-----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, OCODLhtgCP23rr7m14tMdHJ+2oXm99ptK4xTGu1O9UyWGCCb2ff6YaO0UwsqdStC LqFzyF0mVHQCzqE4+lMypw== 0001021408-02-010662.txt : 20020813 0001021408-02-010662.hdr.sgml : 20020813 20020813154043 ACCESSION NUMBER: 0001021408-02-010662 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 7 CONFORMED PERIOD OF REPORT: 20020630 FILED AS OF DATE: 20020813 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: 02729616 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 CEPHALON, INC. SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-Q [X] Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 For the Quarterly Period Ended June 30, 2002 [_] Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 For the Transition Period from ______________ to _______________ Commission File Number 0-19119 --------------------- CEPHALON, INC. ---------------------------------------------------------------- (Exact Name of Registrant as Specified in its Charter) Delaware 23-2484489 - -------------------------------------------- -------------------------------- (State Other Jurisdiction of Incorporation (I.R.S. Employer Identification or Organization) Number) 145 Brandywine Parkway, West Chester, PA 19380-4245 - ------------------------------------------- ----------------- (Address of Principal Executive Offices) (Zip Code) Registrant's Telephone Number, Including Area Code (610) 344-0200 -------------------- Not Applicable - -------------------------------------------------------------------------------- Former Name, Former Address and Former Fiscal Year, If Changed Since Last Report Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes X No _____ --- Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date. Class Outstanding as of August 9, 2002 ---------------------------------- -------------------------------- Common Stock, par value $.01 55,101,389 Shares This Report Includes a Total of 38 Pages CEPHALON, INC. AND SUBSIDIARIES INDEX
Page No. -------- PART I - FINANCIAL INFORMATION Item 1. Consolidated Financial Statements (Unaudited) Consolidated Balance Sheets - 3 June 30, 2002 and December 31, 2001 Consolidated Statements of Operations - 4 Three and six months ended June 30, 2002 and 2001 Consolidated Statements of Stockholders' Equity - 5 June 30, 2002 and December 31, 2001 Consolidated Statements of Cash Flows - 6 Six months ended June 30, 2002 and 2001 Notes to Consolidated Financial Statements 7 Item 2. Management's Discussion and Analysis of 16 Financial Condition and Results of Operations Item 3. Quantitative and Qualitative Disclosure about Market Risk 35 PART II - OTHER INFORMATION Item 1. Legal Proceedings 36 Item 2. Changes in Securities and Use of Proceeds 36 Item 4. Submission of Matters to a Vote of Security Holders 36 Item 6. Exhibits and Reports on Form 8-K 37 SIGNATURES 38
2 CEPHALON, INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS (Unaudited)
June 30, December 31, 2002 2001 --------------- --------------- ASSETS ------ CURRENT ASSETS: Cash and cash equivalents $ 391,786,000 $ 548,727,000 Investments 202,914,000 55,157,000 Receivables, net 83,211,000 75,192,000 Inventory 49,173,000 47,513,000 Other current assets 11,574,000 7,872,000 --------------- --------------- Total current assets 738,658,000 734,461,000 PROPERTY AND EQUIPMENT, net 70,872,000 64,706,000 GOODWILL 248,565,000 248,911,000 INTANGIBLE ASSETS, net 310,984,000 298,269,000 DEBT ISSUANCE COSTS 24,237,000 26,720,000 OTHER ASSETS 13,999,000 16,020,000 --------------- --------------- $ 1,407,315,000 $ 1,389,087,000 =============== =============== LIABILITIES AND STOCKHOLDERS' EQUITY ------------------------------------ CURRENT LIABILITIES: Accounts payable $ 30,781,000 $ 24,536,000 Accrued expenses 40,181,000 49,370,000 Current portion of long-term debt 20,646,000 32,200,000 Current portion of deferred revenues 491,000 824,000 --------------- --------------- Total current liabilities 92,099,000 106,930,000 LONG-TERM DEBT 871,422,000 866,589,000 DEFERRED REVENUES 5,773,000 6,042,000 OTHER LIABILITIES 11,192,000 10,795,000 --------------- --------------- Total liabilities 980,486,000 990,356,000 --------------- --------------- COMMITMENTS AND CONTINGENCIES (Note 8) STOCKHOLDERS' EQUITY: Preferred stock, $.01 par value, 5,000,000 shares authorized, 2,500,000 shares issued, and none outstanding -- -- Common stock, $.01 par value, 200,000,000 shares authorized, 55,096,552 and 54,909,533 shares issued, and 54,867,674 and 54,685,792 shares outstanding 551,000 549,000 Additional paid-in capital 987,739,000 982,123,000 Treasury stock, 228,878 and 223,741 shares outstanding, at cost (9,803,000) (9,523,000) Accumulated deficit (565,133,000) (576,691,000) Accumulated other comprehensive income 13,475,000 2,273,000 --------------- --------------- Total stockholders' equity 426,829,000 398,731,000 --------------- --------------- $ 1,407,315,000 $ 1,389,087,000 =============== ===============
The accompanying notes are an integral part of these consolidated financial statements. 3 CEPHALON, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS (Unaudited)
Three Months Ended Six Months Ended June 30, June 30, ------------------------------ --------------------------------- 2002 2001 2002 2001 ------------------------------ --------------------------------- REVENUES: Product sales $ 108,767,000 $ 44,286,000 $ 204,570,000 $ 85,108,000 Other revenues 11,960,000 11,913,000 27,658,000 18,163,000 ------------- ------------ ------------- ------------ 120,727,000 56,199,000 232,228,000 103,271,000 ------------- ------------ ------------- ------------ COSTS AND EXPENSES: Cost of product sales 15,472,000 9,273,000 29,317,000 17,571,000 Research and development 31,401,000 20,894,000 61,224,000 40,505,000 Selling, general and administrative 44,911,000 27,291,000 85,195,000 51,656,000 Depreciation and amortization 8,042,000 3,562,000 16,335,000 7,051,000 ------------- ------------ ------------- ------------ 99,826,000 61,020,000 $ 192,071,000 116,783,000 ------------- ------------ ------------- ------------ INCOME (LOSS) FROM OPERATIONS 20,901,000 (4,821,000) 40,157,000 (13,512,000) ------------- ------------ ------------- ------------ OTHER INCOME AND EXPENSE Interest income 3,770,000 3,039,000 6,640,000 4,546,000 Interest expense (9,782,000) (4,136,000) (21,280,000) (5,456,000) Other expense (460,000) (72,000) (1,298,000) (1,110,000) ------------- ------------ ------------- ------------ (6,472,000) (1,169,000) (15,938,000) (2,020,000) ------------- ------------ ------------- ------------ INCOME (LOSS) BEFORE INCOME TAXES 14,429,000 (5,990,000) 24,219,000 (15,532,000) INCOME TAXES -- -- (1,985,000) -- ------------- ------------ ------------- ------------ INCOME (LOSS) BEFORE DIVIDENDS ON PREFERRED STOCK, EXTRAORDINARY CHARGE AND CUMULATIVE EFFECT OF CHANGING INVENTORY COSTING METHOD 14,429,000 (5,990,000) 22,234,000 (15,532,000) DIVIDENDS ON CONVERTIBLE EXCHANGEABLE PREFERRED STOCK -- (3,328,000) -- (5,594,000) ------------- ------------ ------------- ------------ INCOME (LOSS) BEFORE EXTRAORDINARY CHARGE AND CUMULATIVE EFFECT OF CHANGING INVENTORY COSTING METHOD 14,429,000 (9,318,000) 22,234,000 (21,126,000) EXTRAORDINARY GAIN (CHARGE) ON EARLY EXTINGUISHMENT OF DEBT -- 3,016,000 (7,142,000) 3,016,000 CUMULATIVE EFFECT OF CHANGING INVENTORY COSTING METHOD FROM FIFO TO LIFO -- -- (3,534,000) -- ------------- ------------ ------------- ------------ INCOME (LOSS) APPLICABLE TO COMMON SHARES $ 14,429,000 $ (6,302,000) $ 11,558,000 $(18,110,000) ============= ============ ============= ============ BASIC INCOME (LOSS) PER COMMON SHARE: Income (loss) per common share before extraordinary charge and cumulative effect of changing inventory costing method $ 0.26 $ (0.19) $ 0.40 $ (0.47) Extraordinary charge on early extinguishment of debt -- 0.06 (0.13) 0.07 Cumulative effect of changing inventory costing method -- -- (0.06) -- ------------- ------------ ------------- ------------ $ 0.26 $ (0.13) $ 0.21 $ (0.40) ============= ============ ============= ============ DILUTED INCOME (LOSS) PER COMMON SHARE: Income (loss) per common share before extraordinary charge and cumulative effect of changing inventory costing method $ 0.25 $ (0.19) $ 0.39 $ (0.47) Extraordinary charge on early extinguishment of debt -- 0.06 (0.13) 0.07 Cumulative effect of changing inventory costing method -- -- (0.06) -- ------------- ------------ ------------- ------------ $ 0.25 $ (0.13) $ 0.20 $ (0.40) ------------- ------------ ------------- ------------ WEIGHTED AVERAGE NUMBER OF COMMON SHARES OUTSTANDING 55,071,000 47,725,000 55,017,000 45,229,000 ============= ============ ============= ============ WEIGHTED AVERAGE NUMBER OF COMMON SHARES OUTSTANDING-ASSUMING DILUTION 57,033,000 47,725,000 57,161,000 45,229,000 ============= ============ ============= ============
The accompanying notes are an integral part of these consolidated financial statements. 4 CEPHALON, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (Unaudited)
Accumulated Other Comprehensive Accumulated Comprehensive Income (Loss) Total Deficit Income --------------- ---------------------------------------------- BALANCE, JANUARY 1, 2001 $165,193,000 $(515,543,000) $ 1,401,000 Loss $(55,484,000) (55,484,000) (55,484,000) -- ------------ Foreign currency translation gain 368,000 Unrealized investment gains 504,000 ------------ Other comprehensive income 872,000 872,000 -- 872,000 ------------ Comprehensive loss $(54,612,000) ============ Conversion of preferred stock into common stock -- -- -- Issuance of common stock -- -- upon conversion of convertible notes 262,590,000 Stock options exercised 25,542,000 -- -- Stock purchase warrants exercised 2,679,000 -- -- Restricted stock award plan 5,349,000 -- -- Employee benefit plan 1,283,000 -- -- Dividends declared on (5,664,000) (5,664,000) -- convertible preferred stock Treasury stock acquired (3,629,000) -- -- ------------ -------------- ------------ BALANCE, DECEMBER 31, 2001 398,731,000 (576,691,000) 2,273,000 Income $ 11,558,000 11,558,000 11,558,000 -- ------------ Foreign currency translation gain 9,437,000 Unrealized investment gains 1,765,000 ------------ Other comprehensive income 11,202,000 11,202,000 -- 11,202,000 ------------ Comprehensive income $ 22,760,000 ============ Stock options exercised 3,065,000 -- -- Restricted stock award plan 1,220,000 -- -- Employee benefit plan 1,224,000 -- -- Treasury stock acquired (171,000) -- -- ------------ ------------- ------------ BALANCE, JUNE 30, 2002 $426,829,000 $(565,133,000) $ 13,475,000 ============ ============= ============ Additional Common Preferred Paid-in Treasury Stock Stock Capital Stock -------- ------- ------------ ----------- BALANCE, JANUARY 1, 2001 $425,000 $25,000 $683,004,000 $(4,119,000) Loss -- -- -- -- Foreign currency translation gain Unrealized investment gains Other comprehensive income -- -- -- -- Comprehensive loss Conversion of preferred stock into common stock 70,000 (25,000) (45,000) -- Issuance of common stock 37,000 -- 262,553,000 -- upon conversion of convertible notes Stock options exercised 13,000 -- 27,304,000 (1,775,000) Stock purchase warrants exercised 2,000 2,677,000 -- Restricted stock award plan 2,000 -- 5,347,000 -- Employee benefit plan -- -- 1,283,000 -- Dividends declared on -- -- -- -- convertible preferred stock Treasury stock acquired -- -- -- (3,629,000) -------- -------- ------------- ----------- BALANCE, DECEMBER 31, 2001 549,000 -- 982,123,000 (9,523,000) Income -- -- -- -- Foreign currency translation gain Unrealized investment gains Other comprehensive income -- -- -- -- Comprehensive income Stock options exercised 2,000 -- 3,172,000 (109,000) Restricted stock award plan -- -- 1,220,000 -- Employee benefit plan -- -- 1,224,000 -- Treasury stock acquired -- -- -- (171,000) -------- ------- ------------ ----------- BALANCE, JUNE 30, 2002 $551,000 $ -- $987,739,000 $(9,803,000) ======== ======= ============ ===========
The accompaning notes are an integral part of these consolidated financial statements. 5 CEPHALON, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited)
Six Months Ended June 30, ----------------------------------- 2002 2001 -------------- -------------- CASH FLOWS FROM OPERATING ACTIVITIES: Income (loss) before preferred dividends $ 11,558,000 $ (12,516,000) Adjustments to reconcile income (loss) to net cash provided by (used for) operating activities: Depreciation and amortization 16,335,000 7,051,000 Extraordinary charge (gain) on extinguishment of debt 7,142,000 (3,016,000) Non-cash interest expense 7,099,000 2,413,000 Cumulative effect of changing inventory costing method from FIFO to LIFO 3,534,000 -- Stock-based compensation expense 2,444,000 3,517,000 Other 3,266,000 216,000 (Increase) decrease in operating assets: Receivables (3,927,000) (8,214,000) Inventory (2,803,000) (11,331,000) Other current assets (3,258,000) (2,762,000) Other long-term assets (3,086,000) 5,000 Increase (decrease) in operating liabilities: Accounts payable 3,781,000 (651,000) Accrued expenses (10,261,000) 3,419,000 Deferred revenues 397,000 (467,000) Other long-term liabilities (1,945,000) (74,000) ------------- ------------- Net cash provided by (used for) operating activities 30,276,000 (22,410,000) ------------- ------------- CASH FLOWS FROM INVESTING ACTIVITIES: Purchases of property and equipment (6,572,000) (4,745,000) Acquistion of intangible assets (23,658,000) -- Sales and maturities (purchases) of investments, net (145,992,000) (239,239,000) ------------- ------------- Net cash used for investing activities (176,222,000) (243,984,000) ------------- ------------- CASH FLOWS FROM FINANCING ACTIVITIES: Proceeds from exercises of common stock options and warrants 3,065,000 20,115,000 Payments to acquire treasury stock (171,000) -- Net proceeds from issuance of long-term debt -- 385,785,000 Preferred dividends paid -- (6,656,000) Principal payments on and retirements of long-term debt (15,354,000) (49,576,000) ------------- ------------- Net cash (used for) provided by financing activities (12,460,000) 349,668,000 ------------- ------------- EFFECT OF EXCHANGE RATE CHANGES ON CASH AND CASH EQUIVALENTS 1,465,000 787,000 ------------- ------------- NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS (156,941,000) 84,061,000 CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD 548,727,000 36,571,000 ------------- ------------- CASH AND CASH EQUIVALENTS, END OF PERIOD $ 391,786,000 $ 120,632,000 ============= ============= Supplemental disclosures of cash flow information: Cash payments for interest $ 13,981,000 $ 1,870,000 Non-cash investing and financing activities: Capital lease additions 663,000 360,000
The accompanying notes are an integral part of these consolidated financial statements. 6 CEPHALON, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) 1. NATURE OF BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES Business Cephalon is an international biopharmaceutical company dedicated to the discovery, development and marketing of innovative products to treat sleep and neurological disorders, cancer and pain. In addition to conducting an active research and development program, we market three products in the United States, PROVIGIL(R) (modafinil) tablets [C-IV], ACTIQ(R) (oral transmucosal fentanyl citrate) [C-II], and GABITRIL(R) (tiagabine hydrochloride), as well as a number of products in various countries throughout Europe. We are headquartered in West Chester, Pennsylvania, and have offices in Salt Lake City, Utah, and internationally in France, the United Kingdom, Germany and Switzerland. Our research and development headquarters are located in the United States. We operate manufacturing facilities in France for the production of bulk pharmaceuticals, including modafinil, which is the active drug substance contained in PROVIGIL. We also operate manufacturing facilities in Salt Lake City, Utah, for the production of ACTIQ for distribution and sale in the European Union. Basis of Presentation The accompanying unaudited consolidated financial statements have been prepared in accordance with generally accepted accounting principles for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnote disclosures required by generally accepted accounting principles for complete financial statements. In the opinion of management, all adjustments (consisting only of normal recurring accruals) considered necessary for a fair presentation have been included. These financial statements should be read in conjunction with the consolidated financial statements and notes thereto included in our annual report on Form 10-K, filed with the Securities and Exchange Commission, which includes audited financial statements as of December 31, 2001 and 2000 and for each of the three years in the period ended December 31, 2001. The results of our operations for any interim period are not necessarily indicative of the results of our operations for any other interim period or for a full year. Revenue Recognition Product sales are recognized upon the transfer of ownership and risk of loss for the product to the customer and are recorded net of estimated reserves for contractual allowances, discounts and returns. The estimated reserves are reviewed at each reporting period and adjusted to reflect data available at that time. To the extent our estimates are inaccurate, we will adjust the reserves which will impact the amount of product sales revenue recognized in the period of the adjustment. Income Taxes We have provided for income taxes related to our foreign subsidiaries in accordance with Statement of Financial Accounting Standards (SFAS) No. 109, "Accounting for Income Taxes," which requires the recognition of deferred tax assets and liabilities for the expected tax consequences of temporary differences between the tax and financial reporting bases of assets and liabilities. We have a history of losses in our U.S. operations, which has generated significant federal and state tax net operating loss (NOL) carryforwards of approximately $344,139,000 and $147,620,000, respectively, as of December 31, 2001. United States generally accepted accounting principles require us to record a valuation allowance against the deferred tax asset associated with this NOL carryforward if it is more likely than not that we will not be able to utilize the NOL carryforward to offset future taxes. Due to the size of the NOL carryforward in relation to our history of unprofitable operations, we have provided a full valuation allowance against this deferred tax asset. 7 CEPHALON, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--CONTINUED (Unaudited) Group Lafon On December 28, 2001, we completed our acquisition of the outstanding shares of capital stock of Laboratoire L. Lafon and affiliated entities (collectively "Group Lafon"). With this acquisition, we control worldwide rights to modafinil, marketed under the trade name PROVIGIL in the United States. To date, the acquisition has increased our product sales, improved gross margins for PROVIGIL, improved profitability and provided us with important research and development, commercial and manufacturing infrastructure in France. The purchase price for Group Lafon was approximately $456,654,000, which was funded in part by the proceeds of our December 11, 2001 offering of $600,000,000 of 2.50% convertible subordinated notes due December 2006. Of the purchase price, $450,000,000 was paid in cash to the sellers with the remainder primarily representing transaction costs of the acquisition and severance payments, partially offset by an estimate of the amount expected to be refunded by the seller under the terms of the acquisition agreement. The purchase accounting for the acquisition may be revised for up to one year from the transaction date due to changes in assessments of contingencies and our integration plans. All such amounts are expected to be paid or received in 2002. The following unaudited pro forma information shows the results of our operations for the three months and the six months ended June 30, 2001 as though the acquisition had occurred as of January 1, 2001:
Three months ended Six months ended June 30, 2001 June 30, 2001 ------------- ------------- Total revenues ................................. $ 77,620,000 $ 144,820,000 Net loss ....................................... $ (9,870,000) $ (24,206,000) Basic and diluted net loss per common share: $ (0.20) $ (0.54)
The pro forma results have been prepared for comparative purposes only and are not necessarily indicative of the actual results of operations had the acquisition taken place as of January 1, 2001, or the results that may occur in the future. Furthermore, the pro forma results do not give effect to all cost savings or incremental costs that may occur as a result of the integration and consolidation of the acquisition. Recent Accounting Pronouncements In June 2001, the Financial Accounting Standards Board (FASB) finalized SFAS No.142, "Goodwill and Other Intangible Assets," which is effective for fiscal years beginning after December 15, 2001. SFAS 142 no longer requires the amortization of goodwill; rather, goodwill will be subject to a periodic assessment for impairment by applying a fair-value-based test. In addition, an acquired intangible asset should be separately recognized if the benefit of the intangible asset is obtained through contractual or other legal rights, or if the intangible asset can be sold, transferred, licensed, rented, or exchanged, regardless of the acquirer's intent to do so. Such acquired intangible assets will be amortized over the period in which the economic benefits of the intangible asset are consumed or otherwise used up. The new criteria for recording intangible assets separate from goodwill did not require us to reclassify any of our intangible assets. We have only recorded goodwill related to our acquisition of Group Lafon effective December 28, 2001; therefore, our transitional impairment test indicated that there was no impairment of goodwill upon our adoption of SFAS 142 effective January 1, 2002. In June 2001, the FASB issued SFAS No. 143, "Accounting for Asset Retirement Obligations," which requires recognition of the fair value of liabilities associated with the retirement of long-lived assets when a legal obligation to incur such costs arises as a result of the acquisition, construction, development and/or the normal operation of a long-lived asset. SFAS 143 requires that the fair value of a liability for an asset retirement obligation be recognized in the period in which it is incurred if a reasonable estimate of fair value can be made. The associated asset retirement costs are capitalized as part of the carrying amount of the long-lived asset and subsequently allocated to expense over the asset's useful life. SFAS 143 is effective for fiscal years beginning after December 15, 2002. The adoption of this new standard will not have any impact on our current financial statements. On January 1, 2002, we adopted SFAS No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets." This Statement provides new guidance on the recognition of impairment losses on long-lived assets to be held 8 CEPHALON, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--CONTINUED (Unaudited) and used or to be disposed of and also broadens the definition of what constitutes a discontinued operation and how the results of a discontinued operation are to be measured and presented. The adoption of this new standard has not had any impact on our current financial statements. In April 2002, the FASB issued SFAS No. 145 "Rescission of FASB Statements No. 4, 44 and 64, Amendment of FASB Statement No. 13, and Technical Corrections." This Statement amends or rescinds certain existing authoritative pronouncements related to lease accounting in order to make various technical corrections, clarify meanings, or describe applicability under changed conditions. SFAS No. 145 is effective for fiscal years beginning after May 15, 2002. The adoption of this new standard will not have any impact on our current financial statements. In June 2002, the FASB issued SFAS No. 146, "Accounting for Exit or Disposal Activities." This Statement addresses the recognition, measurement and reporting of costs that are associated with exit and disposal activities, including restructuring activities that are currently accounted for pursuant to the guidance in EITF Issue No. 94-3, "Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity (including Certain Costs Incurred in a Restructuring)." The Statement requires that costs associated with exit or disposal activities be recorded at their fair values when a liability has been incurred. SFAS No. 146 is effective for disposal activities initiated after December 31, 2002. The adoption of this new standard will not have any impact on our current financial statements. 2. JOINT VENTURE In December 2001, we formed a joint venture with an unaffiliated third party investor to fund additional commercial activities in support of PROVIGIL and GABITRIL in the United States. In exchange for our transfer to the joint venture of certain intellectual property and other rights related to these two products, we received a Class B interest, representing a 50% interest in the joint venture. In exchange for its contribution of $50,000,000 in cash to the joint venture, the investor received Class A interests, also representing a 50% interest in the joint venture. As of December 31, 2001, the $50,000,000 investor's Class A interest was recorded on our balance sheet as debt, and the joint venture's cash balance of $50,000,000 was included in our balance of cash and cash equivalents. On March 29, 2002, we acquired the investor's Class A interests and ended the joint venture by the issuance and sale in a private placement of $55,000,000 aggregate principal amount of 3.875% convertible subordinated notes due March 2007. The notes are convertible into our common stock, at the option of the holder, at a price of $70.36 per share. See "Note 7--Long-Term Debt." The purchase of the investor's Class A interests in the joint venture resulted in the recognition of an extraordinary charge of $7,142,000 on the early extinguishment of debt during the first quarter of 2002. The following table summarizes the calculation of this extraordinary charge: Carrying value of the debt as of December 31, 2001 ....................... $ 50,000,000 Interest accreted during the first quarter 2002 at 20% ................... 2,500,000 ------------ Carrying value of the debt as of March 29, 2002 .......................... 52,500,000 Less: unamortized joint venture formation costs as of March 29, 2002 ..... (4,642,000) ------------ 47,858,000 Fair value of subordinated notes issued on March 29, 2002 ................ (55,000,000) ------------ Extraordinary charge ..................................................... $ (7,142,000) ============
9 CEPHALON, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--CONTINUED (Unaudited) In addition, our statement of operations for the six months ended June 30, 2002 included certain charges related to the operations of the joint venture, as follows: Six months ended June 30, 2002 ------------- Selling, general and administrative expenses ............. $3,508,000 Interest expense ......................................... 3,163,000 Interest income .......................................... (190,000) ---------- $6,481,000 ========== 3. CASH, CASH EQUIVALENTS AND INVESTMENTS Cash, cash equivalents and investments consisted of the following:
June 30, December 31, 2002 2001 ---- ---- Cash and cash equivalents Demand deposits and money market funds ................... $ 333,113,000 $ 4,364,000 Repurchase agreements .................................... -- 155,817,000 U.S. government agency obligations ....................... 586,000 79,985,000 Commercial paper ......................................... 4,993,000 245,158,000 Asset backed securities .................................. 1,114,000 4,636,000 Bonds .................................................... 51,980,000 58,767,000 ------------- ------------- 391,786,000 548,727,000 ------------- ------------- Short-term investments (at market value): U.S. government agency obligations ....................... 7,168,000 8,076,000 Commercial paper ......................................... 80,872,000 17,135,000 Asset backed securities .................................. 19,000 2,878,000 Bonds .................................................... 114,855,000 26,068,000 Certificates of deposit .................................. -- 1,000,000 ------------- ------------- 202,914,000 55,157,000 ------------- ------------- $ 594,700,000 $ 603,884,000 ------------- -------------
The contractual maturities of our investments in cash, cash equivalents, and investments at June 30, 2002 are as follows: Less than one year ..................................... $ 498,903,000 Greater than one year but less than two years .......... 14,900,000 Greater than two years ................................. 80,897,000 ------------- $ 594,700,000 ------------- 10 CEPHALON, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--CONTINUED (Unaudited)
4. RECEIVABLES Receivables consisted of the following: June 30, December 31, 2002 2001 ---- ---- Trade receivables ...................................................... $ 47,645,000 $ 40,790,000 Receivables from collaborations ........................................ 12,102,000 16,438,000 Other receivables ...................................................... 33,212,000 24,790,000 Reserve for sales discounts, returns and allowances .................... (9,748,000) (6,826,000) ------------- ------------- $ 83,211,000 $ 75,192,000 ============= =============
5. INVENTORY Inventory consisted of the following: June 30, December 31, 2002 2001 ---- ---- Raw materials ...................................................... $25,664,000 $19,666,000 Work-in-process .................................................... 5,369,000 7,632,000 Finished goods ..................................................... 18,140,000 20,215,000 ----------- ----------- $49,173,000 $47,513,000 =========== ===========
Effective January 1, 2002, we changed our method of valuing inventories from the first-in, first-out, or FIFO method, to the last-in, first-out, or LIFO method. We recognized a charge of $3,534,000 in the first quarter of 2002 as the cumulative effect of adopting the LIFO inventory costing method. The acquisition of Group Lafon's manufacturing operations and the planned expansion of our internal manufacturing capacity for ACTIQ has reduced and is expected to further reduce our reliance on third party manufacturers. The expansion of our internal manufacturing capabilities should allow us to benefit from efficiencies of scale and lead to lower per unit inventory costs. The LIFO method will reflect these expected changes to manufacturing costs on the statement of operations on a more timely basis, resulting in a better matching of current costs of products sold with product revenues. Cost of product sales under the LIFO inventory costing method was $4,545,000 lower for the three months ended June 30, 2002 and $9,033,000 lower for the six months ended June 30, 2002 than it would have been under the FIFO method. If we had adopted LIFO effective January 1, 2001, the effect on our statement of operations for the three and six months ended June 30, 2001 would have been immaterial. 11 CEPHALON, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--CONTINUED (Unaudited)
6. INTANGIBLE ASSETS Intangible assets consisted of the following: June 30, December 31, 2002 2001 ----- ---- Developed technology acquired from Lafon ..................... $ 132,000,000 $ 132,000,000 Trademarks/tradenames acquired from Lafon .................... 16,000,000 16,000,000 GABITRIL product rights ...................................... 109,553,000 92,648,000 Novartis CNS product rights .................................. 41,641,000 41,641,000 ACTIQ marketing rights ....................................... 29,114,000 29,114,000 Other product rights ......................................... 11,265,000 -- -------------- -------------- 339,573,000 311,403,000 Less accumulated amortization ................................ (28,589,000) (13,134,000) -------------- -------------- $ 310,984,000 $ 298,269,000 ============== ==============
GABITRIL product rights increased by $16,905,000 since December 31, 2001 as a result of a $10,000,000 payment to Abbott stemming from the extension of the composition of matter patent and additional payments for expanded rights in Europe and other countries worldwide. Other product rights increased as a result of payments for the acquisition of additional product rights in Europe and other countries worldwide. Amortization of intangible assets was $12,758,000 for the six months ended June 30, 2002. Estimated amortizaion of intangible assets for each of the next five fiscal years are as follows: 2003 -- $27,582,000; 2004 -- $27,461,000; 2005 - --$27,310,000; 2006-- $27,310,000; and 2007-- $26,224,000.
