-----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, GJKOBwTkEncilscq4gDXTyb4hPD95mDpidhvcqyOdoHX/ToQs2ZrupNJ/p7RJBqT VTcYcWGFtBFwcid4j1/yjw== 0001036050-00-000510.txt : 20000331 0001036050-00-000510.hdr.sgml : 20000331 ACCESSION NUMBER: 0001036050-00-000510 CONFORMED SUBMISSION TYPE: 10-K405 PUBLIC DOCUMENT COUNT: 6 CONFORMED PERIOD OF REPORT: 19991231 FILED AS OF DATE: 20000330 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-K405 SEC ACT: SEC FILE NUMBER: 000-19119 FILM NUMBER: 585578 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-K405 1 FORM 10-K - ------------------------------------------------------------------------------- - ------------------------------------------------------------------------------- SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 ---------------- FORM 10-K (Mark One) [X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the fiscal year ended December 31, 1999 OR [_] 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 or other jurisdiction of (I.R.S. Employer Incorporation or Organization) Identification No.)
145 Brandywine Parkway, West Chester, Pennsylvania 19380-4245 (Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (610) 344-0200 Securities registered pursuant to Section 12(b) of the Act:
Title of Name of each each class exchange on which registered ---------- ---------------------------- None None
Securities registered pursuant to Section 12(g) of the Act: Common Stock, par value $.01 per share (Title of Class) Indicate by check mark whether the registrant (1) has filed all reports 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 by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of the registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. [X] The aggregate market value of the voting stock held by non-affiliates of the registrant is approximately $1,193,374,192. Such aggregate market value was computed by reference to the closing price of the Common Stock as reported on the Nasdaq National Market on March 21, 2000. For purposes of making this calculation only, the registrant has defined affiliates as including all directors, executive officers and beneficial owners of more than ten percent of the Common Stock of the Company. The number of shares of the registrant's Common Stock outstanding as of March 21, 2000 was 33,264,686. DOCUMENTS INCORPORATED BY REFERENCE Portions of the registrant's definitive proxy statement for its 2000 annual meeting of stockholders are incorporated by reference into Part III. - ------------------------------------------------------------------------------- - ------------------------------------------------------------------------------- TABLE OF CONTENTS PART I ITEM 1. Business..................................................... 3 ITEM 2. Properties................................................... 19 ITEM 3. Legal Proceedings............................................ 19 ITEM 4. Submission of Matters to a Vote of Security Holders.......... 20 PART II ITEM 5. Market for Registrant's Common Equity and Related Stockholder Matters...................................................... 21 ITEM 6. Selected Consolidated Financial Data......................... 22 ITEM 7. Management's Discussion and Analysis of Financial Condition and Results of Operations.................................... 23 ITEM 7A. Quantitative and Qualitative Disclosure About Market Risk.... 36 ITEM 8. Financial Statements and Supplementary Data.................. 37 ITEM 9. Changes In and Disagreements with Accountants on Accounting and Financial Disclosure .................................... 54 PART III ITEM 10. Directors and Executive Officers of the Registrant........... 54 ITEM 11. Executive Compensation....................................... 56 ITEM 12. Security Ownership of Certain Beneficial Owners and Management................................................... 56 ITEM 13. Certain Relationships and Related Transactions............... 56 PART IV ITEM 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K.......................................................... 57 SIGNATURES ............................................................. 63
2 PART I ITEM 1. 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 above and in this report. 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 (and we are not obligated) to update publicly any forward-looking statements. Risks that we anticipate are discussed in more detail in the section entitled "Management's Discussion and Analysis of Financial Condition and Results of Operations--Certain Risks Related to Our Business." This discussion is permitted by the Private Securities Litigation Reform Act of 1995. We market PROVIGIL(R) (modafinil) Tablets [C-IV] for treating excessive daytime sleepiness associated with narcolepsy. We began marketing the product in the United States in 1999, and also market the product in the United Kingdom, the Republic of Ireland and Austria. In addition, we hold commercial rights to PROVIGIL in Italy, Switzerland, Latin America, Japan, South Korea and Taiwan; in these territories, we either are collaborating with, or seeking to collaborate with, a corporate partner to develop and further market the product. We have an ongoing clinical program to explore the utility of PROVIGIL in treating excessive daytime sleepiness and fatigue associated with disorders other than narcolepsy. We have completed studies using PROVIGIL in patients suffering from fatigue associated with multiple sclerosis, and excessive daytime sleepiness due to obstructive sleep apnea, as well as a study to demonstrate improvement in performance and alertness in a simulated shiftwork environment. We have initiated a study to investigate PROVIGIL's use in treating attention deficit hyperactivity disorder in adults and a second study in obstructive sleep apnea. Depending upon the results of our studies and discussions with the Food and Drug Administration, or FDA, we may decide to pursue regulatory approval to market PROVIGIL for a range of indications, each of which would require us to successfully complete additional clinical studies. Our future success is highly dependent on the commercial success of PROVIGIL in the United States. In addition to our clinical program focused on PROVIGIL, we have other significant research programs that seek to discover and develop treatments for neurological and oncological disorders. We have formed alliances with TAP Holdings, Inc. and Schwarz Pharma AG for the development of signal transduction modulators to treat cancers, including prostate and pancreatic cancers. TAP has completed two Phase I clinical studies and recently initiated a Phase II clinical program in patients with prostate cancer, using the program's orally administered lead molecule, CEP-701. Schwarz Pharma is expected to initiate clinical studies in Europe in 2000 using CEP-701. We are collaborating with H. Lundbeck A/S for the development of signal transduction modulators to treat neurodegenerative disorders, including Parkinson's and Alzheimer's diseases. Cephalon and Lundbeck have initiated a Phase I clinical study using the program's orally administered lead molecule, CEP-1347. In addition, we are collaborating with Leo Pharmaceuticals for the development of gene transcription regulators for the treatment of Alzheimer's disease. We also enter into collaborative commercial arrangements where we market the products of third parties. In June 1999, we entered into an agreement with Abbott Laboratories, Inc. to market and further develop GABITRIL(R) (tiagabine hydrochloride), an adjunctive treatment for partial seizures associated with epilepsy. 3 COMMERCIAL PRODUCTS
Product Indication Status - ------------------------------------------------------------------------------- PROVIGIL(1)....... Excessive daytime sleepiness (EDS) in narcolepsy Marketed EDS in obstructive sleep apnea (OSA) Phase III and other disorders Fatigue in multiple sclerosis (MS) Phase II Attention deficit hyperactivity disorder (ADHD) Phase II GABITRIL(2)....... Epilepsy Marketed STADOL NS(3)...... Migraine pain Marketed APOKINON(4)....... Parkinson's Disease Marketed
(1) We acquired from Laboratoire L. Lafon rights to develop and market PROVIGIL in Italy, Latin America, the Republic of Ireland, the United Kingdom, the United States, Japan and several other countries in Asia. We granted certain rights in Italy and Japan to Dompe S.p.A. and Azwell, Inc., respectively. We acquired rights to market and promote PROVIGIL in Austria and Switzerland from Merckle GmbH, another licensee of Lafon. (2) In the United States, we co-market and co-develop GABITRIL(R) (tiagabine hydrochloride), a proprietary product of Abbott Laboratories, Inc. (3) In the United States, we promote and market STADOL NS(R) (butorphanol tartrate), a proprietary product of Bristol-Myers Squibb Company. (4) In France, we promote and market APOKINON(R) (apomorphine hydrochloride), a proprietary product of Laboratoire Aguettant S.A. PROVIGIL Narcolepsy Narcolepsy is a debilitating, lifelong disorder that often originates in late childhood. Its most notable symptom is an uncontrollable propensity to fall asleep during the day. There is no cure for narcolepsy, which is estimated to affect over 125,000 people in the United States, of which approximately 45,000 are believed to currently seek treatment from a physician. We believe that there is a proportionate incidence of narcolepsy in the other territories in which we have obtained a license, but the relative extent of diagnosis and treatment in those other countries varies and is believed to be not as high as it is in the United States. We conducted two Phase III, double-blind, placebo-controlled, nine-week multi-center studies of PROVIGIL with more than 550 patients who met the American Sleep Disorders Association criteria for narcolepsy. Subjects in both studies were randomized to a daily dose of PROVIGIL 200 mg, PROVIGIL 400 mg, or placebo. Both studies demonstrated improvement in objective and subjective measures of excessive daytime sleepiness for both the 200 mg and 400 mg doses compared to placebo. PROVIGIL was found to be generally well tolerated, with a low incidence of adverse events relative to placebo. Most adverse events were mild to moderate; the most commonly observed were headache, infection, nausea, nervousness, anxiety, and insomnia. No specific symptoms of withdrawal were observed after discontinuation of PROVIGIL therapy. The FDA approved dosing is 200 mg once daily. Disorders other than narcolepsy Due to the proven efficacy of PROVIGIL in reducing excessive daytime sleepiness, or EDS, associated with narcolepsy, we believe that PROVIGIL may have utility in treating sleepiness and fatigue in disorders other than 4 narcolepsy. Our ongoing clinical program focuses on exploring PROVIGIL's potential use in treating fatigue associated with neurological disorders such as multiple sclerosis, EDS associated with sleep disorders such as obstructive sleep apnea, hypersomnia and shiftwork/circadian rhythm disorders and attention deficit hyperactivity disorder. We can not be sure that we will receive regulatory approval for any indication beyond EDS associated with narcolepsy. Under current FDA regulations, we are limited in our ability to promote PROVIGIL outside its approved use. . EDS in Obstructive Sleep Apnea Individuals with obstructive sleep apnea, or OSA, experience frequent awakenings, sometimes occurring hundreds of times during the night as a result of blockage of the airway passage during sleep. OSA afflicts more than 12 million Americans, of whom approximately 1 million are currently treated. Patients suffering from OSA may be excessively sleepy during the day because of disruption to their normal sleep cycle, even when the underlying disease is treated. We have completed a multi-center, double- blind, placebo-controlled study in the United States which demonstrated that PROVIGIL reduced the daytime sleepiness in these patients in a statistically significant manner. . EDS in Shiftwork/Circadian Rhythm Disorders Because shift workers typically work during the night, they often experience a disruption in their sleep/wake cycle, which can lead to impaired performance. Many industrial accidents occur at night and have been at least partially attributable to operator fatigue. According to the U.S. Department of Labor, approximately 14 million Americans are shift workers. We have completed a placebo-controlled simulated shiftwork study that showed that 200mg of PROVIGIL promoted alertness and improved performance as measured by several validated scales. These data were statistically significant. . Fatigue in Multiple Sclerosis Patients suffering from multiple sclerosis may suffer from fatigue and sleepiness caused either by their disease or by the therapeutics used to treat it. Approximately 80% of the 250,000--350,000 people with multiple sclerosis experience fatigue; in many patients, fatigue may be the most prominent and disabling symptom. We have completed a placebo-controlled multiple sclerosis fatigue study that showed that 200mg of PROVIGIL reduced fatigue in those patients. This reduction was statistically significant as measured by several validated fatigue rating scales. . Attention Deficit Hyperactivity Disorder Attention deficit hyperactivity disorder, or ADHD, is characterized by an inability to concentrate on tasks and may lead to disruptive behavior, especially in children. ADHD afflicts 7 million Americans, of whom approximately 1.5 million are currently treated. We are conducting a multi- center, double-blind, placebo-controlled study with PROVIGIL in adult sufferers of ADHD. PROVIGIL: Collaborations . Laboratoire L. Lafon Under our agreements with Lafon, a French pharmaceutical company, we have obtained an exclusive license to develop, market and sell PROVIGIL in Italy, Japan, Latin America, the Republic of Ireland, the United Kingdom, the United States and several countries in Asia. Under the agreements, Lafon supplies bulk modafinil compound, the active drug substance in PROVIGIL, for our commercial use at a purchase price equal to a percentage of net product sales. In addition, we pay trademark and license royalties, which also are calculated as a percentage of net product sales. . Azwell, Inc. In June 1998, we entered into an agreement with Azwell, a Japanese pharmaceutical company, to develop and market PROVIGIL in Japan. Azwell is responsible for funding product development activities, 5 conducting clinical trials and seeking authorization to market PROVIGIL in Japan. We will supply bulk modafinil compound to Azwell for use in Japanese clinical trials, which are expected to commence in 2000. We will receive a percentage of net product sales as a license royalty and in exchange for supplying bulk compound for commercial use. We also will receive payments upon the achievement of certain milestones. The agreement with Azwell expires ten years from the date of initial commercial sale. .Dompe S.p.A. In June 1998, we entered into an agreement with Dompe, an Italian pharmaceutical company, under which we granted Dompe the right to market, sell and distribute PROVIGIL in Italy. We jointly manage regulatory matters and Dompe is obligated to fund a minimum of promotional activities during the first two years following commercial launch. We supply finished product to Dompe for a purchase price equal to a percentage of net product sales. The agreement with Dompe has an initial term of ten years and automatically renews for successive two-year periods unless terminated by either party upon 180 days notice prior to the expiration. .Merckle GmbH In October 1998, we entered into an agreement with Merckle, a German pharmaceutical company, under which we obtained the rights to market and promote PROVIGIL in Austria and Switzerland for the treatment of narcolepsy. Under the agreement, we are responsible for promoting and marketing the product while Merckle retains responsibility for all other activities. We receive quarterly compensation from Merckle based on sales levels achieved. The agreement with Merckle has a ten-year term. GABITRIL Epilepsy Epilepsy is a chronic disorder characterized by seizures that cause sudden, involuntary, time limited alteration in behavior including a change in motor activity, autonomic function, consciousness, or sensation which is accompanied by an abnormal electrical discharge in the brain. A partial seizure arises from a disorder emanating from a distinct, identifiable region of the brain and produces a given set of symptoms depending on the area of onset. A general seizure arises from a general dysfunction of biochemical mechanisms throughout the brain and may produce different types of convulsions. Epilepsy usually begins in early childhood, but can appear at any time during an individual's lifespan. It is estimated that more than 2 million Americans suffer from epilepsy, of which approximately 1.4 million are treated by physicians. Abbott Laboratories, Inc. In June 1999, we entered into a collaborative agreement with Abbott to market and further develop GABITRIL(R) (tiagabine hydrochloride) in the United States. GABITRIL is an antiepilepsy drug used as adjunctive therapy in the treatment of partial seizures. Under the agreement, we are required to make calls on physicians and contribute to marketing and clinical trial activities for GABITRIL. In exchange, we receive quarterly compensation from Abbott calculated as a percentage of sales in excess of a base amount. The agreement expires in April 2010 unless extended by mutual agreement. Other Commercial Collaborations Bristol-Myers Squibb Company In July 1994, we entered into a co-promotion agreement with Bristol-Myers to promote and market STADOL NS(R) (butorphanol tartrate) to neurologists in the United States. STADOL NS is indicated for the management of pain when the use of an opioid analgesic is appropriate. We receive compensation from Bristol- Myers equal to a percentage of total STADOL NS sales attributed to prescriptions written by neurologists which exceeds a predetermined base amount. This agreement expires at the end of December 2000. We may terminate this agreement upon 90 days notice. 6 Laboratoire Aguettant S.A. In December 1997, we entered into an agreement with Aguettant to promote and market APOKINON(R) (apomorphine hydrochloride) to neurologists in France. APOKINON, which is injected subcutaneously by a unique metered dose injection, is indicated for the treatment of levadopa therapy fluctuations common in late-stage Parkinson's disease. In return for marketing rights, we make annual payments to Aguettant during the first five years of the agreement. We receive quarterly compensation from Aguettant primarily based on a rate per unit of APOKINON sold. The ten-year agreement automatically renews for successive one- year periods unless terminated by either party upon 90 days notice. RESEARCH AND DEVELOPMENT Our research and development efforts focus primarily on two areas: neurodegenerative disorders and cancers. Neurodegenerative disorders are characterized by the death of neurons (the specialized conducting cells of the nervous system) that results in the loss of certain functions such as memory and motor coordination. Cancers are characterized by the uncontrolled proliferation of cells that form tumors. Our research strategy has focused on understanding the intracellular molecular events that underlie the processes of cell proliferation, cell survival and cell death. We utilize our technical expertise in molecular biology, molecular pharmacology, biochemistry, cell biology, tumor biology and chemistry to create novel, orally active, synthetic molecules to inhibit key targets in intracellular pathways that govern cell proliferation, survival and death. These novel molecules are designed to (i) enhance the survival of neurons, thereby intervening in the progression of neurodegenerative disease or (ii) facilitate the death of tumor cells leading to new therapies in oncology. We believe that our technology facilitates the development of a portfolio of potential products for the treatment of (i) neurological disorders in which neuronal death is a primary pathology such as Parkinson's disease, Alzheimer's disease and stroke, and (ii) oncological disorders where cellular proliferation is a primary pathology such as prostate cancer, pancreatic cancer and a variety of other cancers. Our research programs currently focus on four core technology areas: signal transduction modulators, gene transcription regulators, protease inhibitors and neurotrophic factors.
