of the acquisition and severance payments, partially offset by an estimate of the amount expected to be refunded by the seller under the terms of the acquisition agreement. All such amounts are expected to be paid or received in 2002. 7 CEPHALON, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--CONTINUED (Unaudited) The following unaudited pro forma information shows the results of the our operations for the three months ended March 31, 2001 as though the acquisition had occurred as of January 1, 2001: Three months ended March 31, 2001 -------------- Total revenues................................................$ 67,200,000 Net loss......................................................$(14,336,000) Basic and diluted net loss per common share: $ (0.34) The pro forma results have been prepared for comparative purposes only and are not necessarily indicative of the actual results of operations had the acquisition taken place as of January 1, 2001, or the results that may occur in the future. Furthermore, the pro forma results do not give effect to all cost savings or incremental costs that may occur as a result of the integration and consolidation of the acquisition. Recent Accounting Pronouncements In June 2001, the Financial Accounting Standards Board (FASB) finalized SFAS No. 142, "Goodwill and Other Intangible Assets" (SFAS 142), which is effective for fiscal years beginning after December 15, 2001. SFAS 142 no longer requires the amortization of goodwill; rather, goodwill will be subject to a periodic assessment for impairment by applying a fair-value-based test. In addition, an acquired intangible asset should be separately recognized if the benefit of the intangible asset is obtained through contractual or other legal rights, or if the intangible asset can be sold, transferred, licensed, rented, or exchanged, regardless of the acquirer's intent to do so. Such acquired intangible assets will be amortized over their estimated useful lives or contractual lives as appropriate. The application of SFAS 142 did not have a material impact on our financial statements. 2. JOINT VENTURE In December 2001, we formed a joint venture with an unaffiliated third party investor to fund additional commercial activities in support of PROVIGIL and GABITRIL in the United States. In exchange for our transfer to the joint venture of certain intellectual property and other rights related to these two products, we received a Class B interest, representing a 50% interest in the joint venture. In exchange for its contribution of $50,000,000 in cash to the joint venture, the investor received Class A interests, also representing a 50% interest in the joint venture. As of December 31, 2001, the $50,000,000 investor's Class A interest was recorded on our balance sheet as a liability, and the joint venture's cash balance of $50,000,000 was included in our balance of cash and cash equivalents. On March 29, 2002, we acquired the investor's Class A interests and ended the joint venture by the issuance and sale in a private placement of $55,000,000 aggregate principal amount of 3.875% convertible subordinated notes due March 2007. The notes are convertible into our common stock, at the option of the holder, at a price of $70.36 per share. See "Note 4--Long-Term Debt." The purchase of the investor's Class A interests in the joint venture resulted in the recognition of an extraordinary charge of $7,142,000 during the first quarter of 2002. The following table summarizes the calculation of the $7,142,000 extraordinary charge: 8 CEPHALON, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--CONTINUED (Unaudited)
Carrying value of the debt as of December 31, 2001........................... $ 50,000,000 Interest accreted during the first quarter 2002 @ 20%........................ 2,500,000 -------------- Carrying value of the debt as of March 29, 2002.............................. 52,500,000 Less: unamortized debt issuance costs as of March 29, 2002................... (4,642,000) -------------- 47,858,000 Fair value of subordinated notes issued on March 29, 2002.................... (55,000,000) -------------- Extraordinary charge......................................................... $(7,142,000) ==============
In addition, our statement of operations for the three months ended March 31, 2002 included certain charges related to the operations of the joint venture, as follows: Three months ended March 31, 2002 -------------- Selling, general and administrative expenses................ $3,508,000 Interest expense............................................ 3,163,000 Interest income............................................. (190,000) ----------- $6,481,000 =========== 3. INVENTORY Inventory consisted of the following: March 31, December 31, 2002 2001 ---- ---- Raw material.............................. $24,494,000 $19,666,000 Work-in-process........................... 3,412,000 7,632,000 Finished goods............................ 16,859,000 20,215,000 ------------- ------------ $44,765,000 $47,513,000 ============= ============ Effective January 1, 2002, we changed our method of valuing inventories from the first-in, first-out, or FIFO method, to the last-in, first-out, or LIFO method. We recognized a charge of $3,534,000 in the first quarter of 2002 as the cumulative effect of adopting the LIFO inventory costing method. The acquisition of Group Lafon's manufacturing operations and the expansion of our internal manufacturing capacity for ACTIQ has reduced our reliance on third party manufacturers and sharpened management's focus on minimizing the cost of manufacturing products. Consistent with this goal, the LIFO method reflects current changes to manufacturing costs on the statement of operations on a more timely basis, resulting in a better matching of currents costs of products sold with product revenues. Cost of product sales under the LIFO inventory costing method was $4,488,000 lower in the first quarter of 2002 than it would have been under the FIFO method. If we had adopted LIFO effective January 1, 2001, the effect on our statement of operations for the first quarter of 2001 would have been immaterial. 9 CEPHALON, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--CONTINUED (Unaudited) 4. LONG-TERM DEBT Long-term debt consisted of the following:
March 31, December 31, 2002 2001 ---- ---- Capital lease obligations......................................... $ 2,826,000 $ 2,852,000 Mortgage and building improvement loans........................... 11,691,000 12,085,000 Joint venture..................................................... -- 50,000,000 Convertible subordinated notes.................................... 838,000,000 783,000,000 Notes Payable/Other............................................... 9,000,000 13,460,000 Due to Abbott Laboratories........................................ 31,954,000 37,792,000 -------------- -------------- Total debt........................................................ 893,471,000 898,789,000 Less current portion.............................................. (21,359,000) (32,200,000) -------------- -------------- Total long-term debt.............................................. $872,112,000 $866,589,000 ============== ==============
Convertible Subordinated Notes On March 29, 2002, we issued and sold in a private placement $55,000,000 aggregate principal amount of 3.875% Convertible Notes due March 29, 2007. The notes were issued and sold to the purchaser in a transaction exempt from registration requirements of the Securities Act of 1933, as amended, because the offer and sale of the notes did not involve a public offering. We are obligated to pay interest on the notes at a rate of 3.875% per year on each of April 15 and October 15, beginning October 15, 2002. The notes also are convertible into our common stock, at the option of the holders, at a price of $70.36 per share, subject to adjustment upon certain events. The holders of the notes may elect to require us to redeem the notes on March 28, 2005 at a redemption price equal to 100% of the principal amount of notes submitted for redemption, plus accrued and unpaid interest. In certain other circumstances, at the option of the holders, we may be required to repurchase the notes at 100% of the principal amount of the notes submitted for repurchase, plus accrued and unpaid interest. We issued these notes in connection with our acquisition of the Class A interest held by our joint venture partner. See "Note 2--Joint Venture." 5. COMMITMENTS AND CONTINGENCIES Legal Proceedings In August 1999, the U.S. District Court for the Eastern District of Pennsylvania entered a final order approving the settlement of a class action alleging that statements made about the results of certain clinical studies of MYOTROPHIN(R) (mecasermin) Injection were misleading. A related complaint has been filed with the Court by a small number of plaintiffs who decided not to participate in the settlement. This related complaint alleges that we are liable under common law for misrepresentations concerning the results of the MYOTROPHIN clinical trials, and that we and certain of our current and former officers and directors are liable for the actions of persons who allegedly traded in our common stock on the basis of material inside information. We believe that we have valid defenses to all claims raised in this action. Moreover, even if there is a judgment against us in this case, we do not believe it will have a material adverse effect on our financial condition or results of operations. In February 2001, a complaint was filed in Utah state court by Zars, Inc. and one of its research scientists, against us and our subsidiary Anesta Corp. The plaintiffs are seeking a declaratory judgment to establish their right to develop 10 CEPHALON, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--CONTINUED (Unaudited) transdermal or other products containing fentanyl and other pharmaceutically active agents under a royalty and release agreement between Zars and Anesta. The complaint also asks for unspecified damages for breach of contract, interference with economic relations, defamation and slander. We believe that we have valid defenses to all claims raised in this action. In any event, we do not believe any judgment against us will have a material adverse effect on our financial condition or results of operations. We are a party to certain other litigation in the ordinary course of our business, including matters alleging employment discrimination, product liability and breach of commercial contract. However, we are vigorously defending ourselves in all of these actions and do not believe these matters, even if adversely adjudicated or settled, would have a material adverse effect on our financial condition or results of operations. Related party In August 1992, we exclusively licensed our rights to MYOTROPHIN for human therapeutic use within the United States, Canada and Europe to Cephalon Clinical Partners, L.P., or CCP. We developed MYOTROPHIN on behalf of CCP under a research and development agreement. Under this agreement, CCP granted an exclusive license to manufacture and market MYOTROPHIN for human therapeutic use within the United States, Canada and Europe, and we agreed to make royalty payments equal to a percentage of product sales and a milestone payment of approximately $16,000,000 upon regulatory approval. We have a contractual option, but not an obligation, to purchase all of the limited partnership interests of CCP, which is exercisable upon the occurrence of certain events following the first commercial sale of MYOTROPHIN. If, and only if, we decide to exercise this purchase option, we would make an advance payment of approximately $40,275,000 in cash or, at our election, approximately $42,369,000 in shares of common stock or a combination thereof. Should we discontinue development of MYOTROPHIN, or if we do not exercise this purchase option, our license will terminate and all rights to manufacture or market MYOTROPHIN in the United States, Canada and Europe will revert to CCP, which may then commercialize MYOTROPHIN itself or license or assign its rights to a third party. In that event, we would not receive any benefits from such commercialization, license or assignment of rights. 6. OTHER COMPREHENSIVE INCOME SFAS No. 130, "Reporting Comprehensive Income," requires presentation of the components of comprehensive income (loss). Our comprehensive loss includes net loss, unrealized gains and losses from foreign currency translation adjustments, and unrealized investment gains and losses. Our total comprehensive loss is as follows: Three months ended March 31, 2002 2001 ---- ---- Loss before preferred dividends............. $(2,871,000) $(11,808,000) Other comprehensive income (loss): Foreign currency translation adjustment... (263,000) 790,000 Unrealized investment gains (losses)...... (497,000) 105,000 ---------- ----------- Other comprehensive loss.................... $(3,631,000) $(10,913,000) ============ ============= 7. SEGMENT AND SUBSIDIARY INFORMATION On December 28, 2001, we completed our acquisition of Group Lafon. As a result, we now have significant sales, manufacturing, and research operations conducted by several subsidiaries located in Europe. In 2001 and prior years, European operations were immaterial. United States product sales accounted for 98%, 97% and 98% of total product sales for the years ended December 31, 2001, 2000 and 1999, respectively. 11 CEPHALON, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--CONTINUED (Unaudited) The following summarized information presents our revenues and long-lived assets by geographic segment. The summarized information of the European subsidiaries has been prepared from the books and records maintained by each subsidiary. We have determined that all of our operations have similar economic characteristics and may be aggregated into a single segment for reporting purposes. Information concerning our geographic operations is provided below. Revenues for the three months ended March 31, 2002: United States................................... $ 83,469,000 Europe.......................................... 28,032,000 -------------- Total........................................... $ 111,501,000 ============== Long-lived assets at March 31, 2002: United States.................................. $ 200,691,000 Europe......................................... 443,459,000 -------------- Total.......................................... $ 644,150,000 ============== 12 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS RESULTS OF OPERATIONS Three months ended March 31, 2002 compared to three months ended March 31, 2001
Three months ended March 31, 2002 2001 ----- ---- Product sales: PROVIGIL..................................................... $ 44,175,000 $27,024,000 ACTIQ........................................................ 19,267,000 6,582,000 GABITRIL..................................................... 10,164,000 7,216,000 Group Lafon products......................................... 22,197,000 -- ------------- ------------ Total product sales............................................... 95,803,000 40,822,000 ------------- ------------ Other revenues: H. Lundbeck A/S.............................................. 2,200,000 1,300,000 Novartis Pharma AG........................................... 2,328,000 2,325,000 Sanofi-Synthelabo............................................ 9,735,000 -- Takeda Abbott Pharmaceuticals................................ -- 1,200,000 Other........................................................ 1,435,000 1,425,000 ------------- ------------ Total other revenues.............................................. 15,698,000 6,250,000 ------------- ------------ Total revenues.................................................... $111,501,000 $47,072,000 ============ ===========
Revenues-- Product sales in the first quarter of 2002 increased 135% over the first quarter of 2001. The increase is attributable to a number of factors including: . Sales of PROVIGIL increased 63% due to increased market acceptance, as well as a 5% domestic price increase that took effect in the second quarter of 2001. . Sales of ACTIQ increased 193%. After our merger with Anesta in October 2000, we established a dedicated sales force for ACTIQ and have made ongoing changes to our marketing approach that have resulted in higher sales. A 6.6% average domestic price increase in the second quarter of 2001 also contributed to higher sales. . Sales of GABITRIL increased 41%. This increase is the result of increased demand in the U.S. market and the expansion of our sales efforts into Europe in the first quarter of 2002 as a result of the acquisition of European rights to GABITRIL. Additionally, an average increase in domestic prices of 10% in the second quarter of 2001 contributed to the sales increase. . Sales of Group Lafon products, acquired on December 28, 2001, were $22,197,000 during the first quarter of 2002. The most significant product sales during the period were $11,077,000 of SPASFON, used for biliary/urinary tract spasm and irritable bowel syndrome. Additionally, sales include $2,607,000 of MODIODAL, the French trade name for PROVIGIL. Total other revenues increased by $9,448,000, or 151%. This increase was due primarily to revenues recognized under our licensing, development and marketing collaborations with Sanofi-Synthelabo, which began in October 2001, and H. Lundbeck A/S, partially offset by a decrease in revenue due to the March 31, 2001 termination of our collaboration with Takeda Abbott Pharmaceuticals. 13 Cost of Product Sales-- The cost of product sales in the first quarter of 2002 decreased to 14% of product sales from 20% in the first quarter of 2001 due principally to the positive effects of the Group Lafon acquisition. Research and Development Expenses--Research and development expenses increased 52% to $29,823,000 in the first quarter of 2002 from $19,611,000 in the first quarter of 2001. An increase of $3,900,000 is attributable to higher expenditures on drug development and manufacturing costs for our compounds that have progressed into later stages of development and infrastructure costs to support the growing number of ongoing clinical trials including Phase 2 clinical studies for CEP-1347 and studies of PROVIGIL related to our efforts to expand the label for PROVIGIL beyond its current indication. In addition, we incurred $5,038,000 of research and development expenses in the first quarter of 2002 at Group Lafon. Selling, General and Administrative Expenses--Selling, general and administrative expenses increased 65% to $40,284,000 for the quarter ended March 31, 2002 from $24,365,000 for the first quarter of 2001 primarily due to an increase of $3,300,000 in external sales and marketing expenses and an increase of $2,400,000 in the size of our internal sales force to promote and support PROVIGIL, ACTIQ and GABITRIL. In addition, we incurred $8,419,000 of selling, general and administrative expenses in the first quarter of 2002 at Group Lafon. Depreciation and Amortization Expenses--Depreciation and amortization expenses increased to $8,293,000 in the first quarter of 2002 from $3,489,000 in the first quarter of 2001 due primarily to amortization expense of $2,733,000 for intangible assets acquired in our acquisition of Group Lafon. In addition, we incurred $1,216,000 of depreciation expense associated with assets acquired from Group Lafon. Other Income and Expense--Interest income increased by $1,363,000 from the first quarter of 2001 due to higher average investment balances, partially offset by lower average rates of return. Interest expense increased by $10,178,000 from the first quarter of 2001 due primarily to interest recorded on the $783,000,000 of outstanding convertible subordinated notes and the $50,000,000 of debt related to the joint venture restructuring. Other expenses decreased by $212,000 due to the fluctuation in the currency exchange value of the pound Sterling (GBP) relative to the U.S. dollar. Income Taxes--Income taxes of $1,985,000 recorded in the first quarter of 2002 represent foreign income tax expense associated with activities in France. Dividends on Convertible Exchangeable Preferred Stock--In the first quarter of 2001, we recognized $2,266,000 of dividend expense associated with the previously outstanding shares of preferred stock. These outstanding preferred shares were converted during the second and third quarters of 2001 into an aggregate of 6,974,998 shares of our common stock. Extraordinary Charge on Early Extinguishment of Debt-- The purchase of the investor's Class A interests in the joint venture resulted in the recognition of an extraordinary charge of $7,142,000 during the first quarter of 2002. 14 This amount consists of the write-off of $4,642,000 of the remaining costs associated with the formation of the joint venture which were capitalized, and a $2,500,000 loss on the early extinguishment of debt. Cumulative Effect of Changing Inventory Costing Method from FIFO to LIFO-- Effective January 1, 2002, we changed our method of valuing inventories from the first-in, first-out, or FIFO method, to the last-in, first-out, or LIFO method. We recognized a charge of $3,534,000 in the first quarter of 2002 as the cumulative effect of adopting the LIFO inventory valuation method. The acquisition of Group Lafon's manufacturing operations and the expansion of our internal manufacturing capacity for ACTIQ has reduced our reliance on third party manufacturers and sharpened management's focus on minimizing the cost of manufacturing products. Consistent with this goal, the LIFO method reflects current changes to manufacturing costs on the statement of operations on a more timely basis, resulting in a better matching of currents costs of products sold with product revenues. CRITICAL ACCOUNTING POLICIES AND ESTIMATES Management's Discussion and Analysis of Financial Condition and Results of Operations discusses our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of these financial statements requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities at the date of the financial statements, and the reported amounts of revenues and expenses during the reporting period. These estimates and assumptions are developed, and challenged periodically, by management based on historical experience and on various other factors that are believed to be reasonable under the circumstances. Actual results may differ from these estimates under different assumptions or conditions. Our significant accounting policies are described in Note 1 to the consolidated financial statements included in Item 1 of this Form 10-Q and Note 1 to the consolidated financial statements included in Item 8 of our Form 10-K for the year ended December 31, 2001. Management considers the following policies to be the most critical in understanding the more complex judgments that are involved in preparing our consolidated financial statements and the uncertainties that could impact its results of operations, financial position and cash flows. Revenue recognition--Product sales are recognized upon shipment of product and are recorded net of estimated reserves for contractual allowances, discounts and returns. Contractual allowances result from sales under contracts with managed care organizations and government agencies. The reserve for contractual allowances is based on an estimate of prescriptions to be filled for individuals covered by government agencies and managed care organizations with whom we have contracts. The reserve for product returns is determined by reviewing the history of each product's returns and by utilizing reports purchased from external, independent sources which produce prescription data, wholesale stocking levels and wholesale sales to retail pharmacies. This data is reviewed to monitor product movement through the supply chain to identify remaining inventory in the supply chain that may result in reserves for contractual allowances or returns. The reserves are reviewed at each reporting period and adjusted to reflect data available at that time. To the extent our estimate of allowances is inaccurate, we will adjust the reserve which will impact the amount of product sales revenue recognized in the period of the adjustment. Product returns are permitted with respect to unused pharmaceuticals based on expiration dating of our product. To date, product returns have not been material. Revenue from collaborative agreements may consist of up-front fees, ongoing research and development funding and milestone payments. Effective January 1, 2000, we adopted the SEC's Staff Accounting Bulletin No. 101, "Revenue Recognition in Financial Statements" (SAB 101). In accordance with SAB 101, non-refundable up-front fees are deferred and amortized to revenue over the related performance period. We estimate our performance period based on the specific terms of each collaborative agreement, but actual performance may vary. We adjust the performance periods based upon available facts and circumstances. Periodic payments for research and development activities are recognized over the period that we perform the related activities under the terms of the agreements. Revenue resulting from the achievement of milestone events stipulated in the agreements is recognized when the milestone is achieved. Milestones are based upon the occurrence of a substantive element specified in the contract or as measure of substantive progress towards completion under the contract. Allowance for uncollectable accounts receivable--Accounts receivable are reduced by an allowance for amounts that may become uncollectable in the future. On an ongoing basis, management performs credit evaluations of our customers and adjusts credit limits based upon the customer's payment history and creditworthiness, as determined by a review of their current credit information. We continuously monitor collections and payments from our customers. 