7. LONG-TERM DEBT Long-term debt consisted of the following: June 30, December 31, 2002 2001 ---- ---- Capital lease obligations .................................... $ 3,024,000 $ 2,852,000 Mortgage and building improvement loans ...................... 11,491,000 12,085,000 Joint venture ................................................ -- 50,000,000 Convertible subordinated notes ............................... 838,000,000 783,000,000 Notes payable/Other .......................................... 8,092,000 13,460,000 Due to Abbott Laboratories ................................... 31,461,000 37,392,000 -------------- -------------- Total debt ................................................... 892,068,000 898,789,000 Less current portion ......................................... (20,646,000) (32,200,000) -------------- -------------- Total long-term debt ......................................... $ 871,422,000 $ 866,589,000 ============== ==============
Convertible Subordinated Notes On March 29, 2002, we issued and sold $55,000,000 of aggregate principal in a private placement of 3.875% Convertible Notes due March 29, 2007. The notes were issued and sold to the purchaser in a transaction exempt from registration requirements of the Securities Act of 1933, as amended, because the offer and sale of the notes did not involve a public offering. 12 CEPHALON, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--CONTINUED (Unaudited) We are obligated to pay interest on the notes at a rate of 3.875% per year on each of April 15 and October 15, beginning October 15, 2002. The notes also are convertible into our common stock, at the option of the holders, at a price of $70.36 per share, subject to adjustment upon certain events. The holders of the notes may elect to require us to redeem the notes on March 28, 2005 at a redemption price equal to 100% of the principal amount of notes submitted for redemption, plus accrued and unpaid interest. In certain other circumstances, at the option of the holders, we may be required to repurchase the notes at 100% of the principal amount of the notes submitted for repurchase, plus accrued and unpaid interest. We issued these notes in connection with our acquisition of the Class A interest held by our joint venture partner. See "Note 2--Joint Venture." 8. COMMITMENTS AND CONTINGENCIES Legal Proceedings In February 2001, a complaint was filed in Utah state court by Zars, Inc. and one of its research scientists, against us and our subsidiary Anesta Corp. The plaintiffs are seeking a declaratory judgment to establish their right to develop transdermal or other products containing fentanyl and other pharmaceutically active agents under a royalty and release agreement between Zars and Anesta. The complaint also asks for unspecified damages for breach of contract, interference with economic relations, defamation and slander. We believe that we have valid defenses to all claims raised in this action. In any event, we do not believe any judgment against us will have a material adverse effect on our financial condition or results of operations. We are a party to certain other litigation in the ordinary course of our business, including matters alleging employment discrimination, product liability and breach of commercial contract. However, we are vigorously defending ourselves in all of these actions and do not believe these matters, even if adversely adjudicated or settled, would have a material adverse effect on our financial condition or results of operations. Related party In August 1992, we exclusively licensed our rights to MYOTROPHIN(R) for human therapeutic use within the United States, Canada and Europe to Cephalon Clinical Partners, L.P., or CCP. We developed MYOTROPHIN on behalf of CCP under a research and development agreement. Under this agreement, CCP granted an exclusive license to manufacture and market MYOTROPHIN for human therapeutic use within the United States, Canada and Europe, and we agreed to make royalty payments equal to a percentage of product sales and a milestone payment of approximately $16,000,000 upon regulatory approval. We have a contractual option, but not an obligation, to purchase all of the limited partnership interests of CCP, which is exercisable upon the occurrence of certain events following the first commercial sale of MYOTROPHIN. If, and only if, we decide to exercise this purchase option, we would make an advance payment of approximately $40,275,000 in cash or, at our election, approximately $42,369,000 in shares of common stock or a combination thereof. If we discontinue development of MYOTROPHIN, or if we do not exercise this purchase option, our license will terminate and all rights to manufacture or market MYOTROPHIN in the United States, Canada and Europe will revert to CCP, which may then commercialize MYOTROPHIN itself or license or assign its rights to a third party. In that event, we would not receive any benefits from such commercialization, license or assignment of rights. 9. OTHER COMPREHENSIVE INCOME SFAS No. 130, "Reporting Comprehensive Income," requires presentation of the components of comprehensive income (loss). Our comprehensive income (loss) includes net income and loss, unrealized gains and losses from 13 CEPHALON, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--CONTINUED (Unaudited) foreign currency translation adjustments, and unrealized investment gains. Our total comprehensive income (loss) is as follows:
Three months ended Six months ended June 30, June 30, ------- ------- 2002 2001 2002 2001 ---- ---- ---- ---- Income (loss) before preferred dividends ........ $ 14,429,000 $ (2,974,000) $ 11,558,000 $(12,516,000) Other comprehensive income (loss): Foreign currency translation adjustment ....... 9,700,000 (3,000) 9,437,000 787,000 Unrealized investment gains ................... 2,262,000 2,000 1,765,000 107,000 ------------ ------------ ------------ ------------ Other comprehensive income (loss) ............... $ 26,391,000 $ (2,975,000) $ 22,760,000 $(11,622,000) ============ ============ ============ ============
10. EARNINGS PER SHARE We compute income (loss) per common share in accordance with SFAS No. 128, "Earnings Per Share." Basic income (loss) per common share is computed based on the weighted average number of common shares outstanding during the period. Diluted income (loss) per common share is computed based on the weighted average shares outstanding and the dilutive impact of common stock equivalents outstanding during the period. The dilutive effect of employee stock options and restricted stock awards is measured using the treasury stock method. Common stock equivalents are not included in periods where there is a loss, as they are anti-dilutive. The following is a reconciliation of net income (loss) and weighted average common shares outstanding for purposes of calculating basic and diluted income (loss) per common share:
Three months Six months ended June 30, ended June 30, -------------- -------------- 2002 2001 2002 2001 ---- ---- ---- ---- Numerator: Net income (loss) used for basic and diluted income (loss) per common share ................... $ 14,429,000 $ (6,302,000) $ 11,558,000 $(18,110,000) ============ ============ ============ ============ Denominator: Weighted average shares used for basic income (loss) per common share ................... 55,071,000 47,725,000 55,017,000 45,229,000 Effect of dilutive securities: Employee stock options and restricted stock awards ..................................... 1,962,000 -- 2,144,000 -- ------------ ------------ ------------ ------------ Weighted average shares used for diluted income (loss) per common share ................... 57,033,000 47,725,000 57,161,000 45,229,000 ============ ============ ============ ============
The weighted average shares used in the calculation of diluted income per common share for the three months ended June 30, 2002 excludes 2,327,000 shares relating to employee stock options and 10,662,000 shares relating to convertible notes as the inclusion of such shares would be anti-dilutive. The weighted average shares used in the calculation of diluted income per common share for the six months ended June 30, 2002 excludes 2,038,000 shares relating to employee stock options and 10,662,000 shares relating to convertible notes as the inclusion of such shares would be anti-dilutive. 14 CEPHALON, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--CONTINUED (Unaudited) 11. SEGMENT AND SUBSIDIARY INFORMATION On December 28, 2001, we completed our acquisition of Group Lafon. As a result, we now have significant sales, manufacturing, and research operations in Europe. Prior to 2002, our European operations accounted for 2%, 3% and 6% of total product sales for the years ended December 31, 2001, 2000 and 1999, respectively. For the six months ended June 30, 2002, our European operations accounted for approximately 24% of total product sales. The following summarized information presents our revenues and long-lived assets by geographic segment. We have determined that all of our European operations have similar economic characteristics and may be aggregated into a single segment for reporting purposes. Information concerning our geographic operations is provided below. Revenues: Three months ended Six months ended June 30, 2002 June 30, 2002 ------------- ------------- United States ........................ $ 92,081,000 $175,549,000 Europe ............................... 28,646,000 56,679,000 ------------ ------------ Total ................................ $120,727,000 $232,228,000 ============ ============ Long-lived assets at June 30, 2002: United States ........................ $213,579,000 Europe ............................... 455,078,000 ------------ Total ................................ $668,657,000 ============ 15 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS RESULTS OF OPERATIONS Three months ended June 30, 2002 compared to three months ended June 30, 2001 Three months ended June 30, 2002 2001 ---- ---- Product sales: PROVIGIL ........................ $ 47,035,000 $29,848,000 ACTIQ ........................... 28,511,000 9,764,000 GABITRIL ........................ 10,112,000 4,674,000 Group Lafon products ............ 23,109,000 -- ------------ ----------- Total product sales .................. 108,767,000 44,286,000 ------------ ----------- Other revenues: H. Lundbeck A/S ................. 1,966,000 2,211,000 Novartis Pharma AG .............. 2,611,000 2,005,000 Sanofi-Synthelabo ............... 5,772,000 -- Schwarz Pharma AG ............... -- 2,727,000 Other ........................... 1,611,000 4,970,000 ------------ ----------- Total other revenues ................. 11,960,000 11,913,000 ------------ ----------- Total revenues ....................... $120,727,000 $56,199,000 ============ =========== Revenues-- Product sales in the second quarter of 2002 increased 146% over the second quarter of 2001. The increase is attributable to a number of factors including: . Sales of PROVIGIL increased 58% due to increased market acceptance. A domestic price increase of 5% was effective June 1, 2002. . Sales of ACTIQ increased 192%. After our merger with Anesta in October 2000, we established a dedicated sales force for ACTIQ and have made ongoing changes to our marketing approach that have contributed to higher sales. A domestic price increase of 4.9% effective March 1, 2002 also contributed to higher sales. . Sales of GABITRIL increased 116% as a result of both increased demand in the U.S. market and the initiation of sales efforts in Europe in the first quarter of 2002 following our December 2001 acquisition of European rights to GABITRIL. Additionally, an average increase in domestic prices of 9.8% effective March 1, 2002 contributed to the sales increase. . Product sales generated by Group Lafon, which we acquired on December 28, 2001, were $23,109,000 during the second quarter of 2002. The most significant product sales during the period were $10,988,000 of SPASFON(R), used for biliary/urinary tract spasm and irritable bowel syndrome, and $6,612,000 of FONZYLANE(R), used for the treatment of insufficient arterial circulation in the lower limbs. Additionally, sales include $2,644,000 of MODIODAL, the trade name for modafinil in France. Total other revenues were essentially unchanged from period to period. Revenue recognized in the second quarter of 2002 under our licensing, development and marketing collaboration with Sanofi-Synthelabo, which began in October 2001, was partially offset by $3,500,000 of milestone revenues recognized in the second quarter of 2001 upon receiving ACTIQ marketing authorization in certain European countries and by a decrease in revenue recognized 16 under the former research and development collaboration with Schwarz Pharma AG which terminated as of June 30, 2001. Cost of Product Sales-- The cost of product sales in the second quarter of 2002 decreased to approximately 14% of product sales from approximately 21% in the second quarter of 2001 due principally to the fact that PROVIGIL related manufacturing profit and royalties paid by Cephalon to Group Lafon, following our acquisition of Lafon, represent intercompany profits which are eliminated in consolidation. Research and Development Expenses--Research and development expenses increased 50% to $31,401,000 in the second quarter of 2002 from $20,894,000 in the second quarter of 2001. An increase of $6,494,000 is attributable to higher expenditures on drug development costs in the United States for our compounds that have progressed into later stages of development and also for infrastructure costs to support the growing number of ongoing clinical trials, including Phase II/III clinical studies for CEP-1347 and studies related to our efforts to expand the label for PROVIGIL beyond its current indication. In addition, we incurred $5,308,000 of research and development expenses at Group Lafon in the second quarter of 2002. Selling, General and Administrative Expenses--Selling, general and administrative expenses increased 65% to $44,911,000 for the quarter ended June 30, 2002 from $27,291,000 for the second quarter of 2001. Group Lafon represented $7,808,000 of this increase. In addition, we incurred an increase of $4,250,000 in U.S. sales and marketing costs as a result of the expansion of our field sales forces. Depreciation and Amortization Expenses--Depreciation and amortization expenses increased to $8,042,000 in the second quarter of 2002 from $3,562,000 in the second quarter of 2001 due primarily to amortization expense of $2,733,000 for intangible assets acquired in our acquisition of Group Lafon. Other Income and Expense--Interest income increased by $731,000 from the second quarter of 2001 due to higher average investment balances, partially offset by lower average rates of return. Interest expense increased by $5,646,000 from the second quarter of 2001 due primarily to interest recorded on the increase in outstanding convertible subordinated notes. Dividends on Convertible Exchangeable Preferred Stock-- In May 2001, the holders of 2,344,586 shares of the 2,500,000 shares outstanding of our convertible exchangeable preferred stock converted their preferred shares into an aggregate of 6,541,394 shares of our common stock, in accordance with the terms of the preferred stock. As an inducement to the holders to convert their preferred stock prior to August 2001, when we were initially permitted to redeem the preferred stock, we agreed to pay immediately all dividends accrued through the date of conversion as well as all dividends that would have accrued on the converted shares through the August 2001 redemption date. In the second quarter of 2001, we recognized a regular quarterly dividend of $2,265,000 and an additional $1,063,000 of dividend expense associated with the early conversion. The remaining 155,414 shares of preferred stock outstanding at June 30, 2001 were converted into 433,604 shares of common stock in the third quarter of 2001. Extraordinary Gain on Early Extinguishment of Debt-- In May 2001, we paid $24,438,000 to Novartis Pharma AG for deferred obligations due to them under our continuing November 2000 collaboration agreement. In connection with this payment, we recorded an extraordinary gain on the early extinguishment of debt of $3,016,000. 17 Six months ended June 30, 2002 compared to six months ended June 30, 2001 Six months ended June 30, 2002 2001 ---- ---- Product sales: PROVIGIL .......................... $ 91,210,000 $ 56,872,000 ACTIQ ............................. 47,778,000 16,346,000 GABITRIL .......................... 20,276,000 11,890,000 Group Lafon products .............. 45,306,000 -- ------------ ------------ Total product sales .................... 204,570,000 85,108,000 ------------ ------------ Other revenues: H. Lundbeck A/S ................... 4,165,000 3,511,000 Novartis Pharma AG ................ 4,939,000 4,329,000 Sanofi-Synthelabo ................. 15,507,000 -- Schwarz Pharma AG ................. -- 2,805,000 TAP Pharmaceuticals, Inc. ......... -- 1,189,000 Other ............................. 3,047,000 6,329,000 ------------ ------------ Total other revenues ................... 27,658,000 18,163,000 ------------ ------------ Total revenues ......................... $232,228,000 $103,271,000 ============ ============ Revenues-- Product sales in the first half of 2002 increased 140% over the first half of 2001. The increase is attributable to a number of factors including: . Sales of PROVIGIL increased 60% due to increased market acceptance. A domestic price increase of 5% was effective June 1, 2002. . Sales of ACTIQ increased 192%. After our merger with Anesta in October 2000, we established a dedicated sales force for ACTIQ and have made ongoing changes to our marketing approach that have contributed to higher sales. A domestic price increase of 4.9% effective March 1, 2002 also contributed to higher sales. . Sales of GABITRIL increased 71% as a result of both increased demand in the U.S. market and the initiation of sales efforts in Europe during the first quarter of 2002 following our December 2001 acquisition of European rights to GABITRIL. Additionally, an average increase in domestic prices of 9.8% effective March 1, 2002 contributed to the sales increase. . Product sales generated by Group Lafon, which we acquired on December 28, 2001, were $45,306,000 during the first half of 2002. The most significant product sales during the period were $22,100,000 of SPASFON, used for biliary/urinary tract spasm and irritable bowel syndrome, and $12,828,000 of FONZYLANE, used for the treatment of insufficient arterial circulation in the lower limbs. Additionally, sales include $5,258,000 of MODIODAL, the trade name for modafinil in France. Total other revenues increased by $9,495,000 or 52%. Revenue recognized in the first half of 2002 under our licensing, development and marketing collaboration with Sanofi-Synthelabo, which began in October 2001, was partially offset by $3,500,000 in milestone revenues recognized in the second quarter of 2001 upon receiving ACTIQ marketing authorization in certain European countries and by a decrease in revenue recognized under the former research and development collaborations with Schwarz Pharma AG and TAP Pharmaceuticals, Inc. which terminated as of June 30, 2001 and March 31, 2001, respectively. Cost of Product Sales-- The cost of product sales in the first half of 2002 decreased to approximately 14% of product sales from approximately 21% in the first half of 2001 due principally to the fact that PROVIGIL related 18 manufacturing profit and royalties paid by Cephalon to Group Lafon, following our acquisition of Lafon, now represent intercompany profits which are eliminated in consolidation. Research and Development Expenses--Research and development expenses increased 51% to $61,224,000 in the first half of 2002 from $40,505,000 in the first half of 2001. An increase of $11,198,000 is attributable to higher expenditures on drug development costs in the United States for our compounds that have progressed into later stages of development and also for infrastructure costs to support the growing number of ongoing clinical trials, including Phase II/III clinical studies for CEP-1347 and studies related to our efforts to expand the label for PROVIGIL beyond its current indication. In addition, we incurred $10,346,000 of research and development expenses at Group Lafon in the first half of 2002. Selling, General and Administrative Expenses--Selling, general and administrative expenses increased 65% to $85,195,000 for the six months ended June 30, 2002 from $51,656,000 for the first half of 2001. Group Lafon represented $16,227,000 of this increase. In addition, we incurred an increase of $9,847,000 in U. S. sales and marketing costs as a result of the expansion of our field sales forces. Depreciation and Amortization Expenses--Depreciation and amortization expenses increased to $16,335,000 in the first half of 2002 from $7,051,000 in the first half of 2001 due primarily to amortization expense of $5,466,000 for intangible assets acquired in our acquisition of Group Lafon. Other Income and Expense--Interest income increased by $2,094,000 from the first half of 2001 due to higher average investment balances, partially offset by lower average rates of return. Interest expense increased by $15,824,000 from the first half of 2001 due primarily to interest recorded on the increase in outstanding convertible subordinated notes. Income Taxes--Income taxes of $1,985,000 recorded in the first half of 2002 represent foreign income tax expense associated with our Group Lafon operations. Dividends on Convertible Exchangeable Preferred Stock--In May 2001, the holders of 2,344,586 shares of the 2,500,000 shares outstanding of our convertible exchangeable preferred stock converted their preferred shares into an aggregate of 6,541,394 shares of our common stock, in accordance with the terms of the preferred stock. As an inducement to the holders to convert their preferred stock prior to August 2001, when we were initially permitted to redeem the preferred stock, we agreed to pay immediately all dividends accrued through the date of conversion as well as all dividends that would have accrued on the converted shares through the August 2001 redemption date. In the second quarter of 2001, we recognized a regular quarterly dividend of $2,265,000 and an additional $1,063,000 of dividend expense associated with the early conversion. The remaining 155,414 shares of preferred stock outstanding at June 30, 2001 were converted into 433,604 shares of common stock in the third quarter of 2001. Extraordinary Gain (Charge) on Early Extinguishment of Debt--The purchase of the investor's Class A interests in the joint venture resulted in the recognition of an extraordinary charge of $7,142,000 during the first quarter of 2002. In May 2001, we paid $24,438,000 to Novartis Pharma AG for deferred obligations due to them under our continuing November 2000 collaboration agreement. In connection with this payment, we recorded an extraordinary gain on the early extinguishment of debt of $3,016,000. Cumulative Effect of Changing Inventory Costing Method from FIFO to LIFO-- Effective January 1, 2002, we changed our method of valuing inventories from the first-in, first-out, or FIFO method, to the last-in, first-out, or LIFO method. We recognized a charge of $3,534,000 in the first quarter of 2002 as the cumulative effect of adopting the LIFO inventory costing method. The acquisition of Group Lafon's manufacturing operations and the planned expansion of our internal manufacturing capacity for ACTIQ has reduced and is expected to further reduce our reliance on third party manufacturers. The expansion of our internal manufacturing capabilities should allow us to benefit from efficiencies of scale and lead to lower per unit inventory cost. The LIFO method will reflect these 19 expected changes to manufacturing costs on the statement of operations on a more timely basis, resulting in a better matching of current costs of products sold with product revenues. CRITICAL ACCOUNTING POLICIES AND ESTIMATES Management's Discussion and Analysis of Financial Condition and Results of Operations discusses our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of financial statements requires management to make estimates and assumptions that affect the carrying amounts of assets and liabilities, and the reported amounts of revenues and expenses during the reporting period. These estimates and assumptions are developed and adjusted periodically by management based on historical experience and on various other factors that are believed to be reasonable under the circumstances. Actual results may differ from these estimates. Our significant accounting policies are described in Note 1 to the consolidated financial statements included in Item 1 of this Form 10-Q and Note 1 to the consolidated financial statements included in Item 8 of our Form 10-K for the year ended December 31, 2001. Management considers the following policies to be the most critical in understanding the more complex judgments that are involved in preparing our consolidated financial statements and the uncertainties that could impact its results of operations, financial position and cash flows. Revenue recognition--Product sales are recognized upon the transfer of ownership and risk of loss for the product to the customer and are recorded net of estimated reserves for contractual allowances, discounts and returns. Contractual allowances result from sales under contracts with managed care organizations and government agencies. The reserve for contractual allowances is based on an estimate of prescriptions to be filled for individuals covered by government agencies and managed care organizations with whom we have contracts. Product returns are permitted with respect to unused pharmaceuticals based on expiration dating of our product. The reserve for product returns is determined by reviewing the history of each product's returns and by utilizing reports purchased from external, independent sources which produce prescription data and estimates of wholesale stocking levels and wholesale sales to retail pharmacies. This data is reviewed to monitor product movement through the supply chain to identify remaining inventory in the supply chain that may result in reserves for contractual allowances or returns. To date, product returns have not been material. The reserves are reviewed at each reporting period and adjusted to reflect data available at that time. To the extent our estimates prove inaccurate, we will adjust the reserves, which will impact the amount of product sales revenue recognized in the period of the adjustments. Other revenue, which includes revenues from collaborative agreements, consists of up-front fees, ongoing research and development funding, milestone payments and payments under co-promotional or managed services agreements. Effective January 1, 2000, we adopted the SEC's Staff Accounting Bulletin No. 101, "Revenue Recognition in Financial Statements" (SAB 101). In accordance with SAB 101, non-refundable up-front fees are deferred and amortized to revenue over the related performance period. We estimate our performance period based on the specific terms of each collaborative agreement, but actual performance may vary. We adjust the performance periods based upon available facts and circumstances. Periodic payments for research and development activities are recognized over the period that we perform the related activities under the terms of the agreements. Revenue resulting from the achievement of milestone events stipulated in the agreements is recognized when the milestone is achieved. Milestones are based upon the occurrence of a substantive element specified in the contract or as measure of substantive progress towards completion under the contract. Payments under co-promotional or managed services agreements are recognized over the period when the products are sold or the promotional activities are performed under the terms of the agreement. Allowance for uncollectable accounts receivable--Accounts receivable are reduced by an allowance for amounts that may become uncollectable in the future. On an ongoing basis, management performs credit evaluations of our customers and adjusts credit limits based upon the customer's payment history and creditworthiness, as determined by a review of their current credit information. We continuously monitor collections and payments from our customers. Based upon our historical experience and any specific customer collection issues that are identified, management uses its judgment to establish and evaluate the adequacy of our allowance for estimated credit losses. While such credit losses have been within our expectations and the allowance provided, we cannot be sure that we will continue to 20 experience the same credit loss rates as we have in the past. As of June 30, 2002, approximately 91% of our U.S. trade accounts receivable were due from three pharmaceutical wholesalers. A significant change in the liquidity or financial position of any one of these wholesalers could have a material adverse impact on the collectability of our accounts receivable and our future operating results. Inventories--Our inventories are valued at the lower of cost or market, and include the cost of raw materials, labor and overhead. We changed our method of valuing inventories from the first-in, first-out, or FIFO method, to the last-in, first-out, or LIFO method, effective January 1, 2002. The acquisition of Group Lafon's manufacturing operations and the planned expansion of our internal manufacturing capacity for ACTIQ has reduced and is expected to further reduce our reliance on third party manufacturers. The expansion of our internal manufacturing capabilities should allow us to benefit from efficiencies of scale and lead to lower per unit inventory costs. The LIFO method will reflect the expected changes to manufacturing costs on the statement of operations