Program Indication Status(1) Commercial Rights - --------------------------------------------------------------------------------------- Signal Transduction Parkinson's and Phase I Cephalon/Lundbeck/Kyowa Hakko Modulators............. Alzheimer's diseases Prostate and Phase II Cephalon/TAP/Kyowa pancreatic cancer Hakko/Schwarz Pharma Solid tumors Development Cephalon Gene Transcription Regulators............. Alzheimer's disease Development Cephalon/Leo Protease Inhibitors..... Alzheimer's disease Research Cephalon Stroke Research Cephalon Neurotrophic Factors (MYOTROPHIN) .......... ALS NDA(2) Cephalon/Chiron/Kyowa Hakko
- -------- (1) "Research" includes the identification of novel molecular targets, development of assay systems, discovery and evaluation of prototype compounds in vitro and in vivo. "Development" includes product formulation, toxicology and additional animal testing of a lead compound. "Phase I" clinical trials involves administration of a product to a limited number of subjects to assess safety, pharmacokinetics and determine 7 appropriate dosage. "Phase II" clinical trials generally involve administration of a product to a limited number of patients with a particular disorder to determine dosage, efficacy and safety. "Phase III" clinical trials generally examine the clinical efficacy and safety of a product in an expanded patient population at multiple clinical sites. "NDA" indicates that a new drug application has been filed with the FDA in the United States for the treatment of the indication listed. See "Government Regulation." (2) We have conducted clinical trials using MYOTROPHIN(R) (mecasermin) Injection in amyotrophic lateral sclerosis, or ALS, patients in North America and Europe. In February 1997 Cephalon and Chiron submitted an NDA to the FDA for approval to market MYOTROPHIN in the United States for the treatment of ALS. In May 1998 the FDA issued a letter stating that the NDA was "potentially approvable," under certain conditions. At this time, we do not believe those conditions can be met without conducting an additional Phase III clinical study. Signal Transduction Modulators Survival of cells, including neurons, is regulated and influenced by factors that exert differential effects on the cell by promoting cell survival or inducing cell death through activation of intracellular signaling pathways. Once activated, these pathways initiate a series of biochemical events, controlled in large part by intracellular kinases, that regulate the molecular pathways of survival or death. Our signal transduction modulator program focuses on identifying small molecules that modulate these signal transduction events. Neurology In neurodegenerative disorders where neuronal death is a primary pathology and results in the clinical condition, a growing body of research suggests that specific molecular processes are activated which leads to progressive neuronal death. Thus, inhibition of these molecular events in death-promoting pathways provides novel therapeutic targets for molecules. Our research, as well as research conducted by others in the field, has demonstrated that a specific pathway, known as the stress activated protein kinase pathway, is integral in the cell death process. We have developed an extensive proprietary library of molecules that inhibit the activation of this stress activated protein kinase pathway by inhibiting several related kinases known as mixed lineage kinases, or MLKs. We have established that inhibition of the activation of MLKs blocks the cell death process and enhances the survival of neurons, in vitro and in vivo, where damage has been induced by a variety of harmful stimuli. We are pursuing the development of these molecules for the treatment of Alzheimer's disease, Parkinson's disease and other neurodegenerative disorders. . Alzheimer's and Parkinson's Diseases Alzheimer's disease is an intractable, chronic, and progressively incapacitating disease characterized by the presence of core neurotic plaques, neurofibrillary tangles and gliosis in the brain that are associated with significant death and dysfunction of several types of neuronal populations. Patients afflicted with this disease become severely demented. Alzheimer's disease afflicts an estimated 5% to 10% of the population over the age of 65, or approximately 4 million Americans, with more than 100,000 new cases diagnosed each year. The age-dependent nature of the disorder suggests that an increasing percentage of the population may be affected as the population ages. Parkinson's disease is a progressive disorder of the central nervous system affecting over 1 million Americans. The primary pathology of the disease is caused by the degeneration of the pigmented neurons in the substantia nigra of the brain, resulting in a decrease in the dopamine neurotransmitter. This results in the primary clinical symptoms of decrease in spontaneous movements, gait difficulty, postural instability, rigidity and tremor. Several of the MLK inhibitors have been shown to prevent neuronal death in vitro and in several models of neuronal death in vivo. One of these compounds, CEP-1347, currently is in development for use as a potential treatment for Parkinson's disease. In preclinical models of Parkinson's disease, CEP-1347 has demonstrated therapeutic potential in the treatment and prevention of the pathological and behavioral consequences of this disease. In rodents and non-human primate models, treatment with CEP-1347 protected against loss of dopamine neurons in regions of the brain affected in Parkinson's disease and 8 prevented the appearance of behavioral symptoms associated with loss of dopamine neurons. Cephalon and Lundbeck have recently initiated a Phase I clinical study using CEP-1347. CEP-1347 is licensed under our agreement with Kyowa Hakko. Oncology In normal tissues, cellular proliferation is balanced by cellular death and these processes are governed in part by a class of soluble protein molecules (growth factors) that serve as communication signals between cells. Cancer is a disease of uncontrolled proliferation of cells that may sometimes be linked to inappropriate signaling from specific growth factor receptors. Many of these growth factors bind to specific cell surface receptors (or receptor kinases) and initiate intracellular signals that maintain cell survival and/or direct the cell to proliferate. Inhibition of these receptor kinases provides a unique therapeutic strategy for treating a variety of oncological disorders and provides the opportunity for treatment without the undesirable effects on other organ systems produced by traditional chemotherapeutics. . Prostate and Pancreatic Cancer Prostate cancer is the most common form of cancer in men, affecting approximately 1 million men in the United States, and is the second leading cause of cancer death in men. Pancreatic cancer results in approximately 35,000 deaths in men and women each year in the United States. Research conducted with our collaborators has demonstrated that the nerve growth factor, or NGF, and its receptor tyrosine kinase, or trk, may play an integral role in the development and propagation of hormone dependent and independent cancer and also in pancreatic cancer. We have synthesized a class of small, orally active molecules that are selective inhibitors of trk, thus, antagonizing the "survival" signal elicited by this receptor. In preclinical models, we have demonstrated that these selective trk inhibitors inhibit tumor growth in a variety of prostate and pancreatic cancer models. We have entered into two collaborations to develop these trk inhibitors for the treatment of prostate disorders and other cancers: (i) with TAP in the United States and (ii) with Schwarz Pharma in Europe. In the United States, TAP has completed two Phase I clinical studies and has initiated a Phase II clinical program in patients with prostate cancer using the program's orally administered lead molecule, CEP-701. Schwarz Pharma is expected to initiate Phase II clinical studies in Europe in 2000 using CEP- 701. Some of the molecules covered under our agreement with TAP and Schwarz Pharma are licensed under our agreement with Kyowa Hakko. . Solid Tumors As tumor cells aggregate, they promote the formation of new blood vessels that provide nutrients to the growing tumor. This process is called angiogenesis. Angiogenesis is mediated by a number of factors but appears to be particularly dependent upon the vascular endothelial growth factor, or VEGF. As a result, we believe that inhibitors of the receptor kinase for this growth factor have potential utility in the treatment of solid tumors. We have synthesized a number of proprietary orally active molecules, which are potent and selective inhibitors of the VEGF receptor kinase. These molecules have been shown to slow the growth of certain tumors when used in vivo. We have selected one of these molecules as a candidate for further development. Signal Transduction Modulators: Collaborations . Kyowa Hakko Kogyo Co., Ltd. In May 1992, we licensed from Kyowa Hakko patent and other intellectual property rights to a specific class of small molecules that we have identified as signal transduction modulators, two of which are currently in clinical trials. We are developing CEP-1347 for use in the treatment of neurological disorders and CEP-701 for the treatment of cancers. 9 We have exclusive marketing rights to CEP-701 in North America and Europe, and we are developing this compound for the treatment of prostate and pancreatic cancer; Kyowa Hakko retains exclusive marketing rights to this compound in Asia. We have sublicensed our rights to CEP-701 in Europe to Schwarz Pharma and in the United States to TAP. We have exclusive marketing rights to CEP-1347 in North America and semi-exclusive rights to CEP-1347 in Europe, and we are seeking to develop this compound for the treatment of neurological disorders; Cephalon and Kyowa Hakko each hold semi-exclusive marketing rights to CEP-701 and CEP-1347 throughout the rest of the world, including Japan. We have sublicensed our rights to CEP-1347 in Europe to Lundbeck. We will pay Kyowa Hakko a royalty on all net product sales of pharmaceutical products containing the compounds. We recently agreed with Kyowa Hakko to modify the related supply agreement so that we will be responsible for supplying the compounds under development. We have selected another manufacturer to produce these compounds and Kyowa Hakko is working with us to transfer the applicable manufacturing technology to this third party. . TAP Holdings, Inc. In May 1994, Cephalon and TAP entered into a licensing and research and development collaboration to develop and commercialize certain compounds, including CEP-701, for the treatment of prostate disorders and other cancers in the United States. Under the terms of the agreement, we perform research and preclinical development of these compounds for which we are compensated quarterly by TAP. Compensation is based on a contract rate per individual assigned to the program for that quarter and also includes reimbursement of certain external costs. TAP is responsible for conducting and funding all clinical trials in the United States and activities required for regulatory submissions for U.S. marketing approval. The agreement provides for TAP to make milestone payments to us upon the submission and approval of new drug applications that may emanate from the collaboration and to purchase commercial supplies of product from us at a price equal to a fixed percentage of net product sales plus royalties on net product sales. The research under the agreement may be extended for one-year periods. TAP may terminate the research under the agreement upon 90 days notice prior to expiration. . H. Lundbeck A/S In May 1999, Cephalon and Lundbeck entered into a collaborative agreement to discover, develop and market products to treat neurodegenerative disorders, such as Parkinson's and Alzheimer's diseases. The compounds include CEP-1347 and other proprietary orally active small molecules that inhibit specific processes associated with the death of neurons. Under the terms of the agreement, Lundbeck paid a non-refundable license fee and is responsible for the costs of research and development through Phase I clinical testing as well as reimbursing us for certain program related costs. The companies will share the costs of later stage clinical trials. Lundbeck is responsible for commercialization in Europe and certain other territories while we retain exclusive marketing rights in the United States. The agreement provides for Lundbeck to make milestone payments and to pay royalties on net product sales in Europe. Lundbeck may terminate the agreement after one year upon 30 days prior notice. . Schwarz Pharma AG In December 1999, Cephalon and Schwarz Pharma, a German pharmaceutical company, entered into a licensing agreement under which we granted to Schwarz Pharma our rights to develop and market CEP-701 for the treatment of prostate and other cancers in Europe and several other countries outside the United States. We also granted to Schwarz Pharma an option to acquire rights to develop and market other compounds that we are developing. 10 Under the terms of the agreement, Schwarz Pharma paid a non-refundable license fee and is responsible for funding specified levels of product development, including conducting clinical trials and seeking regulatory approval in the territories. We are responsible for providing Schwarz Pharma with data resulting from the conduct of our research and development program with TAP. We also are responsible for supplying clinical supplies at cost and commercial supplies for a percentage of net sales. The agreement provides for Schwarz Pharma to make milestone payments and to pay royalties on net product sales in the territories. Schwarz Pharma may terminate the agreement upon six months prior notice up until commercial launch of a product in the territory or upon twelve months prior notice at any time thereafter. Gene Transcription Regulators Neurotrophic factors have been shown to promote the survival of neurons (see "Neurotrophic Factors"). In particular, nerve growth factor, or NGF, has been shown to promote the survival of one population of neurons that is seriously compromised in Alzheimer's disease. Unfortunately, NGF cannot cross the blood- brain barrier and, as a result, has to be administered through invasive means. The inability of systemically administered trophic factors to cross the blood- brain barrier must be overcome in order to address disorders of the central nervous system, or CNS, where the neurons as well as their axonal projections lie within the blood-brain barrier. We are developing a proprietary series of molecules that have demonstrated the ability to enhance the endogenous expression in the CNS of nerve growth factor and other growth factors. These molecules are believed to influence gene transcription by binding to a receptor in neurons that is widely distributed in the brain. These orally active small molecules cross the blood-brain barrier and initiate transcriptional events at the genes responsible for the production of certain neurologically active factors within the CNS. Elevating levels of neurotrophic factors in the CNS through the regulation of gene transcription may provide a way to circumvent the blood-brain barrier as a limitation on the potential of neurotrophic proteins to treat neurodegenerative disorders. Such agents may have therapeutic potential in disorders such as Alzheimer's disease. Gene Transcription Regulators: Collaborations . Leo Pharmaceutical Products, Ltd. In November 1996, Cephalon and Leo entered into an agreement to collaborate in the development of gene transcription regulators for potential use in the treatment of neurological disorders. Under this agreement, we will use our proprietary technology to evaluate molecules synthesized by Leo. Cephalon and Leo intend to jointly develop selected products and will share the cost of development. Leo is responsible for the cost of Phase I studies, we are responsible for the cost of Phase II, and we will both share equally in the cost of Phase III. We will have the exclusive rights to market and sell jointly developed products in the United States and Mexico in the neurological field; in return, we will pay to Leo a percentage of net sales as a royalty and for the supply of product. We will receive a royalty from Leo's net sales of jointly developed products in other territories. A lead molecule has been identified for development as a potential treatment for Alzheimer's disease. Protease Inhibitors A protease is a naturally occurring enzyme that is responsible for the processing or cleavage of a protein. Certain proteases have been implicated in the pathogenesis of neurodegenerative disorders, either directly by causing neuronal death or indirectly by cleaving proteins into smaller peptide fragments that threaten the survival of neurons. We have developed expertise in identifying, isolating and assaying specific types of proteases believed to be involved in certain neurodegenerative disorders. In addition, our expertise in chemistry has enabled the synthesis of molecules that, in preclinical studies, specifically inhibit the action of these proteases. In the past, we have focused on developing small molecule therapeutics that inhibit the actions of the protease calpain, which is thought to play a role in causing the neuronal damage associated with stroke. We also have focused on developing other compounds that inhibit the protease gamma-secretase, which plays a pivotal role in the production of the toxic beta-amyloid protein associated with the degeneration in Alzheimer's disease. We believe that this core technology can be applied to any number of proteases and disorders. 11 Neurotrophic Factors (MYOTROPHIN) A major advance in neuroscience was the discovery of naturally occurring proteins, referred to as neurotrophic, trophic or growth factors, that promote the survival of neurons. Several different neurotrophic factors have been identified that affect the survival of different types of neurons. Our development efforts in this area focus on using the neurotrophic factor, MYOTROPHIN, in disorders such as amyotrophic lateral sclerosis, or ALS and peripheral neuropathies, where the projections of the damaged neurons lie or extend outside the blood-brain barrier and are therefore accessible to trophic factors. Amyotrophic Lateral Sclerosis Amyotrophic lateral sclerosis is a fatal disorder of the nervous system characterized by the chronic, progressive degeneration of motor neurons. It is the loss of the spinal (lower) motor neurons that leads to muscle weakness, muscle atrophy and, eventually, to the patient's death. The disease usually progresses over a three to five-year period, with death usually resulting from loss of respiratory muscle control rendering the patient unable to breathe. ALS affects approximately 15,000-20,000 people in the United States. We believe that there is a proportionate incidence of ALS in the populations of Europe and Japan. We have conducted clinical trials using MYOTROPHIN in ALS patients in North America and Europe. In February 1997, Cephalon and Chiron submitted an NDA to the FDA for approval to market MYOTROPHIN in the United States for the treatment of ALS. In May 1998, the FDA issued a letter stating that the NDA was "potentially approvable," under certain conditions. At this time, we do not believe those conditions can be met without conducting an additional Phase III clinical study. Neurotrophic Factors (MYOTROPHIN): Collaborations . Cephalon Clinical Partners, L.P. 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 perform any development and clinical testing of MYOTROPHIN on behalf of CCP under a research and development agreement with CCP. CCP has granted us an exclusive license to manufacture and market MYOTROPHIN for human therapeutic use within the United States, Canada and Europe in return for royalty payments equal to a percentage of product sales and a milestone payment of approximately $16 million that will be made if MYOTROPHIN receives regulatory approval. We have a contractual option to purchase all of the limited partnership interests of CCP. To exercise this purchase option, we are required to make an advance payment of $40.3 million in cash or, at our election, $42.4 million in shares of common stock or a combination thereof. The purchase option will become exercisable upon the occurrence of certain events once sales activity commences. Should we discontinue development of MYOTROPHIN or if we do not exercise the 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. . Kyowa Hakko Kogyo Co., Ltd. In July 1993, we entered into an agreement with Kyowa Hakko providing for the development of MYOTROPHIN in Japan. Kyowa Hakko is responsible for funding product development activities, conducting clinical trials in ALS and seeking authorization to market MYOTROPHIN in Japan. We will supply MYOTROPHIN to Kyowa Hakko for commercial use in exchange for a percentage of net product sales. In addition, we are to receive certain licensing, milestone and royalty payments. Under certain circumstances, we have an option to co-promote MYOTROPHIN in Japan. 12 We may terminate the agreement if (i) Kyowa Hakko fails to file for marketing approval of MYOTROPHIN in Japan within eight years from the date of the agreement, except where such failure is not within Kyowa Hakko's control, or (ii) if Kyowa Hakko discontinues the development of MYOTROPHIN because of a lack of safety or efficacy. . Chiron Corporation Since January 1994, Cephalon and Chiron have collaborated in the development of MYOTROPHIN for the treatment of ALS and certain other neurological disorders for commercialization in all countries of the world other than Japan. Through June 1998, the costs of the program had generally been shared equally by the two companies. Since that time, Cephalon and Chiron have funded their own program expenses. Cephalon and Chiron generally will share equally in all profits and losses from the marketing of MYOTROPHIN for the treatment of ALS and other neurological disorders in North America, the countries of the European Community and certain other western European countries. In addition, we will receive a royalty on sales of MYOTROPHIN in western Europe to treat ALS. Chiron will market the products in the collaboration's territories outside of North America and western Europe in return for royalties to the collaboration, which also will be shared equally by Cephalon and Chiron. Either party may terminate the collaboration if there is no reasonable basis for developing any of the collaboration's compounds. If we are the non-terminating party, we may continue to license the technology or require Chiron to supply product on a "cost plus" basis for a certain period of time. The agreement also is subject to termination if we do not exercise the CCP purchase option. PATENTS AND PROPRIETARY TECHNOLOGIES An important part of our product development strategy is to seek protection for our products and technologies through the use of U.S. and foreign patents and trademarks. As described below, we hold rights to and have filed applications for various U.S. and foreign patents, though we cannot be certain that any of these patent applications will issue, or if issued, that they will not be challenged by third parties on the basis of invalidity or non- infringement, or that we will not be found to have infringed upon the rights of others in any case. PROVIGIL PROVIGIL(R) is a licensed trademark used in connection with pharmaceutical products containing modafinil as the active drug substance. The composition- of-matter patent was to have expired in 1998 in the United Kingdom and the United States; however, we have applied for extensions of the patent protection in those countries. We have been granted a Supplemental Protection Certificate for the United Kingdom patent covering modafinil, extending the protection afforded by this patent until March 30, 2003. In the United States, if we were to secure the maximum extension permitted under the terms of the U.S. Drug Price Competition and Patent Term Restoration Act of 1984, as amended, the composition-of-matter patent for modafinil would expire on November 18, 2001. We cannot be certain that we will receive this patent extension or that we will be able to take advantage of any other patent benefits of the patent restoration act. The composition-of-matter patent claiming modafinil as the active drug substance in PROVIGIL expired in 1998 in the Republic of Ireland, Japan, Italy and Mexico. Other than Italy, we do not believe that extension of the protection conferred by the modafinil composition-of-matter patent is possible in any other of our licensed territories. The particle size pharmaceutical composition of modafinil is claimed in our U.S. patent which was issued in 1997 and in our European patent which was granted in January 2000. These patents are currently set to expire on October 6, 2014 and October 4, 2015, respectively. Other foreign patents claiming the particle size pharmaceutical composition of modafinil are pending or issued in other territories. We have filed a reissue application in the United States in order to obtain broader coverage for the modafinil particle size patent. We 13 also hold rights to a U.S. patent that issued in January 1993 for the use of PROVIGIL in treating Parkinson's disease and a U.S. patent issued in 1990 which claims the composition of certain isomers of PROVIGIL. Since modafinil is a new chemical entity, or NCE, PROVIGIL has been granted a five-year period of marketing exclusivity under FDA regulations, preventing the submission of an Abbreviated New Drug Application, or ANDA, for any pharmaceutical product containing modafinil for any indication for a period of five years following FDA approval. This exclusivity period expires in December, 2003. The FDA also has designated PROVIGIL as an orphan drug for use in the treatment of EDS associated with narcolepsy. This designation provides for a seven-year period of marketing exclusivity for PROVIGIL in this indication, and prevents the approval of an ANDA until December, 2005. MYOTROPHIN MYOTROPHIN(R) (mecasermin) Injection is our trademark for recombinant human insulin-like growth factor-I, known as rhIGF-I or IGF-I. We believe that the composition of rhIGF-I is in the public domain and therefore cannot be patented under a composition-of-matter patent. However, we own issued U.S., European, Canadian and Japanese patents which include claims covering the use of IGF-I for the treatment of diseases caused by the death of non-mitotic, cholinergic neurons, including motor neurons compromised in ALS. We also own U.S. patents claiming the use of IGF-I in treating certain types of peripheral neuropathies, and we have filed similar applications in Canada, Europe and Japan. We have filed patent applications in the United States, Canada, Europe and Japan covering the use of IGF-I in enhancing the survival of neuronal cells and use in multiple sclerosis. We also have issued patents and pending patent applications directed to manufacturing and purification processes, and we have obtained a license from SIBIA Neurosciences, Inc. to use certain patent rights and other technology related to the manufacture of rhIGF-I in certain strains of yeast host cells. The issued patents and all patent applications relating to IGF-I in the United States, Canada and Europe have been licensed to Cephalon Clinical Partners, L.P., or CCP. Subject to the rights of CCP, Cephalon and Chiron have agreed to cross-license all of their respective patents and patent applications related to IGF-I (excluding our rights under the SIBIA license, as to which Chiron has the option to sublicense) in the field of neurological diseases and disorders. Under our collaboration with Chiron, Chiron has the primary responsibility for manufacturing commercial supplies of MYOTROPHIN. Chiron is currently involved in interference proceedings with Genentech, Inc. concerning U.S. patent rights related to certain methods for manufacturing rhIGF-I. It is not known when or how these interference proceedings will ultimately conclude, or whether the issued claims will cover any portion of the current manufacturing process. We are aware of other patents and patent applications owned by third parties, which may cover certain aspects of the current method of manufacturing rhIGF-I. Cephalon and Chiron also intend to either seek licenses under any valid patents related to the manufacturing of rhIGF-I as required or, alternatively, modify the manufacturing process. We cannot be sure that, if required, such licenses can be obtained at all or on acceptable terms or that a modified manufacturing process can be implemented at all or without substantial cost or delay. If neither approach is feasible, we could be subject to a claim of patent infringement which, if successful, could prevent us from manufacturing or selling MYOTROPHIN in the United States. We are aware of an issued U.S. patent, and a granted European patent, both owned by Genentech, that claim the use of IGF-I in treating neuronal damage suffered after