15 Based upon our historical experience and any specific customer collection issues that are identified, management uses its judgment to establish and evaluate the adequacy of our allowance for estimated credit losses. While such credit losses have been within our expectations and the allowance provided, we cannot guarantee that it will continue to experience the same credit loss rates as it has in the past. Also, as of March 31, 2002, approximately 91% of our U.S. trade accounts receivable were due from three pharmaceutical wholesalers. Any significant changes in the liquidity or financial position of these wholesalers could have a material adverse impact on the collectability of our accounts receivable and our future operating results. Inventories--Our inventories are valued at the lower of cost or market, and include the cost of raw materials, labor and overhead. We changed our method of valuing inventories from the first-in, first-out, or FIFO method, to the last-in, first-out, or LIFO method, effective January 1, 2002. The acquisition of Group Lafon's manufacturing operations and the expansion of our internal manufacturing capacity for ACTIQ has reduced our reliance on third party manufacturers and sharpened management's focus on minimizing the cost of manufacturing products. Consistent with this goal, the LIFO method reflects current changes to manufacturing costs on the statement of operations on a more timely basis, resulting in a better matching of currents costs of products sold with product revenues. The majority of our inventories are subject to expiration dating. We continually evaluate the carrying value of our inventories and when in the opinion of management, factors indicate that impairment has occurred, either a reserve is established against the inventories' carrying value or the inventories are completely written off. Management bases these decisions on the level of inventories on hand in relation to our estimated forecast of product demand, production requirements over the next twelve months and the expiration dates of raw materials and finished goods. Although we make every effort to ensure the accuracy of forecasts of future product demand, any significant unanticipated decreases in demand could have a material impact on the carrying value of our inventories and our reported operating results. Valuation of Fixed Assets, Goodwill and Intangible Assets--Our fixed assets and intangible assets (which consist primarily of developed technology, trademarks, and product and marketing rights) have been recorded at cost and are being amortized on a straight-line basis over the estimated useful life those assets. In conjunction with acquisitions of businesses or product rights, we allocate the purchase price based upon the relative fair values of the assets acquired and liabilities assumed. In certain circumstances, fair value may be assigned to purchased in-process technology and immediately expensed. The valuation of goodwill and intangible assets and the estimation of appropriate useful lives to apply to them requires us to use our judgment. We continually assess the impairment of intangibles, long-lived assets and goodwill and will adjust the balance whenever events or changes in circumstances indicate that the carrying value of the assets may not be recoverable. Our judgments regarding the existence of impairment indicators are based on legal factors, market conditions and operating performance of our fixed assets and acquired businesses and products. Future events could cause us to conclude that impairment indicators exist and the carrying values of our fixed assets, intangible assets or goodwill are impaired. Any resulting impairment loss could have a material adverse impact on our financial position and results of operations. Income taxes--We have provided for income taxes related to our foreign subsidiaries in accordance with SFAS No. 109, "Accounting for Income Taxes," which requires the recognition of deferred tax assets and liabilities for the expected tax consequences of temporary differences between the tax and financial reporting bases of assets and liabilities. We have a history of losses from U.S. operations, which has generated significant federal and state tax net operating loss (NOL) carryforwards of approximately $344,139,000 and $147,620,000, respectively as of December 31, 2001. Generally accepted accounting principles require us to record a valuation allowance against the deferred tax asset associated with this NOL carryforward if it is more likely than not that we will not be able to utilize the NOL carryforward to offset future taxes. Due to the size of the NOL carryforward in relation to our history of unprofitable operations, we have not recognized a net deferred tax asset. The third quarter of 2001 was our first profitable quarter from commercial operations since inception. Continued profitability in future periods could cause management to conclude that it is more likely than not that we will realize all or a portion of the NOL carryforward. Upon reaching such a conclusion, which is subject to management's judgment, we would immediately record the estimated net realizable value of the deferred tax asset at that time and would then begin to provide for income taxes at a rate equal to our combined federal and state effective rates. Subsequent revisions to the estimated net realizable value of the deferred tax asset could cause our provision for income taxes to vary significantly from period to period. LIQUIDITY AND CAPITAL RESOURCES Cash, cash equivalents and investments at March 31, 2002 were $594,051,000, representing 43% of total assets. 16 Net Cash Provided by (Used for) Operating Activities Net cash provided by operating activities was $8,671,000 for the three months ended March 31, 2002 as compared to net cash used for operating activities of $13,712,000 for the same period in 2001. The main factors that contributed to the net cash provided by operating activities in 2002 are as follows: . The net loss before preferred dividends was $2,871,000 in 2002, as compared to $9,542,000 in 2001, as a result of the increase in product sales. In addition, we recognized the following non-cash transactions in the first quarter of 2002: $8,293,000 of depreciation and amortization expense, $5,055,000 of non-cash interest expense on our convertible subordinated notes, $1,405,000 of non-cash compensation expense, and $3,534,000 associated with changing our inventory costing method from FIFO to LIFO. . Accounts payable decreased $9,013,000 and accrued expenses decreased $4,212,000. The decrease in accrued expenses is due primarily to payments of $4,251,000 for bonuses related to 2001 and payments of $4,641,000 related to the Group Lafon acquisition, partially offset by an increase of $5,986,000 in accrued interest payable for the outstanding convertible subordinated notes. Net Cash (Used for) Provided by Investing Activities A summary of net cash (used for) provided by investing activities is as follows:
Three months ended March 31, 2002 2001 ----- ---- Purchases of property and equipment.......................... $ (3,038,000) $(1,389,000) Acquisition of intangible assets............................. (4,974,000) -- Sales and maturities (purchases) of investments, net......... (83,368,000) 22,972,000 ------------- ------------ Net cash (used for) provided by investing activities......... $(91,380,000) $ 21,583,000 ============= ============
--Acquisition of intangible assets The acquisition of intangible assets during the three months ended March 31, 2002 represents payments in connection with our December, 2001 acquisition of expanded rights to GABITRIL in Europe and other countries worldwide. Net Cash (Used for) Provided by Financing Activities A summary of net cash provided by (used for) financing activities is as follows:
Three months ended March 31, 2002 2001 ----- ---- Proceeds from exercises of common stock options and warrants........ $2,057,000 $13,883,000 Payments to acquire treasury stock.................................. (40,000) -- Preferred dividends paid............................................ -- (2,266,000) Principal payments on and retirement of long-term debt.............. (11,144,000) (669,000) ------------ ----------- Net cash (used for) provided by financing activities................ $(9,127,000) $10,948,000 ============ ===========
17 --Proceeds from exercises of common stock options and warrants During the three months ended March 31, 2002, we received proceeds of approximately $2,057,000 from the exercise of approximately 117,000 common stock options compared to proceeds of $13,883,000 from the exercise of approximately 643,000 common stock options during the same period in 2001. At March 31, 2002, options to purchase approximately 5,541,000 shares of our common stock at various exercise prices were outstanding. The extent and timing of future option exercises, if any, are primarily dependent upon the market price of our common stock and general financial market conditions, as well as the exercise prices and expiration dates of the options. --Payments to acquire treasury stock Under our Equity Compensation Plan, we may grant restricted stock awards to employees. Upon vesting, shares of Cephalon common stock are withheld from the employee's stock award and returned to the treasury for the corresponding dollar value of payroll-related taxes. --Preferred dividends paid The dividend payment of $2,266,000 during the first quarter of 2001 relates to the previously outstanding shares of convertible, exchangeable preferred stock. These outstanding preferred shares were converted during the second and third quarters of 2001 into an aggregate of 6,974,998 shares of our common stock. --Principal payments on long-term debt In January 2002, we made a payment of $6,000,000 to Abbott Laboratories due under our licensing agreement for U.S. product rights to GABITRIL. Payments of $4,481,000 were also made during the first quarter of 2002 on the notes payable, bank debt and other lines of credit assumed with the acquisition of Group Lafon. In addition, for all periods presented, principal payments on long-term debt include payments on mortgage and building improvements loans and payments on capital lease obligations. Commitments and Contingencies --Legal Proceedings In August 1999, the U.S. District Court for the Eastern District of Pennsylvania entered a final order approving the settlement of a class action alleging that statements made about the results of certain clinical studies of MYOTROPHIN(R) (mecasermin) Injection were misleading. A related complaint has been filed with the Court by a small number of plaintiffs who decided not to participate in the settlement. This related complaint alleges that we are liable under common law for misrepresentations concerning the results of the MYOTROPHIN clinical trials, and that we and certain of our current and former officers and directors are liable for the actions of persons who allegedly traded in our common stock on the basis of material inside information. We believe that we have valid defenses to all claims raised in this action. Moreover, even if there is a judgment against us in this case, we do not believe it will have a material adverse effect on our financial condition or results of operations. --Related Party In August 1992, we exclusively licensed our rights to MYOTROPHIN for human therapeutic use within the United States, Canada and Europe to Cephalon Clinical Partners, L.P., or CCP. We developed MYOTROPHIN on behalf of CCP under a research and development agreement. Under this agreement, CCP granted an exclusive license to manufacture and market MYOTROPHIN for human therapeutic use within the United States, Canada and Europe, and we agreed to make royalty payments equal to a percentage of product sales and a milestone payment of approximately $16,000,000 upon regulatory approval. We have a contractual option, but not an obligation, to purchase all of the limited partnership interests of CCP, which is exercisable upon the occurrence of certain events following the first commercial sale of MYOTROPHIN. If, and only if, we decide to exercise this purchase option, we would make an advance payment of approximately $40,275,000 in cash or, at our election, approximately $42,369,000 in shares of common stock or a combination thereof. Should we discontinue development of MYOTROPHIN, or if we do not exercise this purchase option, our license will terminate and all rights to manufacture or market MYOTROPHIN in the United States, Canada and Europe will revert to CCP, which may then commercialize MYOTROPHIN itself or license or assign its rights to a third party. In that event, we would not receive any benefits from such commercialization, license or assignment of rights. 18 In February 2001, a complaint was filed in Utah state court by Zars, Inc. and one of its research scientists, against us and our subsidiary Anesta Corp. The plaintiffs are seeking a declaratory judgment to establish their right to develop transdermal or other products containing fentanyl and other pharmaceutically active agents under a royalty and release agreement between Zars and Anesta. The complaint also asks for unspecified damages for breach of contract, interference with economic relations, defamation and slander. We believe that we have valid defenses to all claims raised in this action. In any event, we do not believe any judgment against us will have a material adverse effect on our financial condition or results of operations. We are a party to certain other litigation in the ordinary course of our business, including matters alleging employment discrimination, product liability and breach of commercial contract. However, we are vigorously defending ourselves in all of these actions and do not believe these matters, even if adversely adjudicated or settled, would have a material adverse effect on our financial condition or results of operations. Outlook Cash, cash equivalents and investments at March 31, 2002 were $594,051,000. Prior to 2001, we historically have had negative cash flows from operations and have used the proceeds of public and private placements of our equity and debt securities to fund operations. We currently believe that projected increases in sales of our three U.S. marketed products, PROVIGIL, ACTIQ and GABITRIL, in combination with other revenues, will allow us to achieve continued profitability and positive cash flows from operations in 2002. At this time, however, we cannot accurately predict the effect of certain developments on future product sales such as the degree of market acceptance of our products, competition, the effectiveness of our sales and marketing efforts and our ability to demonstrate the utility of our products in indications beyond those already included in the FDA approved labels. Other revenues include receipts from collaborative research and development agreements and co-promotion agreements. The continuation of any of these agreements is subject to the achievement of certain milestones and to periodic review by the parties involved. We expect to continue to incur significant expenditures associated with manufacturing, selling and marketing our products and conducting additional clinical studies to explore the utility of these products in treating disorders beyond those currently approved in their respective labels. We also expect to continue to incur significant expenditures to fund research and development activities for our other product candidates. We may seek sources of funding for a portion of these programs through collaborative arrangements with third parties. However, we intend to retain a portion of the commercial rights to these programs and, as a result, we still expect to spend significant funds on our share of the cost of these programs, including the costs of research, preclinical development, clinical research and manufacturing. We may have significant fluctuations in quarterly results based primarily on the level and timing of: . product sales and cost of product sales; . achievement and timing of research and development milestones; . co-promotion and other collaboration revenues; . cost and timing of clinical trials; and . marketing and other expenses. 19 In December 2001, we acquired Group Lafon, which gave us worldwide control of the intellectual property, marketing, and manufacturing rights related to modafinil, the active drug substance in PROVIGIL. PROVIGIL accounted for approximately 66% of our total product sales for the year ended December 31, 2001. By consolidating our financial results with those of Group Lafon, we expect to reduce significantly our cost of goods sold related to PROVIGIL. The bulk of these cost savings result from eliminating the effect of preexisting contractual arrangements between us and Group Lafon. In the second quarter of 2001, we completed a private placement of $400,000,000 of 5.25% convertible subordinated notes due May 2006. In December 2001, we completed a private placement of $600,000,000 of 2.50% convertible subordinated notes due December 2006. In March 2002, we completed a private placement of $55,000,000 of 3.875% convertible notes due March 2007 to acquire all of the joint venture interests of an unaffiliated third party investor. The 5.25% notes, 2.50% notes and 3.875% notes are convertible at the option of the holders into our common stock at per share conversion prices of $74.00, $81.00 and $70.36, respectively. There is currently $838,000,000 of convertible notes outstanding. The annual interest payments on the outstanding balance of convertible notes will be $26,739,000, payable semiannually. On various dates during the fourth quarter of 2001, certain holders of our 5.25% convertible notes approached us, and we agreed, to exchange $217,000,000 of the outstanding 5.25% convertible notes due May 2006 into 3,691,705 shares of our common stock. The exchange transactions were completed using common stock prices that equalized the fair value of the debt instrument with the fair value of our common stock on the dates of the transactions. Since the notes were then trading at a premium, the notes were exchanged at equivalent common stock prices that were less than the original conversion price of $74.00 per share. As a result, we recognized non-cash debt exchange expense totaling $52,444,000 in the fourth quarter of 2001 based on the reduction of the original conversion price in accordance with SFAS No. 84, "Induced Conversion of Convertible Debt." We agreed to these exchanges to improve our debt to equity ratio. Based on our current level of operations and projected sales of our products combined with other revenues and interest income, we believe that we will be able to service our existing debt and meet our capital expenditure and working capital requirements for the next several years. However, we cannot be sure that our anticipated revenue growth will be realized or that we will continue to generate positive cash flow from operations. We may need to obtain additional funding for our operational needs, or for future significant strategic transactions, and we cannot be certain that funding will be available on terms acceptable to us, or at all. 20 CERTAIN RISKS RELATED TO OUR BUSINESS In addition to historical facts or statements of current condition, this report contains forward-looking statements. Forward-looking statements provide our current expectations or forecasts of future events. These may include statements regarding anticipated scientific progress in our research programs, development of potential pharmaceutical products, prospects for regulatory approval, manufacturing capabilities, market prospects for our products, sales and earnings projections, and other statements regarding matters that are not historical facts. Some of these forward-looking statements may be identified by the use of words in the statements such as "anticipate," "estimate," "expect," " project," "intend," "plan," "believe" or other words and terms of similar meaning. Our performance and financial results could differ materially from those reflected in these forward-looking statements due to general financial, economic, regulatory and political conditions affecting the biotechnology and pharmaceutical industries as well as more specific risks and uncertainties such as those set forth below and in our reports to the SEC on Forms 8-K and 10-K. Given these risks and uncertainties, any or all of these forward-looking statements may prove to be incorrect. Therefore, you should not rely on any such forward-looking statements. Furthermore, we do not intend to update publicly any forward-looking statements, except as required by law. This discussion is permitted by the Private Securities Litigation Reform Act of 1995. A significant portion of our revenues is derived from U.S. sales of our three largest products and our future success will depend on the continued acceptance and growth of these products. For the three months ended March 31, 2002, approximately 63% of our total revenues were derived from U.S. sales of PROVIGIL, GABITRIL and ACTIQ. We cannot be certain that these products will continue to be accepted in their markets. Specifically, the following factors, among others, could affect the level of market acceptance of PROVIGIL, GABITRIL and ACTIQ, including: . the perception of the healthcare community of their safety and efficacy, both in an absolute sense and relative to that of competing products; . the effectiveness of our sales and marketing efforts; . unfavorable publicity regarding these products or similar products; . product price relative to other competing drugs or treatments; . changes in government and other third-party payor reimbursement policies and practices; and . regulatory developments affecting the manufacture, marketing or use of these products. Any materials adverse developments with respect to the sale or use of PROVIGIL, GABITRIL or ACTIQ could significantly reduce our product revenue and have a material adverse effect on our ability to generate net income and positive net cash flow from operations. We may be unsuccessful in our efforts to expand the number and scope of authorized uses of PROVIGIL, GABITRIL or ACTIQ, which would hamper sales growth and make it more difficult to sustain profitability. The market for the approved indications of our three largest products is relatively small. We believe that a portion of our product sales is derived from the use of these products outside of their labeled indications. To a large degree, our future success depends on expansion of the approved indications for our products and physicians prescribing our products outside of the approved indications. Under current FDA and European medical authority regulations, we are limited in our ability to promote the use of these products outside their labeled use. Any label expansion will require FDA approval. We have initiated clinical studies to examine whether or not PROVIGIL and GABITRIL are effective and safe when used to treat disorders outside their current indications. Although some study data has been positive, additional studies in these disorders will be necessary before we can apply regulatory authorities to expand the authorized uses of these products. We do not know whether these studies will demonstrate safety and efficacy, or if they do, whether we will succeed in receiving regulatory approval to market PROVIGIL and GABITRIL for additional disorders. If the results of some of these studies are negative, or if adverse experiences are reported in these clinical studies or otherwise in connection with the use of these products by patients, this could undermine physician and patient comfort with the products, limit their commercial success, and diminish their acceptance. Even if the results of these studies 21 are positive, the impact on sales of PROVIGIL and GABITRIL may be minimal unless we are able to obtain FDA and foreign medical authority approval to expand the authorized use of these products. FDA regulations limit our ability to communicate the results of additional clinical studies to patients and physicians without first obtaining approval for any expanded uses. We do not expect to conduct studies for the purpose of requesting an expansion of the authorized use of ACTIQ. Future sales growth, if any, of ACTIQ outside of the treatment of breakthrough cancer pain could come only from physician prescriptions outside this labeled use. Physicians may or may not prescribe ACTIQ for off-label uses and, in any event, sales from such prescriptions may not prove to be significant to our results of operations. As our products are used commercially, unintended side effects, adverse reactions or incidents