on a more timely basis, resulting in a better matching of current costs of products sold with product revenues. The majority of our inventories are subject to expiration dating. We regularly evaluate the carrying value of our inventories and when, in the opinion of management, factors indicate that impairment has occurred, either a reserve is established against the inventories' carrying value or the inventories are completely written off. Management bases these decisions on the level of inventories on hand in relation to our estimated forecast of product demand, production requirements over the next twelve months and the expiration dates of raw materials and finished goods. Although we make every effort to ensure the accuracy of forecasts of future product demand, any significant unanticipated decreases in demand could have a material impact on the carrying value of our inventories and our reported operating results. To date, inventory adjustments have not been material. Valuation of Fixed Assets, Goodwill and Intangible Assets--Our fixed assets and intangible assets (which consist primarily of developed technology, trademarks, and product and marketing rights) have been recorded at cost and are being amortized on a straight-line basis over the estimated useful life of those assets. In conjunction with acquisitions of businesses or product rights, we allocate the purchase price based upon the relative fair values of the assets acquired and liabilities assumed. In certain circumstances, fair value may be assigned to purchased in-process technology and immediately expensed. The valuation of goodwill and intangible assets and the estimation of appropriate useful lives to apply to intangibles requires us to use our judgment. We regularly assess the impairment of intangibles, long-lived assets and goodwill and will adjust the balance whenever events or changes in circumstances indicate that the carrying value of the assets may not be recoverable. Our judgments regarding the existence of impairment indicators are based on legal factors, market conditions and operating performance of our fixed assets and acquired businesses and products. Future events could cause us to conclude that impairment indicators exist and the carrying values of our fixed assets, intangible assets or goodwill are impaired. Any resulting impairment loss could have a material adverse impact on our financial position and results of operations. To date, such impairments have not been material. In June 2001, the FASB finalized SFAS No. 142, "Goodwill and Other Intangible Assets." The provisions of SFAS 142 are summarized in Note 1 to the interim consolidated financial statements. The new criteria for recording intangible assets separate from goodwill did not require us to reclassify any of our intangible assets. We have only recorded goodwill related to our acquisition of Group Lafon effective December 28, 2001; therefore, our transitional impairment test indicated that there was no impairment of goodwill upon our adoption of SFAS 142 effective January 1, 2002. We evaluate the recoverability and measure the possible impairment of our goodwill under SFAS 142. The impairment test is a two-step process that begins with the estimation of the fair value of the reporting unit. The first step screens for potential impairment, and the second step measures the amount of the impairment, if any. Our estimate of fair value considers publicly available information regarding the market capitalization of our company, as well as (i) publicly available information regarding comparable publicly-traded companies in the pharmaceutical industry, (ii) the financial projections and future prospects of our business, including its growth opportunities and likely operational improvements, and (iii) comparable sales prices, if available. As part of the first step to assess potential impairment, we compare our estimate of fair value for the company to the book value of our consolidated net assets. If the book value of our consolidated net assets is greater than our estimate of fair value, we would then proceed to the second step to measure the impairment, if any. The second step compares the implied fair value of goodwill with its carrying value. The implied fair value is determined by allocating the fair value of the reporting unit to all of the assets and liabilities of that unit as if the reporting unit had been acquired in a business combination, and 21 the fair value of the reporting unit was the purchase price paid to acquire the reporting unit. The excess of the fair value of the reporting unit over the amounts assigned to its assets and liabilities is the implied fair value of goodwill. If the carrying amount of the reporting unit goodwill is greater than its implied fair value, an impairment loss will be recognized in the amount of the excess. We do not currently anticipate recognition of any impairment losses. On a quarterly basis, we perform a review of our business to determine if events or changes in circumstances have occurred which could have a material adverse effect on the fair value of the company and its goodwill. If such events or changes in circumstances were deemed to have occurred, we would consult with one or more valuation specialists in estimating the impact on our estimate of fair value. We believe the estimation methods are reasonable and reflective of common valuation practices. Income taxes--We have provided for income taxes related to our foreign subsidiaries in accordance with SFAS No. 109, "Accounting for Income Taxes," which requires the recognition of deferred tax assets and liabilities for the expected tax consequences of temporary differences between the tax and financial reporting bases of assets and liabilities. We have a history of losses from our U.S. operations, which has generated significant federal and state tax net operating loss (NOL) carryforwards of approximately $344,139,000 and $147,620,000, respectively, as of December 31, 2001. United States generally accepted accounting principles require us to record a valuation allowance against the deferred tax asset associated with this NOL carryforward if it is more likely than not that we will not be able to utilize the NOL carryforward to offset future taxes. Due to the size of the NOL carryforward in relation to our history of unprofitable operations, we have provided a full valuation allowance against this deferred tax asset. The third quarter of 2001 was our first profitable quarter from commercial operations since inception. Profitability in future periods could cause management to conclude that it is more likely than not that we will realize all or a portion of the NOL carryforward. Upon reaching such a conclusion, which is subject to management's judgment, we would immediately record the estimated net realizable value of the deferred tax asset at that time and would then begin to provide for income taxes at a rate equal to our combined federal and state effective rates. Subsequent revisions to the estimated net realizable value of the deferred tax asset could cause our provision for income taxes to vary significantly from period to period. 22 LIQUIDITY AND CAPITAL RESOURCES Cash, cash equivalents and investments at June 30, 2002 were $594,700,000, representing 42% of total assets. Net Cash Provided by (Used for) Operating Activities Net cash provided by operating activities was $30,276,000 for the six months ended June 30, 2002 as compared to net cash used for operating activities of $22,410,000 for the same period in 2001. Net income was $11,558,000 in 2002, as compared to a loss before preferred dividends of $12,516,000 in 2001, as a result of the increase in product sales. In addition, we recognized the following non-cash transactions in the first half of 2002: $16,335,000 of depreciation and amortization expense, $7,099,000 of non-cash interest expense on our convertible subordinated notes, $2,444,000 of non-cash compensation expense, and $3,534,000 associated with changing our inventory costing method from FIFO to LIFO. Receivables and inventories increased in 2002 by $3,927,000 and $2,803,000, respectively, as a result of the increase in product sales. Accrued expenses decreased in 2002 by $10,261,000 primarily due to the payment of costs associated with the acquisition of Group Lafon. Net Cash Used for Investing Activities A summary of net cash used for investing activities is as follows:
Six months ended June 30, 2002 2001 ----- ---- Purchases of property and equipment ....................................... $ (6,572,000) $ (4,745,000) Acquisition of intangible assets .......................................... (23,658,000) -- Sales and maturities (purchases) of investments, net ...................... (145,992,000) (239,239,000) ------------- ------------- Net cash used for investing activities .................................... $(176,222,000) $(243,984,000) ============== ==============
--Acquisition of intangible assets GABITRIL product rights increased by $16,905,000 since December 31, 2001 as a result of a $10,000,000 payment to Abbott stemming from the extension of the composition of matter patent and additional payments for expanded rights in Europe and other countries worldwide. Other product rights increased as a result of payments of $6,753,000 for the acquisition of additional product rights in Europe and other countries worldwide. Net Cash (Used for) Provided by Financing Activities A summary of net cash provided by (used for) financing activities is as follows:
Six months ended June 30, 2002 2001 ---- ---- Proceeds from exercises of common stock options and warrants .............. $ 3,065,000 $ 20,115,000 Payments to acquire treasury stock ........................................ (171,000) -- Net proceeds from the issuance of long-term debt .......................... -- 385,785,000 Preferred dividends paid .................................................. -- (6,656,000) Principal payments on and retirement of long-term debt .................... (15,354,000) (49,576,000) ------------ ------------ Net cash (used for) provided by financing activities ...................... $(12,460,000) $349,668,000 ============= ============
23 --Proceeds from exercises of common stock options and warrants During the six months ended June 30, 2002, we received proceeds of $3,065,000 from the exercise of 161,000 common stock options compared to proceeds of $20,115,000 from the exercise of 1,021,000 common stock options during the same period in 2001. At June 30, 2002, options to purchase 5,651,000 shares of our common stock at various exercise prices were outstanding. The extent and timing of future option exercises, if any, are primarily dependent upon the market price of our common stock and general financial market conditions, as well as the exercise prices and expiration dates of the options. --Payments to acquire treasury stock Under our equity compensation plans, we may grant restricted stock awards to employees. Upon vesting, shares of Cephalon common stock are withheld from the employee's stock award and returned to the treasury for the dollar value of payroll taxes withheld. --Preferred dividends paid The dividend payments of $6,656,000 during the first half of 2001 relate to the previously outstanding shares of convertible, exchangeable preferred stock. These outstanding preferred shares were converted during the second and third quarters of 2001 into an aggregate of 6,974,998 shares of our common stock. --Principal payments on long-term debt In January 2002, we made a payment of $6,000,000 to Abbott Laboratories due under our licensing agreement for U.S. product rights to GABITRIL. Payments of $5,339,000 also were made during the first half of 2002 on the notes payable, bank debt and other lines of credit of Group Lafon. In addition, for all periods presented, principal payments on long-term debt include payments on mortgage and building improvements loans and payments on capital lease obligations. Commitments and Contingencies --Legal Proceedings In February 2001, a complaint was filed in Utah state court by Zars, Inc. and one of its research scientists, against us and our subsidiary Anesta Corp. The plaintiffs are seeking a declaratory judgment to establish their right to develop transdermal or other products containing fentanyl and other pharmaceutically active agents under a royalty and release agreement between Zars and Anesta. The complaint also asks for unspecified damages for breach of contract, interference with economic relations, defamation and slander. We believe that we have valid defenses to all claims raised in this action. In any event, we do not believe any judgment against us on any settlement of this claim will have a material adverse effect on our financial condition or results of operations. We are a party to certain other litigation in the ordinary course of our business, including matters alleging employment discrimination, product liability and breach of commercial contract. However, we are vigorously defending ourselves in all of the actions against us and do not believe these matters, even if adversely adjudicated or settled, would have a material adverse effect on our financial condition or results of operations. --Related Party In August 1992, we exclusively licensed our rights to MYOTROPHIN for human therapeutic use within the United States, Canada and Europe to Cephalon Clinical Partners, L.P., or CCP. We developed MYOTROPHIN on behalf of CCP under a research and development agreement. Under this agreement, CCP granted an exclusive license to manufacture and market MYOTROPHIN for human therapeutic use within the United States, Canada and Europe, and we agreed to make royalty payments equal to a percentage of product sales and a milestone payment of approximately $16,000,000 upon regulatory approval. We have a contractual option, but not an obligation, to purchase all of the limited partnership interests of CCP, which is exercisable upon the occurrence of certain events 24 following the first commercial sale of MYOTROPHIN. If, and only if, we decide to exercise this purchase option, we would make an advance payment of approximately $40,275,000 in cash or, at our election, approximately $42,369,000 in shares of common stock or a combination thereof. If we discontinue development of MYOTROPHIN, or if we do not exercise this purchase option, our license will terminate and all rights to manufacture or market MYOTROPHIN in the United States, Canada and Europe will revert to CCP, which may then commercialize MYOTROPHIN itself or license or assign its rights to a third party. In that event, we would not receive any benefits from such commercialization, license or assignment of rights. Outlook Cash, cash equivalents and investments at June 30, 2002 were $594,700,000. Prior to 2001, we historically have had negative cash flows from operations and have used the proceeds of public and private placements of our equity and debt securities to fund operations. We currently believe that projected increases in sales of our three U.S. marketed products, PROVIGIL, ACTIQ and GABITRIL, in combination with other revenues, will allow us to achieve continued profitability and positive cash flows from operations in 2002. At this time, however, we cannot accurately predict the effect of certain developments on future product sales such as the degree of market acceptance of our products, competition, the effectiveness of our sales and marketing efforts and the outcome of our research to demonstrate the utility of our products in indications beyond those already included in the FDA approved labels. Other revenues include receipts from collaborative research and development agreements and co-promotion agreements. The continuation of any of these agreements is subject to the achievement of certain milestones and to periodic review by the parties involved. We expect to continue to incur significant expenditures associated with manufacturing, selling and marketing our products and conducting additional clinical studies to explore the utility of these products in treating disorders beyond those currently approved in their respective labels. We also expect to continue to incur significant expenditures to fund research and development activities, including clinical trials, for our other product candidates. We may seek sources of funding for a portion of these programs through collaborative arrangements with third parties. However, we intend to retain a portion of the commercial rights to these programs and, as a result, we still expect to spend significant funds on our share of the cost of these programs, including the costs of research, preclinical development, clinical research and manufacturing. We may have significant fluctuations in quarterly results based primarily on the level and timing of: . product sales and cost of product sales; . achievement and timing of research and development milestones; . co-promotion and other collaboration revenues; . cost and timing of clinical trials; . marketing and other expenses; and . manufacturing or supply disruptions. In December 2001, we acquired Group Lafon, which gave us worldwide control of the intellectual property, marketing, and manufacturing rights related to modafinil, the active drug substance in PROVIGIL. PROVIGIL accounted for approximately 45% of our total product sales for the six months ended June 30, 2002. By consolidating our financial results with those of Group Lafon, we have reduced significantly our cost of product sales for PROVIGIL by eliminating the effect of preexisting contractual arrangements between us and Group Lafon. In the second quarter of 2001, we completed a private placement of $400,000,000 of 5.25% convertible subordinated notes due May 2006. In December 2001, we completed a private placement of $600,000,000 of 2.50% convertible subordinated notes due December 2006. In March 2002, we completed a private placement of $55,000,000 25 of 3.875% convertible notes due March 2007 to acquire all of the joint venture interests of an unaffiliated third party investor. The 5.25% notes, 2.50% notes and 3.875% notes are convertible at the option of the holders into our common stock at per share conversion prices of $74.00, $81.00 and $70.36, respectively. On various dates during the fourth quarter of 2001, certain holders of our 5.25% convertible notes approached us, and we agreed, to exchange $217,000,000 of the outstanding 5.25% convertible notes due May 2006 into 3,691,705 shares of our common stock. The exchange transactions were completed using common stock prices that equalized the fair value of the debt instrument with the fair value of our common stock on the dates of the transactions. Since the notes were then trading at a premium, the notes were exchanged at equivalent common stock prices that were less than the original conversion price of $74.00 per share. As a result, we recognized non-cash debt exchange expense totaling $52,444,000 in the fourth quarter of 2001 based on the reduction of the original conversion price in accordance with SFAS No. 84, "Induced Conversion of Convertible Debt." We agreed to these exchanges to improve our debt to equity ratio. There are currently $838,000,000 of convertible notes outstanding. The annual interest payment on the outstanding balance of convertible notes is $26,739,000 payable semiannually. Based on our current level of operations and projected sales of our products combined with other revenues and interest income, we believe that we will be able to service our existing debt and meet our capital expenditure and working capital requirements for the next several years. However, we cannot be sure that our anticipated revenue growth will be realized or that we will continue to generate positive cash flow from operations. We may need to obtain additional funding for our operational needs, or for future significant strategic transactions, and we cannot be certain that funding will be available on terms acceptable to us, or at all. 26 CERTAIN RISKS RELATED TO OUR BUSINESS In addition to historical facts or statements of current condition, this report contains forward-looking statements. Forward-looking statements provide our current expectations or forecasts of future events. These may include statements regarding anticipated scientific progress in our research programs, development of potential pharmaceutical products, prospects for regulatory approval, manufacturing capabilities, market prospects for our products, sales and earnings projections, and other statements regarding matters that are not historical facts. Some of these forward-looking statements may be identified by the use of words in the statements such as "anticipate," "estimate," "expect," " project," "intend," "plan," "believe" or other words and terms of similar meaning. Our performance and financial results could differ materially from those reflected in these forward-looking statements due to general financial, economic, regulatory and political conditions affecting the biotechnology and pharmaceutical industries as well as more specific risks and uncertainties such as those set forth below and in our reports to the SEC on Forms 8-K and 10-K. Given these risks and uncertainties, any or all of these forward-looking statements may prove to be incorrect. Therefore, you should not rely on any such forward-looking statements. Furthermore, we do not intend to update publicly any forward-looking statements, except as required by law. This discussion is permitted by the Private Securities Litigation Reform Act of 1995. A significant portion of our revenues is derived from U.S. sales of our three largest products and our future success will depend on the continued acceptance and growth of these products. For the six months ended June 30, 2002, approximately 69% of our total revenues were derived from U.S. sales of PROVIGIL, GABITRIL and ACTIQ. We cannot be certain that these products will continue to be accepted in their markets. Specifically, the following factors, among others, could affect the level of market acceptance of PROVIGIL, GABITRIL and ACTIQ, including: . the perception of the healthcare community of their safety and efficacy, both in an absolute sense and relative to that of competing products; . the effectiveness of our sales and marketing efforts; o unfavorable publicity regarding these products or similar products; . product price relative to other competing drugs or treatments; . changes in government and other third-party payor reimbursement policies and practices; and . regulatory developments affecting the manufacture, marketing or use of these products. Any material adverse developments with respect to the sale or use of PROVIGIL, GABITRIL or ACTIQ could significantly reduce our product revenues and have a material adverse effect on our ability to generate net income and positive net cash flow from operations. We may be unsuccessful in our efforts to expand the number and scope of authorized uses of PROVIGIL or GABITRIL, which would hamper sales growth and make it more difficult to sustain profitability. The market for the approved indications of two of our three largest products is relatively small. We believe that a portion of our product sales is derived from the use of these products outside of their labeled indications. To a large degree, our future success depends on the expansion of the approved indications for PROVIGIL and GABITRIL and physicians prescribing our products outside of the approved indications. Under current FDA and European medical authority regulations, we are restricted from promoting the use of these products outside their labeled use. Any label expansion requires regulatory approval. We have initiated clinical studies to examine whether or not PROVIGIL and GABITRIL are effective and safe when used to treat disorders outside their currently approved uses. Although some study data has been positive, additional studies in these disorders will be necessary before we can apply to regulatory authorities to expand the authorized uses of these products. We do not know whether these studies will demonstrate safety and efficacy, or if they do, whether we will succeed in receiving regulatory approval to market PROVIGIL and GABITRIL for additional disorders. If the results of some of these studies are negative, or if adverse experiences are reported in these clinical studies or otherwise in connection with the use of these products by patients, this could undermine physician and patient comfort with the products, limit their commercial success, and diminish their acceptance. Even if the 27 results of these studies are positive, the impact on sales of PROVIGIL and GABITRIL may be minimal unless we are able to obtain FDA and foreign medical authority approval to expand the authorized use of these products. FDA regulations limit our ability to communicate the results of additional clinical studies to patients and physicians without first obtaining approval for any expanded uses. We may not be able to maintain adequate protection for our intellectual property or market exclusivity for certain of our products and therefore competitors may develop competing products, which could result in a decrease in sales and market share, cause us to reduce prices to compete successfully, and limit our commercial success. We place considerable importance on obtaining patent protection for new technologies, products and processes. To that end, we file applications for 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 U.S. composition of matter patent for modafinil expired in 2001. We own U.S. and foreign patent rights that expire between 2014 and 2015 covering formulations and uses of modafinil having certain particle sizes. Ultimately, these particle-sized patents might be found invalid if challenged by a third party or a potential competitor could develop a competing product or product formulation that avoids 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. 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. 28 We may incur additional losses. The quarter ended September 30, 2001 was our first profitable quarter from commercial operations since inception and at June 30, 2002 our accumulated deficit was $565,133,000. Our historical losses resulted principally from costs incurred in research and development, including clinical trials, and from selling, general and administrative costs associated with our operations. For us to sustain profitability from commercial operations, we must continue to achieve product and other revenues 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 the expansion of the approved indications for our existing products, 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 produce 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 (formerly Circa Pharmaceuticals, Inc.), Copiague, New York and DSM Pharmaceuticals (formerly Catalytica Pharmaceuticals, Inc.), Greenville, North Carolina, 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 our products, perform customer service activities and accept and process product 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 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 is 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. 29 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 the United States or other countries without receiving approval from the FDA or the appropriate foreign medical authority. The approval process is highly uncertain and requires substantial time, effort and financial resources. Ultimately, we may never obtain approval in a timely manner, or at all. 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. With the increased concern for safety by the FDA and the DEA with respect to products containing controlled substances, it is possible that these regulatory agencies could impose additional restrictions on marketing or even withdrawal of regulatory approval for such products. In addition, adverse 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 rights related to modafinil, the active drug substance in PROVIGIL. PROVIGIL accounted for approximately 45% of our total product sales for the six months ended June 30, 2002. By consolidating our financial results with those of Group Lafon, we expect to reduce our cost of product sales related to PROVIGIL. During the first half of 2002, we experienced a significant reduction in the cost of product sales related to PROVIGIL. While the bulk of these cost savings result from eliminating the effect of manufacturing profit and royalties paid by us and Group Lafon, in the future 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 realized, if any, and other anticipated benefits could differ from, or their impact could be delayed compared to, our expectations as described herein. 30 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 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 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 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, which are marketed under a number of brand names, including RITALIN(R) by Novartis, CONCERTA(R) tablets by Alza and METHYLIN(R) by Mallinckrodt, and 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 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 31 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. 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 including 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 partners 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 . 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 32 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. 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 could 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 disruptions. The price of our common stock has been and may continue to be highly volatile. The market price of our common stock is highly volatile, and we expect it to continue to be volatile for the foreseeable future. For example, from January 1, 2001 through August 9, 2002, our common stock traded at a high price of $78.88 and a low price of $35.82. 