a central nervous system insult affecting glia and/or other non- cholinergic cells. We have filed an opposition against the granted European patent and also have initiated interference proceedings against the U.S. patent. We cannot predict the outcome of the opposition or the interference proceeding at this time. If the claims of the issued U.S. patent and the granted European patent are not otherwise invalid or unenforceable, or if the grant is not revoked by the European Patent Office, we could be prevented from selling MYOTROPHIN in the United States and Europe for uses of IGF-I claimed in the patents, unless we obtain a license to any granted or issued patents. We cannot be sure that a license could be obtained, or that any such license would be granted under terms acceptable to us. 14 We also are aware of other third party patents and patent applications that claim the use of IGF-I in affecting a change in the central nervous system and use in diabetic neuropathy. These patents and applications may be construed to cover our commercial activities with IGF-I. We cannot be sure that licenses to such patents and applications could be obtained, or that any such license(s) would be granted under terms acceptable to us. Other Programs We also own issued and pending U.S. patents and applications claiming compositions and/or uses of certain kinase inhibitors including two novel classes of small molecules referred to as "indolocarbazoles" and "fused pyrrolocarbazoles." We have filed foreign counterparts of these patents in other countries, as appropriate. We also own issued and pending U.S. and foreign patents and applications claiming compositions and/or uses of inhibitors of certain proteases, including novel classes of small molecules for inhibition of calpain, and novel classes of small molecules for inhibition of the multicatalytic protease. Through collaborative agreements with researchers at several academic institutions, we have licenses to or the right to license, generally on an exclusive basis, patents and patent applications issued or filed in the United States and certain other countries arising under or related to such collaborations. We also have licensed U.S. and European composition-of-matter and use patents and applications for novel compositions under our collaborative agreement with Kyowa Hakko, including compositions and uses of certain indolocarbazoles for the treatment of pathological conditions of the prostate (including prostate cancer) and for the treatment of neurological disorders. We cannot be sure that any additional patents will be issued on any of the patent applications we own or license from third parties. Furthermore, even if such patents are issued, we cannot be sure that the validity of the patents would be upheld if challenged, that such patents would provide protection against competitive products or otherwise be commercially valuable, or that applications filed by others would not result in patents that would be infringed by the manufacture, use or sale of our products. Our products could infringe the patent rights of others. If licenses required under any such patents or proprietary rights of third parties are not obtained, we could encounter delays in product market introductions, or could find that the development, manufacture or sale of products requiring such licenses is foreclosed. In addition, patent litigation is both costly and time-consuming, even if the outcome is favorable to us. In the event that we are a defendant in such litigation, an adverse outcome would subject us to significant liabilities to third parties, require us to license disputed rights from third parties, or require us to cease selling our products. We also rely upon trade secrets and other unpatented proprietary information in our product development activities. Our employees enter into agreements providing for confidentiality and the assignment of rights to inventions made by them while employed by us. We also have entered into non-disclosure agreements to protect our confidential information delivered to third parties in conjunction with possible corporate collaborations and other purposes. We cannot be sure that these types of agreements will effectively prevent unauthorized disclosure of our confidential information. MANUFACTURING AND PRODUCT SUPPLY Our ability to conduct clinical trials on a timely basis, to obtain regulatory approvals and to commercialize our products will depend in part upon our ability to manufacture our products, either directly or through third parties, at a competitive cost and in accordance with applicable FDA and other regulatory requirements, including current Good Manufacturing Practice, or cGMP, regulations. We do not own manufacturing facilities and we rely on third parties for all of our manufacturing requirements. We rely on Lafon for all of our requirements of bulk modafinil compound and upon third party manufacturers to provide final formulation, tabletting and packaging of PROVIGIL. 15 We rely on Chiron for all of our manufacturing requirements for MYOTROPHIN. To date, we have relied on Kyowa Hakko to supply a key chemical intermediate for our signal transduction modulator programs; however, we recently agreed with Kyowa Hakko to modify the related supply agreements so that we will be responsible for supplying the compounds under development. We have contracted with another manufacturer to develop, scale-up and supply bulk intermediates and Kyowa Hakko is working with us to transfer the applicable manufacturing technology to this third party. This intermediate is supplied to Lundbeck for use in the synthesis of clinical and commercial supplies. It also is used to manufacture product for use in clinical trials, and ultimately for purposes of manufacturing commercial supplies under our agreements with TAP and Schwarz Pharma. COMPETITION 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. Many of these companies and institutions have substantially greater capital resources, research and development staffs and facilities than us, 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 potentially could materially adversely affect any sales of products that might be developed or are currently being sold by us or make them obsolete. Advances in current treatment methods also may adversely affect the market for such products. With respect to PROVIGIL, there are several other products used for the treatment of narcolepsy in the United States 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. We cannot be sure that we will be able to demonstrate the potential advantages of PROVIGIL to prescribing physicians and their patients on an absolute basis and/or in comparison to other presently marketed products. GOVERNMENT REGULATION The manufacture and sale of therapeutics are subject to extensive regulation by U.S. and foreign governmental authorities. In particular, pharmaceutical products are subject to rigorous preclinical and clinical trials and other approval requirements by the FDA under the Federal Food, Drug, and Cosmetic Act and by analogous agencies in countries outside the United States. As an initial step in the FDA regulatory approval process, preclinical studies are typically conducted in animals to identify potential safety problems and, in some cases, evaluate potential efficacy. The results of the preclinical studies are submitted to regulatory authorities as a part of an investigational new drug application, or IND, that is filed with regulatory agencies prior to beginning studies in humans. However, for several of our drug candidates, no animal model exists that is potentially predictive of results in humans. As a result, no in vivo indication of efficacy is available until these drug candidates progress to human clinical trials. Clinical trials are typically conducted in three sequential phases, although the phases may overlap. Phase I typically begins with the initial introduction of the drug into human subjects prior to introduction into patients. In Phase I, the compound is tested for safety, dosage tolerance, absorption, biodistribution, metabolism, excretion and clinical pharmacology, as well as, if possible, to gain early information on effectiveness. Phase II typically involves studies in a small sample of the intended patient population to assess the efficacy of the drug for a specific indication, determine dose tolerance and the optimal dose range, and to gather additional information relating to safety and potential adverse effects. Phase III trials are undertaken to further evaluate clinical safety 16 and efficacy in an expanded patient population, generally at multiple study sites, to determine the overall risk-benefit ratio of the drug and to provide an adequate basis for physician labeling. Each trial is conducted in accordance with certain standards under protocols that detail the objectives of the study, the parameters to be used to monitor safety and the efficacy criteria to be evaluated. In the United States, each protocol must be submitted to the FDA as part of the IND. Further, one or more independent Institutional Review Boards must evaluate each clinical study. The Institutional Review Board considers, among other things, ethical factors, the safety of the study, the adequacy of informed consent by human subjects, and the possible liability of the institution. Similar procedures and requirements must be fulfilled to conduct studies in other countries. The process of completing clinical trials for a new drug is likely to take a number of years and require the expenditure of substantial resources. Data from Phase II preclinical and Phase III clinical trials are submitted to the FDA in a new drug application or NDA for marketing approval and to foreign regulatory authorities under applicable requirements. Preparing an NDA or foreign application involves considerable data collection, verification, analyses and expense, and there can be no assurance that the applicable regulatory authority will grant an approval on a timely basis, if at all. The approval process is affected by a number of factors, including primarily the safety and efficacy demonstrated in clinical trials and the severity of the disease. Regulatory authorities may deny an application in their sole discretion, if they determine that applicable regulatory criteria have not been satisfied or if additional testing or information is required. One of the conditions for marketing approval is that a prospective manufacturer's quality control and manufacturing procedures conform to the cGMP regulations of the regulatory authority. In complying with these regulations, a manufacturer must continue to expend time, money and effort in the area of production, quality control and quality assurance to ensure full technical compliance. Manufacturing establishments, both foreign and domestic, also are subject to inspections by or under the authority of the FDA and by other federal, state, local or foreign agencies. Even after initial regulatory approval has been obtained, further studies, including Phase IV post-marketing studies, may be required to provide additional data on safety or for other reasons. Further studies will be required to gain approval for the use of a product as a treatment for clinical indications other than those for which the product was initially approved. Results of post-marketing programs may limit or expand the further marketing of the products. Further, if there are any modifications to the drug, including any change in indication, manufacturing process, labeling or manufacturing facility, it may be necessary to submit an application seeking approval of such changes to the FDA or foreign regulatory authority. Moreover, marketed products are subject to continued regulatory oversight and the failure to comply with applicable regulations could result in financial penalties or other sanctions. Whether or not FDA approval has been obtained, approval of a product by regulatory authorities in foreign countries must be obtained prior to the commencement of commercial sales of the product in such countries. The requirements governing the conduct of clinical trials and product approvals vary widely from country to country, and the time required for approval may be longer or shorter than that required for FDA approval. Although there are procedures for unified filings for most European countries, in general, each country also has its own additional procedures and requirements, especially related to pricing of new pharmaceuticals. Further, the FDA regulates the export of products produced in the United States and, in some circumstances, may prohibit the export even if such products are approved for sale in other countries. In the United States, the Orphan Drug Act provides incentives to drug manufacturers to develop and manufacture drugs for the treatment of either (i) rare diseases, currently defined as diseases that affect fewer than 200,000 individuals in the United States or, (ii) for a disease that affects more than 200,000 individuals in the United States, where the sponsor does not realistically anticipate its product becoming profitable. The FDA has granted PROVIGIL orphan drug status for use in treating excessive daytime sleepiness associated with narcolepsy and has designated MYOTROPHIN as an orphan drug for use in treating ALS, because each indication currently affects fewer than 200,000 individuals in the United States. Under the Orphan Drug Act, a manufacturer of a designated orphan product can seek certain tax benefits, and the holder of the first FDA approval of a designated orphan product will be granted a seven-year period of marketing exclusivity for that 17 product for the orphan indication. While the marketing exclusivity of an orphan drug would prevent other sponsors from obtaining approval of the same drug compound for the same indication unless the sponsors could demonstrate clinical superiority, it would not prevent other sponsors from obtaining approval of the same compound for other indications or the use of other types of drugs for the same use as the orphan drug. Orphan drug designation does not confer any special or preferential treatment in the regulatory review process. The U.S. Congress has considered, and may consider in the future, legislation that would restrict the duration or scope of the market exclusivity of an orphan drug and, thus, we cannot be sure that the benefits of the existing statute will remain in effect. Under the terms of the U.S. Drug Price Competition and Patent Term Restoration Act of 1984, a sponsor may be granted a maximum five-year extension of the term of a patent for a period of time following the initial FDA approval of an NDA for a new chemical entity. The statute specifically allows a patent owner to extend the term of the patent for a period equal to one-half the period of time elapsed between the approval of the IND and the filing of the corresponding NDA, plus the period of time between the filing of the NDA and FDA approval, up to a maximum of five years of patent term extension. Any such extension, however, cannot extend the patent term beyond a maximum term of fourteen years following FDA approval and is subject to other restrictions. Additionally, under this statute, five years of marketing exclusivity is granted for the first approval of a NCE. During this period of exclusivity, sponsors generally may not file and the FDA may not approve an ANDA or a 505(b)(2) application for a drug product equivalent or identical to the NCE. An ANDA is the application form typically used by manufacturers seeking approval of a generic version of an approved drug. Subsequent approved indications for the NCE are eligible, under this statute, to three years of limited marketing exclusivity for the indication. During any three-year exclusivity period, a third party may file an ANDA or a 505(b)(2) application seeking approval of their version of the drug if any five-year exclusivity granted to the NCE has expired. However the third party would not obtain marketing approval for the generic version of the NCE for the three years of exclusivity. We intend to seek the benefits of this statute as applicable, but there can be no assurance that we will be able to obtain any such benefits. The Controlled Substances Act, or CSA, imposes various registration, record- keeping and reporting requirements, procurement and manufacturing quotas, labeling and packaging requirements, security controls and a restriction on prescription refills on certain pharmaceutical products. A principal factor in determining the particular CSA requirements, if any, applicable to a product is its actual or potential abuse profile. A pharmaceutical product may be listed as a Schedule I, II, III, IV or V substance, with Schedule I substances considered to present the highest risk of substance abuse and Schedule V substances the lowest. Modafinil, the active drug substance in PROVIGIL, has been scheduled under the CSA as a Schedule IV substance. Schedule IV substances are allowed no more than five prescription refills during a six- month period and are subject to special handling procedures relating to the storage, shipment, inventory control and disposal of the product. Additionally, PROVIGIL may be subject to various state statutes regulating controlled substances that, in some cases, may be more restrictive than the CSA. In 1997, STADOL NS was listed as a Schedule IV controlled substance at the request of Bristol-Myers. In addition, a number of state regulatory agencies in the United States have independently controlled the distribution of STADOL NS under their local authority. In addition to the statutes and regulations described above, we also are subject to regulation under the Occupational Safety and Health Act, the Environmental Protection Act, the Toxic Substances Control Act, the Resource Conservation and Recovery Act and other present and potential future federal, state and local regulations. SCIENTIFIC AND MEDICAL ADVISORY BOARDS We maintain a Scientific Advisory Board consisting of individuals with expertise in neuroscience and related fields. Members of the Scientific Advisory Board advise us concerning long-term scientific planning, research 18 and development, and also periodically evaluate our research programs. We compensate the members for their services. The current members of our Scientific Advisory Board are as follows: Stanley H. Appel, M.D., Baylor College of Medicine Stanley Cohen, Ph.D., Vanderbilt University School of Medicine Robert Y. Moore, M.D., Ph.D., University of Pittsburgh Robert H. Roth, Ph.D., Yale University School of Medicine Shirley M. Tilghman, Ph.D., Princeton University We also maintain a Medical Advisory Board consisting of individuals with expertise in clinical development who periodically review and evaluate our clinical development plans and clinical trials. We compensate the members for their services. The current members of our Medical Advisory Board are as follows: Arthur K. Asbury, M.D., University of Pennsylvania Medical Center Robert L. Barchi, M.D., Ph.D., University of Pennsylvania Medical Center Dennis Choi, M.D., Ph.D., Washington University School of Medicine Steven T. DeKosky, M.D., Western Psychiatric Institute and Clinic Richard Johnson, M.D., Johns Hopkins Hospital Robert Y. Moore, M.D., Ph.D., University of Pittsburgh EMPLOYEES As of December 31, 1999, we had a total of 382 full-time employees, of which 356 were employed in the United States and 26 were located at our facilities in Europe. We believe that we have been successful in attracting skilled and experienced personnel; however, competition for such personnel is intense. None of our employees are covered by collective bargaining agreements. ITEM 2. PROPERTIES We own our administrative offices and research facilities, which currently occupy approximately 156,000 square feet of space in West Chester, Pennsylvania. We lease approximately 4,950 square feet of office space in Surrey, England, which serves as our European headquarters. The annual cost of the lease is approximately $185,000. We also lease offices in France and Germany at an aggregate annual cost of approximately $36,000. We believe that our current facilities are adequate for our present purposes. ITEM 3. LEGAL PROCEEDINGS In November 1999, we received a federal grand jury subpoena in connection with an investigation under the supervision of the Office of Consumer Litigation of the U.S. Department of Justice. The grand jury also issued subpoenas to certain of our former and current employees. We believe that the investigation relates to the release of certain lots of MYOTROPHIN used in clinical trials and related reports filed with the FDA during the period 1994- 96. We have not been identified as a target of the investigation, and we are cooperating with this inquiry. We cannot predict the outcome of the investigation. 19 In August 1999, the U.S. District Court for the Eastern District of Pennsylvania entered a final order approving the settlement of a class action in which plaintiffs alleged that statements made about the results of certain clinical studies of MYOTROPHIN were misleading. A related complaint has been filed with the Court by a small number of plaintiffs who decided not to participate in the settlement. This related complaint alleges that we are liable under common law for misrepresentations concerning the results of the MYOTROPHIN clinical trials, and that we and certain of our current and former officers and directors are liable for the actions of persons who allegedly traded in our common stock on the basis of material inside information. We believe that we have valid defenses to all claims raised in this action, and we have filed a motion to dismiss these claims which is pending with the Court. Moreover, even if there is a judgment against us, we do not believe it will have a material negative effect on our financial condition or results of operations. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS We did not submit any matters to the vote of security holders during the fourth quarter of fiscal 1999. 20 PART II ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS Our common stock is quoted on the NASDAQ National Market under the symbol "CEPH." The following table sets forth the range of high and low sale prices for the common stock as reported on the NASDAQ National Market for the periods indicated below.
High Low ----- ----- 1998 First Quarter.................................................. 15.00 9.50 Second Quarter................................................. 16.13 6.75 Third Quarter.................................................. 8.31 3.86 Fourth Quarter................................................. 10.36 4.50 1999 First Quarter.................................................. 11.00 7.25 Second Quarter................................................. 17.75 9.94 Third Quarter.................................................. 22.13 15.13 Fourth Quarter................................................. 37.13 14.00
As of March 21, 2000 there were 633 holders of record of our common stock. On March 21, 2000, the last reported sale price of our common stock as reported on the NASDAQ National Market was $41.31 per share. In August 1999, we issued and sold 2,500,000 shares of convertible exchangeable preferred stock, par value $.01 per share to certain initial purchasers. The aggregate purchase price was $125,000,000, of which $4,375,000 constituted the underwriting discounts and commissions. The initial purchasers were BancBoston Robertson Stephens Inc., SG Cowen Securities Corporation, Hambrecht & Quist LLC and U.S. Bancorp Piper Jaffey. The preferred stock was issued and sold in transactions exempt from the registration requirements of the Securities Act of 1933, as amended, to persons reasonably believed by the managers who placed the Preferred Stock, the initial purchasers, to be qualified institutional buyers (as defined in Rule 144A under the Securities Act). Dividends on the 2,500,000 shares of the preferred stock are cumulative from the date of original issue and are payable quarterly, commencing November 15, 1999 and payable each February 15, May 15, August 15 and November 15 thereafter, at the annual rate of $3.625 per share of preferred stock. Prior to August 17, 2001, we may not redeem the preferred stock. Thereafter the preferred stock is redeemable at our option, in whole or in part, at declining redemption prices, together with accrued dividends. The preferred stock has a liquidation preference of $50 per share, plus accrued and unpaid dividends. The preferred stock is exchangeable, in whole but not in part, at our option on any dividend payment date beginning August 15, 2000 for our 7.25% convertible subordinated debentures at the rate of $50 principal amount of debentures for each share of preferred stock. The debentures, if issued, will mature on the tenth anniversary of the exchange date and will contain conversion and optional redemption provisions substantially identical to those of the preferred stock. Holders of the preferred stock are entitled at any time, subject to prior redemption or repurchase, to convert any of the preferred stock or portions thereof into common stock, at an initial conversion rate of 2.79 shares of common stock for each share of preferred stock, subject to certain adjustments. On October 14, 1999, we filed a registration statement on Form S-3 to register the 2,500,000 shares of the preferred stock, the $125,000,000 debentures and 6,975,447 shares of common stock, issuable upon conversion of the preferred stock or upon conversion of the debentures, if the preferred stock is exchanged for debentures. The effective date of such registration statement was December 22, 1999. 21 ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA The following selected consolidated financial data have been derived from the consolidated financial statements of Cephalon, Inc. as of and for each of the five years in the period ended December 31, 1999 which have been audited by Arthur Andersen LLP, independent public accountants. This data should be read in conjunction with the Company's consolidated financial statements, including the notes thereto, and "Management's Discussion and Analysis of Financial Condition and Results of Operations" included elsewhere herein.
Year Ended December 31, ------------------------------------------------------------------------- 1999 1998 1997 1996 1995 ------------- ------------- ------------- ------------- ------------- Statement of Operations Data: Revenues: Product sales-- PROVIGIL.............. $ 25,370,000 $ 728,000 $ -- $ -- $ -- Other revenues......... 19,549,000 14,927,000 23,140,000 21,366,000 46,999,000 ------------- ------------- ------------- ------------- ------------- 44,919,000 15,655,000 23,140,000 21,366,000 46,999,000 ------------- ------------- ------------- ------------- ------------- Costs and Expenses: Cost of product sales-- PROVIGIL.............. 3,250,000 -- -- -- -- Research and development........... 46,420,000 43,649,000 51,587,000 62,096,000 73,994,000 Selling, general and administrative........ 50,992,000 30,947,000 36,744,000 28,605,000 15,762,000 ------------- ------------- ------------- ------------- ------------- 100,662,000 74,596,000 88,331,000 90,701,000 89,756,000 ------------- ------------- ------------- ------------- ------------- Interest (expense) income, net............ (3,014,000) 3,534,000 4,772,000 6,205,000 9,754,000 Gain on sale of assets.. -- -- -- 9,845,000 -- ------------- ------------- ------------- ------------- ------------- Loss before extraordinary charge... (58,757,000) (55,407,000) (60,419,000) (53,285,000) (33,003,000) Extraordinary charge for early extinguishment of debt................... (11,187,000) -- -- -- -- ------------- ------------- ------------- ------------- ------------- Loss.................... (69,944,000) (55,407,000) (60,419,000) (53,285,000) (33,003,000) Dividends on preferred stock.................. (3,398,000) -- -- -- -- ------------- ------------- ------------- ------------- ------------- Loss applicable to common shares.......... $ (73,342,000) $ (55,407,000) $ (60,419,000) $ (53,285,000) $ (33,003,000) ============= ============= ============= ============= ============= Basic and diluted loss per common share: Loss before extraordinary charge.. $ (2.10) $ (1.95) $ (2.36) $ (2.60) $ (1.63) Extraordinary charge... (.38) -- -- -- -- ------------- ------------- ------------- ------------- ------------- $ (2.48) $ (1.95) $ (2.36) $ (2.60) $ (1.63) ============= ============= ============= ============= ============= Weighted average number of shares outstanding.. 29,584,199 28,413,220 25,637,508 24,319,163 20,262,071 As of December 31, ------------------------------------------------------------------------- 1999 1998 1997 1996 1995 ------------- ------------- ------------- ------------- ------------- Balance Sheet Data: Cash, cash equivalents and investments........ $ 201,562,000 $ 67,346,000 $ 119,471,000 $ 146,848,000 $ 178,067,000 Total assets............ 234,053,000 94,673,000 151,208,000 177,891,000 221,330,000 Long-term debt.......... 14,034,000 15,096,000 27,587,000 16,974,000 21,668,000 Accumulated deficit..... (347,135,000) (273,793,000) (218,386,000) (157,967,000) (104,682,000) Stockholders' equity.... 158,357,000 57,602,000 100,338,000 137,326,000 180,205,000