of misuse may occur that could result in additional regulatory controls, and reduced sales of our products. Prior to 1999, the use of our products had been limited principally to clinical trial patients under controlled conditions and under the care of expert physicians. The widespread commercial use of our products could produce undesirable or unintended side effects that have not been evident in our clinical trials or the relatively limited commercial use to date. In addition, in patients who take multiple medications, drug interactions could occur that can be difficult to predict. Additionally, incidents of product misuse may occur. These events, among others, could result in additional regulatory controls that could limit the circumstances under which the product is prescribed or even lead to the withdrawal of the product from the market. More specifically, ACTIQ has been approved under regulations concerning drugs with certain safety profiles, under which the FDA has established special restrictions to ensure safe use. Any violation of these special restrictions could lead to the imposition of further restrictions or withdrawal of the product from the market. We may not be able to maintain adequate protection for our intellectual property or market exclusivity for our products and therefore potential competitors may develop competing products, which could result in a decrease in sales and market share, cause us to reduce prices to compete successfully, and limit our commercial success. We place considerable importance on obtaining patent protection for new technologies, products and processes. To that end, we file applications for patents covering the composition of matter or uses of our drug candidates or our proprietary processes. The patent positions of pharmaceutical and biotechnology companies can be highly uncertain and involve complex legal, scientific, and factual questions. To date, there has emerged no consistent policy regarding breadth of claims in such companies' patents. Accordingly, the patents and patent applications relating to our products, product candidates and technologies may be challenged, invalidated or circumvented by third parties and might not protect us against competitors with similar products or technology. Patent disputes are frequent and can preclude commercialization of products. If we ultimately lose any disputes, we could be subject to competition or significant liabilities, we could be required to enter into third party licenses or we could be required to cease using the technology or product in dispute. In addition, even if such licenses are available, the terms of the license requested by the third party could be unacceptable to us. The composition of matter patent for modafinil expired in 2001. We license or own U.S. and foreign patent rights covering the particle size pharmaceutical composition of modafinil that expire between 2014 and 2015. Ultimately, these particle size patents might be found invalid if challenged by a third party or a potential competitor could develop a competing product or product formulation that would avoid infringement of these patents. If a competitor developed a competing product that avoided infringement, our revenues from our modafinil-based products could be significantly and negatively impacted. We also rely on trade secrets, know-how and continuing technological advancements to support our competitive position. Although we have entered into confidentiality and invention rights agreements with our employees, consultants, advisors and collaborators, these parties could fail to honor such agreements or we could be unable to effectively protect our rights to our unpatented trade secrets and know-how. Moreover, others could independently develop substantially equivalent proprietary information and techniques or otherwise gain access to our trade secrets and know-how. In addition, many of our scientific and management personnel have been recruited from other biotechnology and pharmaceutical companies where they were conducting research in areas similar to those that we now pursue. As a result, we could be subject to allegations of trade secret violations and other claims. 22 We may incur additional losses. The quarter ended September 30, 2001 was our first profitable quarter from commercial operations since inception and our accumulated deficit was $579,562,000 at March 31, 2002. Our losses have resulted principally from costs incurred in research and development, including clinical trials, and from selling, general and administrative costs associated with our operations. In order for us to maintain profitability from commercial operations, we must continue to achieve product and other revenue at or above their current levels. Moreover, our future growth depends, in part, on our ability to obtain regulatory approvals for future products, or for existing products in new indications, and our ability to successfully develop, commercialize, manufacture and market any other product candidates. Manufacturing, supply and distribution problems may create supply disruptions that could result in a reduction of product sales revenue, and damage commercial prospects for our products. At our two manufacturing facilities in France, we product the active drug substance modafinil and certain other commercial products. At our U.S. facility in Salt Lake City, Utah, we manufacture ACTIQ for international markets. For the remainder of our products, we rely on third parties for product manufacturing. In all cases, we must comply with all applicable regulatory requirements of the FDA and foreign authorities, including cGMP regulations. In addition, we must comply with all applicable regulatory requirements of the Drug Enforcement Administration, and analogous foreign authorities for certain products. The facilities used by us and third parties to manufacture, store and distribute our products are subject to inspection by regulatory authorities at any time to determine compliance with regulations. These regulations are complex, and any failure to comply with them could lead to remedial action, civil and criminal penalties and delays in production or distribution of material. We depend upon sole suppliers for active drug substances contained in our products, including our own French plant that manufactures modafinil, and Abbott Laboratories to manufacture finished commercial supplies of ACTIQ and GABITRIL for the U.S. market. We have two qualified manufacturers, Watson Pharmaceuticals and DSM Pharmaceuticals, for finished commercial supplies of PROVIGIL. The process of changing or adding a manufacturer or changing a formulation requires prior FDA and/or European medical authority approval and is very time-consuming. If we are unable to manage this process effectively, we could face supply disruptions that would result in significant costs and delays, undermine goodwill established with physicians and patients, and damage commercial prospects for our products. We maintain inventories of active drug substances and finished products to protect against supply disruptions. Nevertheless, any disruption in these activities could impede our ability to sell our products and could reduce sales revenue. We also rely on third parties to distribute, provide customer service activities and accept and process returns. Our activities and products are subject to significant government regulations and approvals, which are often costly and could result in adverse consequences to our business if we fail to comply. We currently have a number of products that have been approved for sale in either the United States, foreign countries, or both. All of our approved products are subject to extensive continuing regulations relating to, among other things, testing, manufacturing, quality control labeling, and promotion. The failure to comply with any rules and regulations of the FDA or any foreign medical authority, or the post-approval discovery of previously unknown problems relating to our products could result in, among others: . fines, recalls, or seizures of products; . total or partial suspension of product sales; . non-approval of product license applications; . restrictions on our ability to enter into strategic relationships; and . criminal prosecution. It can be both costly and time-consuming for us to comply with these regulations. Additionally, incidents of adverse drug reactions, unintended side effects or misuse relating to our products could result in additional regulatory controls or restrictions, or even lead to withdrawal of the product from the market. With respect to our product candidates and for new therapeutic indications for our existing products, we conduct research, preclinical testing and clinical trials. We cannot market these product candidates or these new indications in 23 the United States or other countries without receiving approval from the FDA or the appropriate foreign medical authority. The approval process requires substantial time, effort and financial resources, and we may never obtain approval in a timely manner, or at all. We cannot provide you with any assurance that required approvals will be obtained timely or at all. In addition, if the FDA or a foreign medical authority determines that we have not complied with regulations in the research and development of a product candidate or a new indication, they may not grant approval. Without these required approvals, our ability to substantially grow revenues in the future could be adversely affected. In addition, because PROVIGIL and ACTIQ contain active ingredients that are controlled substances, we are subject to regulation by the DEA and analogous foreign organizations relating to the manufacture, shipment, sale and use of the applicable products. These regulations also are imposed on prescribing physicians and other third parties, making the use of such products relatively complicated and expensive. Future products may contain controlled substances. The increased concern for safety by the FDA and the DEA with respect to products containing controlled substances can result in the imposition of restrictions on marketing or even withdrawal of regulatory approval for such products. In addition, negative publicity may bring about rejection of the product by the medical community. If the DEA, FDA or a foreign medical authority withdrew the approval of, or placed additional significant restrictions on the marketing of any of our products, our product sales and ability to promote our products could be substantially affected. The failure to successfully operate Group Lafon could negatively impact our results of operations. The operation of Group Lafon following our December 2001 acquisition involves a number of risks and presents financial, managerial and operational challenges, including: . diversion of management attention from our existing business and operations; . difficulty with integration of personnel, and financial and other systems; and . increased foreign operations that may be difficult to manage, especially since we have limited experience operating in France. In light of these challenges, we may not be able to successfully manage the operations and personnel of Group Lafon. Customer dissatisfaction or manufacturing, supply, or distribution problems associated with Group Lafon's products could cause our pharmaceutical business in France to underperform relative to our expectations, which could have a material adverse effect on our business. We also could experience financial or other setbacks if Group Lafon's businesses have problems or liabilities of which we were not aware or are substantially greater than we anticipated based on our evaluation of the business prior to the acquisition. We may not achieve the expected cost savings and other benefits of the Group Lafon acquisition. In acquiring Group Lafon, we secured worldwide control of the intellectual property, marketing, and manufacturing rights related to modafinil, the active drug substance in PROVIGIL. PROVIGIL accounted for approximately 66% of our total product sales for the year ended December 31, 2001. By consolidating our financial results with those of Group Lafon, we expect to reduce our cost of product sales related to PROVIGIL. During the first quarter of 2002, we experienced a reduction in the cost of product sales related to PROVIGIL from approximately 22% of net sales to approximately 3% of net sales. While the bulk of these cost savings result from eliminating the effect of preexisting contractual arrangements between us and Group Lafon, there could be unanticipated costs associated with our operation and management of the Group Lafon business that could limit or eliminate these cost savings or other anticipated benefits of the Group Lafon acquisition. As a result, the future cost savings actually realized, if any, and other anticipated benefits could differ from, or their impact could be delayed compared to, our expectations as described herein. The efforts of government entities and third party payors to contain or reduce the costs of health care may adversely affect our sales and limit the commercial success of our products. In certain foreign markets, pricing or profitability of pharmaceutical products is subject to various forms of direct and indirect governmental control. In the United States, there have been, and we expect there will continue to be, various federal and state proposals to implement similar government controls. The commercial success of our products could be limited if federal or state governments adopt any such proposals. In addition, in the United States 24 and elsewhere, sales of pharmaceutical products depend in part on the availability of reimbursement to the consumer from third party payors, such as government and private insurance plans. Third party and government payors increasingly challenge the prices charged for products, and limit reimbursement levels offered to consumers for such products. Third party and government payors could focus their cost control efforts on our products, especially with respect to prices of and reimbursement levels for products prescribed outside their labeled indications. In these cases, these efforts could negatively impact sales of and profits, if any, on our products. We experience intense competition in our fields of interest, which may adversely affect our business. Large and small companies, academic institutions, governmental agencies, and other public and private research organizations conduct research, seek patent protection, and establish collaborative arrangements for product development in competition with us. Products developed by any of these entities may compete directly with those we develop or sell. The conditions that our products treat, and some of the other disorders for which we are conducting additional studies, are currently treated with several drugs, many of which have been available for a number of years or are available in inexpensive generic forms. With respect to PROVIGIL, there are several other products used for the treatment of narcolepsy in the United States including methylphenidate, which is marketed under a number of brand names, including RITALIN(R) by Novartis, CONCERTA(R) tablets by Alva and METHYLIN(R) by Mallinckrodt, as well as competitive products in our other licensed territories, all of which have been available for a number of years and many of which are available in inexpensive generic forms. With respect to ACTIQ, we face competition from inexpensive oral opioid tablets and more expensive but quick-acting invasive (intravenous, intramuscular and subcutaneous) opioid delivery systems. Other technologies for rapidly delivering opioids to treat breakthrough pain are being developed, at least one of which is in clinical trials. With respect to GABITRIL, there are several products, including NEURONTIN(R) (gabapentin) by Pfizer, used as adjunctive therapy for the partial seizure market. Some are well-established therapies that have been on the market for several years while others have recently entered the partial seizure marketplace. In addition, several treatments for partial seizures are available in inexpensive generic forms. Thus we will need to demonstrate to physicians, patients and third party payors that the cost of our products is reasonable and appropriate in the light of their safety and efficacy, the price of competing products and the related health care benefits to the patient. In addition, many of our competitors have substantially greater capital resources, research and development staffs and facilities than we have, and substantially greater experience in conducting clinical trials, obtaining regulatory approvals and manufacturing and marketing pharmaceutical products. These entities represent significant competition for us. In addition, competitors who are developing products for the treatment of neurological or oncological disorders might succeed in developing technologies and products that are more effective than any that we develop or sell or that would render our technology and products obsolete or noncompetitive. Competition and innovation from these or other sources, including advances in current treatment methods, could potentially affect sales of our products negatively or make them obsolete. In addition, we may be at a competitive marketing disadvantage against companies that have broader product lines and whose sales personnel are able to offer more complementary products than we can. Any failure to maintain our competitive position could adversely affect our business and results of operations. We face significant product liability risks, which may have a negative effect on our financial performance. The administration of drugs to humans, whether in clinical trials or commercially, can result in product liability claims whether or not the drugs are actually at fault for causing an injury. Furthermore, our products may cause, or may appear to have caused, serious adverse side effects (including death) or potentially dangerous drug interactions that we may not learn about or understand fully until the drug has been administered to patients for some time. As our products are used more widely and in patients with varying medical conditions, the likelihood of an adverse drug reaction, unintended side effect or incidence of misuse may increase. Product liability claims can be expensive to defend and may result in large judgments or settlements against us, which could have a negative effect on our financial performance. We maintain product liability insurance in amounts we believe to be commercially reasonable, but claims could exceed our coverage limits or purchasing sufficient insurance could be expensive. Even if a product liability claim is not successful, the adverse publicity and time and expense of defending such a claim may interfere with our business. 25 The results and timing of our research and development activities, including future clinical trials are difficult to predict, subject to future setbacks and, ultimately, may not result in any additional pharmaceutical products, which may adversely affect our business. In order to remain competitive, we are focused on the search for new pharmaceutical products. These activities include engaging in discovery research and process development, conducting preclinical and clinical studies, and seeking regulatory approval in the United States and abroad. In all of these areas, we have relatively limited resources and compete against larger multinational pharmaceutical companies. Moreover, even if we undertake these activities in an effective and efficient manner, regulatory approval for the sale of new pharmaceutical products remains highly uncertain since the majority of compounds discovered do not enter clinical studies and the majority of therapeutic candidates fail to show the human safety and efficacy necessary for regulatory approval and successful commercialization. Preclinical testing and clinical trials must demonstrate that a product candidate is safe and efficacious. The results from preclinical testing and early clinical trials may not be predictive of results obtained in subsequent clinical trials, and we cannot be sure that these clinical trials will demonstrate the safety and efficacy necessary to obtain regulatory approval for any product candidates. A number of companies in the biotechnology and pharmaceutical industries have suffered significant setbacks in advanced clinical trials, even after obtaining promising results in earlier trials. In addition, certain clinical trials are conducted with patients having the most advanced stages of disease. During the course of treatment, these patients often die or suffer other adverse medical effects for reasons that may not be related to the pharmaceutical agent being tested. Such events can have a negative impact on the statistical analysis of clinical trial results. The completion of clinical trials of our product candidates may be delayed by many factors, including the rate of enrollment of patients. Neither we nor our collaborators can control the rate at which patients present themselves for enrollment, and the rate of patient enrollment may not be consistent with our expectations or sufficient to enable clinical trials of our product candidates to be completed in a timely manner or at all. In addition, we may not be permitted by regulatory authorities to undertake additional clinical trials for any of our product candidates. Even if such trials are conducted, our product candidates may not prove to be safe and efficacious or receive regulatory approvals. Any significant delays in, or termination of, clinical trials of our product candidates could impact our ability to substantially increase our product sales in the future. Our research and development and marketing efforts are often dependent on corporate collaborators and other third parties who may not devote sufficient time, resources and attention to our programs, and which may limit our efforts to successfully develop and market potential products. Because we have limited resources, we have entered into a number of collaboration agreements with other pharmaceutical companies, most importantly with Lundbeck and Sanofi-Synthelabo, related to our research efforts in Parkinson's and Alzheimer's disease, and solid tumors, respectively. In some cases our collaboration agreements call for our partner to control: . the supply of bulk or formulated drugs for commercial use or for use in clinical trials; . the design and execution of clinical studies; . the process of obtaining regulatory approval to market the product; and/or . the marketing and selling of any approved product. In each of these areas, our partners may not support fully our research and commercial interests since our program may compete for time, attention and resources with the internal programs of our corporate collaborators. As such, our program may not move forward as effectively, or advance as rapidly as it might if we had retained complete control of all research, development, regulatory and commercialization decisions. We also rely on several of these collaborators and other third parties for the production of compounds and the manufacture and supply of pharmaceutical products. Additionally, we may find it necessary from time to time to seek new or additional partners to assist us in commercializing our products, though we might not be successful in establishing any such new or additional relationships. 