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 economic conditions, our competitors, changes in government regulations impacting the biotechnology or pharmaceutical industries or the movement of capital into or out of our industry, also are 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, the portion of our product sales denominated in the euro and other local currencies has and may continue to increase. For the sixth months ended June 30, 2002, approximately 24% of our product sales were denominated in currencies other than the U.S. dollar. 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 translation included as a component of stockholders' equity. 33 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 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. While we have employment agreements with our key executives, we do not ordinarily enter into employment agreements with our other key scientific, technical and managerial employees. We do not maintain "key man" life insurance on any of our employees. Our prior use of Arthur Andersen LLP as our independent public accountant could impact our ability to access the capital markets. Our consolidated financial statements as of and for each of the three years in the period ended December 31, 2001 were audited by Arthur Andersen LLP. On March 14, 2002, Andersen was indicted on federal obstruction of justice charges arising from the government's investigation of Enron Corporation. Following this event, our Audit Committee directed management to consider the need to appoint new independent public accountants. On June 4, 2002, at the direction of the Board of Directors, acting upon the recommendation of the Audit Committee, we dismissed Andersen and appointed PricewaterhouseCoopers LLP as our new independent public accountants for fiscal year 2002. On June 15, 2002, a jury found Andersen guilty on the government's charges. SEC rules require us to present our audited financial statements in various SEC filings, along with Andersen's consent to our inclusion of its audit report in those filings. However, Andersen is unable to provide a consent to us for inclusion in our future SEC filings relating to its report on our consolidated financial statements as of and for each of the three years in the period ended December 31, 2001. Additionally, Andersen is unable to provide us with assurance services, such as advice customarily given to underwriters of our securities offerings and other similar market participants. The SEC recently has provided regulatory relief designed to allow companies that file reports with the SEC to dispense with the requirement to file a consent of Andersen in certain circumstances. Notwithstanding this relief, the inability of Andersen to provide its consent or to provide assurance services to us in the future could negatively affect our ability to, among other things, access the public capital markets. Any delay or inability to access the public markets as a result of this situation could have a material adverse impact on our business. Also, an investor's ability to seek potential recoveries from Andersen related to any claims that an investor may assert as a result of the audit performed by Andersen may be limited significantly both as a result of an absence of a consent and the diminished amount of assets of Andersen that are or may in the future be available to satisfy claims. 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 and 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 34 these materials and wastes, and we may be required to incur significant costs to comply with both existing and future environmental laws and regulations. While we believe that our safety procedures for handling and disposing of these materials comply with foreign, federal, state and local laws and regulations, 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 certain 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. We may be unable to service or repay our substantial indebtedness or other contingencies. As of June 30, 2002, we had significant levels of indebtedness that, among other things, could make it difficult for us to make payments on our indebtedness or 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 would consider unacceptable, we may not have 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. 35 PART II - OTHER INFORMATION Item 1. Legal Proceedings The information set forth in Footnote 8 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 filed a registration statement on Form S-3 on May 28, 2002 to register the resale of the shares of common stock issuable upon conversion of the notes that was declared effective by the Securities and Exchange Commission on July 3, 2002. Item 4. Submission of Matters to a Vote of Security Holders: The following matters were considered at the annual meeting of stockholders of Cephalon held in West Chester, Pennsylvania on May 15, 2002: I. On the election of the following persons as directors: Number of Votes --------------------------------- FOR WITHHELD Dr. Frank Baldino, Jr. 45,549,346 219,852 William P. Egan 45,519,813 249,385 Dr. Robert J. Feeney 45,517,817 251,381 Martyn D. Greenacre 45,456,883 312,315 Dr. Charles A. Sanders 45,518,684 250,514 Dr. Horst Witzel 45,543,895 225,303 II. To approve the amendment to the Company's Certificate of Incorporation increasing the number of shares of the Company's common stock authorized for issuance: NUMBER OF VOTES --------------------------------------------- FOR AGAINST ABSTAIN 42,663,994 2,977,460 127,744 36 III. To approve an increase in the number of shares of common stock authorized for issuance under the Company's 1995 Equity Compensation Plan and the amendment and restatement of the 1995 Plan: NUMBER OF VOTES ------------------------------------------------ FOR AGAINST ABSTAIN --- ------- ------- 44,086,323 1,627,250 55,625 Item 6. Exhibits and Reports on Form 8-K (a) Exhibits: Exhibit No. Description --- ----------- 3.1 Certificate of Amendment to the Restated Certificate of Incorporation as filed with the Secretary of State of the State of Delaware on May 16, 2002 3.2 Amended and Restated Bylaws of Cephalon, Inc. (as restated July 25, 2002) 10.1+ Executive Severance Agreement between Cephalon, Inc. and Frank Baldino, Jr. 10.2+ Form of Executive Severance Agreement between certain Cephalon executive officers and Cephalon, Inc. 99.1 Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 99.2 Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 --------------------------------------------------------------- + Compensation plans and arrangements for executives and others (b) Reports on Form 8-K: During the second quarter of 2002, the Registrant filed the following Current Reports on Form 8-K: (i) On April 16, 2002, Cephalon, Inc. filed an amended Current Report on Form 8-K/A to include the consolidated financial statements of Group Lafon. (ii) On May 30, 2002, Cephalon, Inc. filed a Form 8-K that included the Press Release dated May 29, 2002 publicly announcing the appointment of Dr. Gail Wilensky to the Board of Directors of the Company. (iii) On June 6, 2002, Cephalon, Inc. filed a Form 8-K announcing the dismissal of Arthur Andersen LLP as the Company's independent public accountant for the fiscal year 2002, and the appointment of PricewaterhouseCoopers LLP. 37 SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. CEPHALON, INC. (Registrant) August 13, 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) 38 EX-3.1 3 dex31.txt CERTIFICATE OF AMENDMENT Exhibit 3.1 CERTIFICATE OF AMENDMENT OF RESTATED CERTIFICATE OF INCORPORATION OF CEPHALON, INC. ***** Cephalon, Inc., a corporation organized and existing under and by virtue of the General Corporation Law of the State of Delaware, DOES HEREBY CERTIFY: FIRST: The restated Certificate of Incorporation is hereby amended by deleting the first sentence of Article Fourth thereof and inserting the following in lieu thereof: FOURTH: The total number of shares of stock which the corporation shall have authority to issue is two hundred-five million (205,000,000), of which two hundred million (200,000,000) shares are Common Stock and five million (5,000,000) shares are Preferred Stock, and the par value of each of such shares is one cent ($0.01), amounting in the aggregate to two million fifty thousand dollars ($2,050,000.00). SECOND: That said amendment was duly adopted in accordance with the provisions of Section 242 of the General Corporation Law of the State of Delaware. IN WITNESS WHEREOF, said Cephalon, Inc. has caused this certificate to be signed by Frank A. Baldino, Jr., its Chairman and Chief Executive Officer, this 15th day of May, 2002. CEPHALON, INC. By: /s/ Frank A. Baldino, Jr. ----------------------------- Frank A. Baldino, Jr. Chairman and Chief Executive Officer EX-3.2 4 dex32.txt AMENDED AND RESTATED BYLAWS EXHIBIT 3.2 Amended and Restated B Y L A W S OF CEPHALON, INC. (a Delaware Corporation) . . .oo0oo. . . ARTICLE I Office and Fiscal Year SECTION 1.01. Registered Office. -- The registered office of the corporation shall be in the City of Wilmington, County of New Castle, State of Delaware until otherwise established by resolution of the board of directors, and a certificate certifying the change is filed in the manner provided by statute. SECTION 1.02. Other Offices. -- The corporation may also have offices at such other places within or without the State of Delaware as the board of directors may from time to time determine or the business of the corporation requires. SECTION 1.03. Fiscal Year. -- The fiscal year of the corporation shall end on the 31st of December in each year. ARTICLE II Meetings of Stockholders SECTION 2.01. Place of Meeting. -- All meetings of the stockholders of the corporation shall be held at the registered office of the corporation, or at such other place within or without the State of Delaware as shall be designated by the board of directors in the notice of such meeting. SECTION 2.02. Annual Meeting. -- If required by applicable law, the board of directors shall fix the date and time of the annual meeting of the stockholders of the corporation and at said meeting the stockholders then entitled to vote shall elect directors and shall transact such other business as may properly be brought before the meeting. SECTION 2.03. Special Meetings. - Subject to the provisions of the certificate of incorporation and the provisions of these bylaws, special meetings of the stockholders of the corporation may be called at any time only by the chairman of the board, a majority of the board of directors or the president. At any time, upon the written request of any person or persons who have duly called a special meeting in accordance herewith, which written request shall state the purpose or purposes of the meeting, it shall be the duty of the secretary to fix the date of the meeting which shall be held at such date and time as the secretary may fix, not less than ten nor more than 60 days after the receipt of the request, and to give due notice thereof. If the secretary shall neglect or refuse to fix the time and date of such meeting and give notice thereof, the person or persons calling the meeting may do so. SECTION 2.04. Notice of Meetings. -- Notice of the place, date and hour of every meeting of the stockholders, whether annual or special, shall be given to each stockholder of record entitled to vote at the meeting not less than ten nor more than 60 days before the date of the meeting unless otherwise required by law, the certificate of incorporation or these bylaws. Every notice of a special meeting shall state the purpose or purposes thereof. If the notice is sent by mail, it shall be deemed to have been given when deposited in the United States mail, postage prepaid, directed to the stockholder at the address of the stockholder as it appears on the records of the corporation. SECTION 2.05. Quorum, Manner of Acting and Adjournment. (a) Quorum. -- The holders of a majority of the voting power of the outstanding shares of capital stock of the corporation entitled to vote generally in the election of directors, present in person or represented by proxy, shall constitute a quorum at all meetings of the stockholders except as otherwise provided by the General Corporation Law of the State of Delaware ("DGCL"), by the certificate of incorporation or by these bylaws. Any meeting of stockholders, annual or special, may be adjourned from time to time by the Chairman of the meeting, without notice other than announcement at the meeting, until a quorum is present or represented. At any such adjourned meeting at which a quorum is present or represented, the corporation may transact any business which might have been transacted at the original meeting. If the adjournment is for more than 30 days, or if after the adjournment a new record date is fixed for the adjourned meeting, a notice of the adjourned meeting shall be given to each stockholder of record entitled to vote at the meeting. (b) Manner of Acting. -- Directors shall be elected by a plurality of the votes of the shares present in person or represented by proxy at the meeting and entitled to vote on the election of directors. In all matters other than the election of directors, the affirmative vote of the holders of a majority of the voting power of the outstanding shares of capital stock of the corporation present in person or represented by proxy at the meeting and entitled to vote thereon shall be the act of the stockholders, unless the question is one upon which, by express provision of the applicable statute, the rules or regulations of any stock exchange applicable to the corporation, applicable law, pursuant to any regulation applicable to the corporation or its securities, the certificate of incorporation or these bylaws, a different vote is required in which case such express -2- provision shall govern and control the decision of the question. The stockholders present in person or by proxy at a duly organized meeting can continue to do business until adjournment, notwithstanding withdrawal of enough stockholders to leave less than a quorum. SECTION 2.06. Organization. -- At every meeting of the stockholders, the chairman of the board, if there be one, or in the case of a vacancy in the office or absence of the chairman of the board, one of the following persons present in the order stated: the vice chairman, if one has been appointed, the president, the vice presidents in their order of rank or seniority, a chairman designated by the board of directors or a chairman chosen by the stockholders entitled to cast a majority of the votes which all stockholders present in person or by proxy are entitled to cast, shall act as chairman, and the secretary, or, in the absence of the secretary, an assistant secretary, or in the absence of the secretary and the assistant secretaries, a person appointed by the chairman, shall act as secretary. SECTION 2.07. Voting. (a) General Rule. -- Unless otherwise provided in the certificate of incorporation, each stockholder shall be entitled to one vote, in person or by proxy, for each share of capital stock having voting power held by such stockholder. (b) Voting and Other Action by Proxy. -- (1) A stockholder may execute a writing authorizing another person or persons to act for the stockholder as proxy. Such execution may be accomplished by the stockholder or the authorized officer, director, employee or agent of the stockholder signing such writing or causing his or her signature to be affixed to such writing by any reasonable means including, but not limited to, by facsimile signature. A stockholder may authorize another person or persons to act for the stockholder as proxy by transmitting or authorizing the transmission of a telegram, cablegram, or other means of electronic transmission to the person who will be the holder of the proxy or to a proxy solicitation firm, proxy support service organization or like agent duly authorized by the person who will be the holder of the proxy to receive such transmission if such telegram, cablegram or other means of electronic transmission sets forth or is submitted with information from which it can be determined that the telegram, cablegram or other electronic transmission was authorized by the stockholder. (2) No proxy shall be voted or acted upon after three years from its date, unless the proxy provides for a longer period. (3) A duly executed proxy shall be irrevocable if it states that it is irrevocable and if, and only so long as, it is coupled with an interest sufficient in law to support an irrevocable power. A proxy may be made irrevocable regardless of whether the interest with which it is coupled is an interest in the stock itself or an interest in the corporation generally. -3- SECTION 2.08. Consents to Corporate Action. (a) Record Date. The record date for determining stockholders entitled to express consent to corporate action in writing without a meeting shall be as fixed by the board of directors or as otherwise established under this Section 2.08. Any person seeking to have the stockholders of the corporation authorize or take corporate action by written consent without a meeting shall, by written notice addressed to the secretary and delivered to the corporation, request that a record date be fixed for such purpose. The board of directors may fix a record date for such purpose which shall be no more than ten (10) days after the date upon which the resolution fixing the record date is adopted by the board of directors and shall not precede the date such resolution is adopted. If the board of directors fails within ten (10) days after the corporation receives such notice to fix a record date for such purpose, the record date shall be the day on which the first written consent is delivered to the corporation in the manner described in Section 2.08(b) below unless prior action by the board of directors is required under the DGCL, in which event the record date shall be at the close of business on the day on which the board of directors adopts the resolution taking such prior action. (b) Procedures. (i) Every written consent purporting to take or authorizing the taking of corporate action and/or related revocations (each such written consent and related revocation is referred to in this Section 2.08 as a "Consent") shall bear the date of signature of each stockholder who signs the Consent, and no Consent shall be effective to take the corporate action referred to therein unless, within sixty (60) days of the earliest dated Consent delivered in the manner required by this Section 2.08(b), Consents signed by a sufficient number of stockholders to take such action are so delivered to the corporation. Prompt notice of the taking of the corporate action without a meeting by less than unanimous Consent shall be given to those stockholders who have not consented in writing. (ii) A Consent shall be delivered to the corporation by delivery to its registered office in the State of Delaware, its principal place of business, or an officer or agent of the corporation having custody of the book in which proceedings of meetings of stockholders of the corporation are recorded. Delivery to the corporation's registered office shall be made by hand or by certified or registered mail, return receipt requested. (iii) Consents shall be valid for a maximum of sixty (60) days after the date of the earliest dated consent delivered to the corporation in the manner provided in Section 228(c) of the DGCL. Prior to the delivery of consents signed by a sufficient number of holders to take corporate action, consents may be revoked by written notice (a) to the corporation, (b) to the stockholder or stockholders soliciting consents or soliciting revocations in opposition to action by consent (the "Soliciting Stockholders"), or (c) to a proxy solicitor or other agent designated by the corporation or the Soliciting Stockholders, as applicable. -4- (iv) Within ten (10) business days after receipt of the earliest dated Consent delivered to the corporation in the manner provided in Section 228(c) of the DGCL or the determination by the board of directors of the corporation that the corporation should seek corporate action by written consent, as the case may be, the secretary of the corporation shall engage nationally recognized independent inspectors of election for the purpose of performing a ministerial review of the validity of the Consents and revocations. The cost of retaining inspectors of election shall be borne by the corporation. For the purpose of permitting the inspectors to perform such review, no action by written consent without a meeting shall be effective until such date as the independent inspectors certify to the corporation that the consents delivered to the corporation in accordance with this Section 2.08 represent at least the minimum number of votes that would be necessary to take the corporate action. Nothing contained in this Section 2.08(b)(iv) shall in any way be construed to suggest or imply that the board of directors or any stockholder shall not be entitled to contest the validity of any Consent or revocation thereof, whether before or after such certification by the independent inspectors, or to take any other action (including, without limitation, the commencement, prosecution or defense of any litigation with respect thereto, and the seeking of injunctive relief in such litigation). (v) Following appointment of the inspectors, Consents and revocations shall be delivered to the inspectors upon receipt by the corporation, the Soliciting Stockholder or their proxy solicitors or other designated agents. As soon as practicable following the earlier of (a) the receipt by the inspectors, a copy of which shall be delivered to the corporation, of any written demand by the Soliciting Stockholders of the corporation, or (b) sixty (60) days after the date of the earliest dated Consent delivered to the corporation in the manner provided in Section 228(c) of the DGCL, the inspectors shall issue a preliminary report to the corporation and the Soliciting Stockholders stating the number of valid and unrevoked Consents received and whether, based on the preliminary count, the requisite number of valid and unrevoked Consents has been obtained to authorize or take the action specified in the Consents. (vi) Unless the corporation and the Soliciting Stockholders shall agree to a shorter or longer period, the corporation and the Soliciting Stockholders shall have forty-eight (48) hours to review the Consents and revocations and to advise the inspectors and the opposing party in writing as to whether they intend to challenge the preliminary report of the inspectors. If no written notice of an intention to challenge the preliminary report is received within forty-eight (48) hours after the inspectors' issuance of the preliminary report, the inspectors shall issue to the corporation and the Soliciting Stockholders their final report containing the information from the inspectors' determination with respect to whether the requisite number of valid and unrevoked Consents was obtained to authorize and take the action specified in the Consents. If the corporation or the Soliciting Stockholders issue written notice of an intention to challenge the inspectors' preliminary report within forty-eight (48) hours after the issuance of that report, a challenge session shall be scheduled by the inspectors as promptly as practicable. Following completion of the challenge session, the inspectors shall as promptly as practicable issue their final report to the Soliciting Stockholders and the corporation, -5- which report shall contain the information included in the preliminary report, plus any change in the vote total as a result of the challenge and a certification of whether the requisite number of valid and unrevoked Consents was obtained to authorize or take the action specified in the Consents. SECTION 2.09. Voting Lists. -- The officer who has charge of the stock ledger of the corporation shall prepare and make, at least ten days before every meeting of stockholders, a complete list of the stockholders entitled to vote at the meeting. The list shall be arranged in alphabetical order, showing the address of each stockholder and the number of shares registered in the name of each stockholder. Such list shall be open to the examination of any stockholder, for any purpose germane to the meeting, as required by applicable law. SECTION 2.10. Notice of Stockholder Business and Nominations. (a) Annual Meeting of Stockholders. (1) Nominations of persons for election to the board of directors of the corporation and the proposal of business to be considered by the stockholders may be made at an annual meeting of stockholders only (a) pursuant to the corporation's notice of meeting (or any supplement thereto), (b) by or at the direction of the board of directors or the chairman of the board or (c) by any stockholder of the corporation who was a stockholder of the corporation of record at the time the notice provided for in this Section 2.10 is delivered to the secretary of the corporation, who is entitled to vote at the meeting and complies with the notice procedures set forth in this Section 2.10. (2) For nominations or other business to be properly brought before an annual meeting by a stockholder pursuant to clause (c) of paragraph (a)(1) of this Section 2.10, the stockholder must have given timely notice thereof in writing to the secretary of the corporation and such other business must otherwise be a proper matter for stockholder action. To be timely, a stockholder's notice shall be delivered to the secretary of the corporation at the principal executive offices of the corporation not later than the close of business on the ninetieth day nor earlier than the close of business on the one hundred and twentieth day prior to the first anniversary of the preceding year's annual meeting; provided, however, that in the event that the date of the annual meeting is more than thirty (30) days before or more than seventy (70) days after such anniversary date, notice by the stockholder to be timely must be so delivered not earlier than the close of business on the one hundred and twentieth day prior to such annual meeting and not later than the close of business on the later of the ninetieth day prior to such annual meeting or the tenth day following the day on which public announcement of the date of such meeting is first made by the corporation. In no event shall the public announcement of an adjournment of an annual meeting commence a new time period for the giving of a stockholder's notice as described above. Such stockholder's notice shall set forth: (a) as to each person whom the stockholder proposes to nominate for election or re-election as a director all information relating to such person that is required to be disclosed in solicitations of -6- proxies for election of directors in an election contest, or is otherwise required, in each case pursuant to Regulation 14A under the Securities Exchange Act of 1934, as amended (the "Exchange Act") (and such person's written consent to being named in the proxy statement as a nominee and to serving as a director if elected); (b) as to any other business that the stockholder proposes to bring before the meeting, a brief description of the business desired to be brought before the meeting, the text of the proposal or business (including the text of any resolutions proposed for consideration and in the event that such business includes a proposal to amend the by-laws of the corporation, the language of the proposed amendment), the reasons for conducting such business at the meeting and any material interest in such business of such stockholder and the beneficial owner, if any, on whose behalf the proposal is made; and (c) as to the stockholder giving the notice and the beneficial owner, if any, on whose behalf the nomination or proposal is made (i) the name and address of such stockholder, as they appear on the corporation's books, and of such beneficial owner, (ii) the class and number of shares of the corporation which are owned beneficially and of record by such stockholder and such beneficial owner, (iii) a representation that the stockholder is a holder of record of stock of the corporation entitled to vote at such meeting and intends to appear in person or by proxy at the meeting to propose such business or nomination, and (iv) a representation whether the proponent or the beneficial owner, if any, intends or is part of a group which intends to solicit proxies from other stockholders in support of such proposal or nomination. The foregoing notice requirements shall be deemed satisfied by a stockholder if the stockholder has notified the corporation of his or her intention to present a proposal at an annual meeting in compliance with Rule 14a-8 (or any successor thereof) promulgated under the Exchange Act and such stockholder's proposal has been included in a proxy statement that has been prepared by the corporation to solicit proxies for such annual meeting. The corporation may require any proposed nominee to furnish such other information as it may reasonably require to determine the eligibility of such proposed nominee to serve as a director of the corporation. (3) Notwithstanding anything in the second sentence of paragraph (a)(2) of this Section 2.10 to the contrary, in the event that the number of directors to be elected to the board of directors of the corporation is increased and there is no public announcement by the corporation naming all of the nominees for director or specifying the size of the increased board of directors at least one hundred (100) days prior to the first anniversary of the preceding year's annual meeting, a stockholder's notice required by this by-law shall also be considered timely, but only with respect to nominees for any new positions created by such increase, if it shall be delivered to the secretary of the corporation at the principal executive offices of the corporation not later than the close of business