- -------- 22 ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS 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 above and in this report. 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 (and we are not obligated) to update publicly any forward-looking statements. This discussion is permitted by the Private Securities Litigation Reform Act of 1995. During the next several years we will be very dependent on the commercial success of PROVIGIL, and we may be unable to attain profitability on sales of PROVIGIL. In December 1998, the FDA approved PROVIGIL for use by those suffering from excessive daytime sleepiness associated with narcolepsy, and, in February 1999, we commenced selling PROVIGIL in the United States. At our present level of operations, we may not be able to attain profitability if physicians prescribe PROVIGIL only for those who are diagnosed narcoleptics. Under current FDA regulations, we are limited in our ability to promote PROVIGIL outside this approved use. The market for use of PROVIGIL in narcolepsy patients is relatively small; it is limited to approximately 125,000 persons in the United States, of which we estimate approximately 45,000 currently are seeking treatment from a physician. We have initiated clinical studies to examine whether or not PROVIGIL is effective and safe when used to treat disorders other than narcolepsy. Although some study data has been positive, we do not know whether all of these studies will in fact demonstrate safety and efficacy, or if they do, whether we will succeed in receiving regulatory approval to market PROVIGIL for additional disorders. If the results of some of these studies are negative, or if adverse experiences are reported in these clinical studies or otherwise in connection with the use of PROVIGIL by patients, this could undermine physician and patient comfort with the product, could limit the commercial success of the product and could even impact the acceptance of PROVIGIL in the narcolepsy market. Even if the results of these studies are positive, the impact on sales of PROVIGIL may be negligible unless we are able to obtain FDA approval to expand the authorized use of PROVIGIL. FDA regulations restrict our ability to communicate the results of additional clinical studies to patients and physicians without first obtaining approval from the FDA to expand the authorized uses for this product. As a result, it may be several years before we have significant sales revenue from PROVIGIL beyond that attributable to prescriptions for diagnosed narcoleptics. In addition, the following factors could limit the rate and level of market acceptance of PROVIGIL: . the effectiveness of our sales and marketing efforts relative to those of our competitors; . the availability and level of reimbursement for PROVIGIL by third-party payors, including federal, state and foreign government agencies; and . the occurrence of any side effects, adverse reactions or misuse (or unfavorable publicity relating thereto) stemming from the use of PROVIGIL. We have described these and other factors in more detail below. . Our lack of experience selling our own pharmaceutical products, together with significant competition, may impact our ability to effectively market and sell PROVIGIL in the United States. 23 In the United States and elsewhere, PROVIGIL faces significant competition in the marketplace. Narcolepsy is currently treated with several drugs, all of which have been available for a number of years and many of which are available in inexpensive generic forms. Thus, we will need to demonstrate to physicians and third party payors that the cost of PROVIGIL is reasonable and appropriate in light of the safety and efficacy of the product, the price of competing products and the related health care benefits to the patient. . As PROVIGIL is used commercially, unintended side effects, adverse reactions or incidents of misuse may occur which could result in additional regulatory controls, and reduce sales of PROVIGIL. Prior to 1999, the use of PROVIGIL had been limited principally to clinical trial patients under controlled conditions and under the care of expert physicians. We cannot predict whether the widespread commercial use of PROVIGIL will produce undesirable or unintended side effects that have not been evident in our clinical trials or the relatively limited broader use to date. As PROVIGIL becomes more widely utilized by significant numbers of patients who could take multiple medications, adverse drug interactions could occur that are difficult to predict. Additionally, incidents of product misuse may occur. These events, among others, could result in additional regulatory controls, including withdrawal of the product from the market. . 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 PROVIGIL. In certain foreign markets, pricing or profitability of pharmaceutical products is subject to governmental control. In the United States, there have been, and we expect there will continue to be, various federal and state proposals to implement similar government controls. The commercial success of PROVIGIL 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 payors increasingly challenge the prices charged for products, and limit reimbursement levels offered to consumers for such products. If third party payors focus their cost control efforts on PROVIGIL, this could limit the commercial success of the product. . We may not be able to maintain market exclusivity for PROVIGIL, and therefore potential competitors may develop competing products, which could result in a decrease in sales and market share, could cause us to reduce prices to compete successfully, and could prevent PROVIGIL from being a commercial success. We hold exclusive license rights to a composition-of-matter patent covering modafinil as the active drug substance in PROVIGIL; this patent was to have expired in 1998 in the United States, but we have applied for a patent extension that, if granted, would extend the term of this patent until November 18, 2001. In addition, we own a U.S. patent covering the particle size of modafinil that issued in 1997 and expires on October 6, 2014. However, we may not succeed in obtaining any extension for the composition-of-matter patent, and we cannot guarantee that any of our patents will be found to be valid if their validity is challenged by a third party, or that these patents (or any other patent owned or licensed by us) would prevent a potential competitor from developing competing products or product formulations that avoid infringement. In the United States, the Orphan Drug Act provides incentives to drug manufacturers to develop and manufacture drugs for the treatment of rare disorders. The FDA has granted orphan drug status to PROVIGIL for its use in the treatment of excessive daytime sleepiness associated with narcolepsy. The grant of orphan drug status to PROVIGIL allows us a seven-year period of marketing exclusivity for the product in that indication. While the marketing exclusivity provided by the orphan drug law should prevent other sponsors from obtaining approval of the same compound for the same indication (unless the other sponsor can demonstrate clinical superiority or we are unable to provide or obtain adequate supplies of PROVIGIL), it would not prevent approval of the compound for other indications that otherwise are non-exclusive, nor approval of other kinds of compounds for the same indication. . Manufacturing, supply and distribution problems could create supply disruptions that would damage commercial prospects for PROVIGIL. 24 We depend upon Laboratoire L. Lafon as our sole supplier of bulk modafinil compound, the active drug substance contained in PROVIGIL. Moreover, we depend upon a single manufacturer that is qualified to manufacture finished PROVIGIL for commercial purposes. We maintain an inventory of modafinil compound to protect against supply disruptions and are qualifying an additional manufacturer of finished product. We must comply with all applicable regulatory requirements of the FDA and foreign authorities, including current Good Manufacturing Practice, or cGMP, regulations. The facilities used to manufacture, store and distribute our products are subject to inspection by regulatory authorities at any time to determine compliance with regulations. The cGMP regulations are complex, and failure to be in compliance could lead to remedial action, civil and criminal penalties and delays in production of material. A non-active ingredient used in PROVIGIL is no longer manufactured or commercially available. At anticipated levels of demand, we have several years supply of this ingredient. We have prepared a new formulation of PROVIGIL that does not include the now unavailable ingredient; however, the introduction of any such new formulation requires regulatory approval. If we are unable to obtain approval for a new formulation, or if demand for the product were to significantly exceed expectations, 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 PROVIGIL. We rely on several third parties in the United States to distribute, provide customer service activities and accept and process returns. Although we employ a small number of persons to coordinate and manage the activities undertaken by these third parties, we have relatively limited experience in this regard. Any disruption in these activities could impede our ability to sell PROVIGIL and could reduce sales revenue. Our sales of PROVIGIL and related financial results will fluctuate and these fluctuations may adversely affect our stock price. A number of analysts and investors who follow our stock have developed models to attempt to forecast future PROVIGIL sales and have established earnings expectations based upon those models. Forecasting revenue is difficult; especially when there is little commercial history and when the level of market acceptance of the product is uncertain. 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 may adversely affect our stock price. Other factors which may cause our financial results to fluctuate include the cost of PROVIGIL sales, achievement and timing of research and development milestones, co-promotion and other collaboration revenues, cost and timing of clinical trials, marketing and other expenses and manufacturing or supply disruption. We anticipate that we will incur additional losses. To date, we have not been profitable and our accumulated deficit was approximately $347 million at December 31, 1999. Our losses have resulted principally from costs incurred in research and development, including clinical trials, and from selling, general and administrative costs associated with our operations. We expect to continue to incur losses until such time as product revenue from PROVIGIL or other products and product candidates exceed expenses of operating our business. We seek to attain profitability, but we cannot be sure that we will ever achieve product revenues from PROVIGIL or from any of our other product candidates sufficient for us to attain this objective. We cannot be sure that our collaborators or we will obtain required regulatory approvals, or successfully develop, commercialize, manufacture and market any other product candidates. 25 The results and timing of future clinical trials cannot be predicted and future setbacks may materially affect our business. We must demonstrate through preclinical testing and clinical trials 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 hurt the statistical analysis of clinical trial results. The completion of clinical trials of our product candidates may be delayed by many factors. One such factor is the rate of enrollment of patients. Neither we nor our collaborators can control the rate at which patients present themselves for enrollment, and we cannot be sure that the rate of patient enrollment will be consistent with our expectations or be sufficient to enable clinical trials of our product candidates to be completed in a timely manner. Any significant delays in, or termination of, clinical trials of our product candidates may have a material adverse effect on our business. We cannot be sure that we will be permitted by regulatory authorities to undertake additional clinical trials for any of our product candidates, or that if such trials are conducted, any of our product candidates will prove to be safe and efficacious or will receive regulatory approvals. Any delays in or termination of these clinical trial efforts may have a material adverse effect on our business. Our research and development activities may not result in any additional pharmaceutical products, which may adversely affect our business. We are highly focused on the research and development of potential 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, in our industry, the majority of compounds fail to enter clinical studies and the majority of therapeutic candidates entering clinical studies fail to be commercialized. Our research and development and marketing efforts are highly dependent on corporate collaborators who may not devote sufficient time, resources and attention to our programs, which may adversely impact our efforts to develop and market potential products. Because we have limited resources, we have entered into a number of agreements with other pharmaceutical companies. These agreements may call for our partner to control: . the supply of bulk or formulated drugs for commercial use or for use in clinical trials; . the design and execution of clinical studies; . the process of obtaining regulatory approval to market the product; and . the marketing and selling of any approved product. In each of these areas, our partners may not support fully our research and commercial interests since our program may well compete for time, attention and resources with the internal programs of our corporate collaborators. As such, we cannot be sure that our corporate collaborators will share our perspectives on the relative importance of our program, that they will commit sufficient resources to our program to move it forward 26 effectively, or that the program will advance as rapidly as it might if we had retained complete control of all research, development, regulatory and commercialization decisions. For example, we rely on several of these collaborators for the production of compounds and the manufacture and supply of pharmaceutical products. One of them, Kyowa Hakko, has agreed with us to modify the related supply agreement so that we will be responsible for supplying the compounds under development. We have selected another manufacturer to produce these compounds and Kyowa Hakko is working with us to transfer the applicable manufacturing technology to this third party. We cannot be certain that this new manufacturer will be able to manufacture such compounds or products in sufficient quantities, at reasonable prices, and in accordance with cGMP requirements established by the FDA and other regulatory authorities. 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. Many of these companies and institutions have substantially greater capital resources, research and development staffs and facilities than us, 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 potentially could materially adversely affect any sales of products that might be developed or are currently being sold by us or make them obsolete. Advances in current treatment methods also may adversely affect the market for such products. We may not be able to obtain adequate patent protection either in the United States or abroad, which could impact our ability to compete effectively. We place considerable importance on obtaining patent and trade secret protection for new technologies, products and processes. We intend to file applications for patents covering the composition of matter or uses of our drug candidates or our proprietary processes. 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, we cannot be sure that such agreements will be honored or that we will be able to effectively protect our rights to our unpatented trade secrets and know-how. Moreover, we cannot be sure that others will not 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. In addition, we could incur substantial costs in defending any patent infringement suits or in asserting any patent rights, including those licensed to us by third parties, and in defending suits against us or our employees relating to ownership of or rights to intellectual property. Such disputes could substantially delay our drug development or commercialization. The U.S. Patent and Trademark Office, or PTO, or a private party could institute an interference proceeding involving us in connection with one or more of our patents or patent applications. Such proceedings could result in an adverse decision as to priority of invention, in which case we would not be entitled to a patent on the invention at issue in the interference proceeding. The PTO or a private party could also institute reexamination proceedings involving us in connection with one or more of our patents, and such proceedings could result in an adverse decision as to the validity or scope of the patents. We are involved in legal proceedings that, if adversely adjudicated or settled, could materially impact our financial condition. In November 1999, we received a federal grand jury subpoena in connection with an investigation under the supervision of the Office of Consumer Litigation of the U.S. Department of Justice. The grand jury also 27 issued subpoenas to certain of our former and current employees. We believe that the investigation relates to the release of certain lots of MYOTROPHIN used in clinical trials and related reports filed with the FDA during the period 1994-96. We have not been identified as a target of the investigation, and we are cooperating with this inquiry. We cannot predict the outcome of the investigation. In August 1999, the U.S. District Court for the Eastern District of Pennsylvania entered a final order approving the settlement of a class action in which plaintiffs alleged that statements made about the results of certain clinical studies of MYOTROPHIN were misleading. A related complaint has been filed with the Court by a small number of plaintiffs who decided not to participate in the settlement. This related complaint alleges that we are liable under common law for misrepresentations concerning the results of the MYOTROPHIN clinical trials, and that we and certain of our current and former officers and directors are liable for the actions of persons who allegedly traded in our common stock on the basis of material inside information. We believe that we have valid defenses to all claims raised in this action, and we have filed a motion to dismiss these claims which is pending with the Court. Moreover, even if there is a judgment against us, we do not believe it will have a material negative effect on our financial condition or 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 even if our drugs or a collaborator's drugs are not actually at fault for causing an injury. Furthermore, our products may cause, or may appear to have caused, adverse side effects or potentially dangerous drug interactions that we may not learn about or understand fully until the drug is actually manufactured and sold for some time. Product liability claims can be expensive to defend and may result in large judgments or settlements against us, which could have a negative effect on our financial performance. We maintain product liability insurance at a relatively limited level, and as such, claims could exceed our coverage. Furthermore, we cannot be certain that we will always be able to purchase sufficient insurance at an affordable price. 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. We may never obtain approval to market MYOTROPHIN, it may not be cost- effective to pursue MYOTROPHIN for other indications, and therefore we may never derive revenue from MYOTROPHIN. The prospects for regulatory approval of MYOTROPHIN continue to be very uncertain in the United States. We do not believe that the conditions for regulatory approval imposed by the FDA can be met without conducting an additional Phase III study, and we do not intend to conduct such a study. Even if we chose to conduct an additional study, the results of a new study may not be sufficient to obtain regulatory approval. If MYOTROPHIN is not approved for the treatment of ALS, then it is not likely that we would pursue approval for the use of MYOTROPHIN to treat other indications. Additionally, if we do not obtain approval of MYOTROPHIN for ALS or pursue approval for other indications, rights to the product may revert back to CCP. The price of our common stock has been and may continue to be highly volatile. The market price and trading volume of shares of our common stock are volatile, and we expect it to continue to be volatile for the foreseeable future. For example, during the period January 1, 1999 through March 21, 2000, our common stock traded at a high closing price of $72.31 and a low closing price of $7.50. Negative announcements (such as adverse regulatory decisions, disputes concerning patent or other proprietary rights, or operating results that fall below the market's expectations) could trigger significant declines in the price of our common stock. In addition, external events, such as news concerning our competitors, changes in government regulations that may impact the biotechnology or pharmaceutical industries or flows of investor funds into or out of our industry, also are likely to affect the price of our common stock. Our dependence on key executives and scientists could impact the development and management of our business. The nature of our business is such that 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 28 the pharmaceutical and biotechnology industries, and we cannot be sure that we will be able to continue to attract and retain qualified personnel necessary for the development and management of our business. Our research and development programs and our business might be harmed by the loss of the services of existing personnel, as well as the failure to recruit additional key scientific, technical and managerial personnel in a timely manner. Much of the know-how we have developed resides in our scientific and technical personnel and is not readily transferable to other personnel. We do not maintain "key man" life insurance on any of our employees. We may be required to incur significant costs to comply with environmental laws and regulations and our compliance may limit any future profitability. Our research and development activities involve the controlled use of hazardous, infectious and radioactive materials that could be hazardous to human health, safety or the environment. We store these materials and various wastes resulting from their use at our facility pending ultimate use and disposal. We are subject to a variety of federal, state and local laws and regulations governing the use, generation, manufacture, storage, handling and disposal of these materials and wastes resulting from their use, and we may be required to incur significant costs to comply with both existing and future environmental laws and regulations. We believe that our safety procedures for handling and disposing of these materials comply with federal, state and local laws and regulations, but the risk of accidental injury or contamination from these materials cannot be eliminated. In the event of an accident, we could be held liable for any resulting damages. Anti-takeover provisions may 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 Corporation Law, which prohibits us from engaging in a "business combination" with an "interested stockholder" for a period of three years after the date of the transaction in which the person becomes an interested stockholder, unless the business combination is approved in a prescribed manner. The application of Section 203 could have the effect of delaying or preventing a change of control of Cephalon. We also have adopted a "poison pill" rights plan that will dilute the stock ownership of an acquirer of our stock upon the occurrence of certain events. Section 203, the rights plan, and the provisions of our certificate of incorporation, our bylaws and Delaware corporate law, may have the effect of deterring hostile takeovers or delaying or preventing changes in control of our management, including transactions in which stockholders might otherwise receive a premium for their shares over then current market prices. Liquidity and Capital Resources Cash, cash equivalents and investments at December 31, 1999 were $201,562,000, representing 86% of total assets, and at December 31, 1998 were $67,346,000, representing 71% of total assets. The following is a summary of selected cash flow information for each of the years ended December 31:
1999 1998 1997 ------------- ------------ ------------ Net cash used for operating activities........................ $ (58,588,000) $(50,164,000) $(54,677,000) Net cash (used for) provided by investing activities.............. (128,321,000) 21,348,000 53,361,000 Net cash provided by (used for) financing activities.............. 192,377,000 (1,351,000) 28,123,000
29 Net Cash Used for Operating Activities --Operating Cash Inflows A summary of the major sources of cash receipts reflected in net cash used for operating activities for each of the years ended December 31 is as follows:
1999 1998 1997 ----------- ---------- ---------- PROVIGIL sales............................ $26,614,000 $ 727,000 $ -- TAP Holdings Inc.......................... 7,063,000 8,059,000 6,957,000 H. Lundbeck A/S........................... 5,531,000 -- -- Schwarz Pharma AG......................... 2,000,000 -- -- Bristol-Myers Squibb Company.............. 1,008,000 2,005,000 4,682,000 Chiron Corporation........................ -- 1,962,000 5,242,000 Interest.................................. 4,437,000 4,734,000 8,260,000