26 Our product sales and related financial results will fluctuate and these fluctuations may cause our stock price to fall, especially if they are not anticipated by investors. A number of analysts and investors who follow our stock have developed models to attempt to forecast future product sales and have established earnings expectations based upon those models. These models, in turn, are based in part on estimates of projected revenue and earnings that we disclose publicly. Forecasting revenue growth is difficult, especially when there is little commercial history and when the level of market acceptance of our products is uncertain or, in the case of Group Lafon, when we have just recently acquired a portfolio of products. Forecasting is further complicated by the difficulties in estimating stocking levels at pharmaceutical wholesalers and at retail pharmacies and in estimating potential product returns. As a result, it is likely that there will be significant fluctuations in revenues, which may not meet with market expectations and which also may adversely affect our stock price. There are a number of other factors that may cause our financial results to fluctuate unexpectedly, including: . the cost of product sales; . achievement and timing of research and development milestones; . co-promotion and other collaboration revenues; . cost and timing of clinical trials; . marketing and other expenses; and . manufacturing or supply disruption. The price of our common stock has been and may continue to be highly volatile. The market price of our common stock is volatile, and we expect it to continue to be volatile for the foreseeable future. For example, from January 1, 2001 through May 10, 2002, our common stock traded at a high price of $78.880 and a low price of $36.375. Negative announcements, including, among others: . adverse regulatory decisions; . disappointing clinical trial results; . disputes concerning patent or other proprietary rights; or . operating results that fall below the market's expectations could trigger significant declines in the price of our common stock. In addition, external events, such as news concerning our competitors, changes in government regulations that may impact the biotechnology or pharmaceutical industries or the movement of capital into or out of our industry, are also likely to affect the price of our common stock. A portion of our product sales and certain balance sheet items are subject to exchange rate fluctuations in the normal course of business that could adversely affect our reported results of operations. Historically, a portion of our product sales has been earned in currencies other than the U.S. dollar. As a result of our acquisition of Group Lafon, we expect that the portion of our product sales denominated in the euro and other local currencies will increase. We translate revenue earned from product sales into U.S. dollars at the average exchange rate applicable during the relevant period. A strengthening of the dollar could, therefore, reduce our earnings. Consequently, fluctuations in the rate of exchange between the U.S. dollar and the euro and other local currencies may affect period-to-period comparisons of our operating results. In addition, we may face exposure to the extent that exchange rate fluctuations affect the repayment of certain intercompany indebtedness. Finally, the balance sheet of our foreign operations will be translated into U.S. dollars at the period-end exchange rate. This latter exposure will result in changes to the translated value of assets and liabilities, with the impact of the translations included as a component of stockholders' equity. We are involved in or may become involved in the future in legal proceedings that, if adversely adjudicated or settled, could materially impact our financial condition. As a biopharmaceutical company, we are or may become a party to litigation in the ordinary course of our business, including matters alleging employment discrimination, product liability, patent infringement, or breach of commercial contract, among others. In general, litigation claims can be expensive and time consuming to defend and 27 could result in settlements or damages that could significantly impact results of operations and financial condition. We currently are vigorously defending ourselves against certain litigation matters. However, even if these existing lawsuits were adversely adjudicated or settled, we do not believe there would be a material impact on our results of operations or our financial condition. Our dependence on key executives and scientists could impact the development and management of our business. We are highly dependent upon our ability to attract and retain qualified scientific, technical and managerial personnel. There is intense competition for qualified personnel in the pharmaceutical and biotechnology industries, and we cannot be sure that we will be able to continue to attract and retain the qualified personnel necessary for the development and management of our business. Although we do not believe the loss of one individual would materially harm our business, our research and development programs and our business might be harmed by the loss of the services of multiple existing personnel, as well as the failure to recruit additional key scientific, technical and managerial personnel in a timely manner. Much of the know-how we have developed resides in our scientific and technical personnel and is not readily transferable to other personnel. We do not have employment agreements with any of our key scientific, technical and managerial employees. We do not maintain "key man" life insurance on any of our employees. We may be required to incur significant costs to comply with environmental laws and regulations and our compliance may limit any future profitability. Our research and development activities involve the controlled use of hazardous, infectious and radioactive materials that could be hazardous to human health, safety or the environment. We store these materials and various wastes resulting from their use at our facility pending ultimate use and disposal. We are subject to a variety of federal, state and local laws and regulations governing the use, generation, manufacture, storage, handling and disposal of these materials and wastes, and we may be required to incur significant costs to comply with both existing and future environmental laws and regulations. We believe that our safety procedures for handling and disposing of these materials comply with foreign, federal, state and local laws and regulations, but we cannot completely eliminate the risk of accidental injury or contamination from these materials. In the event of an accident, we could be held liable for any resulting damages, which could include fines and remedial costs. These damages could require payment by us of significant amounts over a number of years, which would be reflected in our results of operations and financial condition. Anti-takeover provisions may delay or prevent changes in control of our management or deter a third party from acquiring us, limiting our stockholders' ability to profit from such a transaction. Our Board of Directors has the authority to issue up to 5,000,000 shares of preferred stock, $0.01 par value, of which 1,000,000 have been reserved for issuance in connection with our stockholder rights plan, and to determine the price, rights, preferences and privileges of those shares without any further vote or action by our stockholders. Our stockholder rights plan could have the effect of making it more difficult for a third party to acquire a majority of our outstanding voting stock. We are subject to the anti-takeover provisions of Section 203 of the Delaware General Corporation Law, which prohibits us from engaging in a "business combination" with an "interested stockholder" for a period of three years after the date of the transaction in which the person becomes an interested stockholder, unless the business combination is approved in a prescribed manner. The application of Section 203 could have the effect of delaying or preventing a change of control of Cephalon. We also have adopted a "poison pill" rights plan that will dilute the stock ownership of an acquirer of our stock upon the occurrence of certain events. Section 203, the rights plan, and the provisions of our certificate of incorporation, our bylaws and Delaware corporate law, may have the effect of deterring hostile takeovers or delaying or preventing changes in control of our management, including transactions in which stockholders might otherwise receive a premium for their shares over then current market prices. 28 We may be unable to service or repay our substantial indebtedness or other contingencies. As of March 31, 2002, we had significant levels of indebtedness that, among other things, could make it difficult for us to make payments on our indebtedness or to obtain financing in the future, limit our future flexibility and make us more vulnerable in the event of a downturn in our business. Unless we are able to generate sufficient cash flow from operations to service our indebtedness, we will be required to raise additional funds. Because the financing markets may be unwilling to provide funding to us or may only be willing to provide funding on terms that we could consider unacceptable, we may not have either cash available or be able to obtain funding to permit us to meet our debt service obligations. ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK There have been no material changes in quantitative and qualitative market risk from the disclosure included in the Annual Report on Form 10-K for the fiscal year ended December 31, 2001. 29 PART II - OTHER INFORMATION Item 1. Legal Proceedings The information set forth in Footnote 4 to the Notes to Consolidated Financial Statements included herein is hereby incorporated by reference. Item 2. Changes in Securities and Use of Proceeds On March 29, 2002, we issued and sold in a private placement $55,000,000 aggregate principal amount of 3.875% Convertible Notes due March 29, 2007. The notes were issued and sold to the purchaser in a transaction exempt from registration requirements of the Securities Act of 1933, as amended, because the offer and sale of the notes did not involve a public offering. We are obligated to pay interest on the notes at a rate of 3.875% per year on each of April 15 and October 15, beginning October 15, 2002. The notes also are convertible into our common stock, at the option of the holders, at a price of $70.36 per share, subject to adjustment upon certain events. The holders of the notes may elect to require us to redeem the notes on March 28, 2005 at a redemption price equal to 100% of the principal amount of notes submitted for redemption, plus accrued and unpaid interest. In certain other circumstances, at the option of the holders, we may be required to repurchase the notes at 100% of the principal amount of the notes submitted for repurchase, plus accrued and unpaid interest. In connection with our offer and sale of the notes, we have agreed to file, on or prior to May 28, 2002, a registration statement on Form S-3 to register the resale of the shares of common stock issuable upon conversion of the notes. Item 6. Exhibits and Reports on Form 8-K (a) Exhibits: Exhibit No. Description ---- ----------- 4.1 Form of 3.875% Convertible Promissory Note due March 29, 2007. 4.2 Registration Rights Agreement dated March 29, 200 between Cephalon, Inc. and Anthem Investors, LLC. 10.1 Amendment to Consulting Agreement between Cephalon, Inc. and Martyn D. Greenacre dated April 1, 2002. 18.1 Preferability Letter from Arthur Andersen LLP. (b) Reports on Form 8-K: During the first quarter of 2002, the Registrant filed the following Current Reports on Form 8-K: (i) On January 10, 2002, Cephalon, Inc. filed the Press Release dated December 28, 2001 publicly announcing the completion of the acquisition of Group Lafon. (ii) On February 13, 2002, Cephalon, Inc. filed an amended Current Report on Form 8-K/A to include the pro forma financial information and financial statements of Group Lafon. 30 SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. CEPHALON, INC. (Registrant) May 15, 2002 By /s/ Frank Baldino, Jr. -------------------------- Frank Baldino, Jr., Ph.D. Chairman and Chief Executive Officer (Principal executive officer) By /s/ J. Kevin Buchi ---------------------- J. Kevin Buchi Senior Vice President and Chief Financial Officer (Principal financial and accounting officer) 31 EX-4.1 3 dex41.txt FORM OF 3.875% CONVERTIBLE PROMISSORY NOTE EXHIBIT 4.1 FORM OF 3 7/8% CONVERTIBLE PROMISSORY NOTE DUE MARCH 29, 2007
Note No. Holder: Amount of Note: Permitted Assigns ([sec]14(d)(1)): - -------- ------- --------------- ---------------------------------- A-1 Anthem Investors, LLC $33,000,000 HBK Main Street Investments, L.P. A-2 Anthem Investors, LLC $22,000,000 Delta Opportunity Fund (Institutional), LLC
THIS SECURITY AND THE COMMON STOCK ISSUABLE UPON ITS CONVERSION HAVE NOT BEEN REGISTERED UNDER THE SECURITIES ACT OF 1933, AS AMENDED (THE "SECURITIES ACT"), AND MAY NOT BE OFFERED, SOLD, PLEDGED OR OTHERWISE TRANSFERRED EXCEPT PURSUANT TO AN AVAILABLE EXEMPTION FROM REGISTRATION UNDER THE SECURITIES ACT AND IN ACCORDANCE WITH ALL APPLICABLE SECURITIES LAWS OF THE STATES OF THE UNITED STATES AND OTHER JURISDICTIONS. CEPHALON, INC. 3 7/8% CONVERTIBLE PROMISSORY NOTE DUE MARCH 29, 2007 No. A-__ $__,000,000 Cephalon, Inc., a Delaware corporation (the "Company"), for value ------- received, hereby promises to pay to ANTHEM INVESTORS, LLC or its registered assigns (the "Holder"), the principal sum of _____________ Dollars ($___,000,000), together with all accrued and unpaid interest, on March 29, 2007 (the "Maturity Date"). Interest shall accrue at the rate of 3 7/8% per annum ------------- until the principal hereof is due, except that interest shall accrue at the rate of 8 7/8% per annum on any interest and principal from the date such interest or principal is due until the obligation of the Company with respect to the payment of such interest or principal, as the case may be, on this Convertible Promissory Note (this "Note") shall be discharged. The Company shall pay ---- interest semiannually on April 15 and October 15 of each year, commencing on October 15, 2002. Interest shall accrue on this Note from the most recent date to which interest has been paid or, if no interest has been paid, from March 29, 2002. Interest shall be computed on the basis of a 360-day year of twelve 30-day months. The Company shall pay interest on this Note to the Person who is the Holder of this Note at the close of business on April 1 and October 1, as the case may be, next preceding the related interest payment date. Payment of the principal and accrued and unpaid interest of this Note at maturity (whether by acceleration, redemption or otherwise) shall be made upon the surrender of this Note to the Company, at its chief executive office (or such other office within the United States as shall be designated by the Company to the Holder hereof) (the "Designated Office"), in United States of America legal tender. All amounts ----------------- payable in cash with respect to this Note shall be made by wire transfer to the Holder; provided that if the Holder shall not have furnished wire instructions in writing to the Company on or prior to the third Business Day immediately prior to the date on which the Company shall make such payment, such payment may be made by U.S. dollar check mailed to the address of the Holder as such address shall appear in the Company security register. Capitalized terms used and not otherwise defined herein shall have the respective meanings given to those terms in Section 1 hereof. 1. Definitions. Unless otherwise defined in this Note, the following capitalized terms shall have the following respective meanings when used herein: "Affiliate" of any specified Person means any other Person directly or --------- indirectly controlling or controlled by or under direct or indirect common control with such specified Person. For the purposes of this definition, "control," when used with respect to any specified Person, means the power to direct the management and policies of such Person, directly or indirectly, whether through the ownership of voting securities, by contract or otherwise; and the terms "controlling" and "controlled" have meanings correlative to the foregoing. "Business Day" means any day except a Saturday, Sunday or other day on ------------ which the banks in the State of New York are required or authorized by law to be closed. "Change of Control" has the meaning set forth in Section 9 herein. ----------------- "Closing Price" means, for any date, the price determined by the first ------------- of the following clauses that applies: (a) if the Common Stock is then listed or quoted on an Eligible Market or any other national securities exchange, the highest closing bid price per share of the Common Stock for such date (or the nearest preceding date) on the primary Eligible Market or exchange on which the Common Stock is then listed or quoted; (b) if prices for the Common Stock are then quoted on the OTC Bulletin Board, the closing bid price per share of the Common Stock for such date (or the nearest preceding date) so quoted; (c) if prices for the Common Stock are then reported in the "Pink Sheets" published by the National Quotation Bureau Incorporated (or a similar organization or agency succeeding to its functions of reporting prices), the most recent bid price per share of the Common Stock so reported; or (d) in all other cases, the fair market value of a share of Common Stock as determined in good faith by the mutual agreement of the Company and the Holder. "Common Stock" means the Common Stock, par value $.01 per share, of the ------------ Company. Subject to the provisions of this Section 1, shares issuable on conversion of this Note shall include Common Stock or shares of any class or classes of common stock resulting from any reclassification or reclassifications thereof. "Conversion Price" means $70.36, as adjusted pursuant to Section 7 ---------------- herein. "Effective Date" means the date that the registration statement meeting -------------- the requirements set forth in the Registration Rights Agreement and covering the resale of the Securities by the Holder is first declared effective by the Securities and Exchange Commission. "Eligible Market" means the New York Stock Exchange, the American Stock --------------- Exchange, the Nasdaq National Market or the Nasdaq SmallCap Market. "Exchange Act" means the Securities Exchange Act of 1934, as amended. ------------ 2 "Person" shall mean and include an individual, a partnership, a ------ corporation (including a business trust), a joint stock company, a limited liability company, an unincorporated association, a joint venture or other entity or a governmental authority. "Purchase Agreement" means that certain Class A Interest Purchase ------------------ Agreement executed and delivered in connection herewith by and between the Company and Anthem Investors, LLC. "Original Issue Date" means the date of the first issuance of any ------------------- Notes, regardless of the number of transfers of any particular Note. "Registration Rights Agreement" means that certain Registration Rights ----------------------------- Agreement executed and delivered in connection herewith by and between the Holder and the Company. "Securities" means this Note and the Common Stock. ---------- "Securities Act" means the Securities Act of 1933, as amended. -------------- "Subsidiary" shall mean (a) any corporation of which more than 50% of ---------- the issued and outstanding equity securities having ordinary voting power to elect a majority of the board of directors of such corporation is at the time directly or indirectly owned or controlled by the Company, (b) any partnership, joint venture, limited liability company or other association of which more than 50% of the equity interests having the power to vote, direct or control the management of such partnership, joint venture, limited liability company or other association is at the time directly or indirectly owned and controlled by the Company, and (c) any other entity included in the financial statements of the Company on a consolidated basis. "Trading Day" means (i) if the Common Stock is listed or quoted and ----------- traded on the Nasdaq National Market or any other system of automated dissemination of quotations of securities prices, a day on which trades may be effected through such system; (ii) if the Common Stock is listed or quoted and traded on the New York Stock Exchange or any other national securities exchange, a day on which such exchange is open for business; or (iii) if the Common Stock is not listed or quoted and traded on the Nasdaq National Market or listed or quoted and traded on any national securities exchange or any other system of automated dissemination of quotation of securities prices, a day on which the Common Stock is traded regular way in the over-the-counter market and for which a closing bid and a closing asked price for the Common Stock are available. "Transaction Documents" means this Note, the Registration Rights --------------------- Agreement and the Purchase Agreement. "Triggering Event" means any of the following events: (a) the Common ---------------- Stock is not listed or quoted, or is suspended from trading, on an Eligible Market for a period of three (3) consecutive Trading Days; (b) the Company fails for any reason to deliver a certificate evidencing this Note or shares of Common Stock issuable upon conversion of 3 this Note to the Holder within ten (10) Trading Days after delivery of such certificate is required pursuant to any Transaction Document or if conversion rights, with respect to this Note are otherwise suspended for any reason for a period of more than five (5) consecutive Trading Days; (c) the Company fails to have available a sufficient number of authorized but unissued and otherwise unreserved shares of Common Stock available to issue Common Stock upon any conversion of this Note; (d) at any time after the Required Effectiveness Date (as defined in the Registration Rights Agreement), any Common Stock issuable upon the conversion of this Note is not listed on an Eligible Market for a period of three (3) consecutive Trading Days; (e) the Company effects or publicly announces its intention to effect any exchange, recapitalization or other transaction that effectively requires or rewards physical delivery of certificates evidencing the Common Stock; (f) any other Event (as defined in the Registration Rights Agreement) occurs and remains uncured for sixty (60) consecutive days; (g) the Company fails to make any cash payment required under the Transaction Documents and such failure is not cured within five (5) Trading Days after notice of such default is first given to the Company by the Holder; or (h) the Company defaults in the timely performance of any other obligation under the Transaction Documents and such default continues uncured for a period of twenty (20) days after the date on which notice of such default is first given to the Company by the Holder (it being understood that no prior notice need be given in the case of a default that cannot reasonably be cured within twenty (20) days). 2. Redemption by Holder. (a) The Holder, in its sole option, on March 28, 2005 (the "Optional Redemption Date"), may elect to require the Company to redeem ------------------------ this Note in whole or in part at a redemption price equal to 100% of such principal amount, together with all accrued and unpaid interest through the date of redemption (the "Redemption Price"). To redeem this Note for cash on ---------------- the Optional Redemption Date under this Section 2(a), the Holder shall send at least ten (10) Business Days prior to the Redemption Date to the Company a notice by first-class mail, overnight courier, or hand delivery specifying the amount of principal of this Note to be redeemed by the Holder (the "Optional -------- Redemption Notice") along with this Note duly endorsed or assigned to the - ----------------- Company in blank, provided that any failure of the Holder to surrender the Note as provided herein shall not invalidate the redemption. The Company shall pay or cause to be paid to the Holder the Optional Redemption Price in cash on the Optional Redemption Date or such later date on which this Note is surrendered to the Company at the Designated Office in the manner set forth in the introductory paragraph to this Note. (b) The Holder, in its sole option upon the occurrence of a Triggering Event (the "Triggering Event Redemption Date" and together with the -------------------------------- Optional Redemption Date, a "Redemption Date"), may elect to require the --------------- Company to redeem this Note in whole or in part at the Redemption Price. To exercise its option to redeem this Note for cash under this Section 2(b), the Holder shall send to the Company a notice by first-class mail, overnight courier, or hand delivery specifying the amount of principal of this Note to be redeemed by the Holder (the "Redemption Notice") within sixty (60) days ----------------- following the occurrence of the Triggering Event to which such Triggering Event Redemption Date relates, along with this Note duly endorsed or assigned to the Company 4 in blank, provided that any failure of the Holder to surrender this Note as provided herein shall not invalidate the redemption. The Company shall pay or cause to be paid to the Holder the Redemption Price in cash within ten (10) Business Days following the date of the Redemption Notice or such later date on which this Note is surrendered to the Company at the Designated Office. 3. Registration of Notes. The Company shall register this Note upon records to be maintained by the Company for that purpose (the "Note Register") ------------- in the name of each record holder thereof from time to time. The Company may deem and treat the registered Holder of this Note as the absolute owner hereof for the purpose of any conversion hereof or any payment of interest hereon, and for all other purposes, absent actual notice to the Company to the contrary. 4. Registration of Transfers and Exchanges. The Company shall register the transfer of any portion of this Note in the Note Register upon surrender of this Note to the Company at the Designated Office. Upon any such registration or transfer, a new Note, in substantially the form of this Note (any such new Note, a "New Note"), evidencing the portion of this Note so -------- transferred shall be issued to the transferee and a New Note evidencing the remaining portion of this Note not so transferred, if any, shall be issued to the transferring Holder. The acceptance of the New Note by the transferee thereof shall be deemed the acceptance by such transferee of all of the rights and obligations of a holder of a Note. This Note is exchangeable for an equal aggregate principal amount of Notes of different authorized denominations, as requested by the Holder surrendering the same. No service charge or other fee will be imposed in connection with any such registration of transfer or exchange. 