on the tenth day following the day on which such public announcement is first made by the corporation. (b) Special Meetings of Stockholders. Only such business shall be conducted at a special meeting of stockholders as shall have been brought before the meeting pursuant to the corporation's notice of meeting. Nominations of persons for election to the board of directors may be made at a special meeting of stockholders at which -7- directors are to be elected pursuant to the corporation's notice of meeting (a) by or at the direction of the board of directors or (b) provided that the board of directors has determined that directors shall be elected at such meeting, by any stockholder of the corporation who is a stockholder of record at the time the notice provided for in this Section 2.10 is delivered to the secretary of the corporation, who shall be entitled to vote at the meeting and who complies with the notice procedures set forth in this by-law. In the event the corporation calls a special meeting of stockholders for the purpose of electing one or more directors to the board of directors, any such stockholder may nominate a person or persons (as the case may be) for election to such position(s) as specified in the corporation's notice of meeting, if the stockholder's notice required by paragraph (a)(2) of this Section 2.10 shall be delivered to the secretary at the principal executive offices of the corporation not earlier than the close of business on the one hundred twentieth day prior to such special meeting and not later than he close of business on the later of the ninetieth day prior to such special meeting, or the tenth day following the day on which public announcement is first made of the date of the special meeting and of the nominees proposed by the board of directors to be elected at such meeting. In no event shall the public announcement of an adjournment of a special meeting commence a new time period for the giving of a stockholder's notice as described above. (c) General. (1) Only such persons who are nominated in accordance with the procedures set forth in this Section 2.10 shall be eligible to be elected at an annual or special meeting of stockholders of the corporation to serve as directors and only such business shall be conducted at a meeting of stockholders as shall have been brought before the meeting in accordance with the procedures set forth in this Section 2.10. Except as otherwise provided by law, the certificate of incorporation or these bylaws, the chairman of the meeting shall have the power and duty to (i) determine whether a nomination or any business proposed to be brought before the meeting was made or proposed, as the case may be, in accordance with the procedures set forth in this Section 2.10 (including whether the stockholder or beneficial owner, if any, on whose behalf the nomination or proposal is made solicited (or is part of a group which solicited) or did not so solicit, as the case may be, proxies in support of such stockholder's nominee or proposal in compliance with such stockholder's representation as required by clause (a)(2)(c)(iv) of this Section 2.10)and (ii) if any proposed nomination or business is not in compliance with this Section 2.10, to declare that such defective nomination shall be disregarded or that such proposed business shall not be transacted. Notwithstanding the foregoing provisions of this Section 2.10, if the stockholder (or a qualified representative of the stockholder) does not appear at the annual or special meeting of stockholders of the corporation to present a nomination or business, such nomination shall be disregarded and such proposed business shall not be transacted, notwithstanding that proxies in respect of such vote may have been received by the corporation. -8- (2) For purposes of this Section 2.10, "public announcement" shall mean disclosure in a press release reported by the Dow Jones News Service, Associated Press or comparable national news service or in a document publicly filed by the corporation with the Securities and Exchange Commission pursuant to Section 13, 14 or 15(d) of the Exchange Act. (3) Notwithstanding the foregoing provisions of this Section 2.10, a stockholder shall also comply with all applicable requirements of the Exchange Act and the rules and regulations thereunder with respect to the matters set forth in this Section 2.10. Nothing in this Section 2.10 shall be deemed to affect any rights (i) of stockholders to request inclusion of proposals in the corporation's proxy statement pursuant to Rule 14a-8 under the Exchange Act or (ii) of the holders of any series of Preferred Stock to elect directors pursuant to any applicable provisions of the certificate of incorporation. SECTION 2.11. Inspectors of Election. (a) Appointment. -- All elections of directors shall be by written ballot, unless otherwise provided in the certificate of incorporation; the vote upon any other matter need not be by ballot. In advance of any meeting of stockholders the board of directors may appoint one or more inspectors, who need not be stockholders, to act at the meeting and to make a written report thereof. The board of directors may designate one or more persons as alternate inspectors to replace any inspector who fails to act. If no inspector or alternate is able to act at a meeting of stockholders, the person presiding at the meeting shall appoint one or more inspectors to act at the meeting. Each inspector, before entering upon the discharge of his or her duties, shall take and sign an oath faithfully to execute the duties of inspector with strict impartiality and according to the person's best ability. (b) Duties. -- The inspectors shall ascertain the number of shares outstanding and the voting power of each, shall determine the shares represented at the meeting and the validity of proxies and ballots, shall count all votes and ballots, shall determine and retain for a reasonable period a record of the disposition of any challenges made to any determination by the inspectors, and shall certify their determination of the number of shares represented at the meeting and their count of all votes and ballots. The inspectors may appoint or retain other persons or entities to assist the inspectors in the performance of the duties of the inspectors. (c) Polls. -- The date and time of the opening and the closing of the polls for each matter upon which the stockholders will vote at a meeting shall be announced at the meeting. No ballot, proxies or votes, nor any revocations thereof or changes thereto, shall be accepted by the inspectors after the closing of the polls unless the Court of Chancery upon application by a stockholder shall determine otherwise. (d) Reconciliation of Proxies and Ballots. -- In determining the validity and counting of proxies and ballots, the inspectors shall be limited to an examination of the -9- proxies, any envelopes submitted with those proxies, any information transmitted in accordance with Section 2.07, ballots and the regular books and records of the corporation, except that the inspectors may consider other reliable information for the limited purpose of reconciling proxies and ballots submitted by or on behalf of banks, brokers, their nominees or similar persons which represent more votes than the holder of a proxy is authorized by the record owner to cast or more votes than the stockholder holds of record. If the inspectors consider other reliable information for the limited purpose permitted in this subsection, the inspectors at the time they make their certification pursuant to subsection (b) shall specify the precise information considered by them including the person or persons from whom they obtained the information, when the information was obtained, the means by which the information was obtained and the basis for the inspectors' belief that such information is accurate and reliable. ARTICLE III Board of Directors SECTION 3.01. Powers. -- All powers vested by law in the corporation shall be exercised by or under the authority of, and the business and affairs of the corporation shall be managed under the direction of, the board of directors. SECTION 3.02. Number of Term of Office. -- The board of directors shall consist of such number of directors (other than directors elected by holders of shares of preferred stock of the corporation), not less than three nor more than seven, as may be determined from time to time by resolution of the board of directors. Each director shall hold office until the annual meeting of the stockholders held next after his or her election and until a successor shall have been elected and qualified or until his or her earlier death, resignation or removal. SECTION 3.03. Vacancies. -- Vacancies and newly created directorships resulting from any increase in the authorized number of directors elected by all of the stockholders having a right to vote as a single class may be filled by a majority of the directors then in office, though less than a quorum, or by a sole remaining director, and the directors so chosen shall hold office until their successors are elected and qualified or until their earlier death, resignation or removal. If there are no directors in office, then an election of directors may be held in the manner provided by statute. Subject to the provisions of the certificate of incorporation, whenever the holders of any class or classes of stock or series thereof are entitled to elect one or more directors by the provisions of the certificate of incorporation, vacancies and newly created directorships of such class or classes or series may be filled by a majority of the directors elected by such class of classes or series thereof then in office, or by a sole remaining director so elected. If, at the time of filling any vacancy or any newly created directorship, the directors then in office shall constitute less than a majority of the whole board (as constituted immediately prior to any such increase), the Court of Chancery may, upon application of any stockholder or stockholders holding at least ten percent of the total number of the shares -10- at the time outstanding having the right to vote for such directors, summarily order an election to be held to fill any such vacancies or newly created directorships, or to replace the directors chosen by the directors then in office. SECTION 3.04. Resignations. -- Any director may resign at any time by giving written notice to the corporation. The resignation shall be effective upon receipt thereof by the corporation or at such subsequent time as shall be specified in the notice of resignation and, unless otherwise specified therein, the acceptance of the resignation shall not be necessary to make it effective. SECTION 3.05. Organization. -- At every meeting of the board of directors, the chairman of the board, if there be one, or, in the case of a vacancy in the office or absence of the chairman of the board, one of the following officers present in the order stated: the vice chairman of the board, if there be one, the president, the vice presidents in their order of rank and seniority, or a chairman chosen by a majority of the directors present, shall preside, and the secretary, or, in the absence of the secretary, an assistant secretary, or in the absence of the secretary and the assistant secretaries, any person appointed by the chairman of the meeting, shall act as secretary. SECTION 3.06. Place of Meeting. -- Meetings of the board of directors may be held at such place within or without the State of Delaware as the board of directors may from time to time determine, or as may be designated in the notice of the meeting. SECTION 3.07. Regular Meetings. -- Regular meetings of the board of directors shall be held without notice at such time and place as shall be designated from time to time by resolution of the board of directors. SECTION 3.08. Special Meetings. -- Special meetings of the board of directors shall be held whenever called by the president or by two or more of the directors. Notice of every special meeting of the board of directors shall given to each director by telephone or facsimile or other electronic transmission or in writing at least 24 hours (in the case of notice by telephone or facsimile transmission or other electronic transmission) or 48 hours (in the case of notice by courier service or express mail) or five days (in the case of notice by first class mail) before the time at which the meeting is to be held. Every such notice shall state the time and place of the meeting. Neither the business to be transacted at, nor the purpose of, any meeting of the board need be specified in a notice of the meeting. SECTION 3.09. Quorum, Manner of Acting and Adjournment. (a) General Rule. -- At all meetings of the board one-third of the total number of directors shall constitute a quorum for the transaction of business. The vote of a majority of the directors present at any meeting at which a quorum is present shall be the act of the board of directors, except as may be otherwise specifically provided by the DGCL or by the certificate of incorporation or these by-laws. If a quorum is not present at -11- any meeting of the board of directors, the directors present thereat may adjourn the meeting from time to time, without notice other than announcement at the meeting, until a quorum is present. (b) Unanimous Consent. -- Unless otherwise restricted by the certificate of incorporation, any action required or permitted to be taken at any meeting of the board of directors, or any committee thereof, may be taken without a meeting, if all members of the board or such committee, as the case may be, consent thereto in writing in accordance with applicable law. SECTION 3.10. Executive and Other Committees. (a) Establishment. - The corporation shall be governed by Section 141(c)(2) of the DGCL. The board of directors may by resolution establish an Executive Committee and one or more other committees, each committee to consist of one or more directors. The board may designate one or more directors as alternate members of any committee, who may replace any absent or disqualified member at any meeting of the committee. In the absence or disqualification of a member of a committee and the alternate or alternates, if any, designated for such member, the member or members of the committee present at any meeting and not disqualified from voting, whether or not they constitute a quorum, may unanimously appoint another director to act at the meeting in the place of any such absent or disqualified member. (b) Powers. -- The Executive Committee, if established, and any such other established committee, to the fullest extent permitted by law and to the extent provided in the resolutions of the Board of Directors, shall have and may exercise all the power and authority of the board of directors in the management of the business and affairs of the corporation and may authorize the seal of the corporation to be affixed to all papers which may require it. Each committee so formed shall keep regular minutes of its meetings and report the same to the board of directors when required. (c) Committee Procedures. -- The term "board of directors" or "board," when used in any provision of these bylaws relating to the organization or procedures of or the manner of taking action by the board of directors, shall be construed to include and refer to the Executive Committee or other committee of the board. SECTION 3.11. Compensation of Directors. -- Unless otherwise restricted by the certificate of incorporation, the board of directors shall have the authority to fix the compensation of directors. -12- ARTICLE IV Notice - Waivers - Meetings SECTION 4.01. Notice, What Constitutes. -- Whenever, under the provisions of the DGCL or the certificate of incorporation or of these bylaws, notice is required to be given to any director or stockholder, it shall not be construed to mean personal notice, but such notice may be given in writing, by mail (with messenger service specified), or courier service, charges prepaid, or by facsimile transmission or other means of electronic transmission to the address or fax number of the person appearing on the books of the corporation, or in the case of directors, supplied to the corporation for the purpose of notice. If the notice is sent by mail or courier service, it shall be deemed to be given when deposited in the United States mail or with a courier service for delivery to that person or, in the case of facsimile transmission, when received. If notice is given by electronic transmission, it shall be deemed given as provided by applicable law. SECTION 4.02. Waivers of Notice. (a) Written Waiver. -- Whenever notice is required to be given under any provisions of the DGCL or the certificate of incorporation or these bylaws, a written waiver, given by the person or persons entitled to the notice, whether before or after the time stated therein, shall be deemed equivalent to notice. Neither the business to be transacted at, nor the purpose of, any regular or special meeting of the stockholders, directors, or members of a committee of directors need be specified in any waiver of notice of such meeting. (b) Waiver by Attendance. -- Attendance of a person at a meeting, either in person or by proxy, shall constitute a waiver of notice of such meeting, except where a person attends a meeting for the express purpose of objecting at the beginning of the meeting to the transaction of any business because the meeting was not lawfully called or convened. SECTION 4.03. Exception to Requirements of Notice. (a) General Rule. -- Whenever notice is required to be given, under any provision of the DGCL or of the certificate of incorporation or these bylaws, to any person with whom communication is unlawful, the giving of such notice of such person shall not be required and there shall be no duty to apply to any governmental authority or agency for a license or permit to give such notice to such person. Any action or meeting which shall be taken or held without notice to any such person with whom communication is unlawful shall have the same force and effect as if such notice had been duly given. (b) Stockholders Without Forwarding Addresses. -- Whenever notice is required to be given, under any provision of the DGCL or the certificate of incorporation -13- or these bylaws, to any stockholder to whom (i) notice of two consecutive annual meetings, and all notices of meetings or of the taking of action by written consent without a meeting to such person during the period between such two consecutive annual meetings, or (ii) all, and at least two, payments (if sent by first class mail) of dividends or interest on securities during a 12-month period, have been mailed addressed to such person at his or her address as shown on the records of the corporation and have been returned undeliverable, the giving of such notice to such person shall not be required. Any action or meeting which shall be taken or held without notice of such person shall have the same force and effect as if such notice had been duly given. If any such person shall deliver to the corporation a written notice setting forth the person's then current address, the requirement that notice be given to such person shall be reinstated. SECTION 4.04. Conference Telephone Meetings. -- One or more directors may participate in a meeting of the board, or of a committee of the board, by means of conference telephone or other communications equipment by means of which all persons participating in the meeting can hear each other. Participation in a meeting pursuant to this section shall constitute presence in person at such meeting. ARTICLE V Officers SECTION 5.01. Number, Qualifications and Designation. -- The officers of the corporation shall be chosen by the board of directors and shall be a president, one or more vice presidents, a secretary, a treasurer, and such other officers as may be elected in accordance with the provisions of Section 5.03 of this Article. Any number of offices may be held by the same person. Officers may, but need not, be directors or stockholders of the corporation. The board of directors may elect from among the members of the board a chairman of the board and a vice chairman of the board who shall be officers of the corporation. The president shall be the chief executive officer of the corporation unless the chairman of the board is so designated by the board of directors. SECTION 5.02. Election and Term of Office. -- The officers of the corporation, except those elected by delegated authority pursuant to Section 5.03 of this Article, shall be elected annually by the board of directors, and each such officer shall hold his office until a successor is elected and qualified, or until his or her earlier resignation or removal. Any officer may resign at any time upon notice to the corporation. SECTION 5.03. Subordinate Officers, Committee and Agents. -- The board of directors may from time to time elect such other officers and appoint such committees, employees or other agents as it deems necessary, who shall hold their offices for such terms and shall exercise such powers and perform such duties as are provided in these bylaws, or as the board of directors may from time to time determine. The board of directors may delegate to any officer or committee the power to elect subordinate officers -14- and to retain or appoint employees or other agents, or committees thereof, and to prescribe the authority and duties of such subordinate officers, committees, employees or other agents. SECTION 5.04. The Chairman and Vice Chairman of the Board. -- The chairman of the board, if there be one, or in the absence of the chairman, the vice chairman of the board, if there be one, shall preside at all meetings of the stockholders and of the board of directors, and shall perform such other duties as may from time to time be assigned to them by the board of directors. SECTION 5.05. The President. -- The president shall have general supervision over the business and operations of the corporation, subject, however, to the control of the board of directors. The president shall, in general, perform all duties incident to the office of president, and such other duties as from time to time may be assigned by the board of directors and, if the chairman of the board is the chief executive officer, the chairman of the board. SECTION 5.06. The Vice Presidents. -- The vice presidents shall perform the duties of the president in the absence of the president and such other duties as may from time to time be assigned to them by the board of directors or by the president. SECTION 5.07. The Secretary. -- The secretary, or an assistant secretary, shall attend all meetings of the stockholders and of the board of directors and shall record the proceedings of the stockholders and of the directors and of committees of the board in a book or books to be kept for that purpose; shall see that notices are given and records and reports properly kept and filed by the corporation as required by law; shall be the custodian of the seal of the corporation and see that it is affixed to all documents to be executed on behalf of the corporation under its seal; and, in general, shall perform all duties incident to the office of secretary, and such other duties as may from time to time be assigned by the board of directors or the president. SECTION 5.08. The Treasurer. -- The treasurer, or an assistant treasurer, shall have or provide for the custody of the funds or other property of the corporation and shall keep a separate book account of the same to his credit as treasurer; shall collect and receive or provide for the collection and receipt of moneys earned by or in any manner due to or received by the corporation; shall deposit all funds in his or her custody as treasurer in such banks or other places of deposit as the board of directors may from time to time designate; whenever so required by the board of directors, shall render an account showing his or her transactions as treasurer and the financial condition of the corporation; and, in general, shall discharge such other duties as may from time to time be assigned by the board of directors or the president. SECTION 5.09. Officers' Bonds. -- No officer of the corporation need provide a bond to guarantee the faithful discharge of the officer's duties unless the board of directors shall by resolution so require a bond in which event such officer shall give -15- the corporation a bond (which shall be renewed if and as required) in such sum and with such surety or sureties as shall be satisfactory to the board of directors for the faithful performance of the duties of office. SECTION 5.10. Salaries. -- The salaries of the officers and agents of the corporation elected by the board of directors shall be fixed from time to time by the board of directors. ARTICLE VI Certificates of Stock, Transfer, Etc. SECTION 6.01. Form and Issuance. (a) Issuance. -- The shares of the corporation shall be represented by certificates unless the board of directors shall by resolution provide that some or all of any class or series of stock shall be uncertificated shares. Any such resolution shall not apply to shares represented by a certificate until the certificate is surrendered to the corporation. Notwithstanding the adoption of any resolution providing for uncertificated shares, every holder of stock represented by certificates and upon request every holder of uncertificated shares shall be entitled to have a certificate signed by, or in the name of the corporation by, the chairman or vice chairman of the board of directors, or the president or vice president, and by the treasurer or an assistant treasurer, or the secretary or an assistant secretary, representing the number of shares registered in certificate form. (b) Form and Records. -- Stock certificates of the corporation shall be in such form as approved by the board of directors. The stock record books and the blank stock certificate books shall be kept by the secretary or by any agency designated by the board of directors for that purpose. The stock certificates of the corporation shall be numbered and registered in the stock ledger and transfer books of the corporation as they are issued. (c) Signatures. -- Any of or all the signatures upon the stock certificates of the corporation may be a facsimile. In case any officer, transfer agent or registrar who has signed, or whose facsimile signature has been placed upon, any share certificate shall have ceased to be such officer, transfer agent or registrar, before the certificate is issued, it may be issued with the same effect as if the signatory were such officer, transfer agent or registrar at the date of its issue. SECTION 6.02. Transfer. -- Transfers of shares shall be made on the share registrar or transfer books of the corporation upon surrender of the certificate therefor, endorsed by the person named in the certificate or by an attorney lawfully constituted in writing. No transfer shall be made which would be inconsistent with the provisions of Article 8, Title 6 of the Delaware Uniform Commercial Code-Investment Securities. -16- SECTION 6.03. Lost, Stolen, Destroyed or Mutilated Certificates. -- The board of directors may direct a new certificate of stock or uncertificated shares to be issued in place of any certificate theretofore issued by the corporation alleged to have been lost, stolen or destroyed, upon the making of an affidavit of that fact by the person claiming the certificate of stock to be lost, stolen or destroyed. When authorizing such issue of a new certificate or certificates, the board of directors may, in its discretion and as a condition precedent to the issuance thereof, require the owner of such lost, stolen or destroyed certificate or certificates, or the legal representative of the owner, to give the corporation a bond sufficient to indemnify against any claim that may be made against the corporation on account of the alleged loss, theft or destruction of such certificate or the issuance of such new certificate or uncertificated shares. SECTION 6.04. Record Holder of Shares. -- The corporation shall be entitled to recognize the exclusive right of a person registered on its books as the owner of shares to receive dividends, and to vote as such owner, and to hold liable for calls and assessments a person registered on its books as the owner of shares, and shall not be bound to recognize any equitable or other claim to or interest in such share or shares on the part of any other person, whether or not it shall have express or other notice thereof, except as otherwise provided by the laws of Delaware. SECTION 6.05. Determination of Stockholders of Record. (a) Meetings of Stockholders. -- In order that the corporation may determine the stockholders entitled to notice of or to vote at any meeting of stockholders or any adjournment thereof, the board of directors may fix a record date, which record date shall not precede the date upon which the resolution fixing the record date is adopted by the board of directors, and which record date shall not be more than 60 nor less than ten days before the date of such meeting. If no record date is fixed by the board of directors, the record date for determining stockholders entitled to notice of or to vote at a meeting of stockholders shall be at the close of business on the day next preceding the day on which notice is given, or, if notice is waived, at the close of business on the day next preceding the day on which the meeting is held. A determination of stockholders or record entitled to notice of or to vote at a meeting of stockholders shall apply to any adjournment of the meeting unless the board of directors fixes a new record date for the adjourned meeting. (b) Dividends. -- In order that the corporation may determine the stockholders entitled to receive payment of any dividend or other distribution or allotment of any rights of the stockholders entitled to exercise any rights in respect of any change, conversion or