Sales of PROVIGIL commenced in the United Kingdom in March 1998 and in the United States and the Republic of Ireland in February 1999. In June 1999, we began promoting and marketing PROVIGIL in Austria. We have a licensing and research and development collaboration with TAP Holdings Inc. to develop and commercialize certain compounds, including CEP- 701, for the treatment of prostate disorders and other cancers in the United States. Under the terms of the agreement, we perform research and preclinical development of these compounds for which we are compensated quarterly by TAP, based on a contract rate per individual assigned to the program for that quarter and including reimbursement of certain external costs. At December 31, 1999, $2,691,000 was receivable from TAP. In May 1999, we entered into a collaborative agreement with H. Lundbeck A/S to discover, develop and market products to treat neurodegenerative diseases. Lundbeck will compensate us for our research efforts and will share in joint development costs of CEP-1347 and any other molecules that emerge from the research program. Included in the payments received from Lundbeck in 1999 is a non-refundable license fee of $2,400,000 and reimbursement of research and development costs of $3,131,000. At December 31, 1999, $898,000 was receivable from Lundbeck. In December 1999, we entered into a development and licensing agreement with Schwarz Pharma AG to develop and commercialize certain compounds, including CEP-701, for the treatment of prostate disorders and other cancers in Europe and several other territories outside the United States. Under the agreement, we will receive reimbursement of research activities and clinical supplies, milestone payments and royalty payments on net sales. The $2,000,000 payment received in 1999 from Schwarz Pharma represents a non-refundable license fee paid upon execution of the agreement. We market STADOL NS(R) (butorphanol tartrate) Nasal Spray for Bristol-Myers Squibb to neurologists in the United States. Pursuant to the agreement, we receive quarterly payments equal to a percentage of total STADOL NS sales attributed to prescriptions written by neurologists which exceeds a predetermined base amount. The decrease in amounts received from BMS in 1999 as compared to 1998 and in 1998 as compared to 1997 is due to a reduction in the total amount of STADOL NS sales from the prior comparable period. At December 31, 1999, $607,000 was receivable from BMS. Cephalon has been developing MYOTROPHIN in collaboration with Chiron Corporation for the treatment of ALS and other neurological disorders. The amounts we received generally represented reimbursement from Chiron for MYOTROPHIN program costs incurred in excess of our fifty percent share of program costs. Since June 30, 1998, the companies have been bearing their own MYOTROPHIN costs and we have not received reimbursement of MYOTROPHIN expenditures since that time. --Operating Cash Outflows Operating cash outflows increased in 1999 as compared to 1998 as a result of expenditures associated with the settlement of our securities litigation and an increase in the size of our sales force to fully support both 30 PROVIGIL and our collaboration with Abbott to market GABITRIL. Additionally, cash outflows increased from the prior year because of other expenditures associated with PROVIGIL, including the commercial launch of PROVIGIL in the United States, clinical studies of PROVIGIL and the purchase of PROVIGIL inventories. Operating cash outflows decreased in 1998 as compared to 1997 due to a decrease in the selling, general and administrative costs associated with the MYOTROPHIN program and decreases in external administrative expenses. Research and development funding decreased in 1998 as compared to 1997 primarily because of a decrease in staffing levels, license fees, expenditures associated with the MYOTROPHIN program and other research activities. These reductions offset increased expenditures associated with the PROVIGIL program. --Cash and Funding Requirements Outlook During 1999, we received net proceeds of approximately $196,381,000 through private placements of preferred and common stock, and the exercise of common stock options and warrants. Due to this inflow of funds, we believe that our cash and investment balance as of December 31, 1999 will be adequate to fund our current expected level of operations for at least several years. We expect cash flow from operating activities to continue to be negative until such time, if ever, that sales from PROVIGIL generate cash inflows in excess of the level of cash outflows from operations. Factors such as the degree of market acceptance of PROVIGIL, competition, the effectiveness of our sales and marketing efforts and our ability to demonstrate the utility of PROVIGIL in disorders other than narcolepsy will all have a significant impact on PROVIGIL sales. These factors are difficult to predict at this point in time. Cash inflows also include receipts from our collaborative research and development agreements and from co-promotion agreements. The continuation of funding under any of these agreements is subject to the achievement of milestones and periodic review by the parties involved. We expect our cash requirements for PROVIGIL to increase for the next several years due to efforts associated with the commercialization of PROVIGIL in the United States, including sales and marketing activities, building PROVIGIL inventory and conducting clinical studies of PROVIGIL in disorders other than narcolepsy. Additionally, under our collaboration with Abbott, we are obligated to fund marketing and clinical trial activities for GABITRIL. We expect to increase our funding of research and development activities for our other products in development. We may seek sources of funding for these research programs through collaborative arrangements with third parties but we still expect to spend significant funds on our share of the cost of these programs, including the costs of research, preclinical development, manufacturing and clinical research. During 1999 we issued $30,000,000 of revenue-sharing notes in a private placement. We announced in December 1999 that the notes had been restructured resulting in their retirement in the first quarter of 2000 for an aggregate cash payment of $35,500,000. Additionally, we also will require substantial funds to: . expand and renovate our West Chester facility; . pay quarterly preferred stock dividends; and . obtain additional product rights through licensing or acquisition. Net Cash (Used for) Provided by Investing Activities A summary of net cash (used for) provided by investing activities for each of the years ended December 31 is as follows:
1999 1998 1997 ------------- ----------- ----------- Purchases of property and equipment.. $ (381,000) $ (576,000) $ (823,000) (Purchases) sales and maturities of investments, net.................... (127,940,000) 21,924,000 54,184,000 ------------- ----------- ----------- Net cash (used for) provided by investing activities................ $(128,321,000) $21,348,000 $53,361,000 ============= =========== ===========
31 Net Cash Provided by (Used for) Financing Activities A summary of net cash provided by (used for) financing activities for each of the years ended December 31 is as follows:
1999 1998 1997 ------------ ----------- ----------- Proceeds from issuance of preferred stock.. $120,028,000 $ -- $ -- Proceeds from issuance of common stock..... 12,000,000 -- -- Proceeds from exercises of common stock options and warrants...................... 34,353,000 410,000 3,458,000 Proceeds from issuance of long-term debt... 30,000,000 -- 30,000,000 Preferred dividends paid................... (2,265,000) -- -- Principal payments on long-term debt....... (1,739,000) (1,761,000) (5,335,000) ------------ ----------- ----------- Net cash provided by (used for) financing activities................................ $192,377,000 $(1,351,000) $28,123,000 ============ =========== ===========
During 1999, we completed a sale of 2,500,000 shares of convertible exchangeable preferred stock at $50 per share. The preferred stock is convertible into shares of our common stock at a conversion price of $17.92 per share. Dividends are cumulative at the annual rate of $3.625 per share and are payable quarterly. In connection with the May 1999 collaborative agreement, H. Lundbeck A/S purchased 1,000,000 shares of Cephalon's common stock at a price of $12.00 per share, which was the average market price for the five trading days prior to the closing of the agreement. The extent and timing of future warrant and option exercises, if any, are primarily dependent upon the market price of Cephalon's common stock and general financial market conditions, as well as the exercise prices and expiration dates of the warrants and options. During 1999, investors in Cephalon Clinical Partners, L.P., or CCP, exercised warrants to purchase approximately 1,958,000 shares of common stock. Proceeds associated with these exercises totaled $26,984,000. All outstanding warrants associated with CCP expired on August 31, 1999. During 1999 we issued $30,000,000 of revenue-sharing notes in a private placement. We announced in December 1999 that the notes had been extinguished resulting in their retirement in the first quarter of 2000 for an aggregate cash payment of $35,500,000. In 1997, proceeds from the issuance of long-term debt consist of a $30,000,000 private placement of senior convertible notes. As of December 31, 1998, the principal on the senior convertible notes had been fully converted into 3,148,000 shares of Cephalon's common stock. For all periods presented, principal payments on long-term debt include payments on mortgage loans and payments on capital lease obligations. Additionally, in 1997, we repaid in full the $3,750,000 balance due on an unsecured bank loan. Commitments and Contingencies --Related Party In August 1992, we exclusively licensed our rights to MYOTROPHIN for human therapeutic use within the United States, Canada and Europe to CCP. We perform any development and clinical testing of MYOTROPHIN on behalf of CCP under a research and development agreement with CCP. CCP has granted us an exclusive license to manufacture and market MYOTROPHIN for human therapeutic use within the United States, Canada and Europe in return for royalty payments equal to a percentage of product sales and a milestone payment of approximately $16,000,000 that will be made if MYOTROPHIN receives regulatory approval. 32 We have a contractual option to purchase all of the limited partnership interests of CCP. To exercise this purchase option, we are required to make an advance payment of $40,275,000 in cash or, at our election, $42,369,000 in shares of common stock or a combination thereof. The purchase option will become exercisable upon the occurrence of certain events once sales activity commences. Should we discontinue development of MYOTROPHIN or if we do not exercise the 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. --Legal Proceedings In November 1999, we received a federal grand jury subpoena in connection with an investigation which we believe relates to the release of certain lots of MYOTROPHIN used in clinical trials and related reports filed with the FDA during the period 1994-96. On August 30, 1999, an order issued by the U.S. District Court for the Eastern District of Pennsylvania became final that approved the settlement of an action stemming from allegations that statements made about the results of certain clinical studies of MYOTROPHIN were misleading. A further complaint has been filed with the Court alleging liability under common law for misrepresentations relating to these same studies and for failing to prevent certain non-employees from trading in Cephalon common stock on the basis of material inside information. We have filed a motion to dismiss these claims which is pending with the Court. See "Certain Risks Related to Cephalon's Business." Results of Operations This section should be read in conjunction with the more detailed discussion under "Liquidity and Capital Resources." Sales of PROVIGIL were initiated in the United Kingdom in March 1998 and in the United States and Republic of Ireland in February 1999. Product sales of PROVIGIL are recognized upon shipment of product and are recorded net of reserves for returns and allowances. The reserve for product returns is derived by utilizing reports purchased from external, independent sources, including NDC Health Information, IMS Health and several pharmaceutical wholesalers, which provide prescription data, wholesale stocking levels and wholesale sales to retail pharmacies. From this data, we estimate retail pharmacy stocking levels. This data is reviewed to monitor product movement through the supply chain to identify slow moving product that is more likely to be returned. The reserves are reviewed at each reporting period and adjusted to reflect data available at that time. Any changes in the reserve will result in changes in the amount of revenue recognized in the period. This methodology has resulted in the recognition of revenue for only product that we believe was prescribed to patients or which is currently in inventory at distribution centers and retail pharmacy locations and which we believe, based upon the history of reorders of product by these distribution centers and retail pharmacy locations, is likely to be used. We believe this approach is appropriate given that: (i) PROVIGIL is a new product and we have limited sales, product return and collection history; (ii) at this time PROVIGIL's approved use is limited to a relatively small patient base and, as a result, market penetration has been limited; and, (iii) to date, returns have been limited, however, product may be returned for credit for up to its expiration date, which is currently 36 months from its date of manufacture. At each reporting period, we intend to continue to monitor inventory levels at the wholesalers and retail pharmacies, as well as reorder history. Should this information indicate a steady stream of the product moving through the supply chain, which would indicate that returns are less likely to occur, the product reserve balance would be reduced, resulting in the recognition of additional revenue. Year ended December 31, 1999 compared to year ended December 31, 1998 For the year ended December 31, 1999, shipments of PROVIGIL to customers were $31,488,000 of which $6,118,000 was recorded as a reserve for returns and allowances, resulting in product sales of $25,370,000. 33 Other revenues increased in the 1999 period from the 1998 period due primarily to revenue recognized from the receipt of non-refundable license fees related to the initiation of collaborative agreements with Lundbeck in May 1999 for $2,400,000 and with Schwarz Pharma in December 1999 for $2,000,000. For the year ended December 31, 1999, cost of product sales was 13% of sales and consisted primarily of royalties due to Lafon. This is not indicative of future expectations. Prior to FDA approval of PROVIGIL in December 1998, we recorded the costs of producing PROVIGIL as research and development expense in accordance with Statement of Financial Accounting Standards No. 2 "Accounting for Research and Development Costs." For the year ended December 31, 1999, approximately $3,769,000 of inventory costs were excluded from cost of product sales. As of December 31, 1999, we maintained approximately $354,000 of inventory on hand that was previously charged to research and development expense. We anticipate that this remaining material will be sold during the first quarter of 2000. Once this inventory has been sold, we expect cost of product sales to be between 21% and 26% of sales. For the year ended December 31, 1999, research and development expenses increased from the same 1998 period due to increased expenditures on our clinical program for PROVIGIL and other research programs associated with our collaborative arrangements. These increases were partially offset by a decrease in expenses associated with the purchase of bulk modafinil, the active drug substance in PROVIGIL. Prior to receiving FDA approval to market PROVIGIL, purchases of modafinil were recorded as research and development expense. The increase in the selling, general and administrative area for the year ended December 31, 1999 as compared to the corresponding 1998 period was due principally to marketing expenses associated with the commercial launch of PROVIGIL, an increase in the size of our sales force to fully support both PROVIGIL and our collaboration with Abbott to market GABITRIL and the recording of a $4,300,000 provision related to our securities litigation. In connection with the restructuring of the revenue sharing notes, we recorded a loss in 1999 on the extinguishment of the notes of $11,187,000, which includes the prepayment penalty of $5,500,000 and the write-off of deferred financing costs and the remaining value of the associated warrants of $5,267,000. These notes were retired in the first quarter of 2000 for an aggregate payment of $35,500,000. The decrease in net interest income is primarily due to an increase in interest expense associated with the revenue-sharing notes. Preferred dividends of $3,398,000 were recognized in 1999 in connection with the August 1999 private offering of 2,500,000 shares of convertible exchangeable preferred stock. Year ended December 31, 1998 compared to year ended December 31, 1997 Other revenues decreased in 1998 as compared to 1997 due primarily to the cessation of both the Schering-Plough and Smith-Kline Beecham research and development collaborations and because of a decrease in revenues recognized from Chiron and Kyowa Hakko as a result of the decreased expenditures associated with the MYOTROPHIN program. Research and development expenses decreased in 1998 as compared to 1997 primarily because of a decrease in staffing levels, license fees, expenditures associated with the MYOTROPHIN program and other research activities. These reductions were partially offset by increased clinical research expenditures associated with the PROVIGIL program. 34 The decrease in the selling, general and administrative area for 1998 as compared to the corresponding 1997 period was due primarily to reductions in expenses associated with the MYOTROPHIN program and our co-promotion agreement with Laboratoire Aguettant S.A. Net interest income decreased in 1998 due primarily to lower investment balances throughout the year as compared to the corresponding 1997 period. Results of Operations Outlook We expect to continue to incur operating losses unless and until sales of PROVIGIL exceed operating expenses. We expect that sales of PROVIGIL may be limited since we can only market the product to treat excessive daytime sleepiness associated with narcolepsy. We may never be able to achieve profitability solely through sales of PROVIGIL even if our market-base is expanded to include other indications. Other revenues include revenue recognized under 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 periodic review by the parties involved. We expect to continue to incur significant expenditures associated with the commercialization of PROVIGIL in the United States, including sales and marketing activities, and conducting clinical studies of PROVIGIL in disorders other than narcolepsy. Additionally, under our agreement with Abbott, we are obligated to fund specified levels of marketing and some clinical trial activities for GABITRIL. We expect to increase our expenditures on research and development activities for our other products in development. We may seek sources of funding for these research and development programs through collaborative arrangements with third parties but we still expect to have significant expenditures for our share of the costs of these programs, including the costs of research, preclinical development, manufacturing and clinical research. In connection with our sale of 2,500,000 shares of convertible exchangeable preferred stock during the third quarter of 1999, we will continue to recognize quarterly preferred stock dividends unless the preferred stock is converted into convertible debentures or shares of our common stock. We expect to have significant fluctuations in quarterly results based primarily on the level and timing of: . PROVIGIL sales, including changes in the provision for product returns; . the cost of PROVIGIL sales; . achievement and timing of research and development milestones; . co-promotion and other collaboration revenues; . cost and timing of clinical trials; and . marketing and other expenses. In connection with the issuance in December 1999 of Staff Accounting Bulletin No. 101 "Revenue Recognition in Financial Statements," or SAB 101, we expect that we will be required to defer non-refundable license fees recorded in 1999 from Lundbeck and Schwarz Pharma and recognize that revenue over future periods. We also expect to report a change in accounting principles in accordance with SAB 101, and to record the impact of this change as a cumulative effect in our statement of operations in 2000. We do not believe that inflation has had a material impact on the results of our operations since our inception. Impact of Year 2000 We are not aware of any material problems resulting from Year 2000 issues, either with our products under development, our internal systems, or the products and services of third parties. We will continue to monitor our mission critical computer applications and those of our suppliers and vendors throughout the year 2000 to ensure that any latent Year 2000 matters that may arise are addressed promptly. 35 ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK We do not use derivative financial instruments for speculative or trading purposes. Therefore, our market risk exposure is limited to changes in interest rates affecting the return on our investments and foreign currency fluctuations. Our exposure to market risk for a change in interest rates relates primarily to our investment portfolio. Our investments are classified as short-term and as "available for sale." We do not believe that short-term fluctuations in interest rates would materially affect the value of our securities. Our exposure to market risk for fluctuations in foreign currency relates primarily to the intercompany balance with our U.K. subsidiary. Exchange gains and losses related to amounts due from the U.K. subsidiary have not been material for the periods presented. 36 ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS To Cephalon, Inc.: We have audited the accompanying consolidated balance sheets of Cephalon, Inc. (a Delaware corporation) and subsidiaries as of December 31, 1999 and 1998, and the related consolidated statements of operations, stockholders' equity and cash flows for each of the three years in the period ended December 31, 1999. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with auditing standards generally accepted in the United States. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of Cephalon, Inc. and subsidiaries as of December 31, 1999 and 1998, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 1999, in conformity with accounting principles generally accepted in the United States. Arthur Andersen LLP Philadelphia, Pennsylvania February 17, 2000 37 REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS To Cephalon, Inc.: We have audited, in accordance with auditing standards generally accepted in the United States, the consolidated financial statements for Cephalon, Inc. and have issued our report thereon dated February 17, 2000. Our audit was made for the purpose of forming an opinion on the basic financial statements taken as a whole. The schedule of valuation and qualifying accounts is presented for purposed of complying with the Securities and Exchange Commissions' rules and is not part of the basic financial statements. This schedule has been subject to the auditing procedures applied in the audit of the basic financial statements and, in our opinion, fairly states in all material respects the financial data required to be set forth therein in relation to the basic financial statements taken as a whole. Arthur Andersen LLP Philadelphia, Pennsylvania February 17, 2000 38 CEPHALON, INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS
December 31, December 31, 1999 1998 ------------- ------------- ASSETS CURRENT ASSETS: Cash and cash equivalents (Note 2).............. $ 13,152,000 $ 7,484,000 Short-term investments (Note 2)................. 188,410,000 59,862,000 Receivables, net................................ 5,578,000 3,887,000 Inventory (Note 3).............................. 4,258,000 38,000 Other........................................... 988,000 1,323,000 ------------- ------------- Total current assets........................... 212,386,000 72,594,000 PROPERTY AND EQUIPMENT, net of accumulated depreciation and amortization of $15,192,000 and $13,439,000 (Note 4)............................ 20,001,000 20,505,000 OTHER............................................ 1,666,000 1,574,000 ------------- ------------- $ 234,053,000 $ 94,673,000 ============= ============= LIABILITIES AND STOCKHOLDERS' EQUITY CURRENT LIABILITIES: Accounts payable................................ $ 6,221,000 $ 3,558,000 Accrued expenses (Note 5)....................... 19,328,000 13,298,000 Current portion of long-term debt (Note 6)...... 31,906,000 1,624,000 ------------- ------------- Total current liabilities...................... 57,455,000 18,480,000 LONG-TERM DEBT (Note 6) 14,034,000 15,096,000 OTHER (Note 7)................................... 4,207,000 3,495,000 ------------- ------------- Total liabilities............................ 75,696,000 37,071,000 ------------- ------------- COMMITMENTS AND CONTINGENCIES (Note 8) STOCKHOLDERS' EQUITY: (Note 9) Preferred stock, $.01 par value, 5,000,000 shares authorized, 2,500,000 shares issued and outstanding.................................... 25,000 -- Common stock, $.01 par value, 100,000,000 shares authorized, 32,560,938 and 28,802,323 shares issued and outstanding......................... 326,000 288,000 Additional paid-in capital...................... 505,702,000 331,673,000 Treasury stock.................................. (1,290,000) (487,000) Accumulated deficit............................. (347,135,000) (273,793,000) Accumulated other comprehensive income (loss)... 729,000 (79,000) ------------- ------------- Total stockholders' equity..................... 158,357,000 57,602,000 ------------- ------------- $ 234,053,000 $ 94,673,000 ============= =============
The accompanying notes are an integral part of these financial statements. 39 CEPHALON, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS
Year Ended December 31, ---------------------------------------- 1999 1998 1997 ------------ ------------ ------------ REVENUES: (Notes 1 and 10) Product sales--PROVIGIL............ $ 25,370,000 $ 728,000 $ -- Other revenues..................... 19,549,000 14,927,000 23,140,000 ------------ ------------ ------------ 44,919,000 15,655,000 23,140,000 ------------ ------------ ------------ COSTS AND EXPENSES: Cost of product sales--PROVIGIL (Note 3).......................... 3,250,000 -- -- Research and development........... 46,420,000 43,649,000 51,587,000 Selling, general and administrative.................... 50,992,000 30,947,000 36,744,000 ------------ ------------ ------------ 100,662,000 74,596,000 88,331,000 ------------ ------------ ------------ LOSS FROM OPERATIONS................ (55,743,000) (58,941,000) (65,191,000) ------------ ------------ ------------ INTEREST: Income............................. 5,239,000 5,408,000 7,973,000 Expense (Note 6)................... (8,253,000) (1,874,000) (3,201,000) ------------ ------------ ------------ (3,014,000) 3,534,000 4,772,000 ------------ ------------ ------------ LOSS BEFORE EXTRAORDINARY CHARGE.... (58,757,000) (55,407,000) (60,419,000) EXTRAORDINARY CHARGE FOR EARLY EXTINGUISHMENT OF DEBT (Note 6).... (11,187,000) -- -- ------------ ------------ ------------ LOSS................................ (69,944,000) (55,407,000) (60,419,000) DIVIDENDS ON PREFERRED STOCK (Note 9)................................. (3,398,000) -- -- ------------ ------------ ------------ LOSS APPLICABLE TO COMMON SHARES.... $(73,342,000) $(55,407,000) $(60,419,000) ============ ============ ============ BASIC AND DILUTED LOSS PER COMMON SHARE: Loss per common share before extraordinary charge.............. $ (2.10) $ (1.95) $ (2.36) Extraordinary charge............... (0.38) -- -- ------------ ------------ ------------ $ (2.48) $ (1.95) $ (2.36) ============ ============ ============ WEIGHTED AVERAGE NUMBER OF COMMON SHARES OUTSTANDING................. 29,584,199 28,413,220 25,637,508 ============ ============ ============
The accompanying notes are an integral part of these financial statements. 40 CEPHALON, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
Accumulated Total Other Additional Comprehensive Accumulated Comprehensive Common Preferred Paid-in Treasury Loss Total Deficit Income/(Loss) Stock Stock Capital Stock ------------- ------------ ------------- ------------- -------- --------- ------------ ----------- BALANCE, JANUARY 1, 1997.............. $137,326,000 $(157,967,000) $(43,000) $246,000 $ -- $296,868,000 $(1,778,000) Loss............... $(60,419,000) (60,419,000) (60,419,000) Foreign currency translation....... (1,000) ------------ Other comprehensive loss.............. (1,000) (1,000) (1,000) ------------ Comprehensive loss.............. (60,420,000) ============ Stock options and warrants exercised......... 3,503,000 -- 3,000 3,500,000 -- Restricted stock award plan........ 1,684,000 -- 1,000 1,683,000 -- Employee benefit plan.............. 605,000 -- -- 605,000 -- Conversion of convertible debentures........ 17,695,000 -- 20,000 17,675,000 -- Issuance of warrants in connection with convertible debentures transactions...... 400,000 -- -- 400,000 -- Expired call option............ (1,973,000) -- 5,000 (1,978,000) -- Treasury stock acquired.......... (455,000) -- -- -- (455,000) Treasury stock retirement........ 1,973,000 -- (1,000) -- 1,974,000 ------------ ------------- -------- -------- ------- ------------ ----------- BALANCE, DECEMBER 31, 1997.......... 100,338,000 (218,386,000) (44,000) 274,000 -- 318,753,000 (259,000) Loss............... (55,407,000) (55,407,000) (55,407,000) Foreign currency translation....... (35,000) ------------ Other comprehensive loss.............. (35,000) (35,000) (35,000) ------------ Comprehensive loss.............. (55,442,000) ============ Stock options and warrants exercised......... 216,000 -- -- 216,000 -- Restricted stock award plan........ 1,500,000 -- 1,000 1,499,000 -- Employee benefit plan.............. 583,000 -- 1,000 582,000 -- Conversion of convertible debentures........ 10,635,000 -- 12,000 10,623,000 -- Treasury stock acquired.......... (228,000) -- -- -- (228,000) ------------ ------------- -------- -------- ------- ------------ ----------- BALANCE, DECEMBER 31, 1998.......... 57,602,000 (273,793,000) (79,000) 288,000 -- 331,673,000 (487,000) Loss............... (69,944,000) (69,944,000) (69,944,000) Foreign currency translation....... 200,000 Unrealized investment gains.. 608,000 ------------ Other comprehensive loss.............. 808,000 808,000 808,000 ------------ Comprehensive loss.............. $(69,136,000) ============ Stock options and warrants exercised......... 45,995,000 -- 36,000 45,959,000 -- Restricted stock award plan........ 1,023,000 -- 1,000 1,022,000 -- Employee benefit plan.............. 453,000 -- 1,000 452,000 -- Convertible preferred stock issued............ 120,028,000 -- -- 25,000 120,003,000 -- Dividends declared convertible preferred......... (3,398,000) (3,398,000) -- Revenue-sharing notes issued...... 6,593,000 6,593,000 Treasury stock acquired.......... (803,000) -- -- -- (803,000) ------------ ------------- -------- -------- ------- ------------ ----------- BALANCE, DECEMBER 31, 1999.......... $158,357,000 $(347,135,000) $729,000 $326,000 $25,000 $505,702,000 $(1,290,000) ============ ============= ======== ======== ======= ============ ===========
The accompanying notes are an integral part of these financial statements. 41 CEPHALON, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS
Year Ended December 31, ---------------------------------------- 1999 1998 1997 ------------ ------------ ------------ CASH FLOWS FROM OPERATING ACTIVITIES: Loss................................ $(69,944,000) $(55,407,000) $(60,419,000) Adjustments to reconcile loss to net cash used for operating activities: Depreciation and amortization...... 10,264,000 2,340,000 2,247,000 Non-cash compensation expense...... 381,000 1,854,000 1,811,000 Other.............................. 594,000 47,000 157,000 (Increase) decrease in operating assets: Receivables....................... (184,000) 1,152,000 247,000 Inventory......................... (4,220,000) (38,000) -- Other current assets.............. (1,741,000) 1,195,000 (186,000) Other long-term assets............ (2,010,000) (109,000) (1,656,000) Increase(decrease) in operating liabilities: Accounts payable.................. 2,663,000 874,000 1,086,000 Accrued expenses.................. 4,897,000 (2,817,000) 1,289,000 Other long-term liabilities....... 712,000 745,000 747,000 ------------ ------------ ------------ Net cash used for operating activities....................... (58,588,000) (50,164,000) (54,677,000) ------------ ------------ ------------ CASH FLOWS FROM INVESTING ACTIVITIES: Purchases of property and equipment.......................... (381,000) (576,000) (823,000) Sales and maturities (purchases) of investments, net................... (127,940,000) 21,924,000 54,184,000 ------------ ------------ ------------ Net cash (used for) provided by investing activities............. (128,321,000) 21,348,000 53,361,000 ------------ ------------ ------------ CASH FLOWS FROM FINANCING ACTIVITIES: Proceeds from issuance of preferred stock.............................. 120,028,000 -- -- Proceeds from issuance of common stock.............................. 12,000,000 -- -- Proceeds from exercises of common stock options and warrants......... 34,353,000 410,000 3,458,000 Proceeds from issuance of long-term debt............................... 30,000,000 -- 30,000,000 Preferred dividends paid............ (2,265,000) -- -- Principal payments on long-term debt............................... (1,739,000) (1,761,000) (5,335,000) ------------ ------------ ------------ Net cash provided by (used for) financing activities............. 192,377,000 (1,351,000) 28,123,000 ------------ ------------ ------------ EFFECT OF EXCHANGE RATE CHANGES ON CASH AND CASH EQUIVALENTS........... 200,000 (34,000) -- ------------ ------------ ------------ NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS.................... 5,668,000 (30,201,000) 26,807,000 CASH AND CASH EQUIVALENTS, BEGINNING OF YEAR............................. 7,484,000 37,685,000 10,878,000 ------------ ------------ ------------ CASH AND CASH EQUIVALENTS, END OF YEAR................................ $ 13,152,000 $ 7,484,000 $ 37,685,000 ============ ============ ============
The accompanying notes are an integral part of these financial statements. 42 CEPHALON, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 1. NATURE OF BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES Business Cephalon, Inc., headquartered in West Chester, Pennsylvania, is a biopharmaceutical company dedicated to the discovery, development and marketing of products to treat neurological disorders and cancer. We have had negative cash flow from operations since inception and have funded our operations primarily from the proceeds of public and private placements of our securities. Sales of PROVIGIL(R) (modafinil) Tablets [C-IV] were initiated in the United Kingdom in March 1998 and in the United States and the Republic of Ireland in February 1999. In June 1999, we began promoting and marketing PROVIGIL in Austria. PROVIGIL is approved in those countries for use by those suffering from excessive daytime sleepiness associated with narcolepsy. We entered into a collaborative agreement with Abbott Laboratories in June 1999 to market and further develop GABITRIL(R) (tiagabine hydrochloride), an adjunctive treatment for partial seizures associated with epilepsy. Our business is subject to a number of significant risks, including the risks inherent in pharmaceutical research and development activities. We are highly dependent upon the successful commercialization of PROVIGIL and there is no assurance that we will achieve profitability solely on sales of PROVIGIL. Principles of Consolidation The consolidated financial statements include the results of operations of Cephalon and its wholly owned subsidiaries. Intercompany transactions have been eliminated. Translation of Foreign Financial Statements In accordance with SFAS No. 52, "Foreign Currency Translation," assets and liabilities of our foreign operations are translated at the year-end rate of exchange and the income statements are translated at the average rate of exchange for the year. Gains or losses from translating foreign currency financial statements are accumulated in a separate component of stockholders' equity. Transaction gains and losses are included in results of operations. Pervasiveness of Estimates The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the amounts reported in the financial statements. Actual results could differ from those estimates. Cash Equivalents Cash equivalents include investments in liquid securities with original maturities of three months or less. In accordance with SFAS No. 115, "Accounting for Certain Investments in Debt and Equity Securities," we consider our investments to be "available for sale." We classify these investments as short-term and carry them at fair market value. The unrealized gain for the year ended December 31, 1999 has been recorded as a separate component of stockholders' equity. All realized gains and losses on our available for sale securities are recognized in results of operations. Inventory Inventory is stated at the lower of cost or market value using the first-in, first-out, or FIFO, method. Property and Equipment Property and equipment are stated at cost and depreciated using the straight-line method over the estimated useful lives of the assets, which range from three to forty years. Property and equipment under capital leases are depreciated or amortized over the shorter of the lease term or the expected useful life of the assets. Expenditures for maintenance and repairs are charged to expense as incurred, while major renewals and betterments are 43 CEPHALON, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) capitalized. Our assets are reviewed and adjusted for impairment whenever events or circumstances have occured that indicate that the remaining useful lives of the assets should be revised or that the remaining balance of such assets may not be recoverable based upon expectations of future undiscounted cash flows. No such adjustments were required as of December 31, 1999. Fair Value of Financial Instruments The book values of cash, cash equivalents, short-term investments, accounts receivable, accounts payable and accrued expenses are considered to approximate their respective fair values. None of our debt instruments that were outstanding as of December 31, 1999 have readily ascertainable market values; however, the carrying values approximate their respective fair values. Revenue Recognition Product sales of PROVIGIL are recognized upon shipment of product and are recorded net of reserves for returns and allowances. The reserve for product returns is derived by utilizing reports purchased from external, independent sources, including NDC Health Information Services, IMS Health and several pharmaceutical wholesalers, which provide prescription data, wholesale stocking levels and wholesale sales to retail pharmacies. From this data, we estimate retail pharmacy stocking levels. This data is reviewed to monitor product movement through the supply chain to identify slow moving product that is more likely to be returned. The reserves are reviewed at each reporting period and adjusted to reflect data available at that time. Any changes in the reserve will result in changes in the amount of revenue recognized in the period. This methodology has resulted in the recognition of revenue for only product that we believe was prescribed to patients or that is currently in inventory at distribution centers and retail pharmacy locations and that we believe, based upon the history of reorders of product by these distribution centers and retail pharmacy locations, is likely to be used. We believe this approach is appropriate given that: (i) PROVIGIL is a new product and we have limited sales, product return and collection history; (ii) at this time PROVIGIL's approved use is limited to a relatively small patient base and, as a result, market penetration has been limited; and, (iii) to date, returns have been limited, however, product may be returned for credit up to its expiration date, which is currently 36 months from its date of manufacture. At each reporting period, we intend to continue to monitor inventory levels at the wholesalers and retail pharmacies, as well as reorder history. Should this information indicate a steady stream of the product moving through the supply chain, which would indicate that returns are less likely to occur, the product reserve balance would be reduced, resulting in the recognition of additional revenue. On contracts in which we receive payments based upon the level of our related research and development expenses, revenues are recognized as the related expenses are incurred. On contracts which provide for the receipt of milestone payments, revenues are recognized when the payor confirms that the milestone has been achieved. On contracts which provide for payments based upon pre-determined rates for personnel working on the contract and reimbursement of third-party expenses, revenues are recognized as the work is performed and the third-party expenses are incurred. Payments received that relate to future performance are deferred and recognized as revenue over the specified future performance periods. Under our co-promotion agreements, revenue is recognized upon the achievement of the stipulated sales activity and performance targets. Under agreements in which we supply product to third parties for clinical trials, we recognize revenue upon product shipment. Research and Development All research and development costs are charged to expense as incurred. 44 CEPHALON, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) Loss Per Common Share Basic loss per share is computed by dividing net loss by the weighted- average number of common shares outstanding during the period. For the years ended December 31, 1999, 1998 and 1997, diluted loss per common share is the same as basic loss per common share since the calculation of diluted loss per share excludes stock options, restricted stock awards, warrants and the conversion of convertible notes because their inclusion would be antidilutive. Stock-based Compensation We account for stock-based compensation in accordance with the provisions of Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees," and related interpretations. Accordingly, compensation cost is not required to be recognized on options granted. Disclosures required with respect to alternative fair value measurement and recognition methods prescribed by Statement of Financial Accounting Standards (SFAS) No. 123, "Accounting for Stock-Based Compensation," are presented in Note 9. Reclassifications Certain reclassifications of prior year amounts have been made to conform with the current year presentation. Recent Accounting Pronouncements In December 1999, the Securities and Exchange Commission issued Staff Bulletin No. 101, "Revenue Recognition in Financial Statements" (SAB 101) which is effective for fiscal years beginning after December 15, 1999. The bulletin draws on existing accounting rules and provides specific guidance on how those accounting rules should be applied, and specifically addresses revenue recognition for non-refundable technology access fees in the biotechnology industry. We expect that we will be required to defer non- refundable technology fees and recognize revenue over future periods. We also expect to report a change in accounting principle in accordance with SAB 101, and to record the impact of this change as a cumulative effect in our statement of operations in 2000. (See Note 10 Revenues--Research and development collaborations). 2. CASH, CASH EQUIVALENTS AND INVESTMENTS At December 31, cash, cash equivalents and investments consisted of the following:
1999 1998 ------------ ----------- Cash and cash equivalents.......................... $ 13,152,000 $ 7,484,000 ------------ ----------- Short-term investments: U.S. treasury securities......................... -- 30,108,000 U.S. government agency obligations............... 91,115,000 19,722,000 Commercial paper................................. 66,346,000 10,032,000 Asset backed securities.......................... 29,699,000 -- Corporate bonds.................................. 1,250,000 -- ------------ ----------- 188,410,000 59,862,000 ------------ ----------- $201,562,000 $67,346,000 ============ ===========
45 CEPHALON, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) The contractual maturities of our investments in debt securities at December 31, 1999 are as follows:
Maturity -------- Less than one year........................................... $117,927,000 Greater than one year but less than two years................ 53,725,000 Greater than two years but less than three years............. 16,758,000 ------------ $188,410,000 ============
Some of our lease agreements contain covenants that obligate us to maintain minimum cash and investment balances (see Note 6). 3. INVENTORY At December 31, inventory consisted of the following:
1999 1998 ---------- ------- Raw material............................................ $1,570,000 $ -- Work-in-process......................................... 1,616,000 -- Finished goods.......................................... 1,072,000 38,000 ---------- ------- $4,258,000 $38,000 ========== =======
All of the PROVIGIL sold in the United States during 1999 was produced prior to its December 1998 FDA approval and, in accordance with SFAS No. 2 "Accounting for Research and Development Costs," the costs of producing that material were recorded as research and development expense in those prior periods. As of December 31, 1999, we maintained approximately $354,000 of inventory on hand that was previously charged to research and development expense. We expect that this remaining expensed material will be sold during the first quarter of 2000 and, as a result, we anticipate that our cost of sales expressed as a percentage of sales will approximately double from the levels recorded in 1999. Cost of product sales through December 31, 1999 consisted primarily of royalties due to Laboratoire L. Lafon. 4. PROPERTY AND EQUIPMENT At December 31, property and equipment consisted of the following:
1999 1998 ------------ ------------ Land and buildings............................. $ 20,101,000 $ 20,046,000 Laboratory and office equipment................ 15,092,000 13,898,000 ------------ ------------ 35,193,000 33,944,000 Less allowances for depreciation and amortization.................................. (15,192,000) (13,439,000) ------------ ------------ $ 20,001,000 $ 20,505,000 ============ ============
46 CEPHALON, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) 5. ACCRUED EXPENSES At December 31, accrued expenses consisted of the following:
1999 1998 ----------- ----------- Accrued premium on early extinguishment of revenue sharing notes........................... $ 5,500,000 $ -- Accrued compensation and benefits................ 3,668,000 876,000 Accrued professional and consulting fees......... 3,422,000 2,556,000 Accrued clinical trial fees and related expenses........................................ 1,619,000 2,177,000 Accrued license fees and royalties............... 2,249,000 2,096,000 Accrued litigation-related costs................. -- 4,838,000 Accrued preferred dividends...................... 1,133,000 -- Other accrued expenses........................... 1,737,000 755,000 ----------- ----------- $19,328,000 $13,298,000 =========== ===========
6. LONG-TERM DEBT At December 31, long-term debt consisted of the following:
1999 1998 ----------- ----------- Capital lease obligations.......................... $ 1,608,000 $ 1,335,000 Mortgage loans..................................... 14,332,000 15,385,000 Revenue sharing notes.............................. 30,000,000 -- ----------- ----------- 45,940,000 16,720,000 Less current portion............................... (31,906,000) (1,624,000) ----------- ----------- $14,034,000 $15,096,000 =========== ===========
Aggregate maturities of long-term debt for the next five years are as follows: 2000--$31,906,000; 2001--$1,650,000; 2002--$1,423,000; 2003-- $1,336,000; 2004--$1,320,000; 2005 and thereafter--$8,305,000. The current portion of long-term debt consists of payments due on the capital lease obligations, mortgage loans and the early extinguishment of the revenue sharing notes. We paid interest related to debt instruments of $6,885,000, $1,170,000, and $2,242,000 in 1999, 1998 and 1997, respectively. Revenue Sharing Notes In February 1999, we completed a private placement of $30,000,000 of revenue sharing notes. The notes are secured by our rights to PROVIGIL in the United States and bear an annual interest rate of 11%. In connection with the notes, we issued warrants to purchase 1,920,000 shares of common stock at an exercise price of $10.08. The estimated fair value of the warrants of $6,236,000 was recorded as a discount to the notes for amortization over the term of the notes. In December 1999, the notes were restructured whereby the maturity of these notes was accelerated and holders of the notes will receive a payment of 6% of net sales of PROVIGIL in the United States through December 31, 2001, versus 2003 in the original agreements. The notes were retired in the first quarter of 2000 for an aggregate cash payment of $35,500,000. In connection with the restructuring, we recorded a loss in 1999 on the extinguishment of the notes of $11,187,000, which includes the prepayment penalty of $5,500,000 and the write-off of deferred financing costs and the remaining value of the warrants of $5,267,000. Capital Lease Obligations We currently lease laboratory, production and computer equipment with a cost of $4,282,000 under lease agreements. Under the terms of the agreements, we must maintain a minimum balance in unrestricted cash and 47 CEPHALON, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) investments of $30,000,000 or deliver to the lessor an irrevocable letter of credit in the amount of the then outstanding balance due on all equipment leased under the agreements. At December 31, 1999, the balance due under the lease agreements was $1,608,000. Our lease agreements provide us with an option to purchase the leased equipment at the conclusion of the lease. Mortgage Loans In March 1995, we purchased the buildings housing our administrative offices and research facilities in West Chester, Pennsylvania for $11,000,000. We financed the purchase through the assumption of an existing $6,900,000 first mortgage and from $11,600,000 in state funding provided by the Commonwealth of Pennsylvania. The first mortgage has a 15-year term with an annual interest rate of 9 5/8%. The state funding has a 15-year term with an annual interest rate of 2%. The 2% interest rate may be increased to prime plus 2% because we failed to hire a specified number of new employees in Chester County, Pennsylvania by the end of 1999. We are discussing modifications to the agreement with the State. The loans require annual aggregate principal and interest payments of $1,800,000. The loans are secured by the buildings and fixtures therein and a portion of the state funding also is secured by all our equipment located in Pennsylvania that is otherwise unsecured. 7. OTHER LIABILITIES At December 31, other liabilities consisted of the following:
1999 1998 ---------- ---------- Accrued interest (See Note 6)......................... $4,009,000 $3,210,000 Deferred compensation................................. 198,000 285,000 ---------- ---------- $4,207,000 $3,495,000 ========== ==========
8. COMMITMENTS AND CONTINGENCIES Leases We lease certain of our offices and automobiles under operating leases. We do not consider our future annual minimum payments under these leases to be material. Lease expense under all operating leases totaled $416,000, $866,000, and $725,000 in 1999, 1998, and 1997, respectively. 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 perform any development and clinical testing of MYOTROPHIN on behalf of CCP under a research and development agreement with CCP. CCP has granted us an exclusive license to manufacture and market MYOTROPHIN for human therapeutic use within the United States, Canada and Europe in return for royalty payments equal to a percentage of product sales and a milestone payment of approximately $16,000,000 that will be made if MYOTROPHIN receives regulatory approval. 48 CEPHALON, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) We have a contractual option to purchase all of the limited partnership interests of CCP. To exercise this purchase option, we are required to make an advance payment of $40,275,000 in cash or, at our election, $42,369,000 in shares of common stock or a combination thereof. The purchase option will become exercisable upon the occurrence of certain events once sales activity commences. Should we discontinue development of MYOTROPHIN or if we do not exercise the 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. Legal Proceedings In November 1999, we received a federal grand jury subpoena in connection with an investigation under the supervision of the Office of Consumer Litigation of the U.S. Department of Justice. The grand jury also issued subpoenas to certain of our former and current employees. We believe that the investigation relates to the release of certain lots of MYOTROPHIN used in clinical trials and related reports filed with the FDA during the period 1994- 1996. We have not been identified as a target of the investigation, and we are cooperating with the inquiry. We cannot predict the outcome of the investigation. In August 1999, the U.S. District Court for the Eastern District of Pennsylvania entered a final order approving the settlement of a class action alleging that statements made about the results of certain clinical studies of MYOTROPHIN were misleading. Of the $17,000,000 settlement amount, $7,500,000 was paid by our directors' and officers' liability insurance carriers and the remaining $9,500,000 was paid by Cephalon. Of the $9,500,000 that we paid, $4,300,000 was recognized as expense in 1999 and the remainder was recognized in prior periods. A related complaint has been filed with the Court by a small number of plaintiffs who decided not to participate in the settlement. This related complaint alleges that we are liable under common law for misrepresentations concerning the results of the MYOTROPHIN clinical trials, and that we and certain of our current and former officers and directors are liable for the actions of persons who allegedly traded in our common stock on the basis of material inside information. We believe that we have valid defenses to all claims raised in this action and we have filed a motion to dismiss these claims, which is pending with the Court. Moreover, even if there is a judgment against us, we do not believe it will have a material negative effect on our financial condition or results of operations. 9. STOCKHOLDERS' EQUITY Convertible Exchangeable Preferred Stock During the third quarter of 1999, we completed a private offering to institutional investors of 2,500,000 shares of convertible exchangeable preferred stock at $50 per share. Proceeds from the offering, net of fees and expenses, totaled $120,028,000. Dividends on the preferred stock are payable quarterly as of November 15, 1999 and are cumulative at the annual rate of $3.625 per share. We recognized $3,398,000 of preferred dividends during 1999. The preferred stock is convertible into an aggregate of approximately 6,975,000 shares of our common stock at a conversion price of $17.92 per share, subject to adjustment in certain circumstances. The preferred stock will be exchangeable, at our option, into 7 1/4% convertible debentures which also are convertible into shares of our common stock. We may redeem the preferred stock and the debentures at declining redemption prices commencing in August 2001. Equity Compensation Plans Cephalon has established the Stock Option Plan and the Equity Compensation Plan for its employees, directors and certain other individuals. All grants and terms are authorized by the Compensation Committee of 49 CEPHALON, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) Cephalon's Board of Directors. We may grant either non-qualified or incentive stock options under both plans, and also may grant restricted stock awards under the Equity Compensation Plan. The options and restricted stock awards generally become exercisable or vested ratably over four years from the grant date and the options must be exercised within ten years of the grant date. The following tables summarize the aggregate option activity under both plans:
1999 1998 1997 ------------------- ------------------- ------------------- Weighted Weighted Weighted Average Average Average Exercise Exercise Exercise Shares Price Shares Price Shares Price --------- -------- --------- -------- --------- -------- Outstanding, January 1,..... 4,034,299 $12.42 3,518,258 $13.96 3,181,020 $14.07 Granted................... 788,000 24.51 1,009,000 8.18 873,520 12.94 Exercised................. (668,622) 10.49 (57,379) 10.21 (223,493) 8.27 Canceled.................. (340,536) 13.59 (435,580) 16.20 (312,789) 19.16 --------- ------ --------- ------ --------- ------ Outstanding, December 31,... 3,813,141 $15.17 4,034,299 $12.42 3,518,258 $13.96 ========= ====== ========= ====== ========= ====== Exercisable at end of year.. 2,033,784 $13.88 2,279,718 $13.31 1,961,945 $12.93 Weighted average fair value of options granted during the year................... $14.45 $ 4.75 $ 7.67
Options Outstanding Options Exercisable ----------------------------------------- ------------------------- Weighted Average Weighted Weighted Remaining Average Average Range of Exercise Price Options Contractual Life Exercise Price Options Exercise Price ----------------------- --------- ---------------- -------------- ---------- -------------- $.80--$10.00 1,267,497 7.2 years $ 7.89 $ 673,925 $ 7.98 $10.01--$20.00 1,586,169 5.7 $13.56 1,119,608 $14.05 $20.01--$31.00 959,475 8.8 $27.43 240,251 $29.68 --------- --- ------ ---------- ------ 3,813,141 7.0 $15.17 2,033,784 $13.88 ========= === ====== ========== ======
In May 1999, the Equity Compensation Plan was amended to increase the number of shares subject to the annual grants awarded under the plan by 1,200,000 shares. At December 31, 1999, 975,543 shares were available for future grants under the plans. During 1999, 1998 and 1997, we received proceeds of $7,369,000, $410,000 and $2,205,000, respectively, from the exercise of stock options. The following table summarizes restricted stock award activity for the years ended December 31:
Restricted Stock Awards ---------------------------------- 1999 1998 1997 ---------- ---------- ---------- Outstanding, January 1,.................. $ 280,425 $ 237,825 $ 190,700 Granted................................ 355,550 142,450 113,450 Vested................................. (83,300) (75,725) (54,325) Canceled............................... (55,975) (24,125) (12,000) ---------- ---------- ---------- Outstanding, December 31,................ 496,700 280,425 237,825 ---------- ---------- ---------- Compensation expense recognized.......... $1,023,000 $1,450,000 $1,684,000 ========== ========== ==========
50 CEPHALON, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) If we had elected to recognize compensation cost based on the fair value of stock options as prescribed by Statement of Financial Accounting Standards No. 123 ("SFAS 123"), "Accounting for Stock-Based Compensation," pro forma loss and loss per share amounts would have been reflected as set forth below:
1999 1998 1997 ------------ ------------ ------------ As reported Loss.............................. $(73,342,000) $(55,407,000) $(60,419,000) Basic and diluted loss per share.. $ (2.48) $ (1.95) $ (2.36) Pro forma Loss.............................. $(79,121,000) $(60,659,000) $(62,315,000) Basic and diluted loss per share.. $ (2.67) $ (2.13) $ (2.43)
The fair value of the options granted during 1999, 1998 and 1997 were estimated on the date of grant using the Black-Scholes option-pricing model based on the following assumptions:
1999 1998 1997 ------- ------- ------- Risk free interest rate........................... 5.89% 5.23% 6.35% Expected life..................................... 6 years 6 years 6 years Expected volatility............................... 56% 56% 56% Expected dividend yield........................... 0% 0% 0%