5. Conversion. At the option of the Holder, all (or any portion thereof equal to $1,000 or any integral multiple thereof) of the principal amount of this Note may be converted into Common Stock based on the then-applicable Conversion Price. The Holder may convert this Note into Common Stock pursuant to this paragraph at any time and from time to time after the Original Issue Date, by delivering to the Company a notice, in the form attached hereto (the "Conversion Notice"), appropriately completed and duly ---------------- signed (and accompanied or preceded by a certificate as to the incumbency and signature of such signatory), and the date any such Conversion Notice is delivered to the Company (as determined in accordance with the notice provisions hereof) is a "Conversion Date." --------------- 6. Mechanics of Conversion. (a) The number of shares of Common Stock issuable upon any conversion hereunder shall equal the outstanding principal amount of this Note to be converted, divided by the Conversion Price on the Conversion Date. (b) Upon conversion of this Note, the Company shall promptly (but in no event later than three (3) Trading Days after the Conversion Date) issue or cause to be issued and cause to be delivered to or upon the written order of the Holder and in such name or names as the Holder may designate on the Conversion Notice a certificate for the 5 Common Stock issuable upon such conversion, with appropriate restrictive legends and shall pay or cause to be paid to the Holder, or its designee, in cash the amount of any accrued and unpaid interest, if any, through the Conversion Date. The Holder, or any Person so designated by the Holder to receive Common Stock, shall be deemed to have become holder of record of such Common Stock as of the Conversion Date. The Company shall, upon request of the Holder, use its commercially reasonable efforts to deliver Common Stock hereunder electronically through the Depository Trust Corporation or another established clearing corporation performing similar functions. (c) The Holder shall be required to deliver this Note in order to receive certificates for common stock pursuant to a conversion hereunder. Execution and delivery of the Conversion Notice shall have the same effect as cancellation of the original Note and issuance of a New Note representing the remaining outstanding principal amount. Upon surrender of this Note following one or more partial conversions, the Company shall promptly deliver to the Holder a New Note representing the remaining outstanding principal amount. (d) The Company's obligations to issue and deliver Common Stock upon conversion of this Note in accordance with the terms hereof are absolute and unconditional, irrespective of any action or inaction by the Holder to enforce the same, any waiver or consent with respect to any provision hereof, the recovery of any judgment against any Person or any action to enforce the same, or any setoff, counterclaim, recoupment, limitation or termination, or any breach or alleged breach by the Holder or any other Person of any obligation to the Company or any violation or alleged violation of law by the Holder or any other Person, and irrespective of any other circumstance which might otherwise limit such obligation of the Company to the Holder in connection with the issuance of such Common Stock. 7. Certain Adjustments. The Conversion Price is subject to adjustment from time to time as set forth in this Section 7. (a) In case the Company shall (i) pay a dividend on its Common Stock in shares of Common Stock, (ii) make a distribution on its Common Stock in shares of Common Stock, (iii) subdivide its outstanding Common Stock into a greater number of shares, or (iv) combine its outstanding Common Stock into a smaller number of shares, the Conversion Price in effect immediately prior thereto shall be adjusted so that the Holder thereafter shall be entitled to receive that number of shares of Common Stock which it would have owned had this Note been converted immediately prior to the happening of such event. An adjustment made pursuant to this subsection (a) shall become effective immediately after the record date in the case of a dividend or distribution and shall become effective immediately after the effective date in the case of subdivision or combination. (b) In case the Company shall issue rights or warrants to all or substantially all holders of its Common Stock entitling them (for a period commencing no earlier than the record date described below and expiring not more than 60 days after such record date) to subscribe for or purchase shares of Common Stock (or securities 6 convertible into Common Stock) at a price per share (or having a conversion price per share) less than the Current Market Price per share of Common Stock (as determined in accordance with subsection (f) of this Section 7) on the record date for the determination of stockholders entitled to receive such rights or warrants, the Conversion Price in effect immediately prior thereto shall be adjusted so that the same shall equal the price determined by multiplying the Conversion Price in effect immediately prior to such record date by a fraction of which the numerator shall be the number of shares of Common Stock outstanding on such record date plus the number of shares which the aggregate offering price of the total number of shares of Common Stock so offered (or the aggregate conversion price of the convertible securities so offered, which shall be determined by multiplying the number of shares of Common Stock issuable upon conversion of such convertible securities by the conversion price per share of Common Stock pursuant to the terms of such convertible securities) would purchase at the Current Market Price per share (as defined in subsection (f) of this Section 7) of Common Stock on such record date, and of which the denominator shall be the number of shares of Common Stock outstanding on such record date plus the number of additional shares of Common Stock offered (or into which the convertible securities so offered are convertible). Such adjustment shall be made successively whenever any such rights or warrants are issued, and shall become effective immediately after such record date. If at the end of the period during which such rights or warrants are exercisable not all rights or warrants shall have been exercised, the adjusted Conversion Price shall be immediately readjusted to what it would have been based upon the number of additional shares of Common Stock actually issued (or the number of shares of Common Stock issuable upon conversion of convertible securities actually issued). (c) In case the Company shall distribute to all or substantially all holders of its Common Stock any shares of capital stock of the Company (other than Common Stock), evidences of indebtedness or other non-cash assets (including securities of any person other than the Company but excluding (a) dividends or distributions paid exclusively in cash or (b) dividends or distributions referred to in subsection (a) of this Section 7, or shall distribute to all or substantially all holders of its Common Stock rights or warrants to subscribe for or purchase any of its securities (excluding those rights and warrants referred to in subsection (b) of this Section 7 and also excluding the distribution of rights to all holders of Common Stock pursuant to the adoption of a stockholders rights plan or the detachment of such rights under the terms of such stockholder rights plan), then in each such case the Conversion Price shall be adjusted so that the same shall equal the price determined by multiplying the current Conversion Price by a fraction of which the numerator shall be the Current Market Price per share (as defined in subsection (f) of this Section 7) of the Common Stock on the record date mentioned below less the fair market value on such record date (as determined in good faith by the Board of Directors, whose determination shall be conclusive evidence of such fair market value and which shall be evidenced by an officers' certificate delivered to the Holder) of the portion of the capital stock, evidences of indebtedness or other non-cash assets so distributed or of such rights or warrants applicable to one share of Common Stock (determined on the basis of the number of shares of Common Stock outstanding on the record date), and of which the denominator shall be the Current Market Price per share (as defined in subsection (f) of this Section 7) of the Common Stock on such record date. Such adjustment shall be 7 made successively whenever any such distribution is made and shall become effective immediately after the record date for the determination of shareholders entitled to receive such distribution. In the event the then fair market value (as so determined) of the portion of the capital stock, evidences of indebtedness or other non-cash assets so distributed or of such rights or warrants applicable to one share of Common Stock is equal to or greater than the Current Market Price (or the Conversion Price) per share of the Common Stock on such record date, in lieu of the foregoing adjustment, adequate provision shall be made so that the Holder of the Note shall have the right to receive upon conversion the amount of capital stock, evidences of indebtedness or other non-cash assets so distributed or of such rights or warrants such holder would have received had such holder converted each Note on such record date. In the event that such dividend or distribution is not so paid or made, the Conversion Price shall again be adjusted to be the Conversion Price which would then be in effect if such dividend or distribution had not been declared. If the Board of Directors determines the fair market value of any distribution for purposes of this Section 7(c) by reference to the actual or when issued trading market for any securities, it must in doing so consider the prices in such market over the same period used in computing the Current Market Price of the Common Stock. In the event that the Company implements a stockholder rights splan ("Rights Plan"), upon conversion of the Note into Common Stock, to the extent that the Rights Plan has been implemented and is still in effect upon such conversion, the holders of the Note will receive, in addition to the Common Stock, the rights described therein (whether or not the rights have separated from the Common Stock at the time of conversion), subject to the limitations set forth in the Rights Plan. Any distribution of rights or warrants pursuant to a Rights Plan complying with the requirements set forth in the immediately preceding sentence of this paragraph shall not constitute a distribution of rights or warrants pursuant to this Section 7(c). Rights or warrants distributed by the Company to all holders of Common Stock entitling the holders thereof to subscribe for or purchase shares of the Company's Capital Stock (either initially or under certain circumstances), which rights or warrants, until the occurrence of a specified event or events ("Specified Event"): (i) are deemed to be transferred with such --------------- shares of Common Stock; (ii) are not exercisable; and (iii) are also issued in respect of future issuances of Common Stock, shall be deemed not to have been distributed for purposes of this Section 7 (and no adjustment to the Conversion Price under this Section 7 will be required) until the occurrence of the earliest Specified Event, whereupon such rights and warrants shall be deemed to have been distributed and an appropriate adjustment (if any is required) to the Conversion Price shall be made under this Section 7(c). If any such right or warrant, including any such existing rights or warrants distributed prior to the date of this Note, are subject to events, upon the occurrence of which such rights or warrants become exercisable to purchase different securities, evidences of indebtedness or other assets, then the date of the occurrence of any and each such event shall be deemed to be the date of distribution and record date with respect to new rights or warrants with such rights (and a termination or expiration of the existing rights or warrants without exercise by any of the holders 8 thereof). In addition, in the event of any distribution (or deemed distribution) of rights or warrants, or any Specified Event or other event (of the type described in the preceding sentence) with respect thereto that was counted for purposes of calculating a distribution amount for which an adjustment to the Conversion Price under this Section 7 was made, (a) in the case of any such rights or warrants which shall all have been redeemed or repurchased without exercise by any holders thereof, the Conversion Price shall be readjusted upon such final redemption or repurchase to give effect to such distribution or Specified Event, as the case may be, as though it were a cash distribution, equal to the per share redemption or repurchase price received by a holder or holders of Common Stock with respect to such rights or warrants (assuming such holder had retained such rights or warrants), made to all holders of Common Stock as of the date of such redemption or repurchase, and (b) in the case of such rights or warrants which shall have expired or been terminated without exercise by any holders thereof, the Conversion Price shall be readjusted as if such rights and warrants had not been issued. (d) Distributions. In case the Company shall, by dividend or ------------- otherwise, at any time distribute (a "Triggering Distribution") to all or ----------------------- substantially all holders of its Common Stock cash, the Holder shall be entitled to such cash distribution as if such Holder had converted this Note into shares of Common Stock. (e) Tender Offer. In case any tender offer made by the ------------ Company or any of its Subsidiaries for Common Stock shall expire and such tender offer (as amended upon the expiration thereof) shall involve the payment of aggregate consideration in an amount (determined as the sum of the aggregate amount of cash consideration and the aggregate fair market value (as determined in good faith by the Board of Directors, whose determination shall be conclusive evidence thereof and which shall be evidenced by an officers' certificate delivered to the Holder) of any other consideration) that exceeds the product of the lesser of (x) the Conversion Price then in effect and (y) the Current Market Price per share of Common Stock (as determined in accordance with subsection (f) of this Section 7 as of the last date (the "Expiration ---------- Date") tenders could have been made pursuant to such tender offer (as it may be - ---- amended) (the last time at which such tenders could have been made on the Expiration Date is hereinafter sometimes called the "Expiration Time"), --------------- multiplied by the number of shares of Common Stock outstanding (including tendered shares but excluding any shares held in the treasury of the Company) at the Expiration Time, then, immediately prior to the opening of business on the day after the Expiration Date, the Conversion Price shall be reduced by the amount of such excess (determined on a per share basis), such reduction to become effective immediately prior to the opening of business on the day following the Expiration Date. In the event that the Company is obligated to purchase shares pursuant to any such tender offer, but the Company is permanently prevented by applicable law from effecting any or all such purchases or any or all such purchases are rescinded, the Conversion Price shall again be adjusted to be the Conversion Price which would have been in effect based upon the number of shares actually purchased. If the application of this Section 7(e) to any tender offer would result in an increase in the Conversion Price, no adjustment shall be made for such tender offer under this Section 7(e) 9 (f) For the purpose of any computation under this Section 7, the current market price (the "Current Market Price") per share of Common Stock -------------------- on any date shall be deemed to be the average of the daily Closing Prices for the 30 consecutive Trading Days commencing 45 Trading Days before (i) the Determination Date or the Expiration Date, as the case may be, with respect to distributions or tender offers under subsections (d) and (e) of this Section 7 or (ii) the record date with respect to distributions, issuances or other events requiring such computation under subsection (b) or (c) of this Section 7. If the Closing Prices are unavailable, the Current Market Price per share shall be the fair value of a share of Common Stock as determined by the Board of Directors (which shall be evidenced by an officers' certificate delivered to the Holder). (g) No adjustment in the Conversion Price shall be required unless the adjustment would require an increase or decrease of at least 1% in the Conversion Price as last adjusted; provided, however, that any adjustments which by reason of this Section 7 are not required to be made shall be carried forward and taken into account in any subsequent adjustment. All calculations under this Section 7 shall be made to the nearest cent or to the nearest one-hundredth of a share, as the case may be. No adjustment need be made for issuances of Common Stock pursuant to a Company plan for reinvestment of dividends or interest or for a change in the par value or a change to no par value of the Common Stock. To the extent that the Note become convertible into the right to receive cash, no adjustment need be made thereafter as to the cash. Interest will not accrue on the cash. (h) The Company shall be entitled to make such reductions in the Conversion Price, in addition to those required by Section 7(b), as it in its discretion shall determine to be advisable in order that any stock dividends, subdivisions of shares, distributions of rights to purchase stock or securities or distributions of securities convertible into or exchangeable for stock hereafter made by the Company to its stockholders shall not be taxable. (i) Whenever the Conversion Price or conversion privilege is adjusted, the Company shall promptly mail to the Holder an officers' certificate briefly stating the facts requiring the adjustment and the manner of computing it. (j) In the event that: (1) the Company takes any action which would require an adjustment in the Conversion Price; (2) the Company consolidates or merges with, or transfers all or substantially all of its property and assets to, another corporation and shareholders of the Company must approve the transaction; or (3) there is a dissolution or liquidation of the Company, the Company shall mail to the Holder a notice stating the proposed record or effective date, as the case may be. The Company shall mail the notice at least ten days before such 10 date. Failure to mail such notice or any defect therein shall not affect the validity of any transaction referred to in clause (a), (b) or (c) of this Section 7. (k) If any of the following events occur, namely (i) any reclassification or change of the outstanding shares of Common Stock (other than a change in par value, or from par value to no par value, or from no par value to par value, or as a result of a subdivision or combination), (ii) any consolidation, merger or combination of the Company with another Person as a result of which holders of Common Stock shall be entitled to receive stock, securities or other property or assets (including cash) with respect to or in exchange for such Common Stock, or (iii) any sale or conveyance of the properties and assets of the Company as, or substantially as, an entirety to any other Person as a result of which holders of Common Stock shall be entitled to receive stock, securities or other property or assets (including cash) with respect to or in exchange for such Common Stock, then prior to such reclassification, change, consolidation, merger, combination or sale the Company or the successor or purchasing Person, as the case may be, shall execute with the Holder a written agreement providing that (x) this Note shall be convertible into the kind and amount of shares of stock and other securities or property or assets (including cash) receivable upon such reclassification, change, consolidation, merger, combination, sale or conveyance by the holder of a number of shares of Common Stock issuable upon conversion of this Note immediately prior to such reclassification, change, consolidation, merger, combination, sale or conveyance, and, if holders of Common Stock have the right to elect as to the kind or amount of securities, cash or other property receivable upon such reclassification, change, consolidation, merger, combination, sale or conveyance, the Holder shall be provided the option (on the same time frame as is afforded to holders of Common Stock) to elect as to which kind or amount of securities, cash or other property receivable upon such reclassification, change, consolidation, merger, combination, sale or conveyance into which the Note will be convertible after the consummation of such reclassification, change, consolidation, merger, combination, sale or conveyance (provided that, if the Holder does not make any such election within the time frame provided, then for the purposes of this Section 7(k) the Holder shall be deemed to have elected to have the Note become convertible into the same kind or amount of securities, cash or other property receivable upon such reclassification, change, consolidation, merger, combination, sale or conveyance as is received by the holders of a plurality of the shares of Common Stock as to which an election has been made), (y) in the case of any such successor or purchasing Person, upon such consolidation, merger, combination, sale or conveyance such successor or purchasing Person shall be jointly and severally liable with the Company for the payment and performance of all of the Company's obligations under this Note, the Registration Rights Agreement and the Purchase Agreement and (z) if registration or qualification is required under the Securities Act or applicable state law for the public resale by the Holder of the shares of stock or other securities so issuable upon conversion of this Note, such registration or qualification shall be completed and effective prior to such reclassification, change, consolidation, merger, combination, sale or conveyance (it being understood that if the requirements of this clause (z) cannot be achieved by the Company, using commercially reasonable efforts, then such requirements shall be satisfied by the Company and/or successor or purchasing Person as promptly as practicable (but in no event later than thirty (30) days after the date of such event)). Such written agreement 11 shall provide for adjustments which shall be as nearly equivalent as may be practicable to the adjustments provided for in this Section. If, in the case of any such reclassification, change, consolidation, merger, combination, sale or conveyance, the stock or other securities and assets receivable thereupon by a holder of shares of Common Stock includes shares of stock or other securities and assets of a Person other than the successor or purchasing Person, as the case may be, in such reclassification, change, consolidation, merger, combination, sale or conveyance, then such written agreement shall also be executed by such other Person and shall contain such additional provisions to protect the interests of the Holder as the Board of Directors shall reasonably consider necessary by reason of the foregoing, including, without limitation, the provisions providing for the Holder's redemption rights set forth in Section 2 herein. The above provisions of this Section shall similarly apply to successive reclassifications, changes, consolidations, mergers, combinations, sales and conveyances. (l) The Company from time to time may reduce the Conversion Price by any amount for any period of time if the period is at least 20 days and if the reduction is irrevocable during the period if our Board of Directors determines that such reduction would be in the best interest of the Company or to avoid or diminish income tax to holders of shares of our Common Stock in connection with a dividend or distribution of stock or similar event, and the Company provides 15 days prior notice of any reduction in the Conversion Price; provided, however, that in no event may the Company reduce the Conversion Price to be less than the par value of a share of Common Stock. (m) Calculations. All calculations under this Section 7 shall ------------ be made to the nearest cent or the nearest 1/100th of a share, as applicable. The number of shares of Common Stock outstanding at any given time shall not include shares owned or held by or for the account of the Company, and the disposition of any such shares shall be considered an issue or sale of Common Stock. (n) Notice of Adjustments. Upon the occurrence of each --------------------- adjustment pursuant to this Section 7, the Company at its expense will promptly compute such adjustment in accordance with the terms hereof and prepare a certificate describing in reasonable detail such adjustment and the transactions giving rise thereto, including all facts upon which such adjustment is based. Upon written request, the Company will promptly deliver a copy of each such certificate to the Holder. (o) Notice of Corporate Events. If the Company (i) declares -------------------------- a dividend or any other distribution of cash, securities or other property in respect of its Common Stock, including without limitation any granting of rights or warrants to subscribe for or purchase any capital stock of the Company or any Subsidiary, (ii) authorizes or approves, enters into any agreement contemplating or solicits stockholder approval for any Change in Control or (iii) authorizes the voluntary dissolution, liquidation or winding up of the affairs of the Company, then the Company shall deliver to the Holder a notice describing the material terms and conditions of such transaction, at least ten (10) calendar days prior to the applicable record or effective date on which a Person would need to hold Common Stock in order to participate in or vote with respect to such transaction; provided, 12 however, that the failure to deliver such notice or any defect therein shall not affect the validity of the corporate action required to be described in such notice. 