exchange of stock, or for the purpose of any other lawful action, the board of directors may fix a record date, which record date shall not precede the date upon which the resolution fixing the record date is adopted, and which record date shall be not more than 60 days prior to such action. If no record date is fixed, the record date for determining stockholders for any such purpose shall be at the close of business on the day on which the board of directors adopts the resolution relating thereto. -17- SECTION 6.06. Transfer of Rights by Acquiring Person. Rights issued pursuant to the Amended and Restated Rights Agreement, dated as of January 1, 1999, between the Company and StockTrans (the "Rights Agreement") may be transferred by an Acquiring Person or an Associate or Affiliate of an Acquiring Person (as such terms are defined in the Rights Agreement) only in accordance with the terms of, and subject to the restrictions contained in, the Rights Agreement. ARTICLE VII Indemnification of Directors, Officers and Other Authorized Representatives SECTION 7.01. Indemnification of Authorized Representatives in Third Party Proceedings. -- The corporation shall indemnify any person who was or is an authorized representative of the corporation, and who was or is a party, or is threatened to be made a party to any third party proceeding, by reason of the fact that such person was or is an authorized representative of the corporation, against expenses, judgments, fines and amounts paid in settlement actually and reasonably incurred by such person in connection with such third party proceeding if such person acted in good faith and in a manner such person reasonably believed to be in, or not opposed to, the best interests of the corporation and, with respect to any criminal third party proceeding, had no reasonable cause to believe such conduct was unlawful. The termination of any third party proceeding by judgment, order, settlement, conviction or upon a plea of nolo contendere or its equivalent, shall not of itself create a presumption that the authorized representative did not act in good faith and in a manner which such person reasonably believed to be in or not opposed to, the best interests of the corporation, and, with respect to any criminal third party proceeding, had reasonable cause to believe that such conduct was unlawful. Notwithstanding anything to the contrary herein, and except as otherwise provided in Section 7.06, the corporation shall not be required to indemnify any person in connection with a proceeding (or part thereof) commenced by such person unless the commencement of such proceeding (or part thereof) was authorized by the board of directors. SECTION 7.02. Indemnification of Authorized Representatives in Corporate Proceedings. -- The corporation shall indemnify any person who was or is an authorized representative of the corporation and who was or is a party or is threatened to be made a party to any corporate proceeding, by reason of the fact that such person was or is an authorized representative of the corporation, against expenses actually and reasonably incurred by such person in connection with the defense or settlement of such corporate proceeding if such person acted in good faith and in a manner reasonably believed to be in, or not opposed to, the best interests of the corporation and except that no indemnification shall be made in respect of any claim, issue or matter as to which such person shall have been adjudged to be liable to the corporation unless and only to the extent that the Court of Chancery or the court in which such corporate proceeding was brought shall determine upon application that, despite the adjudication of liability but in -18- view of all the circumstances of the case, such authorized representative is fairly and reasonably entitled to indemnity for such expenses which the Court of Chancery or such other court shall deem proper. SECTION 7.03. Mandatory Indemnification of Authorized Representatives. -- To the extent that an authorized representative or other employee or agent of the corporation has been successful on the merits or otherwise in defense of any third party or corporate proceeding or in defense of any claim, issue or matter therein, such person shall be indemnified against expenses actually and reasonably incurred by such person in connection therewith. SECTION 7.04. Determination of Entitlement to Indemnification. -- Any indemnification under Section 7.01, 7.02 or 7.03 of this Article (unless ordered by a court) shall be made by the corporation only as authorized in the specific case upon a determination that indemnification of the authorized representative or other employee or agent is proper in the circumstances because such person has either met the applicable standard of conduct set forth in Section 7.01 or 7.02 or has been successful on the merits or otherwise as set forth in Section 7.03 and that the amount requested has been actually and reasonably incurred. Such determination shall be made: (1) by the board of directors by a majority vote of the directors who were not parties to such third party or corporate proceeding, even though less than a quorum; or (2) by a committee of such directors designated by majority vote of such directors, even though less than a quorum; or (3) if there are no such directors, or if such directors so directs, by independent legal counsel in a written opinion; or (4) by the stockholders. SECTION 7.05. Advancing Expenses. -- Expenses actually and reasonably incurred in defending a third party or corporate proceeding shall be paid on behalf of an authorized representative by the corporation in advance of the final disposition of such third party or corporate proceeding upon receipt of an undertaking (if required by law) by or on behalf of the authorized representative to repay such amount if it shall ultimately be determined that the authorized representative is not entitled to be indemnified by the corporation as authorized in this Article. The financial ability of any authorized representative to make a repayment contemplated by this Section shall not be a prerequisite to the making of an advance. Expenses incurred by other employees and agents may be so paid upon such terms and conditions, if any, as the board of directors deems appropriate. -19- SECTION 7.06. Claims. - If a claim for indemnification or advancement of expenses under this Article VII is not paid in full within thirty days after a written claim therefor by a person covered by Article VII hereof has been received by the corporation, such person may file suit to recover the unpaid amount of such claim and, if successful in whole or in part, shall be entitled to be paid the expenses of prosecuting such claim. In any such action, the corporation shall have the burden of proving that such person is not entitled to the requested indemnification or advancement of expenses under applicable law. SECTION 7.07. Definitions. -- For purposes of this Article: (1) "authorized representative" shall mean any and all directors and officers of the corporation and any person designated as an authorized representative by the board of directors of the corporation (which may, but need not, include any person serving at the request of the corporation as a director, officer, employee or agent of another corporation, partnership, joint venture, trust or other enterprise); (2) "corporation" shall include, in addition to the resulting corporation, any constituent corporation (including any constituent of a constituent) absorbed in a consolidation of merger which, if its separate existence had continued, would have had power and authority to indemnify its directors, officers, employees or agents, so that any person who is or was a director, officer, employee or agent of such constituent corporation, or is or was serving at the request of such constituent corporation as a director, officer, employee or agent of another corporation, partnership, joint venture, trust or other enterprise, shall stand in the same position under the provisions of this Article with respect to the resulting or surviving corporation as such person would have with respect to such constituent corporation if its separate existence had continued; (3) "corporate proceeding" shall mean any threatened, pending or completed action or suit by or in the right of the corporation to procure a judgment in its favor or investigative proceeding by the corporation; (4) "criminal third party proceeding" shall include any action or investigation which could or does lead to a criminal third party proceeding; (5) "expenses" shall include attorneys' fees and disbursements; (6) "fines" shall include any excise taxes assessed on a person with respect to an employee benefit plan; (7) "not opposed to the best interests of the corporation" shall include actions taken in good faith and in a manner the authorized representative reasonably believed to be in the interest of the participants and beneficiaries of an employee benefit plan; -20- (8) "other enterprises" shall include employee benefit plans; (9) "party" shall include the giving of testimony or similar involvement; (10) "serving at the request of the corporation" shall include any service as a director, officer or employee of the corporation which imposes duties on, or involves services by, such director, officer or employee with respect to an employee benefit plan, its participants, or beneficiaries; and (11) "third party proceeding" shall mean any threatened, pending or completed action, suit or proceeding, whether civil, criminal, administrative, or investigative, other than an action by or in the right of the corporation. SECTION 7.08. Insurance. -- The corporation may purchase and maintain insurance on behalf of any person who is or was a director, officer, employee or agent of the corporation, or is or was serving at the request of the corporation as a director, officer, employee or agent of another corporation, partnership, joint venture, trust or person and incurred by the person in any such capacity, or arising out of his or her status as such, whether or not the corporation would have the power or the obligation to indemnify such person against such liability under the provisions of this Article. SECTION 7.09. Scope of Article. -- The indemnification of authorized representatives and advancement of expenses, as authorized by the preceding provisions of this Article, shall not be deemed exclusive of any other rights to which those seeking indemnification or advancement of expenses may be entitled under any agreement, vote of stockholders or disinterested directors or otherwise, both as to action in an official capacity and as to action in another capacity while holding such office. The indemnification and advancement of expenses provided by or granted pursuant to this Article shall, unless otherwise provided when authorized or ratified, continue as to a person who has ceased to be an authorized representative and shall inure to the benefit of the heirs, executors and administrators of such a person. SECTION 7.10. Reliance on Provisions. -- Each person who shall act as an authorized representative of the corporation shall be deemed to be doing so in reliance upon rights of indemnification provided by this Article. ARTICLE VIII General Provisions SECTION 8.01. Dividends. -- Subject to the restrictions contained in the DGCL and any restrictions contained in the certificate of incorporation, the board of directors may declare and pay dividends upon the shares of capital stock of the corporation. -21- SECTION 8.02. Contracts. -- Except as otherwise provided in these bylaws, the board of directors may authorize any officer or officers including the chairman and vice chairman of the board of directors, or any agent or agents, to enter into any contract or to execute or deliver any instrument on behalf of the corporation and such authority may be general or confined to specific instances. SECTION 8.03. Checks. -- All checks, notes, bills of exchange or other orders in writing shall be signed by such person or persons as the board of directors may from time to time designate. SECTION 8.04. Corporate Seal. -- The corporation may have a corporate seal, which shall have inscribed thereon the name of the corporation, the year of its organization and the words "Corporate Seal, Delaware." The seal may be used by causing it or a facsimile thereof to be impressed or affixed or in any other manner reproduced. SECTION 8.05. Deposits. -- All funds of the corporation shall be deposited from time to time to the credit of the corporation in such banks, trust companies, or other depositories as the board of directors may approve or designate, and all such funds shall be withdrawn only upon checks signed by such one or more officers or employees as the board of directors shall from time to time determine. SECTION 8.06. Corporate Records. (a) Examination by Stockholders. -- Every stockholder of record shall, upon written demand under oath stating the purpose thereof, have a right to examine, in person or by agent or attorney, during the usual hours for business, for any proper purpose, the stock ledger, list of stockholders, books or records of account, and records of the proceedings of the stockholders and directors of the corporation, and to make copies or extracts therefrom. A proper purpose shall mean a purpose reasonably related to such person's interest as a stockholder. In every instance where an attorney or other agent shall be the person who seeks the right to inspection, the demand under oath shall be accompanied by a power of attorney or such other writing which authorizes the attorney or other agent to so act on behalf of the stockholder. The demand under oath shall be directed to the corporation at its registered office in Delaware or at its principal place of business. Where the stockholder seeks to inspect the books and records of the corporation, other than its stock ledger or list of stockholders, the stockholder shall first establish (1) that the stockholder has complied with the provisions of this section respecting the form and manner of making demand for inspection of such documents; and (2) that the inspection sought is for a proper purpose. Where the stockholder seeks to inspect the stock ledger or list of stockholders of the corporation and has complied with the provisions of this section respecting the form and manner of making demand for inspection of such documents, the burden of proof shall be upon the corporation to establish that the inspection sought is for an improper purpose. -22- (b) Examination by Directors. -- Any director shall have the right to examine the corporation's stock ledger, a list of its stockholders and its other books and records for a purpose reasonably related to the person's position as a director. SECTION 8.07. Amendment of Bylaws. These bylaws may be altered, amended or repealed or new bylaws may be adopted either (1) by vote of the stockholders at a duly organized annual or special meeting of stockholders by the affirmative vote of the holders of a majority of voting power of the outstanding shares of capital stock of the corporation entitled to vote generally in the election of directors, or (2) by vote of a majority of the board of directors at any regular or special meeting of directors if such power is conferred upon the board of directors by the certificate of incorporation. These Amended and Restated Bylaws reflect all amendments as adopted by the Board of Directors of the corporation on or before July 25, 2002. -23- EX-10.1 5 dex101.txt EXECUTIVE SEVERANCE AGREEMENT EXHIBIT 10.1 EXECUTIVE SEVERANCE AGREEMENT This Severance Agreement is made as of the 25/th/ day of July, 2002 by and between Cephalon, Inc., a Delaware corporation (the "Company"), and Frank Baldino, Jr., Ph.D. ("Executive"). WHEREAS, Executive is an executive of the Company, currently serving as its Chairman and Chief Executive Officer; WHEREAS, the Company has determined that appropriate steps should be taken to, and encourage the attention and dedication of, Executive to his assigned duties without distraction; and WHEREAS, in consideration of Executive's continued employment with the Company and agreeing to keep Company information confidential and not to compete with the Company in the event Executive's employment is terminated, the Company agrees that Executive shall receive the compensation and benefits set forth in this Agreement as a cushion against the financial and career impact on Executive in the event Executive's employment with the Company is terminated for a reason set forth in this Agreement. NOW, THEREFORE, in consideration of the foregoing and the mutual covenants and agreements hereinafter set forth and intending to be legally bound hereby, the Company and Executive (individually a "Party" and together, the "Parties") agree as follows: 1. Definitions. (a) "Annual Base Salary" shall mean twelve times the greater of (i) the highest monthly base salary paid or payable (including any base salary which has been earned but deferred) to the Executive by the Company and its affiliates (as defined in section 1504 of the Code without regard to subsection (b) thereof), together with any and all salary reduction authorized amounts under any of the Company's benefit plans or programs, or (ii) the monthly base salary paid or payable to the Executive by the Company (including authorized deferrals, salary reduction amounts and any car allowance) immediately prior to the Executive's Termination Date. (b) "Annual Bonus" shall mean 100% of Executive's target annual bonus for the year in which Executive's Termination Date occurs, plus 100% of any other bonuses Executive receives, or is entitled to receive, during the year in which Executive's Termination Date occurs, including, but not limited to, bonuses under the Company's executive special bonus program. (c) "Board" shall mean the Board of Directors of the Company. (d) "Bonus Multiplier" shall mean the quotient determined by dividing the total number of months in which the Executive performed services for the Company during the calendar year in which his Termination Date occurs divided by 12. (e) "Cause" shall mean Executive has engaged in any act of unethical conduct, willful misconduct, fraud or embezzlement, any unauthorized disclosure of confidential information or trade secrets, or any other act that is materially and demonstrably detrimental to the Company. (f) "Change in Control" shall be deemed to have occurred if any of the following events occurs: (i) the direct or indirect acquisition by any person or related group of persons (other than the Company or a person that directly or indirectly controls, is controlled by, or is under common control with, the Company) of beneficial ownership (within the meaning of Rule 13d-3 of the Securities Exchange Act of 1934) of securities possessing more than thirty percent (30%) of the combined voting power of the Company's outstanding securities pursuant to a tender or exchange offer made directly to the Company's shareholders which the Board does not recommend such shareholders to accept; (ii) a change in the composition of the Board over a period of twenty-four (24) months or less such that a majority of the Board members ceases, by reason of one or more contested elections for Board membership, to be comprised of individuals who either (x) have been Board members continuously since the beginning of such period, or (y) have been elected or nominated for election as Board members during such period by at least a majority of the Board members described in clause (x) who were still in office at the time such election or nomination was approved by the Board; (iii) a merger or consolidation in which securities possessing more than fifty percent (50%) of the combined voting power of the Company's outstanding securities are transferred to a person or persons different from the persons holding those securities immediately prior to such transaction; or (iv) the sale, transfer or other disposition of more than seventy-five percent (75%) of the Company's assets in a single or related series of transactions. (g) "Code" means the Internal Revenue Code of 1986, as amended. (h) "Constructive Termination" means: (i) with respect to a termination of employment prior to a Change in Control, Executive's voluntary resignation following either of the following events: (x) a change in his position with the Company which materially reduces his level of responsibility or (y) a reduction in his base salary by more than twenty-five percent (25%); or -2- (ii) with respect to a termination of employment after, or in connection with, a Change in Control, Executive's voluntary resignation following any of the following events: (x) a change in his position with the Company or the successor thereto which materially reduces his level of responsibility; (y) a reduction in his level of compensation (including base salary, significant fringe benefits or any non-discretionary and objective-standard incentive payment or bonus award) by more than ten percent (10%) in the aggregate; or (z) a relocation of the Executive's place of employment by more than fifty (50) miles; provided, however, such change, reduction or relocation is effected by the Company or the successor thereto without Executive's consent. (i) "Disability" shall mean Executive is, by reason of any medically determinable physical or mental impairment expected to result in death or to be of continuous duration of not less than one year, unable to engage in any substantial gainful employment or service. (j) "Notice of Termination" means a written notice which (i) indicates the specific termination provision in this Agreement relied upon, and (ii) briefly summarizes the facts and circumstances deemed to provide a basis for termination of the Executive's employment under the provision so indicated. (k) "Termination Date" shall mean the last day of Executive's employment with the Company. (l) "Termination of Employment" shall mean the termination of Executive's active employment relationship with the Company. 2. Termination of Employment Prior to a Change in Control. (a) Termination Prior to a Change in Control. In the event that Executive's employment with the Company is terminated prior to a Change in Control on account of: (i) an involuntary termination by the Company for any reason other than Cause, death or Disability, or (ii) the Executive voluntarily terminates employment with the Company on account of a Constructive Termination, Executive shall be entitled to the benefits provided in subsection (b) of this Section 2. (b) Compensation Upon Termination Prior to Change in Control. Subject to the provisions of Section 5 hereof, in the event a termination described in subsection (a) of this Section 2 occurs, the Company shall pay to Executive within thirty (30) days after the Termination Date (or the end of the revocation period for the Release (as defined in Section 5), if later), the following: (i) Executive shall receive a lump sum payment equal to the sum of (x) three (3) times Executive's Annual Base Salary at the rate in effect immediately before the Executive's Termination Date, (y) three (3) times Executive's Annual Bonus, and (z) the Bonus Multiplier times Executive's Annual Bonus. (ii) For a period of thirty-six (36) months following his Termination Date, Executive shall continue to receive the medical and dental coverage in effect on his -3- Termination Date (or generally comparable coverage) for himself and, where applicable, his spouse and dependents, as the same may be changed from time to time for employees generally, as if Executive had continued in employment during such period; or, as an alternative, the Company may elect to pay Executive cash in lieu of such coverage in an amount equal to Executive's after-tax cost of continuing such coverage, where such coverage may not be continued (or where such continuation would adversely affect the tax status of the plan pursuant to which the coverage is provided). The COBRA health care continuation coverage period under section 4980B of the Code, shall run concurrently with the foregoing thirty-six (36) month benefit period. (iii) To cover the cost of outplacement assistance services for Executive provided by an outplacement agency selected by Executive in an amount not to exceed $15,000. (iv) Executive shall receive any amounts earned, accrued or owing but not yet paid to Executive as of his Termination Date, payable in a lump sum, and any benefits accrued or earned in accordance with the terms of any applicable benefit plans and programs of the Company. (c) Notice of Termination. Any termination on account of this Section 2 shall be communicated by a Notice of Termination to the other Parties hereto given in accordance with Section 18 hereof. 3. Termination of Employment on Account of a Change in Control. (a) Termination on Account of a Change in Control. In the event that Executive's employment with the Company is terminated after, or in connection with, a Change in Control on account of: (i) an involuntary termination by the Company following a Change in Control for any reason other than Cause, death or Disability, (ii) the Executive voluntarily terminates employment with the Company following a Change in Control on account of a Constructive Termination, (iii) by the Company (other than for Cause, death or Disability) prior to or in connection with an anticipated Change in Control at the request or direction of the acquirer involved in the Change in Control, or (iv) voluntarily by Executive for any reason (other than for death, Disability, or under circumstances in which Executive engaged in conduct that would constitute Cause) during the thirty (30) day period immediately following the first anniversary of the occurrence of a Change in Control, Executive shall be entitled to the benefits provided in subsection (b) of this Section 3. If Executive is entitled to benefits described in subsection (b) of this Section 3 by reason of clause (a)(iii) above, Executive shall be entitled to such benefits upon his Termination of Employment regardless of whether the Change in Control actually occurs. (b) Compensation in Connection With a Termination on Account of a Change in Control. Subject to the provisions of Sections 5 and 12 hereof, in the event of a termination described in subsection (a) of this Section 3 occurs, the Company shall pay to Executive within thirty (30) days after the Termination Date (or, as soon as possible thereafter in the event that the procedures set forth in Section 12(b) hereof cannot be completed within thirty (30) days, or the end of the revocation period for the Release (as defined in Section 5), if later), the following: -4- (i) Executive shall receive a lump sum payment equal to the sum of (x) three (3) times Executive's Annual Base Salary at the rate in effect immediately before the Executive's Termination Date, (y) three (3) times Executive's Annual Bonus, and (z) the Bonus Multiplier times Executive's Annual Bonus. (ii) For a period of thirty-six (36) months following his Termination Date, Executive shall continue to receive the medical and dental coverage in effect on his Termination Date (or generally comparable coverage) for himself and, where applicable, his spouse and dependents, as the same may be changed from time to time for employees generally, as if Executive had continued in employment during such period; or, as an alternative, the Company may elect to pay Executive cash in lieu of such coverage in an amount equal to Executive's after-tax cost of continuing such coverage, where such coverage may not be continued (or where such continuation would adversely affect the tax status of the plan pursuant to which the coverage is provided). The COBRA health care continuation coverage period under section 4980B of the Code, shall run concurrently with the foregoing thirty-six (36) month benefit period. (iii) All stock options and restricted stock held by Executive will become fully vested and/or exercisable, as the case may be, on the Termination Date, and all stock options shall remain exercisable after the Executive's Termination Date as set forth in the applicable option agreements with the Company. (iv) To cover the cost of outplacement assistance services for Executive provided by an outplacement agency selected by Executive in an amount not to exceed $15,000. (v) Executive shall receive any amounts earned, accrued or owing but not yet paid to Executive as of his Termination Date, payable in a lump sum, and any benefits accrued or earned in accordance with the terms of any applicable benefit plans and programs of the Company. (c) Notice of Termination. Any termination on account of this Section 3 shall be communicated by a Notice of Termination to the other Parties hereto in accordance with Section 18 hereof. 4. Termination of Employment on Account of Disability. Notwithstanding anything in this Agreement to the contrary, if Executive's employment terminates on account of Disability, Executive shall be entitled to receive disability benefits under any disability program maintained by the Company that covers Executive, and Executive shall not be considered to have terminated employment under this Agreement and shall not receive benefits pursuant to Sections 2 and 3 hereof. 5. Release. Notwithstanding the foregoing, no such payments shall be made unless Executive executes, and does not revoke, the Company's standard written release (the "Release"), of any and all claims against the Company and all related parties with respect to all matters arising out of Executive's employment by the Company (other than any entitlements under the terms of this Agreement or under any other plans or programs of the Company in -6- which Executive participated and under which Executive has accrued or become entitled to a benefit) or the termination thereof. 