Warrants and Other Options During 1999, investors in Cephalon Clinical Partners, L.P., or CCP, exercised 1,958,291 warrants to purchase shares of common stock. Proceeds associated with these exercises totaled $26,984,000. All outstanding warrants associated with CCP expired on August 31, 1999. During 1998, no warrants were exercised. In 1997, 102,004 warrants were exercised for an aggregate exercise price of $1,183,000. At December 31, 1999, warrants to purchase shares of Cephalon common stock were outstanding as follows:
Number Of Shares Issuable Upon Exercise Exercise Price Of Warrants Expiration Date Per Share ---------------------- --------------- -------------- 1,920,000 March 1, 2004 $10.08 750,000 February 8, 2002 $18.50 84,000 April 7, 2000 $24.77 --------- 2,754,000 =========
The private placement of the revenue-sharing notes included the issuance of warrants, expiring March 1, 2004, to purchase 1,920,000 shares of our common stock at an exercise price of $10.08. The estimated aggregate value of the warrants of $6,593,000 was recorded as a discount to the notes a portion of this amount was charged to interest expense. In connection with the restructuring of the revenue sharing notes in 1999, we recorded a loss which included the remaining value of the warrants (see Note 6). In February 1994, Chiron was issued a warrant to purchase 750,000 shares of common stock with an exercise price of $18.50 per share. In April 1997, we issued warrants to purchase 84,000 shares of Cephalon common stock at an exercise price of $24.77 per share to the placement agent in connection with the private placement of senior convertible notes. 51 CEPHALON, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) Qualified Savings and Investment Plan We have a profit sharing plan pursuant to section 401(k) of the Internal Revenue Code, whereby eligible employees may contribute up to 15% of their annual salary to the plan, subject to statutory maximums. The plan provides for discretionary matching contributions by Cephalon in cash or a combination of cash and shares of Cephalon's common stock. Our contribution for the years 1997 through 1999 was 100% of the first 6% of employee salaries contributed in the ratio of 50% cash and 50% Cephalon stock. We contributed $1,369,000, $1,155,000, and $1,090,000 in cash and common stock to the plan for the years 1999, 1998, and 1997, respectively. Proforma Aggregate Conversions or Exercises At December 31, 1999, the conversion or exercise of outstanding options, warrants and convertible exchangeable preferred stock into shares of Cephalon common stock in accordance with their terms would increase the outstanding number of shares of common stock by approximately 13,543,000 shares, or 42%. Preferred Share Purchase Rights In November 1993, the Board of Directors of Cephalon declared a dividend distribution of one right for each outstanding share of common stock. In addition, a right attaches to and trades with each new issue of Cephalon's common stock. Each right entitles each registered holder, upon the occurrence of certain events, to purchase from Cephalon a unit consisting of one one- hundredth of a share of the Series A Junior Participating Preferred Stock of Cephalon, or a combination of securities and assets of equivalent value, at a purchase price of $90.00 per Unit, subject to adjustment. 10. REVENUES At December 31, revenues consisted of the following:
1999 1998 1997 ----------- ----------- ----------- Product sales--PROVIGIL.............. $25,370,000 $ 728,000 $ -- Commercial collaborations............ 2,751,000 5,598,000 5,228,000 Research and development collaborations...................... 16,793,000 9,085,000 17,912,000 Other................................ 5,000 244,000 -- ----------- ----------- ----------- $44,919,000 $15,655,000 $23,140,000 =========== =========== ===========
Product sales Sales of PROVIGIL were initiated in the United Kingdom in March 1998 and in the United States and the Republic of Ireland in February 1999. Shipments of PROVIGIL to customers were $31,488,000 in 1999 and $6,118,000 was recorded for the reserve for returns and allowances, resulting in product sales of $25,370,000. Commercial collaborations We have entered into several agreements under which our sales organization markets the proprietary products of third parties. We focus our sales efforts on neurologists and other neurological specialists. Under these agreements, we receive payments generally for achievement of the stipulated sales activity and performance targets, and also may be responsible for payment of fees to the third party collaborator and funding promotional and clinical trial activities. In the United States, we are promoting and marketing STADOL NS(R) (butorphanol tartrate) for Bristol-Myers Squibb Company. We also are collaborating with Abbott Laboratories, Inc. to market and further develop GABITRIL(R) (tiagabine hydrochloride) in the United States. In France, we are promoting and marketing APOKINON(R) (apomorphine hydrochloride) for Laboratoire Aguettant S.A. 52 CEPHALON, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) Research and development collaborations We have entered into several collaborative research and development agreements under which we are reimbursed generally for our research efforts and for product supply. In addition, we typically receive development milestones and license fees. Under a collaborative agreement with TAP, we perform research and development for which we are compensated quarterly by TAP for both internal and external expenses. Under the terms of a collaborative agreement with H. Lundbeck A/S, Lundbeck is reimbursing us for certain costs related to the CEP- 1347 program. In addition, we are to receive milestone payments and royalties on net product sales in Europe from Lundbeck. In December 1999, we entered into a licensing agreement with Schwarz Pharma AG under which we granted our rights to Schwarz Pharma to develop and market CEP-701 for the treatment of prostate disorders and other cancers in Europe and several other countries outside the United States. The agreement provides for Schwarz Pharma to make milestone payments and to pay royalties on net product sales in the territories. During 1999, we recognized revenue from the receipt of non- refundable license fees related to the initiation of the Lundbeck collaboration in the amount of $2,400,000 and the Schwarz Pharma collaboration in the amount of $2,000,000. Under collaborative agreements with Kyowa Hakko, we are reimbursed for our cost to supply MYOTROPHIN in Japanese clinical trials and certain expenditures related to our signal transduction modulator research and development program. 11. INCOME TAXES Deferred income taxes reflect the net tax effects of temporary differences between the bases of assets and liabilities recognized for financial reporting purposes and the tax bases thereon, and operating loss and tax credit carryforwards. Significant components of our net deferred tax assets as of December 31 are as follows:
1999 1998 ------------- ------------- Net operating loss carryforwards............. $ 81,874,000 $ 59,240,000 Capitalized research and development expenditures................................ 42,920,000 32,357,000 Federal research and development tax credits..................................... 7,379,000 5,724,000 Other--net................................... 1,205,000 3,576,000 ------------- ------------- Total deferred tax assets.................... 133,378,000 100,897,000 Valuation allowance for deferred tax assets.. (133,378,000) (100,897,000) ------------- ------------- Net deferred tax assets...................... $ -- $ -- ============= =============
The deferred tax asset valuation allowance increased by $32,481,000 during the year. This increase is primarily the result of our analysis of the likelihood of realizing the future tax benefit of tax loss carryforwards and additional temporary differences. A valuation allowance was established for 100% of the deferred tax assets, as realization of the tax benefits is not assured. At December 31, 1999, we had net operating loss carryforwards for U.S. federal income tax purposes of approximately $217,754,000 that will begin to expire in 2003. The net operating loss carryforwards differ from the accumulated deficit principally due to differences in the recognition of certain research and development expenses for financial and federal income tax reporting. Federal research tax credits of $7,379,000 are available to offset future tax payments, and begin to expire in 2003. The amount of net operating loss carryforwards which can be utilized in any one period will be limited by federal income tax regulations since a change in ownership as defined in Section 382 of the Internal Revenue Code occurred in the current and prior years. We do not believe that such limitation will have a material adverse impact on the utilization of our carryforwards. 53 ITEM 9: CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE None. PART III ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT The names, ages and positions held by our directors and executive officers are as follows:
Name Age Position - ---- --- -------- Frank Baldino, Jr., Ph.D................... 46 Chairman and Chief Executive Officer William P. Egan(1)...... 55 Director Robert J. Feeney, Ph.D.(2)............... 74 Director Martyn D. Greenacre(1).. 58 Director David R. King........... 50 Director Kevin E. Moley(1)....... 53 Director Horst Witzel, Dr.- Ing.(2)................ 72 Director J. Kevin Buchi.......... 44 Senior Vice President and Chief Financial Officer Peter E. Grebow, Ph.D... 53 Senior Vice President, Business Development Earl W. Henry, M.D...... 52 Senior Vice President, Clinical Research and Regulatory Affairs John E. Osborn.......... 42 Senior Vice President, General Counsel and Secretary Robert P. Roche, Jr..... 44 Senior Vice President, Sales and Marketing Carl A. Savini.......... 50 Senior Vice President, Human Resources Jeffry L. Vaught, Ph.D................... 49 Senior Vice President and President, Research and Development
- -------- (1) Members of the Audit Committee of the Board of Directors. (2) Members of the Stock Option and Compensation Committee of the Board of Directors. All directors hold office until our next annual meeting of stockholders and until their successors are elected and qualified or until their earlier resignation or removal. All executive officers are elected annually by the Board of Directors to serve in their respective capacities until their successors are elected and qualified or until their earlier resignation or removal. Dr. Baldino founded Cephalon and has served as Chief Executive Officer and a director since its inception. He was appointed Chairman of the Board of Directors in December 1999. Dr. Baldino received his Ph.D. degree from Temple University and holds several adjunct academic appointments. Dr. Baldino currently serves as a director of Adolor Corporation, a pharmaceutical company, Pharmacopeia, Inc., a developer of proprietary technology platforms for pharmaceutical companies, and ViroPharma, Inc., a biopharmaceutical company. Mr. Egan has been a director since 1988. Since 1979, Mr. Egan has served as President of Burr, Egan, Deleage & Co., a venture capital company. He is also a general partner of ALTA Communications VI, L.P., and ALTA Communications VII, L.P. and ALTA Communications VIII, L.P., venture capital firms, and a director of Cypress Communications, a communications service provider. Dr. Feeney has been a director since 1988. From October 1987 to August 1997, Dr. Feeney served as a general partner of Hambrecht & Quist Life Science Technology Fund, a life sciences venture capital fund affiliated with Hambrecht & Quist Incorporated. For 37 years prior thereto, Dr. Feeney was employed at Pfizer Inc., a pharmaceutical company, and last served as its Vice President of Licensing and Development. Dr. Feeney currently serves as a director of QLT PhotoTherapeutics Inc., a Canadian biotechnology company. 54 Mr. Greenacre has been a director since 1992. Mr. Greenacre has been President, Chief Executive Officer and Director of Delsys Pharmaceutical Corporation, a formulation and drug delivery system company, since June 1997. From 1993-96, Mr. Greenacre served with Zynaxis Inc., a biopharmaceutical company, as President, Chief Executive Officer and a director. From 1989-92, Mr. Greenacre served as Chairman Europe, SmithKline Beecham Pharmaceuticals. He joined SmithKline & French, the predecessor to SmithKline Beecham, in 1973 where he held positions of increasing responsibility in commercial operations and management. Mr. Greenacre currently serves as a director of Creative Biomolecules, Inc., a biotechnology company, and Genset s.a., a human genome sciences company. Mr. King was appointed a director in 1999. Since 1981, Mr. King has been a partner in the Business and Finance Section of the law firm of Morgan, Lewis & Bockius LLP, Philadelphia, Pennsylvania. Mr. King's practice focuses on biotechnology and emerging growth companies and he has extensive experience in corporate and securities law matters. Mr. Moley has been a director since 1994. From November 1998 to December 1999, Mr. Moley served as Chairman of the Board of Directors of Patient Care Dynamics LLC, a provider of computer hardware and software to physicians. From January 1996 to February 1998, Mr. Moley was President and Chief Executive Officer of Integrated Medical Systems, Inc., where he served as a director since 1994. From February 1993 to December 1995, Mr. Moley was Senior Vice President of PCS Health Systems, a provider of prescription management services. From 1989-92 Mr. Moley served in the Bush administration as an Assistant Secretary of the U.S. Department of Health and Human Services ("HHS"), and from 1992-93 as Deputy Secretary of HHS. Mr. Moley also serves as a director of Innovative Clinical Solutions, Ltd., a site management company, Merge Technologies, Inc., a medical imaging software company, Perse Technologies, a medical billing company and ProxyMed, a medical claims clearing house company. Dr. Witzel has been a director since 1991. From 1986 until his retirement in 1989, Dr. Witzel served as the Chairman of the Board of Executive Directors of Schering AG, a German pharmaceutical company and, prior to 1986, was a member of the Board of Executive Directors in charge of Production and Technology. Dr. Witzel currently serves as a director of The Liposome Company, Inc., a biotechnology company. Mr. Buchi joined Cephalon as Controller in March 1991 and held several financial positions with the Company prior to being appointed Senior Vice President and Chief Financial Officer in April 1996. Between 1985 and 1991, Mr. Buchi served in a number of financial positions with E.I. duPont de Nemours and Company. Mr. Buchi received his masters of management degree from the J.L. Kellogg Graduate School of Management, Northwestern University in 1982 and is a Certified Public Accountant. Dr. Grebow joined Cephalon in January 1991 and was Senior Vice President, Drug Development prior to his current position as Senior Vice President, Business Development. From 1988-90, Dr. Grebow served as Vice President of Drug Development for Rorer Central Research, a division of Rhone-Poulenc Rorer Pharmaceuticals Inc., a pharmaceutical company. Dr. Grebow received his Ph.D. degree in Chemistry from the University of California, Santa Barbara. Dr. Henry joined Cephalon in August 1997 as Vice President, Clinical Operations, and was appointed Senior Vice President, Clinical Research and Regulatory Affairs in October 1998. Prior to Cephalon, Dr. Henry served as Vice President, Clinical Research for Guilford Pharmaceuticals. From 1992-95, he was Executive Director, Clinical Research at Sandoz, Inc. and spent five years at Pfizer Central Research. Dr. Henry received his M.D. degree from the University of Chicago and completed his clinical training in neurology and neuropathology at Harvard Medical School, where he held a faculty appointment. Mr. Osborn joined Cephalon in March 1997 and has served as Senior Vice President, General Counsel and Secretary since January 1999. He was appointed Senior Vice President in September 1998 and prior to that served as Vice President, Legal Affairs. From 1992-97, Mr. Osborn was employed by The DuPont Merck Pharmaceutical Company, most recently as Vice President, Associate General Counsel and Assistant Secretary. 55 Prior to that, he served in the Bush administration with the U.S. Department of State, practiced corporate law with firms in Boston and Philadelphia, and clerked for a U.S. Court of Appeals judge. Mr. Osborn received his law degree from the University of Virginia and also holds a masters degree in international studies from The Johns Hopkins University. Mr. Roche joined Cephalon in January 1995 as Vice President, Sales and Marketing and was appointed to his current position in June 1999. Previously, Mr. Roche was Director and Vice President, Worldwide Strategic Product Development, for SmithKline Beecham's (SB) central nervous system and gastrointestinal products business. He also was managing director of SB's pharmaceutical operations in the Philippines, and held senior marketing positions in Canada and Spain and product planning responsibility for SB in Latin America and worked as a U.S. pharmaceutical sales representative. Mr. Roche graduated from Colgate University and received a master of business administration degree from The Wharton School, University of Pennsylvania. Mr. Savini joined Cephalon in June 1993 as Director, Human Resources and has served as Senior Vice President, Human Resources since January 2000. He was appointed Vice President, Human Resources in January 1995. From 1983-93, Mr. Savini was employed by Bristol-Myers Squibb Company, in Human Resources positions of increasing responsibility, most recently as Director, Staffing for the Pharmaceutical Group. Prior to joining Bristol-Myers, he was employed by Johnson & Johnson's McNeil Pharmaceuticals from 1981-83, most recently as Manager, Organization Development. Mr. Savini graduated from Pennsylvania State University and received a master of business administration degree from La Salle College. Dr. Vaught has headed Cephalon's research operations since joining Cephalon in August 1991 and currently serves as Senior Vice President and President, Research and Development. Prior to joining Cephalon, Dr. Vaught served as CNS Research Assistant Director for the R.W.J. Pharmaceutical Research Institute, a subsidiary of the pharmaceutical and consumer products company Johnson & Johnson, and CNS Therapeutic Team Leader for Johnson & Johnson sector management from 1990-91. Dr. Vaught received his Ph.D. degree from the University of Minnesota. ITEM 11. EXECUTIVE COMPENSATION The information required by Item 11 is incorporated by reference to the information under the caption "Compensation of Executive Officers and Directors" in our definitive proxy statement for the 2000 annual meeting of stockholders. ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT The information required by Item 12 is incorporated by reference to the information under the caption "Security Ownership of Certain Beneficial Owners and Management" in our definitive proxy statement for the 2000 annual meeting of stockholders. ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS The information required by Item 13 is incorporated by reference to the information under the caption "Certain Relationships and Related Transactions" in our definitive proxy statement for the 2000 annual meeting of stockholders. 56 PART IV ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K Financial Statements The following is a list of our consolidated financial statements and our subsidiaries and supplementary data included in this report under Item 8: Report of Independent Public Accountants. Consolidated Balance Sheets as of December 31, 1999 and 1998. Consolidated Statements of Operations for the years ended December 31, 1999, 1998 and 1997. Consolidated Statements of Stockholders' Equity for the years ended December 31, 1999, 1998 and 1997. Consolidated Statements of Cash Flows for the years ended December 31, 1999, 1998 and 1997. Notes to Consolidated Financial Statements. Financial Statement Schedules Schedule II--Valuation and Qualifying Accounts Schedules, other than those listed above, are omitted because they are not applicable or are not required, or because the required information is included in the consolidated financial statements or notes thereto. Reports on Form 8-K During the fiscal quarter ended December 31, 1999, we filed a Current Report on Form 8-K on December 14, 1999 announcing that we are responding to a federal grand jury subpoena in connection with an investigation under the supervision of the Office of Consumer Litigation of the U.S. Department of Justice. Exhibits The following is a list of exhibits filed as part of this annual report on Form 10-K. Where so indicated by footnote, exhibits which were previously filed are incorporated by reference. For exhibits incorporated by reference, the location of the exhibit in the previous filing is indicated in parenthesis.
Exhibit No. Description ------- ----------- 3.1 Restated Certificate of Incorporation, as amended. (Exhibit 3.1) (19). 3.2 Bylaws of the Registrant, as amended. (Exhibit 3.1) (19). 4.1 Specimen copy of stock certificate for shares of Common Stock of the Registrant. (Exhibit 4.1) (10). 4.2 Amended and Restated Rights Agreement, dated as of January 1, 1999, between Cephalon, Inc. and StockTrans, Inc. as Rights Agent. (Exhibit 1) (27). 4.3(a) Form of Note Purchase Agreement dated as of February 24, 1999 by and between Cephalon and Investor. (Exhibit 4.3(a)) (20). 4.3(b) Form of Revenue Sharing Senior Secured Note due 2002 dated March 1, 1999. (Exhibit 4.3(b)) (25). 4.3(c) Form of Class A Warrant. (Exhibit 4.3(c)) (20). 4.3(d) Form of Class B Warrant. (Exhibit 4.3(d)) (20). 4.3(e) Security Agreement dated March 1, 1999 between Cephalon, Inc. and Delta Opportunity Fund, Ltd., as collateral agent. (Exhibit 4.3(e)) (20). 4.3(f) Patent and Trademark Agreement dated March 1,1999 between Cephalon, Inc. and Delta Opportunity Fund, Ltd., as collateral agent. (Exhibit 4.3(f)) (20).
57
Exhibit No. Description ------- ----------- 4.4(a) Specimen Preferred Stock Certificate of Cephalon, Inc. (Exhibit 4.1) (24). 4.4(b) Certificate of the Powers, Designations, Preferences and Rights of the $3.625 Convertible Exchangeable Preferred Stock filed August 17, 1999. (Exhibit 4.2) (24). 4.4(c) Indenture, dated as of August 18, 1999, between Cephalon, Inc. and State Street Bank and Trust Company, as Trustee. (Exhibit 4.3) (24). 4.4(d) Form of Series A Warrant to purchasers of Units including a limited partnership interest in Cephalon Clinical Partners, L.P. (Exhibit 10.4) (6). 4.4(e) Form of Series B Warrant to purchasers of Units including a limited partnership interest in Cephalon Clinical Partners, L.P. (Exhibit 10.5) (6). 4.4(f) Incentive Warrant to purchase 115,050 shares of Common Stock of Cephalon, Inc. issued to PaineWebber Incorporated. (Exhibit 10.6) (6). 4.4(g) Fund Warrant to purchase 19,950 shares of Common Stock of Cephalon, Inc. issued to PaineWebber R&D Partners III, L.P. (Exhibit 10.7) (6). 10.1 Letter agreement dated March 22, 1995, between Cephalon, Inc. and the Salk Institute for Biotechnology Industrial Associates, Inc. (Exhibit 99.1) (15). 10.2 Deliberately omitted. 10.3 Stock Purchase Agreement dated July 28, 1995, between Cephalon, Inc. and Kyowa Hakko Kogyo Co., Ltd. (Exhibit 99.3) (16). 10.4(a) License Agreement, dated May 15, 1992, between Cephalon, Inc. and Kyowa Hakko Kogyo Co., Ltd. (Exhibit 10.6) (4) (25). 10.4(b) Letter agreement dated March 6, 1995 amending the License Agreement between Cephalon, Inc. and Kyowa Hakko Kogyo Co., Ltd. (Exhibit 10.4(b)) (14) (25). *10.4(c) Letter agreement dated May 11, 1999 amending the License Agreement between Cephalon, Inc. and Kyowa Hakko Kogyo Co., Ltd. (26). 10.5(a) Supply Agreement, dated January 20, 1993, between Cephalon, Inc. and Laboratoire L. Lafon. (Exhibit 10.5(a)) (22). 10.5(b) License Agreement, dated January 20, 1993, between Cephalon, Inc. and Laboratoire L. Lafon. (Exhibit 10.5(b)) (22). 10.5(c) Trademark Agreement, dated January 20, 1993, between Cephalon, Inc. and Genelco S.A. (Exhibit 10.5(c)) (22). 10.5(d) Amendment to License Agreement and Supply Agreement, dated July 21, 1993, between Cephalon, Inc. and Laboratoire L. Lafon. (Exhibit 10.5(d)) (22). 10.5(e) Amendment to Trademark Agreement, dated July 21, 1993, between Cephalon, Inc. and Genelco S.A. (Exhibit 10.5(e)) (22). 10.5(f) Amendment No. 2 to License Agreement dated January 3, 1994 between Cephalon, Inc. and Laboratoire L. Lafon. (Exhibit 99.1) (21). 10.5(g) Amendment No. 2 to Trademark Agreement dated August 23, 1995 between Cephalon, Inc. and Genelco S.A. (Exhibit 99.2) (21). 10.5(h) Amendment No. 3 to License Agreement dated June 8, 1995, between Cephalon, Inc. and Laboratoire L. Lafon. (Exhibit 99.2) (15). 10.5(i) Amendment No. 4 to License Agreement and Supply Agreement dated August 23, 1995, between Cephalon, Inc. and Laboratoire L. Lafon. (Exhibit 10.5(g)) (22).
58
Exhibit No. Description ------- ----------- 10.5(j) Amendment No. 5 to License Agreement and Supply Agreement dated January 21, 1998 between Cephalon, Inc. and Laboratoire L. Lafon. (Exhibit 10.5(h)) (20) (25). 10.5(k) Amendment No. 6 to License Agreement and Supply Agreement dated February 2, 1998 between Cephalon, Inc. and Laboratoire L. Lafon. (Exhibit 10.5(i)) (20) (25). 10.5(l) Amendment No. 3 to Trademark Agreement dated January 21, 1998 between Cephalon, Inc. and Genelco S.A. (Exhibit 10.5(j)) (20) (25). 10.5(m) Amendment No. 4 to Trademark Agreement dated February 9, 1998 between Cephalon, Inc. and Genelco S.A. (Exhibit 10.5(k)) (20) (25). +10.6(a) Cephalon, Inc. Amended and Restated 1987 Stock Option Plan. (Exhibit 10.7) (4). +10.6(b) Cephalon, Inc. Equity Compensation Plan. (Exhibit 10.6(b)) (17). +10.6(c) Cephalon, Inc. Non-Qualified Deferred Compensation Plan. (Exhibit 10.6(c)) (10). 10.7 Form of Note Purchase Agreement, dated as of January 15, 1997, between Cephalon, Inc. and the several purchasers of Cephalon's Senior Convertible Notes, without exhibits. (Exhibit 10.1) (18). 10.8(a) Amended and Restated Agreement of Limited Partnership, dated as of June 22, 1992, by and among Cephalon Development Corporation, as general partner, and each of the limited partners of Cephalon Clinical Partners, L.P. (Exhibit 10.1) (6). 10.8(b) Amended and Restated Product Development Agreement, dated as of August 11, 1992, by and between Cephalon, Inc. and Cephalon Clinical Partners, L.P. (Exhibit 10.2) (6) (25). 10.8(c) Purchase Agreement, dated as of August 11, 1992, by and between Cephalon, Inc. and each of the limited partners of Cephalon Clinical Partners, L.P. (Exhibit 10.3) (6) (25). 10.8(d) Pledge Agreement, dated as of August 11, 1992, by and between Cephalon Clinical Partners, L.P. and Cephalon, Inc. (Exhibit 10.8) (6). 10.8(e) Promissory Note, dated as of August 11, 1992, issued by Cephalon Clinical Partners, L.P. to Cephalon, Inc. (Exhibit 10.9) (6). 10.8(f) Form of Promissory Note, issued by each of the limited partners of Cephalon Clinical Partners, L.P. to Cephalon Clinical Partners, L.P. (Exhibit 10.10) (6). 10.9 Supply, Distribution and License Agreement, dated as of July 27, 1993, by and between Kyowa Hakko Kogyo Co., Ltd. and Cephalon, Inc. (Exhibit 10.3) (11) (25). 10.10(a) Agreement between Cephalon, Inc. and Chiron Corporation dated as of January 7, 1994. (Exhibit 10.1) (12) (25). 10.10(b) Letter agreement dated January 13, 1995 amending Agreement between Cephalon, Inc. and Chiron Corporation. (Exhibit 10.12(b)) (14) (25). 10.10(c) Letter agreement dated May 23, 1995 amending Agreement between Cephalon, Inc. and Chiron Corporation. (Exhibit 10.12(c)) (17) (25). 10.11(a) Agreement between Cephalon, Inc. and TAP Holdings Inc. (formerly TAP Pharmaceuticals Inc.) dated as of May 17, 1994. (Exhibit 99.2) (13) (25). 10.11(b) Amendment dated June 28, 1996 amending Agreement between Cephalon, Inc. and TAP Holdings Inc. (Exhibit 10.13(b)) (19) (25). 10.12 Toll Manufacturing and Packaging Agreement dated February 24, 1998 between Cephalon, Inc. and Circa Pharmaceuticals, Inc. (Exhibit 10.12) (20) (25). 10.13 Marketing and Development Collaboration Agreement between Cephalon, Inc. and Abbott Laboratories Inc., dated June 10, 1999. (Exhibit 10.13) (22) (26).
59
Exhibit No. Description ------- ----------- 10.14 Joint Research, Development and License Agreement between Cephalon, Inc. and H. Lundbeck A/S, dated May 28 1999. (Exhibit 10.14) (22) (26). 10.15 Amended and Restated Copromotion Agreement between Cephalon, Inc. and Bristol Myers Squibb Company, dated January 1, 1999. (Exhibit 10.15) (22) (26). *10.16 Development and License Agreement between Schwarz Pharma AG and Cephalon, Inc., dated December 15, 1999. (26). *21 Subsidiaries of Cephalon, Inc. *23.1 Consent of Arthur Andersen LLP. *24 Power of Attorney (included on the signature page to this Form 10-K Report). *27 Financial Data Schedule.