8. Limitation on Conversion. Notwithstanding anything to the contrary contained herein, the number of shares of Common Stock that may be acquired by the Holder upon any conversion of this Note (or otherwise in respect hereof) shall be limited to the extent necessary to insure that, following such conversion (or other issuance), the total number of shares of Common Stock then beneficially owned by such Holder and its Affiliates and any other Persons whose beneficial ownership of Common Stock would be aggregated with the Holder's for purposes of Section 13(d) of the Exchange Act, does not exceed 4.999% (the "Maximum Percentage") of the total number of issued and outstanding shares of Common Stock (including for such purpose the shares of Common Stock issuable upon such conversion). For such purposes, beneficial ownership shall be determined in accordance with Section 13(d) of the Exchange Act and the rules and regulations promulgated thereunder. Each delivery of a Conversion Notice by the Holder will constitute a representation by the Holder that it has evaluated the limitation set forth in this paragraph and determined that issuance of the full number of shares of Common Stock requested in such Conversion Notice is permitted under this paragraph. By written notice to the Company, the Holder may waive the provisions of this Section or increase or decrease the Maximum Percentage to any other percentage specified in such notice, but (i) any such waiver or increase will not be effective until the 61st day after such notice is delivered to the Company, and (ii) any such waiver or increase or decrease will apply only to the Holder and not to any other holder of Notes. 9. Change in Control. (a) If at any time that this Note remains outstanding there shall occur a Change in Control, the Holder shall have the right to receive, at its option, on the date of the consummation of such Change in Control or as of the date that is thirty (30) Business Days after the occurrence of the Change in Control (the "Change in Control Purchase Date"), either (A) for each share ------------------------------- of Common Stock that would have been issuable upon such conversion of the Notes upon the effective time of such Change of Control, the same kind and amount of securities, cash or property as it would have been entitled to receive upon the occurrence of such Change of Control if it had been, immediately prior to such Change of Control, the holder of one share of Common Stock, (B) from March 29, 2002 but on or before March 29, 2003, cash in an amount equal to 110% of the outstanding principal amount of this Note plus all accrued but unpaid interest thereon through the date of payment, and after March 29, 2003, cash in an amount equal to 100% of the outstanding principal amount of this Note plus all accrued but unpaid interest thereon through the date of payment (in either case, the "Change in Control Purchase Price") or (C) to have such successor to -------------------------------- the Company or surviving entity in the Change of Control issue to the Holder a New Note with a principal balance equal to the outstanding principal balance of this Note, plus all accrued but unpaid interest thereon, and consistent with terms substantially equivalent to the terms of this Note held by such Holder and evidencing the Holder's right to convert such Note into the consideration described in clause (A). If holders of Common Stock are given any choice as to the securities, cash or property to be received in a Change of Control transaction, then the Holder shall be given 13 the same choice as to the consideration it receives pursuant to clause (A) above. Failure of the Holder to timely provide written notice of its election shall be deemed an election by such Holder to receive the consideration specified in clause (C) above. (b) If the Holder elects to receive the consideration specified in clause (C) in Section 9(a) above, (i) the successor entity shall be jointly and severally liable with the Company for the payment and performance of all of the Company's obligations under this Note, the Registration Rights Agreement and the Purchase Agreement and (ii) the Company and the successor entity shall, if registration or qualification is required under the Securities Act or applicable state law for the public resale by the Holder of the shares of stock or other securities so issuable upon conversion of this Note or the New Note, have such registration or qualification completed prior to such Change of Control (it being understood that if the requirements of this clause (ii) cannot be achieved by the Company, using commercially reasonable efforts, then such requirements shall be satisfied by the Company and/or successor or purchasing Person as promptly as practicable (but in no event later than thirty (30) days after the date of such event)). To the extent the Company elects to have the successor to the Company or the surviving entity issue a New Note, the terms of any agreement pursuant to which a Change of Control is effected shall include terms requiring any such successor or surviving entity to comply with the provisions substantially equivalent to the provisions of this Section 9 and providing that this Note (or any such replacement security) will be similarly adjusted upon any subsequent transaction analogous to a Change of Control. A "Change in Control" shall be deemed to have occurred ----------------- if any of the following occurs after the date hereof: (1) any "person" or "group" (as such terms are defined below) is or becomes the "beneficial owner" (as defined below), directly or indirectly, of shares of Voting Stock of the Company representing 50% or more of the total voting power of all outstanding classes of Voting Stock of the Company or has the power, directly or indirectly, to elect a majority of the members of the Board of Directors of the Company; or (2) the Company consolidates with, or merges with or into, another Person or the Company sells, assigns, conveys, transfers, leases or otherwise disposes of all or substantially all of the assets of the Company, or any Person consolidates with, or merges with or into, the Company, in any such event other than pursuant to a transaction in which the Persons that "beneficially owned" (as defined below), directly or indirectly, shares of Voting Stock of the Company immediately prior to such transaction "beneficially own" (as defined below), directly or indirectly, shares of Voting Stock of the Company representing at least a majority of the total voting power of all outstanding classes of Voting Stock of the surviving or transferee Person; or (3) the holders of capital stock of the Company approve any plan or proposal for the liquidation or dissolution of the Company (whether or not otherwise in compliance with the terms hereof). 14 For the purpose of the definition of "Change in Control," (i) "person" and "group" have the meanings given such terms under Section 13(d) and 14(d) of the Exchange Act or any successor provision to either of the foregoing, and the term "group" includes any group acting for the purpose of acquiring, holding or disposing of securities within the meaning of Rule 13d-5(b)(1) under the Exchange Act (or any successor provision thereto), (ii) a "beneficial owner" shall be determined in accordance with Rule 13d-3 under the Exchange Act, as in effect on the date of this Note, except that the number of shares of Voting Stock of the Company shall be deemed to include, in addition to all outstanding shares of Voting Stock of the Company and Unissued Shares deemed to be held by the "person" or "group" (as such terms are defined above) or other Person with respect to which the Change in Control determination is being made, all Unissued Shares deemed to be held by all other Persons, and (iii) the terms "beneficially owned" and "beneficially own" shall have meanings correlative to that of "beneficial owner". The term "Unissued Shares" means shares of Voting Stock not outstanding that are subject to options, warrants, rights to purchase or conversion privileges exercisable within sixty (60) days of the date of determination of a Change in Control. (c) Within ten (10) Business Days after the occurrence of a Change in Control, the Company shall mail a written notice of the Change in Control to the Holder. The notice shall include the form of a Change in Control Purchase Notice to be completed by the Holder and shall state: (1) the date of such Change in Control and, briefly, the events causing such Change in Control; (2) the date by which the Change in Control Purchase Notice pursuant to this Section 9 must be given; (3) the Change in Control Purchase Date; (4) the Change in Control Purchase Price; (5) the Holder's right to require the Company to purchase the Note; (6) briefly, the conversion rights of the Note; (7) the Conversion Price and any adjustments thereto; (8) that Note as to which a Change in Control Purchase Notice has been given may be converted into Common Stock pursuant to Section 7 of this Note only to the extent that the Change in Control Purchase Notice has been withdrawn by the Holder; (9) the procedures that the Holder must follow to exercise rights under this Section 9; 15 (10) the procedures for withdrawing a Change in Control Purchase Notice, including a form of notice of withdrawal; and (11) that the Holder must satisfy the requirements set forth in the Note in order to convert the Note. (d) The Holder may exercise its rights specified in subsection (a) of this Section 9 upon delivery of a written notice (which may be delivered by letter, overnight courier, hand delivery, facsimile transmission or in any other written form) of the exercise of such rights (a "Change in Control Purchase Notice") to any the Company at any time prior to --------------------------------- the close of business on the Business Day next preceding the Change in Control Purchase Date. The delivery of such Note to the Company (together with all necessary endorsements) at the office of the Company shall be a condition to the receipt by the Holder of the Change in Control Purchase Price therefor. The Company shall purchase from the Holder, pursuant to this Section 9, a portion of the Note if the principal amount of such portion is $1,000 or an integral multiple of $1,000. Notwithstanding anything herein to the contrary, a Holder delivering to the Company the Change in Control Purchase Notice contemplated by this subsection (d) shall have the right to withdraw such Change in Control Purchase Notice in whole or in a portion thereof that is a principal amount of $1,000 or in an integral multiple thereof at any time prior to the close of business on the Business Day next preceding the Change in Control Purchase Date by delivery of a written notice of withdrawal to the Company in accordance with Section 9(e) below. (e) Upon receipt by the Company of the Change in Control Purchase Notice, the Holder shall (unless such Change in Control Purchase Notice is withdrawn as specified below) thereafter be entitled to receive the Change in Control Purchase Price with respect to the Note. Such Change in Control Purchase Price shall be paid to the Holder promptly following the later of (a) the Change in Control Purchase Date with respect to the Note (provided the conditions in this Section 9 have been satisfied) and (b) the time of delivery of such Note to the Paying Agent by the Holder thereof in the manner required by Section 9(a). A Note in respect of which a Change in Control Purchase Notice has been given by the Holder thereof may not be converted into shares of Common Stock pursuant to Section 7 on or after the date of the delivery of such Change in Control Purchase Notice unless such Change in Control Purchase Notice has first been validly withdrawn. A Change in Control Purchase Notice may be withdrawn by means of a written notice (which may be delivered by mail, overnight courier, hand delivery, facsimile transmission or in any other written form) of withdrawal delivered by the Holder to the Company at any time prior to the close of business on the Business Day immediately preceding the Change in Control Purchase Date, specifying the principal 16 amount of the Note or portion thereof (which must be a principal amount of $1,000 or an integral multiple of $1,000 in excess thereof) with respect to which such notice of withdrawal is being submitted. (f) On or before 11:00 a.m. New York City time on the Change in Control Purchase Date, the Company shall deposit with a bank or trust company having a combined capital and surplus of at least $50,000,000 (the "Paying Agent") an amount of money (in immediately available funds if deposited ------------ on such Change in Control Purchase Date) sufficient to pay the aggregate Change in Control Purchase Price of the Note or portion thereof that are to be purchased as of such Change in Control Purchase Date. The manner in which the deposit required by this Section 9(f) is made by the Company shall be at the option of the Company; provided that such deposit shall be made in a manner such that the Paying Agent shall have immediately available funds on the Change in Control Purchase Date. If the Paying Agent holds, in accordance with the terms hereof, money sufficient to pay the Change in Control Purchase Price of the Note for which a Change in Control Purchase Notice has been tendered and not withdrawn in accordance with this Note then, on the Change in Control Purchase Date, such Note will cease to be outstanding and the rights of the Holder in respect thereof shall terminate (other than the right to receive the Change in Control Purchase Price as aforesaid). (g) Any Note that is to be purchased only in part shall be surrendered at the office of the Paying Agent, and promptly after the Change in Control Purchase Date the Company shall execute and deliver to the Holder of the Note, without service charge, a New Note or Notes, of such authorized denomination or denominations as may be requested by the Holder, in aggregate principal amount equal to, and in exchange for, the portion of the principal amount of the Note so surrendered that is not purchased. (h) In connection with any offer to purchase or purchase of a Note under Section 9, the Company shall (a) comply with Rule 13e-4 and Rule 14e-1 (or any successor to either such Rule), if applicable, under the Exchange Act, (b) file the related Schedule TO (or any successor or similar schedule, form or report) if required under the Exchange Act, and (c) otherwise comply with all federal and state securities laws in connection with such offer to purchase or purchase of Securities, all so as to permit the rights of the Holder and obligations of the Company to be exercised in the time and in the manner specified therein. (i) To the extent that the aggregate amount of cash deposited by the Company pursuant to Section 9(f) exceeds the aggregate Change in Control Purchase Price together with interest, if any, thereon of the Note or portions thereof that the Company is obligated to purchase, then promptly after the Change in Control Purchase Date the Paying Agent shall return any such excess cash to the Company. 10. Fractional Shares. The Company shall not be required to issue or cause to be issued fractional Common Stock on conversion of this Note; in lieu thereof, an amount 17 will be paid in cash based upon the Closing Price of the Common Stock on the Trading Day immediately prior to the Conversion Date. 11. Event or Events of Default. (a) An "Event of Default" shall occur if ---------------- (1) the Company defaults in the payment of any interest on the Note when the same becomes due and payable and the default continues for a period of thirty (30) days; (2) the Company defaults in the payment of any principal of (including, without limitation, any premium, if any, on) the Note when the same becomes due and payable (whether at maturity, upon redemption, on a Change of Control Purchase Date or otherwise); (3) the Company fails to comply with any of its other agreements contained in the Note and the default continues for the period and after the notice specified below; (4) the Company defaults in the payment of the Redemption Price or the Change in Control Purchase Price of the Note when the same becomes due and payable; or (5) the Company fails to provide a Change in Control Purchase Notice when required by Section 9; or (6) any indebtedness under any bond, debenture, note or other evidence of indebtedness for money borrowed by the Company or any Subsidiary (all or substantially all of the outstanding voting securities of which are owned, directly or indirectly, by the Company) or under any mortgage, indenture or instrument under which there may be issued or by which there may be secured or evidenced any indebtedness for money borrowed by the Company or any Subsidiary (all or substantially all of the outstanding voting securities of which are owned, directly or indirectly, by the Company) (an "Instrument") with a principal amount then outstanding in excess of U.S. $10,000,000, whether such indebtedness now exists or shall hereafter be created, is not paid at final maturity of the Instrument (either at its stated maturity or upon acceleration thereof), and such indebtedness is not discharged, or such acceleration is not rescinded or annulled, within a period of thirty (30) days after there shall have been given, by registered or certified mail, to the Company by the Holder a written notice specifying such default and requiring the Company to cause such indebtedness to be discharged or cause such default to be cured or waived or such acceleration to be rescinded or annulled and stating that such notice is a "Notice of Default" hereunder; or (7) the Company or any Subsidiary, pursuant to or within the meaning of any Bankruptcy Law: (i) commences a voluntary case or proceeding; 18 (ii) consents to the entry of an order for relief against it in an involuntary case or proceeding; (iii) consents to the appointment of a Custodian of it or for all or substantially all of its property; or (iv) makes a general assignment for the benefit of its creditors; or (8) a court of competent jurisdiction enters an order or decree under any Bankruptcy Law that: (i) is for relief against the Company or any Subsidiary in an involuntary case or proceeding; (ii) appoints a Custodian of the Company or any Subsidiary or for all or substantially all of the property of the Company or any Subsidiary; or (iii) orders the liquidation of the Company or any Subsidiary; and in each case the order or decree remains unstayed and in effect for sixty (60) consecutive days. The term "Bankruptcy Law" means Title 11 of the United States Code (or any successor thereto) or any similar federal or state law for the relief of debtors. The term "Custodian" means any receiver, trustee, assignee, liquidator, sequestrator or similar official under any Bankruptcy Law. Clauses (7) and (8) of this Section 11(a) shall each be referred to as a "Bankruptcy Event". A default under clause (3) above is not an Event of Default until the Holder notifies the Company in writing of the default, and the Company does not cure the default within sixty (60) days after receipt of such notice. The notice given pursuant to this Section 11 must specify the default, demand that it be remedied and state that the notice is a "Notice of Default." When any default under this Section 11 is cured, it ceases. (b) If an Event of Default (other than an Event of Default specified in clause (7) or (8) of Section 11(a) above) occurs and is continuing, the Holder may, by notice to the Company, declare all unpaid principal to the date of acceleration on the Note then outstanding (if not then due and payable) to be due and payable upon any such declaration, and the same shall become and be immediately due and payable. If an Event of Default specified in clause (7) or (8) of Section 11(a) occurs, all unpaid principal of the Note then outstanding shall ipso facto become and be immediately due and payable without any declaration or other act on the part of the Holder. The Holder, by notice to the Company, may rescind an acceleration and its consequences if (a) all existing Events of Default, other than the nonpayment of the principal of the Note which has become due solely by such declaration of acceleration, have been cured or waived; (b) to the extent the payment of such interest is lawful, interest (calculated at the rate per annum borne by 19 the Note) on overdue installments of interest and overdue principal, which has become due otherwise than by such declaration of acceleration, has been paid; and (c) the rescission would not conflict with any judgment or decree of a court of competent jurisdiction. No such rescission shall affect any subsequent default or impair any right consequent thereto. (c) A delay or omission by the Holder in exercising any right or remedy accruing upon an Event of Default shall not impair the right or remedy or constitute a waiver of or acquiescence in the Event of Default. No remedy is exclusive of any other remedy. All available remedies are cumulative to the extent permitted by law. (d) The Holder, by notice to the Company, may waive an existing default or Event of Default and its consequence. When a default or Event of Default is waived, it is cured and ceases. (e) Notwithstanding any other provision of this Note, the right of the Holder to receive payment of the principal of and interest on the Note, on or after the respective due dates expressed in the Note, to convert the Note in accordance with Section 7 and to bring suit for the enforcement of any such payment on or after such respective dates or the right to convert, is absolute and unconditional and shall not be impaired or affected without the consent of the Holder. 12. Covenants of the Company. (a) The Company shall duly and punctually pay or cause to be paid the principal of and interest on this Note, at the respective times and in the manner provided for herein. (b) The Common Stock which may be delivered upon conversion of the Note, upon such delivery, will have been duly authorized and validly issued and will be fully paid, nonassessable and free of preemptive rights (and shall be issued out of the Company's authorized but unissued Common Stock). (c) The Company shall file all reports and other information and documents which it is required to file with the Securities Exchange Commission pursuant to Section 13 or 15(d) of the Exchange Act. (d) Upon request of the Holder, the Company will execute and deliver such further instruments and do such further acts as may be reasonably necessary or proper to carry out more effectively the purposes of this Note. (e) The Company will do or cause to be done all things necessary to preserve and keep in full force and effect its corporate existence. (f) Within the period prior to the expiration of the holding period applicable to sales thereof under Rule 144(k) under the Securities Act (or any successor provision), the Company covenants and agrees that it shall, during any period in which it is not subject to Section 13 or 15(d) of the Exchange Act, upon the request of the Holder 20 or beneficial owner of this Note make available to such Holder or beneficial owner of Notes or any shares of Common Stock issued upon conversion thereof which continue to be restricted securities in connection with any sale hereof and any prospective purchaser of this Note or such Common Stock designated by such Holder or beneficial owner, the information required pursuant to Rule 144A(d)(4) under the Securities Act (if this Note qualifies for trading pursuant to Rule 144A under the Securities Act) or such Common Stock and it will take such further reasonable action as the Holder or beneficial owner of this Note or such Common Stock may reasonably request, all to the extent required from time to time to enable such Holder or beneficial owner to sell this Note or the shares of Common Stock issued or issuable upon its conversion without registration under the Securities Act within the limitation of the exemption provided by Rule 144A under the Securities Act (if Rule 144A is available for such sale), as such Rule may be amended from time to time. Upon the request of the Holder or any beneficial owner of this Note or such Common Stock, the Company will deliver to such Holder a written statement as to whether it has complied with such requirements. (g) The Company covenants (to the extent that it may lawfully do so) that it shall not at any time insist upon, plead, or in any manner whatsoever claim or take the benefit or advantage of, any stay, extension or usury law or other law which would prohibit or forgive the Company from paying all or any portion of the principal of, premium, if any, or interest on the Notes as contemplated herein, wherever enacted, now or at any time hereafter in force, or which may affect the covenants or the performance of this Indenture, and the Company (to the extent it may lawfully do so) hereby expressly waives all benefit or advantage of any such law and covenants that it will not, by resort to any such law, hinder, delay or impede the execution of any power herein granted to the Holder, but will suffer and permit the execution of every such power as though no such law had been enacted. (h) The Company will effect all registrations with, and obtain all approvals by, all governmental authorities that may be necessary under any United States Federal or state law for the Common Stock issuable upon conversion of this Note to be lawfully issued and delivered as provided herein and as set forth in the Registration Rights Agreement. 