6. Other Payments. The payments due under Sections 2 and 3 hereof shall be in addition to and not in lieu of any payments or benefits due to Executive under any other plan, policy or program of the Company, including, but not limited to, benefits required to be provided to him under the terms of his split dollar life insurance agreement, if any, with the Company, except that no cash payments shall be paid to Executive under the Company's then current severance pay policies. 7. Enforcement. (a) In the event that the Company shall fail or refuse to make payment of any amounts due Executive under Sections 2, 3 and 6 hereof within the respective time periods provided therein, the Company shall pay to Executive, in addition to the payment of any other sums provided in this Agreement, interest, compounded daily, on any amount remaining unpaid from the date payment is required under Sections 2, 3 and 6, as appropriate, until paid to Executive, at the rate from time to time announced by First Union Bank as its "prime rate" plus 2%, each change in such rate to take effect on the effective date of the change in such prime rate. (b) It is the intent of the Parties that Executive not be required to incur any expenses associated with the enforcement of his rights under Sections 2, 3 and 6 of this Agreement by arbitration, litigation or other legal action because the cost and expense thereof would substantially detract from the benefits intended to be extended to Executive hereunder. Accordingly, the Company shall pay Executive on demand the amount necessary to advance to or reimburse Executive in full for all expenses (including all attorneys' fees and legal expenses) incurred by Executive in enforcing any of the obligations of the Company under this Agreement. 8. No Mitigation. Executive shall not be required to mitigate the amount of any payment or benefit provided for in this Agreement by seeking other employment or otherwise, nor shall the amount of any payment or benefit provided for herein be reduced by any compensation earned by other employment or otherwise. 9. Non-Exclusivity of Rights. Except as provided in Section 6, nothing in this Agreement shall prevent or limit Executive's continuing or future participation in or rights under any benefit, bonus, incentive or other plan or program provided by the Company or any of its subsidiaries or affiliates and for which Executive may qualify. 10. No Set-Off. The Company's obligation to make the payments provided for in this Agreement and otherwise to perform its obligations hereunder shall not be affected by any circumstances, including, without limitation, any set-off, counterclaim, recoupment, defense or other right which the Company may have against Executive or others. 11. Taxes. Any payment required under this Agreement shall be subject to all requirements of the law with regard to the withholding of taxes, filing, making of reports and the like, and the Company shall use its best efforts to satisfy promptly all such requirements. -6- 12. Certain Increases in Payment. (a) Anything in this Agreement to the contrary notwithstanding, in the event that it shall be determined that any payment or distribution by the Company to or for the benefit of Executive, whether paid or payable or distributed or distributable pursuant to the terms of this Agreement or otherwise (the "Payment"), would constitute an "excess parachute payment" within the meaning of section 280G of the Code, Executive shall be paid an additional amount (the "Gross-Up Payment") such that the net amount retained by Executive after deduction of any excise tax imposed under section 4999 of the Code, and any federal, state and local income and employment tax and excise tax imposed upon the Gross-Up Payment shall be equal to the Payment. For purposes of determining the amount of the Gross-Up Payment, Executive shall be deemed to pay federal income tax and employment taxes at the highest marginal rate of federal income and employment taxation in the calendar year in which the Gross-Up Payment is to be made and state and local income taxes at the highest marginal rate of taxation in the state and locality of Executive's residence (or, if greater, the state and locality in which Executive is required to file a nonresident income tax return with respect to the Payment) on the Termination Date, net of the maximum reduction in federal income taxes that may be obtained from the deduction of such state and local taxes. (b) All determinations to be made under this Section 12 shall be made by the Company's independent public accountant immediately prior to the Change in Control (the "Accounting Firm"), which firm shall provide its determinations and any supporting calculations both to the Company and Executive within 10 days of the Termination Date. Any such determination by the Accounting Firm shall be binding upon the Company and Executive. Within five days after the Accounting Firm's determination, the Company shall pay (or cause to be paid) or distribute (or cause to be distributed) to or for the benefit of Executive such amounts as are then due to Executive under this Agreement. (c) Executive shall notify the Company in writing of any claim by the Internal Revenue Service that, if successful, would require the payment by the Company of the Gross-Up Payment. Such notification shall be given as soon as practicable but no later than ten business days after Executive knows of such claim and shall apprise the Company of the nature of such claim and the date on which such claim is requested to be paid. Executive shall not pay such claim prior to the expiration of the thirty day period following the date on which he gives such notice to the Company (or such shorter period ending on the date that any payment of taxes with respect to such claim is due). If the Company notifies Executive in writing prior to the expiration of such period that it desires to contest such claim, Executive shall: (i) give the Company any information reasonably requested by the Company relating to such claim; (ii) take such action in connection with contesting such claim as the Company shall reasonably request in writing from time to time, including, without limitation, accepting legal representation with respect to such claim by an attorney reasonably selected by the Company; -7- (iii) cooperate with the Company in good faith in order to effectively contest such claim; and (iv) permit the Company to participate in any proceedings relating to such claim; provided, however, that the Company shall bear and pay directly all costs and expenses (including additional interest and penalties) incurred in connection with such contest and shall indemnify and hold Executive harmless, on an after-tax basis, for any excise tax, income tax or employment tax, including interest and penalties, with respect thereto, imposed as a result of such representation and payment of costs and expenses. Without limitation on the foregoing provisions of this Section 12, the Company shall control all proceedings taken in connection with such contest and, at its sole option, may pursue or forego any and all administrative appeals, proceedings, hearing and conferences with the taxing authority in respect of such claim and may, at its sole option, either direct Executive to pay the tax claimed and sue for a refund or contest the claim in any permissible manner, and Executive agrees to prosecute such contest to a termination before any administrative tribunal, in a court of initial jurisdiction and in one or more appellate courts, as the Company shall determine; provided further, however, that if the Company directs Executive to pay such claim and sue for a refund, the Company shall advance the amount of such payment to Executive, on an interest-free basis and shall indemnify and hold Executive harmless, on an after-tax basis, from any excise tax, income tax or employment tax, including interest or penalties with respect thereto, imposed with respect to such advance or with respect to any imputed income with respect to such advance; and provided further that any extension of the statute of limitations relating to payment of taxes for the taxable year of Executive with respect to which such contested amount is claimed to be due is limited solely to such contested amount. Furthermore, the Company's control of the contest shall be limited to issues with respect to which a Gross-Up Payment would be payable hereunder and Executive shall be entitled to settle or contest, as the case may be, any other issue raised by the Internal Revenue Service or any other taxing authority. (d) If, after the receipt by Executive of an amount advanced by the Company pursuant to this Section, Executive becomes entitled to receive any refund with respect to such claim, Executive shall (subject to the Company's complying with the requirements of this Section) promptly pay to the Company the amount of such refund (together with any interest paid or credited thereon after taxes applicable thereto). If, after the receipt by Executive of an amount advanced by the Company pursuant to this Section, a determination is made that Executive shall not be entitled to any refund with respect to such claim and the Company does not notify Executive in writing of its intent to contest such denial of refund prior to the expiration of thirty days after such determination, then such advance shall be forgiven and shall not be required to be repaid and the amount of such advance shall offset, to the extent thereof, the amount of Gross-Up Payment required to be paid. (e) All of the fees and expenses of the Accounting Firm in performing the determinations referred to in this Section shall be borne solely by the Company. The Company agrees to indemnify and hold harmless the Accounting Firm of and from any and all claims, damages and expenses resulting from or relating to its determinations pursuant to this Section, -8- except for claims, damages or expenses resulting from the gross negligence or willful misconduct of the Accounting Firm. 13. Confidential Information. Executive shall remain subject to the terms and conditions of his Employee Confidentiality Agreement, which shall continue in full force and effect, except as specifically modified herein. 14. Non-Competition. (a) During the period of Executive's employment by the Company and, if Executive's employment with the Company terminates for any reason other that described in Section 3(a) above, for a period of one (1) year thereafter, except with the written consent of the Board, Executive shall not directly or indirectly, own, manage, operate, join, control, finance or participate in the ownership, management, operation, control or financing of, or be connected as an officer, director, employee, partner, principal, agent, representative, stockholder, consultant, investor or otherwise with, or use or permit his name to be used in connection with, any person, business or enterprise which directly or indirectly engages in (i) the development of compounds, or (ii) the sale or marketing of products, that compete with the Company's compounds or products (the "Company's Business"). In further consideration for the Company's promises herein, Executive agrees that for the period beginning with the termination of his employment with the Company for any reason other than that described in Section 3(a) above, and for a period of one (1) year thereafter, Executive will not: (i) except with the prior written consent of the Board, directly or indirectly solicit, entice or induce any customer to become a customer of any other person, firm or corporation with respect to the Company's Business or to cease doing business with the Company or its subsidiaries or affiliates, and that Executive will not approach any such person, firm or corporation for such purpose or authorize or knowingly approve, encourage or assist the taking of such actions by any other person, firm or corporation; or (ii) directly or indirectly solicit, recruit or hire any part-time or full-time employee, representative or consultant of the Company or its subsidiaries or affiliates to work for a third party other than the Company or its subsidiaries or affiliates or engage in any activity that would cause any employee, representative or consultant to violate any agreement with the Company or its subsidiaries or affiliates. The foregoing covenant shall not apply to any person after twelve (12) months have elapsed after the date on which such person's employment by the Company has terminated. (b) The foregoing restrictions shall not be construed to prohibit Executive's ownership of less than five percent of any class of securities of any corporation which is engaged in any of the foregoing businesses and has a class of securities registered pursuant to the Securities Exchange Act of 1934, as amended, provided that such ownership represents a passive investment and that neither Executive nor any group of persons including Executive in any way, either directly or indirectly, manages or exercises control of any such corporation, guarantees any of its financial obligations, otherwise takes any part in its business, other than exercising Executive's rights as a stockholder, or seeks to do any of the foregoing. -9- 15. Equitable Relief. (a) Executive acknowledges that the restrictions contained in Sections 13 and 14 hereof are reasonable and necessary to protect the legitimate interests of the Company and its affiliates, that the Company would not have entered into this Agreement in the absence of such restrictions, and that any violation of any provision of those Sections will result in irreparable injury to the Company. Executive represents that his experience and capabilities are such that the restrictions contained in Section 14 hereof will not prevent Executive from obtaining employment or otherwise earning a living at the same general level of economic benefit as is currently the case. Executive further represents and acknowledges that (i) he has been advised by the Company to consult his own legal counsel in respect of this Agreement, and (ii) that he has had full opportunity, prior to execution of this Agreement, to review thoroughly this Agreement with his counsel. (b) Executive agrees that the Company shall be entitled to preliminary and permanent injunctive relief, without the necessity of proving actual damages, as well as an equitable accounting of all earnings, profits and other benefits arising from any violation of Sections 13 or 14 hereof, which rights shall be cumulative and in addition to any other rights or remedies to which the Company may be entitled. In the event that any of the provisions of Sections 13 or 14 hereof should ever be adjudicated to exceed the time, geographic, service, or other limitations permitted by applicable law in any jurisdiction, then such provisions shall be deemed reformed in such jurisdiction to the maximum time, geographic, service, or other limitations permitted by applicable law. (c) Executive irrevocably and unconditionally (i) agrees that any suit, action or other legal proceeding arising out of Section 13 or 14 hereof, including without limitation, any action commenced by the Company for preliminary and permanent injunctive relief or other equitable relief, may be brought in the United States District Court for the District of Delaware, or if such court does not have jurisdiction or will not accept jurisdiction, in any court of general jurisdiction in Delaware, (ii) consents to the non-exclusive jurisdiction of any such court in any such suit, action or proceeding, and (iii) waives any objection which Executive may have to the laying of venue of any such suit, action or proceeding in any such court. Executive also irrevocably and unconditionally consents to the service of any process, pleadings, notices or other papers in a manner permitted by the notice provisions of Section 18 hereof. 16. Term of Agreement. This Agreement shall continue in full force and effect for the duration of Executive's employment with the Company; provided, however, that after the termination of Executive's employment during the term of this Agreement, this Agreement shall remain in effect until all of the obligations of the Parties hereunder are satisfied or have expired. 17. Successor Company. The Company shall require any successor or successors (whether direct or indirect, by purchase, merger, consolidation or otherwise) to all or substantially all of the business and/or assets of the Company, by agreement in form and substance satisfactory to Executive, to acknowledge expressly that this Agreement is binding upon and enforceable against the Company in accordance with the terms hereof, and to become jointly and severally obligated with the Company to perform this Agreement in the same manner and to the same extent that the Company would be required to perform if no such succession or successions had taken place. Failure of the Company to obtain such agreement prior to the effectiveness of any such succession shall be a breach of this Agreement. As used in this Agreement, the Company shall mean the Company as herein before defined and any such successor or successors to its business and/or assets, jointly and severally. 18. Notice. All notices and other communications required or permitted hereunder or necessary or convenient in connection herewith shall be in writing and shall be delivered personally or mailed by registered or certified mail, return receipt requested, or by overnight express courier service, as follows: If to the Company, to: Cephalon, Inc. 145 Brandywine Parkway West Chester, PA 19380 Attn: Robert J. Feeney, Ph.D. With a copy to: Morgan, Lewis & Bockius LLP 1701 Market Street Philadelphia, PA 19103-2921 Attn: I. Lee Falk, Esquire If to Executive, to: Frank Baldino, Jr., Ph.D. 106 Bellefair Lane West Chester, PA 19382 or to such other names or addresses as the Company or Executive, as the case may be, shall designate by notice to the other Parties hereto in the manner specified in this Section; provided, however, that if no such notice is given by the Company following a change in control, notice at the last address of the Company or to any successor pursuant to this Section 18 shall be deemed sufficient for the purposes hereof. Any such notice shall be deemed delivered and effective when received in the case of personal delivery, five days after deposit, postage prepaid, with the U.S. Postal Service in the case of registered or certified mail, or on the next business day in the case of overnight express courier service. 19. Governing Law. This Agreement shall be governed by and interpreted under the laws of the State of Delaware without giving effect to any conflict of laws provisions. -11- 20. Contents of Agreement, Amendment and Assignment. (a) This Agreement supersedes all prior agreements, sets forth the entire understanding between the Parties hereto with respect to the subject matter hereof and cannot be changed, modified, extended or terminated except upon written amendment executed by Executive and executed on the Company's behalf by a duly authorized officer. The provisions of this Agreement may provide for payments to Executive under certain compensation or bonus plans under circumstances where such plans would not provide for payment thereof. It is the specific intention of the Parties that the provisions of this Agreement shall supersede any provisions to the contrary in such plans, and such plans shall be deemed to have been amended to correspond with this Agreement without further action by the Company or the Board. (b) Nothing in this Agreement shall be construed as giving Executive any right to be retained in the employ of the Company, or as changing or modifying the "at will" nature of Executive's employment status. (c) All of the terms and provisions of this Agreement shall be binding upon and inure to the benefit of and be enforceable by the respective heirs, representatives, successors and assigns of the Parties hereto, except that the duties and responsibilities of Executive and the Company hereunder shall not be assignable in whole or in part by the Company. If Executive should die after his Termination Date and while any amount payable hereunder would still be payable to Executive hereunder if Executive had continued to live, all such amounts, unless otherwise provided herein, shall be paid in accordance with the terms of this Agreement to Executive's devises, legates or other designees or, if there is no such designee, to Executive's estate. 21. Severability. If any provision of this Agreement or application thereof to anyone or under any circumstances shall be determined to be invalid or unenforceable, such invalidity or unenforceability shall not affect any other provisions or applications of this Agreement which can be given effect without the invalid or unenforceable provision or application. 22. Remedies Cumulative; No Waiver. No right conferred upon the Parties by this Agreement is intended to be exclusive of any other right or remedy, and each and every such right or remedy shall be cumulative and shall be in addition to any other right or remedy given hereunder or now or hereafter existing at law or in equity. No delay or omission by a Party in exercising any right, remedy or power hereunder or existing at law or in equity shall be construed as a waiver thereof. 23. Miscellaneous. All section headings are for convenience only. This Agreement may be executed in several counterparts, each of which is an original. It shall not be necessary in making proof of this Agreement or any counterpart hereof to produce or account for any of the other counterparts. -12- IN WITNESS WHEREOF, the undersigned, intending to be legally bound, have executed this Agreement as of the date first above written. CEPHALON, INC. Attest: __________________ By: /s/ Robert J. Feeney -------------------------------------- Robert J. Feeney, Ph.D. Its: Chairman of the Compensation and Stock Option Committee, and Member of the Board of Directors /s/ Frank Baldino, Jr. __________________________ ---------------------------------------------------- Witness EXECUTIVE -13- EX-10.2 6 dex102.txt FORM OF EXECUTIVE SEVERANCE AGREEMENT EXHIBIT 10.2 FORM OF EXECUTIVE SEVERANCE AGREEMENT BETWEEN CEPHALON, INC. AND CERTAIN EXECUTIVES
Executive Title - --------- ----- Paul Blake, FRCP Sr. Vice President, Clinical Research & Regulatory Affairs J. Kevin Buchi Sr. Vice President and Chief Financial Officer Peter E. Grebow, Ph.D Sr. Vice President, Worldwide Business Development John E. Osborn, Esq. Sr. Vice President, General Counsel & Secretary Robert P. Roche, Jr. Sr. Vice President, Pharmaceutical Operations Carl A. Savini Sr. Vice President, Human Resources Jeffry L. Vaught, Ph.D Sr. Vice President and President, Research & Development
EXECUTIVE SEVERANCE AGREEMENT This Severance Agreement is made as of the 25/th/ day of July, 2002 by and between Cephalon, Inc., a Delaware corporation (the "Company"), and ________________ ("Executive"). WHEREAS, Executive is an executive of the Company, currently serving as its _______________________; WHEREAS, the Company has determined that appropriate steps should be taken to, and encourage the attention and dedication of, Executive to his assigned duties without distraction; and WHEREAS, in consideration of Executive's continued employment with the Company and agreeing to keep Company information confidential and not to compete with the Company in the event Executive's employment is terminated, the Company agrees that Executive shall receive the compensation and benefits set forth in this Agreement as a cushion against the financial and career impact on Executive in the event Executive's employment with the Company is terminated for a reason set forth in this Agreement. NOW, THEREFORE, in consideration of the foregoing and the mutual covenants and agreements hereinafter set forth and intending to be legally bound hereby, the Company and Executive (individually a "Party" and together, the "Parties") agree as follows: 1. Definitions. (a) "Annual Base Salary" shall mean twelve times the greater of (i) the highest monthly base salary paid or payable (including any base salary which has been earned but deferred) to the Executive by the Company and its affiliates (as defined in section 1504 of the Code without regard to subsection (b) thereof), together with any and all salary reduction authorized amounts under any of the Company's benefit plans or programs, or (ii) the monthly base salary paid or payable to the Executive by the Company (including authorized deferrals, salary reduction amounts and any car allowance) immediately prior to the Executive's Termination Date. (b) "Annual Bonus" shall mean 100% of Executive's target annual bonus for the year in which Executive's Termination Date occurs, plus 100% of any other bonuses Executive receives, or is entitled to receive, during the year in which Executive's Termination Date occurs, including, but not limited to, bonuses under the Company's executive special bonus program. (c) "Board" shall mean the Board of Directors of the Company. (d) "Bonus Multiplier" shall mean the quotient determined by dividing the total number of months in which the Executive performed services for the Company during the calendar year in which his Termination Date occurs divided by 12. (e) "Cause" shall mean Executive has engaged in any act of unethical conduct, willful misconduct, fraud or embezzlement, any unauthorized disclosure of confidential information or trade secrets, or any other act that is materially and demonstrably detrimental to the Company. (f) "Change in Control" shall be deemed to have occurred if any of the following events occurs: (i) the direct or indirect acquisition by any person or related group of persons (other than the Company or a person that directly or indirectly controls, is controlled by, or is under common control with, the Company) of beneficial ownership (within the meaning of Rule 13d-3 of the Securities Exchange Act of 1934) of securities possessing more than thirty percent (30%) of the combined voting power of the Company's outstanding securities pursuant to a tender or exchange offer made directly to the Company's shareholders which the Board does not recommend such shareholders to accept; (ii) a change in the composition of the Board over a period of twenty-four (24) months or less such that a majority of the Board members ceases, by reason of one or more contested elections for Board membership, to be comprised of individuals who either (x) have been Board members continuously since the beginning of such period, or (y) have been elected or nominated for election as Board members during such period by at least a majority of the Board members described in clause (x) who were still in office at the time such election or nomination was approved by the Board; (iii) a merger or consolidation in which securities possessing more than fifty percent (50%) of the combined voting power of the Company's outstanding securities are transferred to a person or persons different from the persons holding those securities immediately prior to such transaction; or (iv) the sale, transfer or other disposition of more than seventy-five percent (75%) of the Company's assets in a single or related series of transactions. (g) "Code" means the Internal Revenue Code of 1986, as amended. (h) "Constructive Termination" means Executive's voluntary resignation following any of the following events: (i) a change in his position with the Company or the successor thereto which materially reduces his level of responsibility; (ii) a reduction in his level of compensation (including base salary, significant fringe benefits or any non-discretionary and objective-standard incentive payment or bonus award) by more than ten percent (10%) in the aggregate; or (iii) a relocation of the Executive's place of employment by more than fifty (50) -2- miles; provided, however, such change, reduction or relocation is effected by the Company or the successor thereto without Executive's consent. (i) "Disability" shall mean Executive is, by reason of any medically determinable physical or mental impairment expected to result in death or to be of continuous duration of not less than one year, unable to engage in any substantial gainful employment or service. (j) "Notice of Termination" means a written notice which (i) indicates the specific termination provision in this Agreement relied upon, and (ii) briefly summarizes the facts and circumstances deemed to provide a basis for termination of the Executive's employment under the provision so indicated. (k) "Termination Date" shall mean the last day of Executive's employment with the Company. (l) "Termination of Employment" shall mean the termination of Executive's active employment relationship with the Company. 2. Termination of Employment Prior to a Change in Control. (a) Termination Prior to a Change of Control. In the event that Executive's employment with the Company is terminated prior to a Change in Control on account of an involuntary termination by the Company for any reason other than Cause, death or Disability, Executive shall be entitled to the benefits provided in subsection (b) of this Section 2. (b) Compensation Upon Termination Prior to Change in Control. Subject to the provisions of Section 5 hereof, in the event a termination described in subsection (a) of this Section 2 occurs, the Company shall pay to Executive within thirty (30) days after the Termination Date (or the end of the revocation period for the Release (as defined in Section 5), if later), the following: (i) Executive shall receive a lump sum payment equal to one and a half (1.5) times Executive's Annual Base Salary at the rate in effect immediately before the Executive's Termination Date. (ii) For a period of eighteen (18) months following his Termination Date, Executive shall continue to receive the medical and dental coverage in effect on his Termination Date (or generally comparable coverage) for himself and, where applicable, his spouse and dependents, as the same may be changed from time to time for employees generally, as if Executive had continued in employment during such period; or, as an alternative, the Company may elect to pay Executive cash in lieu of such coverage in an amount equal to Executive's after-tax cost of continuing such coverage, where such coverage may not be continued (or where such continuation would adversely affect the tax status of the plan pursuant to which the coverage is provided). The COBRA health care continuation coverage period under section 4980B of the Code, shall run concurrently with the foregoing eighteen (18) month benefit period. -3- (iii) To cover the cost of outplacement assistance services for Executive provided by an outplacement agency selected by Executive in an amount not to exceed $15,000. (iv) Executive shall receive any amounts earned, accrued or owing but not yet paid to Executive as of his Termination Date, payable in a lump sum, and any benefits accrued or earned in accordance with the terms of any applicable benefit plans and programs of the Company. (c) Notice of Termination. Any termination on account of this Section 2 shall be communicated by a Notice of Termination to the other Parties hereto given in accordance with Section 18 hereof. 3. Termination of Employment on Account of a Change in Control. (a) Termination on Account of a Change in Control. In the event that Executive's employment with the Company is terminated after, or in connection with, a Change in Control on account of: (i) an involuntary termination by the Company following a Change in Control for any reason other than Cause, death or Disability, (ii) the Executive voluntarily terminates employment with the Company following a Change in Control on account of a Constructive Termination, (iii) by the Company (other than for Cause, death or Disability) prior to or in connection with an anticipated Change in Control at the request or direction of the acquirer involved in the Change in Control, or (iv) voluntarily by Executive for any reason (other than for death, Disability, or under circumstances in which Executive engaged in conduct that would constitute Cause) during the thirty (30) day period immediately following the first anniversary of the occurrence of a Change in Control, Executive shall be entitled to the benefits provided in subsection (b) of this Section 3. If Executive is entitled to benefits described in subsection (b) of this Section 3 by reason of clause (a)(iii) above, Executive shall be entitled to such benefits upon his Termination of Employment regardless of whether the Change in Control actually occurs. (b) Compensation in Connection With a Termination on Account of a Change in Control. Subject to the provisions of Sections 5 and 12 hereof, in the event of a termination described in subsection (a) of this Section 3 occurs, the Company shall pay to Executive within thirty (30) days after the Termination Date (or, as soon as possible thereafter in the event that the procedures set forth in Section 12(b) hereof cannot be completed within thirty (30) days, or the end of the revocation period for the Release (as defined in Section 5), if later), the following: (i) Executive shall receive a lump sum payment equal to the sum of (x) three (3) times Executive's Annual Base Salary at the rate in effect immediately before the Executive's Termination Date, (y) three (3) times Executive's Annual Bonus, and (z) the Bonus Multiplier times Executive's Annual Bonus. (ii) For a period of thirty-six (36) months following his Termination Date, Executive shall continue to receive the medical and dental coverage in effect on his Termination Date (or generally comparable coverage) for himself and, where applicable, his spouse and dependents, as the same may be changed from time to time for employees generally, as if Executive had continued in employment during such period; or, as an -4- alternative, the Company may elect to pay Executive cash in lieu of such coverage in an amount equal to Executive's after-tax cost of continuing such coverage, where such coverage may not be continued (or where such continuation would adversely affect the tax status of the plan pursuant to which the coverage is provided). The COBRA health care continuation coverage period under section 4980B of the Code, shall run concurrently with the foregoing thirty-six (36) month benefit period. (iii) All stock options and restricted stock held by Executive will become fully vested and/or exercisable, as the case may be, on the Termination Date, and all stock options shall remain exercisable after the Executive's Termination Date as set forth in the applicable option agreements with the Company. (iv) To cover the cost of outplacement assistance services for Executive provided by an outplacement agency selected by Executive in an amount not to exceed $15,000. (v) Executive shall receive any amounts earned, accrued or owing but not yet paid to Executive as of his Termination Date, payable in a lump sum, and any benefits accrued or earned in accordance with the terms of any applicable benefit plans and programs of the Company. (c) Notice of Termination. Any termination on account of this Section 3 shall be communicated by a Notice of Termination to the other Parties hereto in accordance with Section 18 hereof. 4. Termination of Employment on Account of Disability. Notwithstanding anything in this Agreement to the contrary, if Executive's employment terminates on account of Disability, Executive shall be entitled to receive disability benefits under any disability program maintained by the Company that covers Executive, and Executive shall not be considered to have terminated employment under this Agreement and shall not receive benefits pursuant to Sections 2 and 3 hereof. 5. Release. Notwithstanding the foregoing, no such payments shall be made unless Executive executes, and does not revoke, the Company's standard written release (the "Release"), of any and all claims against the Company and all related parties with respect to all matters arising out of Executive's employment by the Company (other than any entitlements under the terms of this Agreement or under any other plans or programs of the Company in which Executive participated and under which Executive has accrued or become entitled to a benefit) or the termination thereof. 6. Other Payments. The payments due under Sections 2 and 3 hereof shall be in addition to and not in lieu of any payments or benefits due to Executive under any other plan, policy or program of the Company, including, but not limited to, benefits required to be provided to him under the terms of his split dollar life insurance agreement, if any, with the Company, except that no cash payments shall be paid to Executive under the Company's then current severance pay policies. -5- 7. Enforcement. (a) In the event that the Company shall fail or refuse to make payment of any amounts due Executive under Sections 2, 3 and 6 hereof within the respective time periods provided therein, the Company shall pay to Executive, in addition to the payment of any other sums provided in this Agreement, interest, compounded daily, on any amount remaining unpaid from the date payment is required under Sections 2, 3 and 6, as appropriate, until paid to Executive, at the rate from time to time announced by First Union Bank as its "prime rate" plus 2%, each change in such rate to take effect on the effective date of the change in such prime rate. (b) It is the intent of the Parties that Executive not be required to incur any expenses associated with the enforcement of his rights under Sections 2, 3 and 6 of this Agreement by arbitration, litigation or other legal action because the cost and expense thereof would substantially detract from the benefits intended to be extended to Executive hereunder. Accordingly, the Company shall pay Executive on demand the amount necessary to advance to or reimburse Executive in full for all expenses (including all attorneys' fees and legal expenses) incurred by Executive in enforcing any of the obligations of the Company under this Agreement. 8. No Mitigation. Executive shall not be required to mitigate the amount of any payment or benefit provided for in this Agreement by seeking other employment or otherwise, nor shall the amount of any payment or benefit provided for herein be reduced by any compensation earned by other employment or otherwise. 9. Non-Exclusivity of Rights. Except as provided in Section 6, nothing in this Agreement shall prevent or limit Executive's continuing or future participation in or rights under any benefit, bonus, incentive or other plan or program provided by the Company or any of its subsidiaries or affiliates and for which Executive may qualify. 10. No Set-Off. The Company's obligation to make the payments provided for in this Agreement and otherwise to perform its obligations hereunder shall not be affected by any circumstances, including, without limitation, any set-off, counterclaim, recoupment, defense or other right which the Company may have against Executive or others. 11. Taxes. Any payment required under this Agreement shall be subject to all requirements of the law with regard to the withholding of taxes, filing, making of reports and the like, and the Company shall use its best efforts to satisfy promptly all such requirements. 12. Certain Increases in Payment. (a) Anything in this Agreement to the contrary notwithstanding, in the event that it shall be determined that any payment or distribution by the Company to or for the benefit of Executive, whether paid or payable or distributed or distributable pursuant to the terms of this Agreement or otherwise (the "Payment"), would constitute an "excess parachute payment" within the meaning of section 280G of the Code, Executive shall be paid an additional amount (the "Gross-Up Payment") such that the net amount retained by Executive after deduction of any excise tax imposed under section 4999 of the Code, and any federal, state and local income and employment tax and excise tax imposed upon the Gross-Up Payment shall be equal to the Payment. For purposes of determining the amount of the Gross-Up Payment, Executive shall be -6- deemed to pay federal income tax and employment taxes at the highest marginal rate of federal income and employment taxation in the calendar year in which the Gross-Up Payment is to be made and state and local income taxes at the highest marginal rate of taxation in the state and locality of Executive's residence (or, if greater, the state and locality in which Executive is required to file a nonresident income tax return with respect to the Payment) on the Termination Date, net of the maximum reduction in federal income taxes that may be obtained from the deduction of such state and local taxes. (b) All determinations to be made under this Section 12 shall be made by the Company's independent public accountant immediately prior to the Change in Control (the "Accounting Firm"), which firm shall provide its determinations and any supporting calculations both to the Company and Executive within 10 days of the Termination Date. Any such determination by the Accounting Firm shall be binding upon the Company and Executive. Within five days after the Accounting Firm's determination, the Company shall pay (or cause to be paid) or distribute (or cause to be distributed) to or for the benefit of Executive such amounts as are then due to Executive under this Agreement. (c) Executive shall notify the Company in writing of any claim by the Internal Revenue Service that, if successful, would require the payment by the Company of the Gross-Up Payment. Such notification shall be given as soon as practicable but no later than ten business days after Executive knows of such claim and shall apprise the Company of the nature of such claim and the date on which such claim is requested to be paid. Executive shall not pay such claim prior to the expiration of the thirty day period following the date on which he gives such notice to the Company (or such shorter period ending on the date that any payment of taxes with respect to such claim is due). If the Company notifies Executive in writing prior to the expiration of such period that it desires to contest such claim, Executive shall: (i) give the Company any information reasonably requested by the Company relating to such claim; (ii) take such action in connection with contesting such claim as the Company shall reasonably request in writing from time to time, including, without limitation, accepting legal representation with respect to such claim by an attorney reasonably selected by the Company; (iii) cooperate with the Company in good faith in order to effectively contest such claim; and (iv) permit the Company to participate in any proceedings relating to such claim; provided, however, that the Company shall bear and pay directly all costs and expenses (including additional interest and penalties) incurred in connection with such contest and shall indemnify and hold Executive harmless, on an after-tax basis, for any excise tax, income tax or employment tax, including interest and penalties, with respect thereto, imposed as a result of such representation and payment of costs and expenses. Without limitation on the foregoing provisions of this Section 12, the Company shall control all proceedings taken in connection with -7- such contest and, at its sole option, may pursue or forego any and all administrative appeals, proceedings, hearing and conferences with the taxing authority in respect of such claim and may, at its sole option, either direct Executive to pay the tax claimed and sue for a refund or contest the claim in any permissible manner, and Executive agrees to prosecute such contest to a termination before any administrative tribunal, in a court of initial jurisdiction and in one or more appellate courts, as the Company shall determine; provided further, however, that if the Company directs Executive to pay such claim and sue for a refund, the Company shall advance the amount of such payment to Executive, on an interest-free basis and shall indemnify and hold Executive harmless, on an after-tax basis, from any excise tax, income tax or employment tax, including interest or penalties with respect thereto, imposed with respect to such advance or with respect to any imputed income with respect to such advance; and provided further that any extension of the statute of limitations relating to payment of taxes for the taxable year of Executive with respect to which such contested amount is claimed to be due is limited solely to such contested amount. Furthermore, the Company's control of the contest shall be limited to issues with respect to which a Gross-Up Payment would be payable hereunder and Executive shall be entitled to settle or contest, as the case may be, any other issue raised by the Internal Revenue Service or any other taxing authority. (d) If, after the receipt by Executive of an amount advanced by the Company pursuant to this Section, Executive becomes entitled to receive any refund with respect to such claim, Executive shall (subject to the Company's complying with the requirements of this Section) promptly pay to the Company the amount of such refund (together with any interest paid or credited thereon after taxes applicable thereto). If, after the receipt by Executive of an amount advanced by the Company pursuant to this Section, a determination is made that Executive shall not be entitled to any refund with respect to such claim and the Company does not notify Executive in writing of its intent to contest such denial of refund prior to the expiration of thirty days after such determination, then such advance shall be forgiven and shall not be required to be repaid and the amount of such advance shall offset, to the extent thereof, the amount of Gross-Up Payment required to be paid. (e) All of the fees and expenses of the Accounting Firm in performing the determinations referred to in this Section shall be borne solely by the Company. The Company agrees to indemnify and hold harmless the Accounting Firm of and from any and all claims, damages and expenses resulting from or relating to its determinations pursuant to this Section, except for claims, damages or expenses resulting from the gross negligence or willful misconduct of the Accounting Firm. 13. Confidential Information. Executive shall remain subject to the terms and conditions of his Employee Confidentiality Agreement, which shall continue in full force and effect, except as specifically modified herein. 14. Non-Competition. (a) During the period of Executive's employment by the Company and, if Executive's employment with the Company terminates for any reason other that described in Section 3(a) above, for a period of one (1) year thereafter, except with the written consent of the Board, Executive shall not directly or indirectly, own, manage, operate, join, control, finance or -8- participate in the ownership, management, operation, control or financing of, or be connected as an officer, director, employee, partner, principal, agent, representative, stockholder, consultant, investor or otherwise with, or use or permit his name to be used in connection with, any person, business or enterprise which directly or indirectly engages in (i) the development of compounds, or (ii) the sale or marketing of products, that compete with the Company's compounds or products (the "Company's Business"). In further consideration for the Company's promises herein, Executive agrees that for the period beginning with the termination of his employment with the Company for any reason other than that described in Section 3(a) above, and for a period of one (1) year thereafter, Executive will not: (i) except with the prior written consent of the Board, directly or indirectly solicit, entice or induce any customer to become a customer of any other person, firm or corporation with respect to the Company's Business or to cease doing business with the Company or its subsidiaries or affiliates, and that Executive will not approach any such person, firm or corporation for such purpose or authorize or knowingly approve, encourage or assist the taking of such actions by any other person, firm or corporation; or (ii) directly or indirectly solicit, recruit or hire any part-time or full-time employee, representative or consultant of the Company or its subsidiaries or affiliates to work for a third party other than the Company or its subsidiaries or affiliates or engage in any activity that would cause any employee, representative or consultant to violate any agreement with the Company or its subsidiaries or affiliates. The foregoing covenant shall not apply to any person after twelve (12) months have elapsed after the date on which such person's employment by the Company has terminated. (b) The foregoing restrictions shall not be construed to prohibit Executive's ownership of less than five percent of any class of securities of any corporation which is engaged in any of the foregoing businesses and has a class of securities registered pursuant to the Securities Exchange Act of 1934, as amended, provided that such ownership represents a passive investment and that neither Executive nor any group of persons including Executive in any way, either directly or indirectly, manages or exercises control of any such corporation, guarantees any of its financial obligations, otherwise takes any part in its business, other than exercising Executive's rights as a stockholder, or seeks to do any of the foregoing. 15. Equitable Relief. (a) Executive acknowledges that the restrictions contained in Sections 13 and 14 hereof are reasonable and necessary to protect the legitimate interests of the Company and its affiliates, that the Company would not have entered into this Agreement in the absence of such restrictions, and that any violation of any provision of those Sections will result in irreparable injury to the Company. Executive represents that his experience and capabilities are such that the restrictions contained in Section 14 hereof will not prevent Executive from obtaining employment or otherwise earning a living at the same general level of economic benefit as is currently the case. Executive further represents and acknowledges that (i) he has been advised by the Company to consult his own legal counsel in respect of this Agreement, and (ii) that he -9- has had full opportunity, prior to execution of this Agreement, to review thoroughly this Agreement with his counsel. (b) Executive agrees that the Company shall be entitled to preliminary and permanent injunctive relief, without the necessity of proving actual damages, as well as an equitable accounting of all earnings, profits and other benefits arising from any violation of Sections 13 or 14 hereof, which rights shall be cumulative and in addition to any other rights or remedies to which the Company may be entitled. In the event that any of the provisions of Sections 13 or 14 hereof should ever be adjudicated to exceed the time, geographic, service, or other limitations permitted by applicable law in any jurisdiction, then such provisions shall be deemed reformed in such jurisdiction to the maximum time, geographic, service, or other limitations permitted by applicable law. (c) Executive irrevocably and unconditionally (i) agrees that any suit, action or other legal proceeding arising out of Section 13 or 14 hereof, including without limitation, any action commenced by the Company for preliminary and permanent injunctive relief or other equitable relief, may be brought in the United States District Court for the District of Delaware, or if such court does not have jurisdiction or will not accept jurisdiction, in any court of general jurisdiction in Delaware, (ii) consents to the non-exclusive jurisdiction of any such court in any such suit, action or proceeding, and (iii) waives any objection which Executive may have to the laying of venue of any such suit, action or proceeding in any such court. Executive also irrevocably and unconditionally consents to the service of any process, pleadings, notices or other papers in a manner permitted by the notice provisions of Section 18 hereof. 16. Term of Agreement. This Agreement shall continue in full force and effect for the duration of Executive's employment with the Company; provided, however, that after the termination of Executive's employment during the term of this Agreement, this Agreement shall remain in effect until all of the obligations of the Parties hereunder are satisfied or have expired. 17. Successor Company. The Company shall require any successor or successors (whether direct or indirect, by purchase, merger, consolidation or otherwise) to all or substantially all of the business and/or assets of the Company, by agreement in form and substance satisfactory to Executive, to acknowledge expressly that this Agreement is binding upon and enforceable against the Company in accordance with the terms hereof, and to become jointly and severally obligated with the Company to perform this Agreement in the same manner and to the same extent that the Company would be required to perform if no such succession or successions had taken place. Failure of the Company to obtain such agreement prior to the effectiveness of any such succession shall be a breach of this Agreement. As used in this Agreement, the Company shall mean the Company as herein before defined and any such successor or successors to its business and/or assets, jointly and severally. 18. Notice. All notices and other communications required or permitted hereunder or necessary or convenient in connection herewith shall be in writing and shall be delivered personally or mailed by registered or certified mail, return receipt requested, or by overnight express courier service, as follows: -10- If to the Company, to: Cephalon, Inc. 145 Brandywine Parkway West Chester, PA 19380 Attn:_______________ With a copy to: Morgan, Lewis & Bockius LLP 1701 Market Street Philadelphia, PA 19103-2921 Attn: I. Lee Falk, Esquire If to Executive, to: ____________ ____________ ____________ or to such other names or addresses as the Company or Executive, as the case may be, shall designate by notice to the other Parties hereto in the manner specified in this Section; provided, however, that if no such notice is given by the Company following a change in control, notice at the last address of the Company or to any successor pursuant to this Section 18 shall be deemed sufficient for the purposes hereof. Any such notice shall be deemed delivered and effective when received in the case of personal delivery, five days after deposit, postage prepaid, with the U.S. Postal Service in the case of registered or certified mail, or on the next business day in the case of overnight express courier service. 19. Governing Law. This Agreement shall be governed by and interpreted under the laws of the State of Delaware without giving effect to any conflict of laws provisions. 20. Contents of Agreement, Amendment and Assignment. (a) This Agreement supersedes all prior agreements, sets forth the entire understanding between the Parties hereto with respect to the subject matter hereof and cannot be changed, modified, extended or terminated except upon written amendment executed by Executive and executed on the Company's behalf by a duly authorized officer. The provisions of this Agreement may provide for payments to Executive under certain compensation or bonus plans under circumstances where such plans would not provide for payment thereof. It is the specific intention of the Parties that the provisions of this Agreement shall supersede any provisions to the contrary in such plans, and such plans shall be deemed to have been amended to correspond with this Agreement without further action by the Company or the Board. -11- (b) Nothing in this Agreement shall be construed as giving Executive any right to be retained in the employ of the Company, or as changing or modifying the "at will" nature of Executive's employment status. (c) All of the terms and provisions of this Agreement shall be binding upon and inure to the benefit of and be enforceable by the respective heirs, representatives, successors and assigns of the Parties hereto, except that the duties and responsibilities of Executive and the Company hereunder shall not be assignable in whole or in part by the Company. If Executive should die after his Termination Date and while any amount payable hereunder would still be payable to Executive hereunder if Executive had continued to live, all such amounts, unless otherwise provided herein, shall be paid in accordance with the terms of this Agreement to Executive's devises, legates or other designees or, if there is no such designee, to Executive's estate. 21. Severability. If any provision of this Agreement or application thereof to anyone or under any circumstances shall be determined to be invalid or unenforceable, such invalidity or unenforceability shall not affect any other provisions or applications of this Agreement which can be given effect without the invalid or unenforceable provision or application. 22. Remedies Cumulative; No Waiver. No right conferred upon the Parties by this Agreement is intended to be exclusive of any other right or remedy, and each and every such right or remedy shall be cumulative and shall be in addition to any other right or remedy given hereunder or now or hereafter existing at law or in equity. No delay or omission by a Party in exercising any right, remedy or power hereunder or existing at law or in equity shall be construed as a waiver thereof. 23. Miscellaneous. All section headings are for convenience only. This Agreement may be executed in several counterparts, each of which is an original. It shall not be necessary in making proof of this Agreement or any counterpart hereof to produce or account for any of the other counterparts. -12- IN WITNESS WHEREOF, the undersigned, intending to be legally bound, have executed this Agreement as of the date first above written. CEPHALON, INC. Attest: ____________________ By: __________________________ Its: __________________________ _____________________________ _______________________________ Witness EXECUTIVE -13- EX-99.1 7 dex991.txt CERTIFICATION FOR FRANK BALDINO, JR. Exhibit 99.1 CERTIFICATION PURSUANT TO 18 U.S.C. SECTION 1350, AS ADOPTED PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002 In connection with the Quarterly Report of Cephalon, Inc. (the "Company") on Form 10-Q for the period ending June 30, 2002 as filed with the Securities and Exchange Commission on the date hereof (the "Report"), I, Frank Baldino, Jr., Chairman and Chief Executive Officer of the Company, certify, pursuant to 18 U.S.C. (S) 1350, as adopted pursuant to (S) 906 of the Sarbanes-Oxley Act of 2002, that: (1) The Report fully complies with the requirements of section 13(a) or 15(d) of the Securities Exchange Act of 1934; and (2) The information contained in the Report fairly presents, in all material respects, the financial condition and result of operations of the Company. /s/ Frank Baldino, Jr. Frank Baldino, Jr., Ph.D. Chairman and Chief Executive Officer August 13, 2002 EX-99.2 8 dex992.txt CERTIFICATION FOR J. KEVIN BUCHI Exhibit 99.2 CERTIFICATION PURSUANT TO 18 U.S.C. SECTION 1350, AS ADOPTED PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002 In connection with the Quarterly Report of Cephalon, Inc. (the "Company") on Form 10-Q for the period ending June 30, 2002 as filed with the Securities and Exchange Commission on the date hereof (the "Report"), I, J. Kevin Buchi, Sr. Vice President and Chief Financial Officer of the Company, certify, pursuant to 18 U.S.C. (S) 1350, as adopted pursuant to (S) 906 of the Sarbanes-Oxley Act of 2002, that: (1) The Report fully complies with the requirements of section 13(a) or 15(d) of the Securities Exchange Act of 1934; and (2) The information contained in the Report fairly presents, in all material respects, the financial condition and result of operations of the Company. /s/ J. Kevin Buchi J. Kevin Buchi Sr. Vice President and Chief Financial Officer August 13, 2002 -----END PRIVACY-ENHANCED MESSAGE-----