13.Notices. Any and all notices or other communications or deliveries hereunder (including without limitation any Conversion Notice) shall be in writing and shall be deemed given and effective on the earliest of (i) the date of transmission, if such notice or communication is delivered via facsimile at the facsimile number specified in this Section prior to 5:30 p.m. (New York City time) on a Trading Day, (ii) the next Trading Day after the date of transmission, if such notice or communication is delivered via facsimile at the facsimile number specified in this Section on a day that is not a Trading Day or later than 5:30 p.m. (New York City time) on any Trading Day, (iii) the Trading Day following the date of mailing, if sent by nationally recognized overnight courier service, or (iv) upon actual receipt by the party to whom such notice is required to be given. The addresses for such communications shall be: (i) if to the Company, to 145 Brandywine Parkway, West Chester, PA 19380, facsimile: (610) 738-6258, attention John E. Osborn, Esq., or (ii) if to the Holder, to the address or facsimile number 21 appearing on the Company's noteholder records or such other address or facsimile number as the Holder may provide to the Company in accordance with this Section. 14. Miscellaneous. (a) No provision of this Note shall alter or impair the obligation of the Company, which is absolute and unconditional, to pay the principal of and interest, if any, on this Note at the times, places and rate, and in the coin or currency, herein prescribed. (b) The Company will give prompt written notice to the Holder of any change in the location of the its designated office. Any notice to the Company or to the Holder shall be given in the manner set forth herein, provided that the Holder may specify alternative notice instructions to the Company. (c) The Company waives presentment, demand, protest and notice of dishonor and protest and all other demands and notices in connection with the payment and enforcement of this Note. No waiver on the part of any party hereto in exercising any right hereunder shall operate as a waiver of such right or any other right. (d) This Note may not be Transferred (as defined below), except as set forth below. (1) This Note and the Common Stock issuable upon conversion of this Note have not been registered under the Securities Act, or the securities laws of any state or other jurisdiction. Neither the Common Stock issuable upon conversion of this Note nor any interest or participation herein may be reoffered, sold, assigned, transferred, pledged, encumbered or otherwise disposed of (a "Transfer"), except by the Holder to ___________________. and to -------- any Affiliate thereof, in the absence of such registration or unless such transaction is exempt from, or not subject to, registration. (2) Upon receipt by the Company of evidence reasonably satisfactory to it of the loss, theft, destruction or mutilation of this Note, and in the case of loss, theft or destruction, receipt of indemnity or security reasonably satisfactory to the Company, and upon reimbursement to the Company of all reasonable expenses incidental thereto, and upon surrender and cancellation of such Note, if mutilated, the Company will deliver a New Note of like tenor and dated as of such cancellation, in lieu of such Note. (3) Such holder represents that it is an "accredited investor" within the meaning of Rule 501(a) of the Securities Act. Such holder has been advised that this Note has not been registered under the Securities Act, or any state securities laws, and cannot be resold. (4) Neither this Note nor any term hereof may be amended or waived orally or in writing, except that any term of this Note may be amended and the observance of any term of this Note may be waived (either generally or in a particular instance and either retroactively or prospectively), and such amendment or waiver shall 22 be applicable to this Note, upon the written approval of the Company and the Holder hereof. (5) The Holder understands that until the shares of Common Stock into which this Note may convert (the "Shares") have been registered ------ under the Securities Act or otherwise may be sold by the Holder under Rule 144 thereunder, the certificates for the Shares shall bear a restrictive legend in substantially the following form: "THE SHARES REPRESENTED BY THIS CERTIFICATE HAVE NOT BEEN REGISTERED UNDER THE SECURITIES ACT OF 1933, AS AMENDED, OR THE SECURITIES LAWS OF ANY STATE OF THE UNITED STATES. THE SHARES REPRESENTED HEREBY MAY NOT BE OFFERED OR SOLD IN THE ABSENCE OF AN EFFECTIVE REGISTRATION STATEMENT FOR THE SHARES UNDER APPLICABLE SECURITIES LAWS UNLESS OFFERED, SOLD OR TRANSFERRED UNDER AN AVAILABLE EXEMPTION FROM THE REGISTRATION REQUIREMENTS OF THOSE LAWS." Certificates evidencing Securities shall not be required to contain such legend or any other legend (i) following any sale of such Securities pursuant to Rule 144 under the Securities Act, or (ii) if such Securities are eligible for sale under Rule 144(k) under the Securities Act, or (iii) if such legend is not required under applicable requirements of the Securities Act (including judicial interpretations and pronouncements issued by the Staff of the Commission). The Company may not make any notation on its records or give instructions to any transfer agent of the Company that enlarge the restrictions on transfer set forth in this Section. Promptly upon the effectiveness of a registration statement covering the resale of the Shares, the Company shall use its reasonable best efforts to cause its counsel to deliver an opinion and instructions to the transfer agent of the Company instructing such transfer agent to remove the foregoing legend from any certificates representing the Shares upon receipt of confirmation from a Holder that such Holder intends to sell the Shares in accordance with the Plan of Distribution included in the applicable registration statement. (6) The Company acknowledges and agrees that the Holder may from time to time pledge pursuant to a bona fide margin agreement or grant a security interest in some or all of the Securities and, if required under the terms of such arrangement, such Holder may transfer pledged or secured Securities to the pledgees or secured parties to the extent permitted under applicable laws and regulations. Such a pledge or transfer would not be subject to approval of the Company and no legal opinion of the pledgee, secured party or pledgor shall be required in connection therewith unless the Company reasonably and in good faith believes that such pledge or grant of security interest may violate applicable laws or regulations. Further, no notice shall be required of such pledge. At the appropriate Holder's expense, the Company will execute and deliver such reasonable documentation as a pledgee or secured party of Securities may reasonably request in connection with a pledge or transfer of the Securities, including the 23 preparation and filing of any required prospectus supplement under Rule 424(b)(3) of the Securities Act or other applicable provision of the Securities Act to appropriately amend the list of Selling Stockholders thereunder. (e) THIS SECURITY SHALL BE GOVERNED BY AND CONSTRUED IN ACCORDANCE WITH THE LAWS OF THE STATE OF NEW YORK. THE COMPANY AND THE HOLDER OF THIS SECURITY IRREVOCABLY AND UNCONDITIONALLY CONSENTS TO SUBMIT TO THE EXCLUSIVE JURISDICTION OF THE COURTS OF THE STATE OF NEW YORK AND OF THE UNITED STATES OF AMERICA, IN EACH CASE LOCATED IN THE COUNTY OF NEW YORK, FOR ANY DISPUTE ARISING OUT OF OR RELATING TO THIS SECURITY. [Remainder of page intentionally left blank.] 24 IN WITNESS WHEREOF, the Company has caused this Note to be duly executed. Dated: March 29, 2002 CEPHALON, INC. By: /s/ J. Kevin Buchi ----------------------------------- Name: J. Kevin Buchi Title: Senior Vice President and Chief Financial Officer Attest: /s/ John E. Osborn ------------------------ Name: John E. Osborn Title: Senior Vice President, General Counsel & Secretary CONVERSION NOTICE To convert this Note into Common Stock of the Company, check the box:[] To convert only part of this Note, state the principal amount to be converted (must be $1,000 or a integral multiple of $1,000): $------------. If you want the stock certificate made out in another person's name, fill in the form below: ___________________________________________________________________________ (Insert assignee's soc. sec. or tax I.D. no.) ___________________________________________________________________________ ___________________________________________________________________________ ___________________________________________________________________________ ___________________________________________________________________________ (Print or type assignee's name, address and zip code) Your Signature: Date:_____________________________ ________________________________________ (Sign exactly as your name appears on the other side of this Note) This Conversion Notice must be accompanied by an Incumbency Certificate or the Company must have been previously provided with an Incumbency Certificate that has not been revoked by the Person completing this form. OPTION TO ELECT REPURCHASE UPON A CHANGE OF CONTROL To: Cephalon, Inc. The undersigned registered owner of this Note hereby irrevocably acknowledges receipt of a notice from Cephalon, Inc. (the "Company") as to the occurrence of a Change in Control with respect to the Company and requests and instructs the Company to redeem the entire principal amount of this Note, or the portion thereof (which is $1,000 or an integral multiple thereof) below designated, in accordance with the terms of this Note at the Change in Control Purchase Price, together with accrued interest to, but excluding, such date, to the registered Holder hereof. Dated: ___________________________ _________________________________________ _________________________________________ Signature(s) Principal amount to be redeemed (in an integral multiple of $1,000, if less than all): ----------------------- NOTICE: The signature to the foregoing Election must correspond to the Name as written upon the face of this Note in every particular, without alteration or any change whatsoever. EX-4.2 4 dex42.txt REGISTRATION RIGHTS AGREEMENT EXHIBIT 4.2 $55,000,000 Cephalon, Inc. 3 7/8% Convertible Subordinated Notes due March 29, 2007 REGISTRATION RIGHTS AGREEMENT ----------------------------- March 29, 2002 ANTHEM INVESTORS, LLC c/o Wilmington Trust Company 1100 North Market Street Wilmington, DE 19801 Attn: Corporate Trust Administration Ladies and Gentlemen: Cephalon, Inc., a Delaware corporation (the "Company"), proposes to issue to Anthem Investors, LLC ("Anthem") upon the terms set forth in a Class A Interest Purchase Agreement dated as of the date hereof (the "Purchase Agreement"), $55,000,000 aggregate principal amount of its 3 7/8% Convertible Subordinated Notes due March 29, 2007 (the "Notes"). The Notes will be convertible into shares of common stock, par value $0.01 per share, of the Company (the "Common Stock") at the conversion price set forth in the Notes. Capitalized terms used herein but not defined shall have the meaning ascribed to them in the Note or Purchase Agreement, as applicable. As a condition to Anthem's agreement to enter into the Purchase Agreement, the Company agrees with Anthem, for the benefit of (i) Anthem and (ii) any subsequent holder or holders of the Notes and the Common Stock issuable upon conversion of the Notes (the "Conversion Shares") from time to time until such time as such Conversion Shares have been sold pursuant to a Shelf Registration Statement (as defined below) (each of the foregoing a "Holder" and collectively the "Holders"), as follows: 1. Shelf Registration. (a) The Company shall, at its cost, prepare and, within sixty (60) days after the date hereof (the "Filing Date"), file with the Securities and Exchange Commission (the "Commission") and thereafter use its commercially reasonable efforts to cause to be declared effective as promptly as possible, but not later than 120 days after the date hereof (the "Required Effectiveness Date"), a registration statement on Form S-3 (the "Shelf Registration Statement") relating to the offer and sale of the Transfer Restricted Securities (as defined below) by the Holders thereof from time to time in accordance with the methods of distribution set forth in the Shelf Registration Statement and Rule 415 under the Securities Act of 1933, as amended (the "Securities Act") (hereinafter, the "Shelf Registration"); provided, however, that no Holder shall -------- ------- be entitled to have the Conversion Shares held by it covered by such Shelf 1 Registration Statement unless such Holder agrees in writing to be bound by all the provisions of this Agreement applicable to such Holder. The Company also shall respond in writing to any comments received from the Commission on the Shelf Registration Statement and any amendment thereto within ten (10) calendar days after the receipt of such comments. As used in this agreement, "Transfer Restricted Securities" means each Conversion Share until (i) the date on which such Conversion Share has been effectively registered under the Securities Act and disposed of in accordance with the Shelf Registration Statement or (ii) the date on which such Conversion Share is distributed to the public pursuant to Rule 144 under the Securities Act or is saleable pursuant to Rule 144(k) under the Securities Act. (b) The Company shall use commercially reasonable efforts to keep the Shelf Registration Statement continuously effective in order to permit the prospectus included therein (the "Prospectus") to be lawfully delivered by the Holders of the relevant Conversion Shares until the Conversion Shares can be sold to the public under Rule 144(k) under the Securities Act, or any successor rule thereof, assuming for this purpose that the Holders thereof are not affiliates of the Company (in any such case, such period being called the "Shelf Registration Period"). (c) Notwithstanding any other provisions of this Agreement to the contrary, the Company shall cause the Shelf Registration Statement and the Prospectus and any amendment or supplement thereto, as of the effective date of the Shelf Registration Statement, amendment or supplement, (i) to comply in all material respects with the applicable requirements of the Securities Act and the rules and regulations of the Commission and (ii) not to contain any untrue statement of a material fact or omit to state a material fact required to be stated therein or necessary in order to make the statements therein, in light of the circumstances under which they were made, not misleading. (d) Upon the occurrence of any Event (as defined below) and on every monthly anniversary thereof until the applicable Event is cured, as partial relief for the damages suffered therefrom by the Holders (which remedy shall not be exclusive of any other remedies available at law or in equity), the Company shall pay to each Holder an amount in cash, as liquidated damages and not as a penalty, equal to 1.0% of the aggregate principal balance of the Notes held by such Holder. The liquidated damages payable pursuant to the terms hereof shall apply on a pro-rata basis for any portion of a month prior to the cure of an Event. For such purposes, each of the following that occurs shall constitute an "Event": i. a Shelf Registration Statement is not filed on or prior to the Filing Date or is not declared effective on or prior to the applicable Required Effectiveness Date; ii. after the Effective Date for the Shelf Registration Statement, a Holder is not permitted to sell Conversion Shares under such Shelf Registration Statement (or a subsequent Shelf Registration Statement filed in replacement thereof) for any reason for five or more Trading Days (whether or not consecutive); iii. the Common Stock is not listed or quoted, or is suspended from trading, on an Eligible Market for a period of three Trading Days (which need not be consecutive Trading Days); 2 iv. the Company fails for any reason to deliver a certificate evidencing any Securities to a Holder within three Trading Days after delivery of such certificate is required pursuant to any Transaction Document or the exercise or conversion rights of the Holders pursuant to the Transaction Documents are otherwise suspended for any reason; v. the Company fails to have available a sufficient number of authorized but unissued and otherwise unreserved shares of Common Stock available to issue Conversion Shares upon any conversion of convertible Notes; or vi. after the Effective Date for a Shelf Registration Statement, any Conversion Shares covered by such Shelf Registration Statement are not listed on an Eligible Market. 2. Registration Procedures. In connection with the Shelf Registration contemplated by Section 1 hereof, the following provisions shall apply: (a) The Company shall (i) furnish to Anthem, (A) prior to the filing thereof with the Commission, a copy of the Shelf Registration Statement, (B) within three days following the filing thereof with the Commission, each amendment to the Shelf Registration Statement and each supplement, if any, to the Prospectus, and (C) shall use its reasonable efforts to reflect in the Shelf Registration Statement, when so filed with the Commission, such comments as the Holders reasonably may propose; and (ii) include the names of the Holders who propose to sell Conversion Shares pursuant to the Shelf Registration Statement as selling securityholders and who have completed and returned to the Company a questionnaire to be provided to the Holders by the Company (a "Completed Questionnaire"). (b) The Company shall give written notice to the Holders of the Conversion Shares from whom the Company has received a Completed Questionnaire (which notice pursuant to clauses (iii)-(vi) hereof shall be accompanied by an instruction to suspend the use of the Prospectus until the requisite changes have been made): (i) when the Shelf Registration Statement or any amendment thereto has been filed with the Commission; (ii) when the Shelf Registration Statement or any post- effective amendment thereto has become effective; (iii) of any request by the Commission for amendments or supplements to the Shelf Registration Statement or the Prospectus included therein or for additional information; (iv) of the issuance by the Commission of any stop order suspending the effectiveness of the Shelf Registration Statement or the initiation of any proceedings for that purpose; 3 (v) of the receipt by the Company or its legal counsel of any notification with respect to the suspension of the qualification of the Conversion Shares for sale in any jurisdiction or the initiation or threatening of any proceeding for such purpose; and (vi) of the happening of any event that requires the Company to make changes in the Shelf Registration Statement or the Prospectus in order that the Shelf Registration Statement or the Prospectus does not contain an untrue statement of a material fact nor omit to state a material fact required to be stated therein or necessary to make the statements therein (in the case of the Prospectus, in light of the circumstances under which they were made) not misleading. (c) The Company shall use its commercially reasonable efforts to avoid the issuance of or, if issued, obtain the withdrawal at the earliest possible time, of any order suspending the effectiveness of the Shelf Registration Statement. (d) The Company shall promptly furnish to each Holder of Conversion Shares included as a selling securityholder in the Shelf Registration Statement, without charge, at least one copy of the Shelf Registration Statement and any post-effective amendment thereto, including financial statements and schedules, and, if the Holder so requests in writing, all exhibits thereto (including those, if any, incorporated by reference). (e) The Company shall, during the Shelf Registration Period, deliver to each Holder of Conversion Shares included as a selling securityholder in the Shelf Registration Statement, without charge, as many copies of the Prospectus and any amendment or supplement thereto as such person may reasonably request. The Company consents, subject to the provisions of this Agreement, to the use of the Prospectus or any amendment or supplement thereto by each of the selling Holders of the Conversion Shares in connection with the offering and sale of the Conversion Shares covered by the Prospectus, or any amendment or supplement thereto, included in the Shelf Registration Statement. (f) Prior to any public offering of the Conversion Shares pursuant to the Shelf Registration Statement, the Company shall register or qualify or cooperate with the Holders of the Conversion Shares included therein and their respective counsel in connection with the registration or qualification of the Conversion Shares for offer and sale under the securities or "blue sky" laws of such states of the United States as any Holder of the Conversion Shares reasonably requests in writing and do any and all other acts or things necessary or advisable to enable the offer and sale in such jurisdictions of the Conversion Shares covered by such Shelf Registration Statement; provided, -------- however, that the Company shall not be required to (i) qualify generally to do - ------- business in any jurisdiction where it is not then so qualified or (ii) take any action which would subject it to general service of process or to taxation in any jurisdiction where it is not then so subject. (g) The Company shall cooperate with the Holders of the Conversion Shares to facilitate the timely preparation and delivery of certificates representing the Conversion Shares to be sold pursuant to any Shelf Registration Statement free of any restrictive legends and in such denominations and registered in such names as the Holders may request. 4 (h) Upon the occurrence of any event contemplated by paragraphs (iii) through (vi) of Section 2(b) above during the period for which the Company is required to maintain an effective Shelf Registration Statement, the Company shall promptly prepare and file a post-effective amendment to the Shelf Registration Statement or an amendment or supplement to the Prospectus and any other required document so that, as thereafter delivered to Holders or purchasers of the Conversion Shares, the Prospectus will not contain an untrue statement of a material fact or omit to state any material fact required to be stated therein or necessary to make the statements therein, in light of the circumstances under which they were made, not misleading. If the Company notifies the Holders in accordance with paragraphs (iii) through (vi) of Section 2(b) above to suspend the use of the Prospectus until the requisite changes to the Prospectus have been made, then the Holders shall suspend use of such prospectus, and the period of effectiveness of the Shelf Registration Statement provided for in Section 1(b) above shall be extended by the number of days from and including the date of the giving of such notice to and including the date when the Holders shall have received such amended or supplemented prospectus pursuant to this Section 2(h). (i) The Company will comply with all rules and regulations of the Commission to the extent and so long as they are applicable to the Shelf Registration Statement and will make generally available to its security holders (or otherwise provide in accordance with Section 11(a) of the Securities Act), an earnings statement satisfying the provisions of Section 11(a) of the Securities Act, no later than 45 days after the end of a 12-month period (or 90 days, if such period is a fiscal year) beginning with the first month of the Company's first fiscal quarter commencing after the effective date of the Shelf Registration Statement, which statement shall cover such 12-month period. (j) The Company may require each Holder of Conversion Shares to be sold pursuant to the Shelf Registration Statement to furnish to the Company such information regarding the Holder and the distribution of the Conversion Shares as the Company may from time to time reasonably require for inclusion in the Shelf Registration Statement, and the Company may exclude from such registration the Conversion Shares of any Holder that unreasonably fails to furnish such information within a reasonable time after receiving such request. (k) The Company shall use commercially reasonable efforts to take all other steps necessary to effect the registration of the Conversion Shares covered by a Shelf Registration Statement contemplated hereby. (l) The Company shall use commercially reasonable efforts to list the Conversion Shares covered by the Shelf Registration Statement with the applicable Eligible Market; (m) The Company shall cooperate with any due diligence investigation undertaken by the Holders in connection with the sale of Conversion Shares, including without limitation by making available any documents and information; provided that the Company will not deliver or make available to any Holder material, nonpublic information unless such Holder specifically requests in advance to receive material, nonpublic information. 5 (n) The Company may, after 20 consecutive Trading Days of continuous effectiveness of the initial Shelf Registration Statement filed and declared effective pursuant to this Agreement, by written notice to the Holders, suspend sales under a Shelf Registration Statement after the effective date thereof and/or require that the Holders immediately cease the sale of shares of Common Stock pursuant thereto and/or defer the filing of any subsequent Shelf Registration Statement if: (i) the Company is engaged in a material merger, acquisition or sale and the Board of Directors of the Company determines in good faith, by appropriate resolutions, that, as a result of such activity, (A) it would be materially detrimental to the Company (other than as relating solely to the price of the Common Stock) to file a Shelf Registration Statement at such time and (B) it is in the best interests of the Company to defer proceeding with such registration at such time, or (ii) the Company files a Shelf Registration Statement with the Commission for the purpose of registering under the Securities Act any securities to be publicly offered and sold by the Company in a bona fide firm commitment underwritten offering. Upon receipt of such notice, each Holder shall immediately discontinue any sales of Conversion Shares pursuant to such registration until such Holder has received copies of a supplemented or amended Prospectus or until such Holder is advised in writing by the Company that the then-current Prospectus may be used and has received copies of any additional or supplemental filings that are incorporated or deemed incorporated by reference in such Prospectus. In no event, however, shall this right be exercised to suspend sales beyond the period during which (in the good faith determination of the Company's Board of Directors) the failure to require such suspension would be materially detrimental to the Company. The Company's rights under this Section 2(n) may be exercised (A) with respect to clause (i) above, not more than three (3) times (which may be consecutive) in any twelve-month period and may not be exercised for a period of more than 30 days each, and (B) with respect to clause (ii) above, not more than one (1) time and may not be exercised for a period of more than 20 days in any twelve-month period. In no event may the Company exercise its rights pursuant to subclauses (A) and (B) above for an aggregate of more than 90 days. Immediately after the end of any suspension period under this Section 2(n), the Company shall take all necessary actions (including filing any required supplemental prospectus) to restore the effectiveness of the applicable Shelf Registration Statement and the ability of the Holders to publicly resell their Conversion Shares pursuant to such effective Shelf Registration Statement. 3. Registration Expenses. (a) All expenses incident to the Company's performance of and compliance with this Agreement will be borne by the Company, regardless of whether a Shelf Registration Statement is ever filed or becomes effective, including without limitation; (i) all registration and filing fees and expenses; (ii) all fees and expenses of compliance with federal securities and state "blue sky" or securities laws; 6 (iii) all expenses of printing (including printing of Prospectuses), messenger and delivery services and telephone; (iv) all fees and disbursements of counsel for the Company; (v) all application and filing fees in connection with listing the Conversion Shares on a national securities exchange or automated quotation system pursuant to the requirements hereof; and (vi) all fees and disbursements of independent certified public accountants of the Company (including the expenses of any special audit and comfort letters required by or incident to such performance). The Company will bear its internal expenses (including, without limitation, all salaries and expenses of its officers and employees performing legal or accounting duties), the expenses of any annual audit and the fees and expenses of any person, including special experts, retained by the Company. (b) In connection with the Shelf Registration Statement required by this Agreement, the Company will reimburse the Holders of Conversion Shares covered by the Shelf Registration Statement, for the reasonable fees and disbursements of counsel, not to exceed $15,000. 4. Indemnification. (a) The Company agrees to indemnify and hold harmless each Holder and each person, if any, who controls such Holder within the meaning of the Securities Act or the Securities Exchange Act of 1934, as amended (the "Exchange Act") (each Holder, and such controlling persons are referred to collectively as the "Indemnified Parties") from and against any losses, claims, damages or liabilities, joint or several, or any actions in respect thereof (including, but not limited to, any losses, claims, damages, liabilities or actions relating to purchases and sales of the Conversion Shares) to which each Indemnified Party may become subject under the Securities Act, the Exchange Act or otherwise, insofar as such losses, claims, damages, liabilities or actions arise out of or are based upon any untrue statement or alleged untrue statement of a material fact contained in the Shelf Registration Statement or Prospectus including any document incorporated by reference therein, or in any amendment or supplement thereto or in any preliminary Prospectus relating to the Shelf Registration, or arise out of, or are based upon, the omission or alleged omission to state therein a material fact required to be stated therein or necessary to make the statements therein not misleading, and shall reimburse, as incurred, the Indemnified Parties for any legal or other expenses reasonably incurred by them in connection with investigating or defending any such loss, claim, damage, liability or action in respect thereof; provided, however, that -------- ------- (i) the Company shall not be liable in any such case to the extent that such loss, claim, damage or liability arises out of or is based upon any untrue statement or alleged untrue statement or omission or alleged omission made in the Shelf Registration Statement or Prospectus or in any amendment or supplement thereto or in any preliminary Prospectus relating to the Shelf Registration in reliance upon and in conformity with written information pertaining to such Holder and furnished to the Company by or on behalf of such Holder specifically for inclusion therein (which shall include, without limitation, the information provided to the Company by such Indemnified Party in the Completed 7 Questionnaire) and (ii) with respect to any untrue statement or omission or alleged untrue statement or omission made in any preliminary Prospectus relating to the Shelf Registration Statement, the indemnity agreement contained in this subsection (a) shall not inure to the benefit of any Holder from whom the person asserting any such losses, claims, damages or liabilities purchased the Conversion Shares concerned, to the extent that a Prospectus relating to such Conversion Shares was required to be delivered by such Holder under the Securities Act in connection with such purchase and any such loss, claim, damage or liability of such Holder results from the fact that there was not sent or given to such person, at or prior to the written confirmation of the sale of such Conversion Shares to such person, a copy of the final Prospectus if the Company had previously furnished copies thereof to such Holder; provided -------- further, however, that this indemnity agreement will be in addition to any - ------- ------- liability which the Company may otherwise have to such Indemnified Party. (b) Each Holder, severally and not jointly, will indemnify and hold harmless the Company, its officers and directors and each person, if any, who controls the Company within the meaning of the Securities Act or the Exchange Act from and against any losses, claims, damages or liabilities or any actions in respect thereof, to which the Company or any such controlling person may become subject under the Securities Act, the Exchange Act or otherwise, insofar as such losses, claims, damages, liabilities or actions arise out of or are based upon any untrue statement or alleged untrue statement of a material fact contained in the Shelf Registration Statement or Prospectus or in any amendment or supplement thereto or in any preliminary Prospectus relating to the Shelf Registration, or arise out of or are based upon the omission or alleged omission to state therein a material fact necessary to make the statements therein not misleading, but in each case only to the extent that the untrue statement or omission or alleged untrue statement or omission was made in reliance upon and in conformity with written information pertaining to such Holder and furnished to the Company by or on behalf of such Holder specifically for inclusion therein (which shall include, without limitation, the information provided to the Company by such Indemnified Party in the Completed Questionnaire); and, subject to the limitation set forth immediately preceding this clause, shall reimburse, as incurred, the Company for any legal or other expenses reasonably incurred by the Company or any such controlling person in connection with investigating or defending any loss, claim, damage, liability or action in respect thereof. This indemnity agreement will be in addition to any liability which such Holder may otherwise have to the Company or any of its controlling persons. In no event shall the liability of any selling Holder hereunder be greater in amount than the dollar amount of the net proceeds received by such Holder upon the sale of the Conversion Shares giving rise to such indemnification obligation. (c) Promptly after receipt by an indemnified party under this Section 4 of notice of the commencement of any action or proceeding (including a governmental investigation), such indemnified party will, if a claim in respect thereof is to be made against the indemnifying party under this Section 4, notify the indemnifying party of the commencement thereof; but the omission so to notify the indemnifying party will not, in any event, relieve the indemnifying party from any obligations to any indemnified party other than the indemnification obligation provided in paragraph (a) or (b) above. In case any such action is brought against any indemnified party, and it notifies the indemnifying party of the commencement thereof, the indemnifying party will be entitled to participate therein and, to the extent that it may wish, 8 jointly with any other indemnifying party similarly notified, to assume the defense thereof, with counsel reasonably satisfactory to such indemnified party (who shall not, except with the consent of the indemnified party, be counsel to the indemnifying party), and after notice from the indemnifying party to such indemnified party of its election so to assume the defense thereof the indemnifying party will not be liable to such indemnified party under this Section 4 for any legal or other expenses, other than reasonable costs of investigation, subsequently incurred by such indemnified party in connection with the defense thereof. No indemnifying party shall, without the prior written consent of the indemnified party, effect any settlement of any pending or threatened action in respect of which any indemnified party is or could have been a party and indemnity could have been sought hereunder by such indemnified party unless such settlement (i) includes an unconditional release of such indemnified party from all liability on any claims that are the subject matter of such action, and (ii) does not include a statement as to or an admission of fault, culpability or a failure to act by or on behalf of any indemnified party. (d) If the indemnification provided for in this Section 4 is unavailable or insufficient to hold harmless an indemnified party under subsections (a) or (b) above, then each indemnifying party shall contribute to the amount paid or payable by such indemnified party as a result of the losses, claims, damages or liabilities (or actions in respect thereof) referred to in subsection (a) or (b) above in such proportion as is appropriate to reflect the relative fault of the indemnifying party or parties on the one hand and the indemnified party on the other in connection with the statements or omissions that resulted in such losses, claims, damages or liabilities (or actions in respect thereof) as well as any other relevant equitable considerations. The relative fault of the parties shall be determined by reference to, among other things, whether the untrue or alleged untrue statement of a material fact or the omission or alleged omission to state a material fact relates to information supplied by the Company on the one hand or such Holder or such other indemnified party, as the case may be, on the other, and the parties' relative intent, knowledge, access to information and opportunity to correct or prevent such statement or omission. The amount paid by an indemnified party as a result of the losses, claims, damages or liabilities referred to in the first sentence of this subsection (d) shall be deemed to include any legal or other expenses reasonably incurred by such indemnified party in connection with investigating or defending any action or claim which is the subject of this subsection (d). Notwithstanding any other provision of this Section 4(d), the Holders shall not be required to contribute any amount in excess of the amount by which the net proceeds received by such Holders from the sale of the Conversion Shares pursuant to the Shelf Registration Statement exceeds the amount of damages which such Holders have otherwise been required to pay by reason of such untrue or alleged untrue statement or omission or alleged omission. No person guilty of fraudulent misrepresentation (within the meaning of Section 11(f) of the Securities Act) shall be entitled to contribution from any person who was not guilty of such fraudulent misrepresentation. For purposes of this paragraph (d), each person, if any, who controls such indemnified party within the meaning of the Securities Act or the Exchange Act shall have the same rights to contribution as such indemnified party and each person, if any, who controls the Company within the meaning of the Securities Act or the Exchange Act shall have the same rights to contribution as the Company. (e) The agreements contained in this Section 4 shall survive the sale of the Conversion Shares pursuant to the Shelf Registration Statement and shall remain in full force and effect, 9 regardless of any termination or cancellation of this Agreement or any investigation made by or on behalf of any indemnified party. 5. Rule 144. The Company shall use commercially reasonable efforts to file the reports required to be filed by it under the Securities Act and the Exchange Act in a timely manner and, if at any time the Company is not required to file such reports, it will, upon the request of any Holder, make publicly available other information so long as necessary to permit sales of their securities pursuant to Rule 144 under the Securities Act. The Company covenants that it will take such further action as any Holder may reasonably request in writing, all to the extent required from time to time to enable such Holder to sell Transfer Restricted Securities without registration under the Securities Act within the limitation of the exemptions provided by Rule 144 under the Securities Act. Upon the written request of any Holder, the Company shall deliver to such Holder a written statement as to whether it has complied with such requirements. Notwithstanding the foregoing, nothing in this Section 5 shall be deemed to require the Company to register any of its securities pursuant to the Exchange Act. 6. Miscellaneous. (a) No Inconsistent Agreements. The Company will not on or after the date of this Agreement enter into any agreement with respect to its securities that is inconsistent with the rights granted to the Holders in this Agreement or otherwise conflicts with the provisions hereof. The rights granted to the Holders hereunder do not in any way conflict with and are not inconsistent with the rights granted to the holders of the Company's securities under any agreement in effect on the date hereof. (b) Amendments and Waivers. The provisions of this Agreement may not be amended, modified or supplemented, and waivers or consents to departures from the provisions hereof may not be given, except by the Company and the written consent of the holders of a majority in principal amount of the Notes affected by such amendment, modification, supplement, waiver or consents (provided that holders of Conversion Shares shall not be deemed holders of Common Stock, but shall be deemed to be holders of the aggregate principal amount of Notes from which such Common Stock was converted). (c) Notices. All notices and other communications provided for or permitted hereunder shall be made in writing by hand delivery, first-class mail, facsimile transmission, or air courier which guarantees overnight delivery: (1) if to a Holder of the Notes, at the most current address given by such Holder to the Company. 10 (2) if to the Company, at its address as follows: Cephalon, Inc. 145 Brandywine Parkway West Chester, PA 19380 Fax No.: (610) 344-7563 Attn: General Counsel with a copy to: Morgan, Lewis & Bockius LLP 1701 Market Street Philadelphia, PA 19103 Fax No.: (215) 963-5299 Attn: Richard A. Silfen, Esq. All such notices and communications shall be deemed to have been duly given: at the time delivered by hand, if personally delivered; three business days after being deposited in the mail, postage prepaid, if mailed; when receipt is acknowledged by recipient's facsimile machine operator, if sent by facsimile transmission; and on the day delivered, if sent by overnight air courier guaranteeing next day delivery. (d) Remedies. In the event of a breach by the Company or by a Holder of any of their obligations under this Agreement, each Holder or the Company, as the case may be, in addition to being entitled to exercise all rights granted by law and under this Agreement, including recovery of damages, will be entitled to specific performance of its rights under this Agreement. The Company and each Holder agree that monetary damages would not provide adequate compensation for any losses incurred by reason of a breach by it of any of the provisions of this Agreement and hereby further agrees that, in the event of any action for specific performance in respect of such breach, it shall waive the defense that a remedy at law would be adequate. (e) Third Party Beneficiaries. The Holders shall be third party beneficiaries to the agreements made hereunder between the Company, on the one hand, and Anthem, on the other hand, and shall have the right to enforce such agreements directly to the extent they may deem such enforcement necessary or advisable to protect their rights or the rights of Holders hereunder. (e) Successors and Assigns. This Agreement shall be binding upon the Company and its successors and assigns. (f) Counterparts. This Agreement may be executed in any number of counterparts and by the parties hereto in separate counterparts, each of which when so executed shall be deemed to be an original and all of which taken together shall constitute one and the same agreement. 11 (g) Headings. The headings in this Agreement are for convenience of reference only and shall not limit or otherwise affect the meaning hereof. (h) Governing Law. THIS AGREEMENT SHALL BE GOVERNED BY, AND CONSTRUED IN ACCORDANCE WITH, THE LAWS OF THE STATE OF NEW YORK WITHOUT REGARD TO PRINCIPLES OF CONFLICTS OF LAWS. By the execution and delivery of this Agreement, the Company submits to the nonexclusive jurisdiction of any federal or state court in the State of New York. (i) Severability. If any one or more of the provisions contained herein, or the application thereof in any circumstance, is held invalid, illegal or unenforceable, the validity, legality and enforceability of any such provision in every other respect and of the remaining provisions contained herein shall not be affected or impaired thereby. 12 If the foregoing is in accordance with your understanding of our agreement, please sign and return to the Company a counterpart hereof, whereupon this instrument, along with all counterparts, will become a binding agreement among you and the Company in accordance with its terms. Very truly yours, CEPHALON, INC. By: /s/ J. Kevin Buchi --------------------------------------- Name: J. Kevin Buchi Title:Senior Vice President and Chief Financial Officer The foregoing Registration Rights Agreement is hereby confirmed and accepted as of the date first above written. ANTHEM INVESTORS, LLC By: /s/ Kevin O'Neal ------------------------------------- Name: Kevin O'Neal Title: Authorized Signatory EX-10.1 5 dex101.txt AMENDMENT TO CONSULTING AGREEMENT EXHIBIT 10.1 Amendment to Consulting Agreement This Amendment to Consulting Agreement (the "Amendment") is entered into as of April 1, 2002, by and between Cephalon, Inc., a Delaware corporation ("Cephalon") and Martyn D. Greenacre ("Consultant"). WHEREAS, Cephalon and Consultant have previously entered into a Consulting Agreement (the "Consulting Agreement") dated as of October 1, 2001; WHEREAS, pursuant to the Consulting Agreement the Consultant has provided Cephalon with valuable consulting services in connection with Cephalon's acquisition of the French pharmaceutical company Laboratoire L. Lafon; WHEREAS, Cephalon is considering undertaking other strategic transactions that would expand its presence in Europe; and WHEREAS, Consultant has substantial expertise in the pharmaceutical industry, particularly in Europe. NOW, THEREFORE, in consideration of the mutual promises set forth herein, and intending to be bound legally hereby, Cephalon and Consultant hereby agree as follows: 1. Amendments. The Consulting Agreement is hereby amended as follows, effective ---------- as of the date set forth above: 1.1. Section 2. Section 2 is hereby amended to extend the initial term of the Consulting Agreement until December 31, 2002. 1.2 Section 6. Section 6 is hereby amended to provide that either Cephalon or Consultant may terminate the Consulting Agreement for any reason whatsoever by providing to the other thirty (30) days prior written notice of such termination. 1.3 Exhibit A. Exhibit A is hereby amended by deleting existing Exhibit A in its entirety and replacing it with the attached Exhibit A. 2. Other Matters. ------------- 2.1 Except as amended hereby, the Consulting Agreement shall remain in full force and effect. 2.2 This Amendment shall be binding on the parties and their respective successors and assigns. 2.3 This Amendment shall be governed and interpreted in accordance with the laws of the State of Delaware, without giving effect to any conflict of laws provisions. IN WITNESS WHEREOF, the undersigned have executed this Agreement as of the date first written above. CEPHALON, INC. By: /s/ Frank Baldino, Jr., Ph.D. ----------------------------- Name: Frank Baldino, Jr., Ph.D. Title: Chairman and Chief Executive Officer MARTYN D. GREENACRE By: /s/ Martyn D. Greenacre ----------------------------- Exhibit A Description of Consulting Services and Compensation Scope of Services: Consultant shall provide consulting services as requested relating to the possible expansion of Cephalon's European Operations. Compensation: Cephalon shall pay Consultant a total of $19,200 per month as compensation for the Services as well as travel, hotel, and meal expenses. Schedule of Payments: Cephalon shall pay Consultant twice each month during the term of this Agreement. Please send all invoices to: Cephalon, Inc. Attn: Accounts Payable 145 Brandywine Parkway West Chester, PA 19380 -----END PRIVACY-ENHANCED MESSAGE-----