- -------- * Filed herewith. + Compensation plans and arrangements for executives and others. (1) Filed as an Exhibit to the Registration Statement on Form S-1 filed on March 15, 1991. (2) Filed as an Exhibit to Pre-Effective Amendment No. 1 to the Registration Statement on Form S-1 (Registration No. 33-39413) filed on April 19, 1991. (3) Filed as an Exhibit to Pre-Effective Amendment No. 2 to the Registration Statement on Form S-1 (Registration No. 33-39413) filed on April 22, 1991. (4) Filed as an Exhibit to the Transition Report on Form 10-K for transition period from January 1, 1991 to December 31, 1991, as amended by Amendment No. 1 filed on September 4, 1992 on Form 8. (5) Filed as an Exhibit to the Company's Current Report on Form 8-K filed on December 31, 1992. (6) Filed as an Exhibit to the Registration Statement on Form S-3 (Registration No. 33-56816) filed on January 7, 1993. (7) Filed as an Exhibit to the Registration Statement on Form S-3 (Registration No. 33-58006) filed on February 8, 1993. (8) Filed as an Exhibit to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1992. (9) Filed as an Exhibit to the Company's Current Report on Form 8-K dated June 8, 1993. (10) Filed as an Exhibit to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1993. (11) Filed as an Exhibit to the Registration Statement on Form S-3 (Registration No. 33-73896) filed on January 10, 1994. (12) Filed as an Exhibit to the Company's Current Report on Form 8-K dated January 10, 1994. (13) Filed as an Exhibit to the Company's Current Report on Form 8-K dated May 17, 1994. (14) Filed as an Exhibit to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1994. (15) Filed as an Exhibit to the Registration Statement on Amendment No. 1 to Form S-3 (Registration No. 33-93964) filed on June 30, 1995. (16) Filed as an Exhibit to the Registration Statement on Amendment No. 2 to Form S-3 (Registration No. 33-93964) filed on July 31, 1995. (17) Filed as an Exhibit to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1995. (18) Filed as an Exhibit to the Registration Statement on Form S-3 (Registration No. 333-20321) filed on January 24, 1997. (19) Filed as an Exhibit to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1996. 60 (20) Filed as an Exhibit to the Company's Annual report on Form 10-K for the fiscal year ended December 31, 1998. (21) Filed as an Exhibit to the Company's Current Report on Form 8-K filed August 3, 1999. (22) Filed as an Exhibit to the Company's Quarterly Report on Form 10-Q for the period ending June 30, 1999. (23) Filed as an Exhibit to the Company's Registration Statement on Form S-8 (Registration No. 333-87421) filed September 20, 1999. (24) Filed as an Exhibit to the Company's Registration Statement on Form S-3 (Registration No. 333-88985) filed October 14, 1999. (25) Portions of the Exhibit have been omitted and have been filed separately pursuant to an application for confidential treatment granted by the Securities and Exchange Commission. (26) Portions of the Exhibit have been omitted and have been filed separately pursuant to an application for confidential treatment filed with the Securities and Exchange Commission pursuant to Rule 24b-2 under the Securities Exchange Act of 1934, as amended. (27) Filed as an Exhibit to the Company's Form 8-A/A (12G) filed on January 20, 1999. 61 CEPHALON, INC. AND SUBSIDIARIES SCHEDULE II--VALUATION AND QUALIFYING ACCOUNTS
Balance at Balance at Beginning of End of the Year Ended December 31, the Year Additions(1) Deductions Year - ----------------------- ------------ ------------ ---------- ---------- Reserve for returns and allowances: 1999............................. $-- $6,607,000 $658,000 $5,949,000
- -------- (1) Amounts represent charges and reductions to expenses and revenue. 62 SIGNATURES Pursuant to the requirements of Section 13 or 15(d) 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. Date: March 29, 2000 Cephalon, Inc. /s/ Frank Baldino, Jr., Ph.D. By: _________________________________ Frank Baldino, Jr., Ph.D. Chairman and Chief Executive Officer Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated. Each person in so signing also makes, constitutes and appoints Frank Baldino, Jr. his true and lawful attorney-in-fact, with full power of substitution, to execute and cause to be filed with the Securities and Exchange Commission any or all amendments to this report.
Signature Title Date --------- ----- ---- /s/ Frank Baldino, Jr., Ph.D. Chairman and Chief March 29, 2000 ______________________________________ Executive Officer Frank Baldino, Jr., Ph.D (Principal executive officer) /s/ J. Kevin Buchi Sr. Vice President and March 29, 2000 ______________________________________ Chief Financial Officer J. Kevin Buchi (Principal financial and accounting officer) /s/ William P. Egan Director March 29, 2000 ______________________________________ William P. Egan /s/ Robert J. Feeney, Ph.D. Director March 29, 2000 ______________________________________ Robert J. Feeney, Ph.D. /s/ Martyn D. Greenacre Director March 29, 2000 ______________________________________ Martyn D. Greenacre /s/ David R. King Director March 29, 2000 ______________________________________ David R. King /s/ Kevin E. Moley Director March 29, 2000 ______________________________________ Kevin E. Moley /s/ Horst Witzel, Dr.-Ing. Director March 29, 2000 ______________________________________ Horst Witzel, Dr.-Ing.
63 EX-10.4C 2 LETTER AGREEMENT May 11, 1999 Via facsimile - ------------- Kyowa Hakko Kogyo Co., Ltd. Attn: George Goto, Licensing & Business Development 1-6-1 Ohtemachi Chiyoda-ku Tokyo 100-8185 JAPAN Gentlemen: Reference is made to that certain License Agreement between Cephalon, Inc. ("CEPHALON") and Kyowa Hakko Kogyo Co., Ltd. ("KYOWA") dated as of May 12, 1992, as amended (the "License Agreement"), and further reference is made to that certain Supply Agreement between CEPHALON and KYOWA dated as of August 1, 1994, as amended (the "Supply Agreement"). All capitalized terms not otherwise defined herein shall have the respective meanings ascribed to them in the License Agreement and the Supply Agreement, as may be applicable. Insofar as the parties now have determined that Cephalon is in a better position to assume responsibility for the manufacture and supply of the Substance(s), and insofar as Cephalon has agreed to assume the risk and responsibility the parties hereby amend the License Agreement as follows: 1. The third sentence of Section 2.1 of the License Agreement relating to the retention by KYOWA of all manufacturing rights is hereby deleted, and the following terms are hereby added in lieu thereof: In connection with this grant of right and license to CEPHALON, KYOWA hereby grants to CEPHALON the exclusive right to manufacture the Substance(s) (except that KYOWA shall retain the right to manufacture the Substance(s) for use and sale in those areas where KYOWA has retained exclusive rights to commercialize the Pharmaceutical(s)). KYOWA hereby further agrees to provide to CEPHALON certain Know-How relating to the manufacture of the Substance(s) as may be necessary or advisable to facilitate the efficient manufacture of the Substance(s) and further to provide additional or updated Know-How from time to time to reflect developments (if any) in the manufacturing process. KYOWA acknowledges that, in the course of engaging a third party to serve as contract manufacturer of Substance(s), that CEPHALON necessarily will disclose to such third party Know-How and other confidential information. KYOWA hereby consents to such disclosure on the condition that any such disclosure will be made pursuant to the terms of Article 9 of this License Agreement, and further that CEPHALON will **Certain portions of this exhibit have been omitted based upon a request for confidential treatment that has been filed with the Commission. The emitted portions have been filed separately with the Commission. 1 require that any such third party agree to be bound by such terms. Moreover, during the term hereof KYOWA hereby agrees to consult free of charge with CEPHALON (and with a third party manufacturer to be designated by CEPHALON) with respect to the KNOW HOW and to any technical issues relating to the manufacturing of Substance(s). 2. Section 4.2 of the License Agreement is hereby deleted, and the following terms are hereby inserted in substitution therefor: In consideration of the rights granted to CEPHALON thereunder, CEPHALON shall pay KYOWA an amount equal to [**] percent [**] of the Net Selling Price of the corresponding Pharmaceutical(s) in the Territory. For purposes of clarification, the parties acknowledge that this new provision shall be in lieu of the terms set forth in Section E(1)(b) of the Supply Agreement and that the new supply agreement to be negotiated and agreed upon by the parties shall not contain any similar provision. 3. The entirety of Article 7 of the License Agreement relating to the supply of Substance(s) by KYOWA is hereby deleted, and the following terms are hereby inserted in substitution therefor: CEPHALON shall make available to KYOWA Substance(s) on such terms and conditions as may be agreed upon by the parties in a new supply agreement that will be substantially similar to those set forth in the Supply Agreement (except as otherwise provided herein), provided that KYOWA shall pay CEPHALON for the Substance(s) an amount equal to CEPHALON's Cost of Manufacture. For purposes of clarification, the parties acknowledge that KYOWA shall be responsible for transferring in a timely manner Know-How relating to the manufacture and formulation of the Substance(s) to CEPHALON or to a third party manufacturer to be designated by CEPHALON (with the approval of KYOWA), but that following a period not to exceed one year from the date of transfer of Know-How CEPHALON shall thereafter have sole responsibility for managing the manufacturing process. 4. Furthermore, the parties hereby agree to terminate the Supply Agreement, to be effective as of the effective date of a new supply agreement between the parties reflecting the terms and conditions of this amendment as set forth above. **Certain portions of this exhibit have been omitted based upon a request for confidential treatment that has been filed with the Commission. The emitted portions have been filed separately with the Commission. 2 Please indicate your consent and agreement to the aforementioned terms by signing a copy of this letter in the space provided below. CEPHALON, INC. By:__________________________ Peter E. Grebow, Ph.D. Senior Vice President Worldwide Business Development KYOWA HAKKO KOGYO CO., LTD. By:____________________________ **Certain portions of this exhibit have been omitted based upon a request for confidential treatment that has been filed with the Commission. The emitted portions have been filed separately with the Commission. 3 EX-10.16 3 DEVELOPMENT AND LICENSE AGREEMENT Exhibit 10.16 DEVELOPMENT AND LICENSE AGREEMENT This Development and License Agreement (the "Agreement") is made and shall be effective as of December 15, 1999 by and between Cephalon, Inc., a Delaware corporation with its principal place of business located at 145 Brandywine Parkway, West Chester, Pennsylvania 19380-4245, U.S.A. ("Cephalon") and Schwarz Pharma AG, a German corporation with its principal place of business located at Alfred-Nobel-StraBe 10, Monheim am Rhein, D-40789 Germany ("Schwarz Pharma"). WITNESSETH: WHEREAS, Kyowa Hakko Kogyo, Co. Ltd. ("Kyowa") granted to Cephalon the right to make, develop, use and sell pharmaceutical products containing the Substances, KT5555,KT6587 and KT8391 (each a derivative of K252a), under the terms and conditions of a license agreement ("Kyowa License") dated May 15, 1992, as amended; said right, including the right to sublicense in certain territories, including Europe, Mexico, Canada, the Middle East, Africa, Latin America, South America, Australia and New Zealand; WHEREAS, Cephalon wishes to grant, and Schwarz Pharma wishes to accept, a sublicense as described herein of certain of Cephalon's rights under the Kyowa License, in that certain territory to be defined herein, to product(s) developed by Cephalon that contain any of KT5555, KT6587 and KT8391, such product(s) to be known hereinafter respectively as CEP-701, CEP-751 and CEP-2563; WHEREAS, Cephalon has developed a chemical platform of [**] compounds believed to have potential efficacy in treating cancers that rely upon the family of neurotrophin receptors for survival; WHEREAS, Cephalon wishes to grant, and Schwarz Pharma wishes to accept, an exclusive option to license, in that certain territory to be defined herein, certain fused pyrrolocarbazoles as described herein for use as provided herein; WHEREAS, Cephalon and Schwarz Pharma desire to enter into a collaboration to develop and commercialize compounds for uses related to cancer therapeutics; and **Certain portions of this exhibit have been omitted based upon a request for confidential treatment that has been filed with the Commission. The omitted portions have been filed separately with the Commission. 1 WHEREAS, Cephalon and Schwarz Pharma desire to establish commercial licensing and supply arrangements under which Cephalon Licensed Products and Kyowa Licensed Products (as defined below) will be marketed and sold exclusively by Schwarz Pharma in the Territory (as defined below). NOW, THEREFORE, for good and valuable consideration, the adequacy of which is hereby affirmed, the parties hereby agree as follows. Article 1. Definitions. Terms that are capitalized as defined terms in this Agreement shall have the meanings set forth below, and defined terms may be used in their singular and plural sense: 1.1 "Affiliate" shall mean any individual or entity directly or indirectly controlling, controlled by or under common control with, a Party to this Agreement. Without limiting the foregoing, the direct or indirect ownership of fifty percent (50%) or more of the outstanding voting securities of an entity, or the right to receive fifty percent (50%) or more of the profits or earnings of an entity, or the right to control the policy decisions of a person or entity, shall be deemed to constitute control. 1.2 "At Cost" shall mean all direct and indirect expenses incurred which shall be allocated in a fair and equitable manner in conformance with United States generally accepted accounting principles ["US GAAP"], consistently applied with those established with respect to other products, and shall include: (a) the arms-length transfer price to Cephalon for Compounds and clinical supplies manufactured by a third party including Cephalon's expenses incurred in connection with such third party manufacture; such Cephalon expenses include, but are not limited to, those relating to existing or acquired equipment (current procedures for such equipment allocations shall be provided within thirty (30) days of the Effective Date and upon any amendment of such procedures thereafter), technology transfer, scale-up, validation, quality control and quality assurance testing, stability testing, storage, regulatory filings, shipping and import/export services; (b) all expenses for Compounds and clinical supplies manufactured by Cephalon including, but not limited to, existing and acquired equipment (current procedures for such equipment allocations shall be provided within thirty (30) days of the Effective Date and upon any amendment of such procedures thereafter), technology transfer, scale-up, validation, quality control and quality assurance testing, stability testing, storage, regulatory filings, shipping and import/export services; and **Certain portions of this exhibit have been omitted based upon a request for confidential treatment that has been filed with the Commission. The omitted portions have been filed separately with the Commission. 2 (c) all incremental expenses incurred by or on behalf of Cephalon in the US Program at the written request of Schwarz Pharma which are not otherwise required for regulatory or commercial purposes under the US Program but which specifically support Schwarz Pharma's Development Program. 1.3 "Backup Compounds" shall mean the fused pyrrolocarbazoles known as CEP- 4416, CEP-4715, and CEP-4574 or any other fused pyrrolocarbazoles owned by Cephalon which inhibit the Target(s) and are selected under the US Program for clinical development in the Field. 1.4 "Cephalon Licensed Products" shall mean all pharmaceutical products that contain Backup Compounds. 1.5 "Cephalon Technology" shall mean collectively, Patent Rights, Know-How and Improvements, including but not limited to technology and data obtained or licensed from TAP through the US Program, but excluding Kyowa Technology. For purposes of clarification, the term Cephalon Technology expressly excludes any Patent Rights and Know-How that Cephalon may license from a third party after the Effective Date of this Agreement, unless (i) Cephalon is permitted to grant a sublicense or other rights thereunder to Schwarz Pharma; and (ii) Schwarz Pharma shall have executed and delivered a sublicense or other agreement in a form reasonably required in connection therewith. Cephalon Technology includes the drug development dossier related to the filing of an investigational new drug application by or on behalf of Cephalon that supports clinical studies of a Compound; as well as any Patent Rights, Improvements and Know-How to the extent that it relates to the composition, manufacture, use, and commercialization of the Compounds in the Field or Licensed Products. 1.6 "Compounds" shall mean the Lead Compound (as defined herein), CEP-751, CEP- 2563 and the Backup Compounds. 1.7 "Development Program" shall mean a program including, but not limited to, preclinical, clinical and regulatory development of a Compound conducted by Schwarz Pharma pursuant to this Agreement primarily with the intent, and for the purpose, of generating data for submission to regulatory authorities in support of an application for governmental approval necessary to permit the commercialization of a Licensed Product in the Field within the Territory. 1.8 "Effective Date" shall mean the date hereof. 1.9 "Field" shall mean the treatment of cancer, including but not limited to prostate cancer and **Certain portions of this exhibit have been omitted based upon a request for confidential treatment that has been filed with the Commission. The omitted portions have been filed separately with the Commission. 3 pancreatic cancer. 1.10 "Improvements" shall have the meaning set forth in Section 11.1. 1.11 "Know-How" shall mean know-how, trade secrets, Targets, technical information , formulae, processes, expert opinions, data, and other confidential and proprietary information, other than Kyowa Technology, concerning or relating to the composition, manufacture, use or commercialization of Compounds or Licensed Products, including, without limitation, CMC, preclinical, clinical, and other data generated pursuant to the US Program and the Development Program, which is owned or controlled by a Party to this Agreement. 1.12 "Kyowa Licensed Products" shall mean all pharmaceutical products that contain the Lead Compound (as defined herein), CEP-751 or CEP-2563. 1.13 "Kyowa Technology" shall mean: the patent rights, including all patent applications and issued patents owned, licensed or controlled by Kyowa and/or its Affiliates anywhere in the world that contain a Valid Claim covering the composition, manufacture or use of the Lead Compound, CEP-751 or CEP-2563 (as well as the use of K252a solely in connection with the manufacture of the Lead Compound, CEP-751 or CEP-2563) including but not limited to any provisionals, divisionals, continuations, continuations-in-part, reissues, reexaminations, extensions derived therefrom, as well as all foreign patent applications, granted foreign patents and all counterparts thereof including, but not limited to, supplemental protection certificates, administrative protection certificates (or other governmental actions) which provide exclusive rights to the patent holders in the patented subject matter; manufacturing rights; and know-how, trade secrets and technical information relating to K252a and the Lead Compound, CEP-751 and CEP-2563 only to the extent that such patent rights, manufacturing rights, know-how, trade secrets or technical information have been granted to Cephalon pursuant to the Kyowa License. A copy of the Kyowa License, as amended, is attached hereto as Exhibit D. 1.14 "Lead Compound" shall mean CEP-701. The chemical formula of CEP-701 is set forth on Exhibit B. 1.15 "Licensed Products" shall mean Cephalon Licensed Products and Kyowa Licensed Products. 1.16 "Marketing Authorization Application" or "MAA" shall mean an application seeking the approval of the competent regulatory authority in any country in the Territory (including, without limitation, the European Medicines Evaluation Agency or "EMEA") to enable Schwarz Pharma **Certain portions of this exhibit have been omitted based upon a request for confidential treatment that has been filed with the Commission. The omitted portions have been filed separately with the Commission. 4 (or an Affiliate or assignee thereof) to market a Licensed Product(s). 1.17 "Net Sales" shall mean the gross receipts derived in arms-length transactions from the sale of Licensed Products in the Territory by Schwarz Pharma (or by its Affiliates, sublicensees), to independent third parties in the Territory, less the sum of the following items: a) Import, export, excise and sales taxes and custom duties paid or allowed by the selling party and any other governmental charges imposed upon the production, importation, use or sale of Licensed Products by Schwarz and/or its Affiliates; b) Credit for returns, refunds, rebates and allowances, or trades to customers for returned or recalled Licensed Product; c) Trade, quantity and cash discounts actually allowed; d) Transportation, freight and insurance allowances; and e) Rebates actually granted to wholesalers, administrative fees in lieu of rebates paid to managed care and other similar institutions, chargebacks and retroactive price adjustments and any other similar allowances which effectively reduce the net selling price. Gross and Net Sales shall be calculated according to US GAAP. Sales or transfers between or among a party to this Agreement and its Affiliates or sublicensees shall be excluded from the computation of Net Sales except where such Affiliates or sublicensees are end users, but Net Sales shall include the subsequent final sales to third parties by such Affiliates or sublicensees. Where (i) Licensed Products are sold as one of a number of items without a separate price; or (ii) the consideration for the Licensed Products shall include any non-cash element; or (iii) the Licensed Products shall be transferred in any manner other than an invoiced sale, except for Licensed Products transferred as samples or any other similar transfer for promotional purposes usually made in the relevant part of the Territory, the gross sales applicable to any such transaction shall be deemed to be Schwarz Pharma's average gross sales for the applicable quantity of Licensed Products during the calendar quarter and in the country in which the transaction occurred. If there are no independent gross sales of Licensed Products in the country at that time, then Schwarz Pharma and Cephalon shall mutually agree on a surrogate measure to be used in lieu thereof. 1.18 "Party" or "Parties" shall mean Cephalon and/or Schwarz Pharma, as the case may be. **Certain portions of this exhibit have been omitted based upon a request for confidential treatment that has been filed with the Commission. The omitted portions have been filed separately with the Commission. 5 1.19 "Patent Rights" shall mean all patent rights, including but not limited to, U.S. patent applications (whether in preparation or filed) and issued patents, owned, controlled or licensed (with the right to assign or sublicense) by Cephalon (and/or an Affiliate thereof) anywhere in the world covering the assays, Targets, Improvements, processes, composition, manufacture or use of any Compound (as well as any Know-How that may be patentable), including but not limited to any provisionals, divisionals, continuations, continuations-in-part, reissues, reexaminations, extensions derived therefrom, as well as all foreign patent applications, granted patents and all counterparts thereof including, but not limited to, substitutions, confirmations, registrations, revalidations, supplemental protection certificates, administrative protection certificates (or other governmental actions) which provide exclusive rights to the patent holders in the patented subject matter. All such Patent Rights in the Territory for all Compounds and the filing dates of each, in existence as of the Effective Date shall be as set forth on Exhibit A hereto. 1.20 "Pivotal Trial" shall mean an adequate and well controlled, clinical study designed to demonstrate sufficient efficacy and safety to directly support a regulatory filing for marketing approval by a competent regulatory authority . 1.21 "Reasonable Business Efforts" shall mean necessary and prudent efforts applied in a prompt, commercially reasonable manner, to the maximum extent feasible consistent with the exercise of good business judgment for the attainment of the goals and purposes of this Agreement consistent with current industry standards and practice. 1.22 "TAP" shall refer to Takeda Abbott Pharmaceutical Holdings Inc., a Delaware corporation headquartered at 2355 Waukegan Road, Deerfield, Illinois 60015. 1.23 "TAP Agreement" means that certain collaborative research, development and licensing agreement dated May 17, 1994 between Cephalon and TAP as amended. A copy of the TAP Agreement, as amended as of the date of this Agreement, is attached hereto as Exhibit C. Any additional amendments to the TAP Agreement during the term of this Agreement (including any amendments referred to in Section 16.3 (h)(iv) of this Agreement) will be provided to Schwarz Pharma promptly and added to Exhibit C. 1.24 "Target" or "Targets" shall mean the [**] 1.25 "Territory" shall mean generally the regions of Europe, Mexico, Canada, the Middle East, Africa, Latin America and South America (including specifically, without limitation, the countries within those regions listed in Exhibit F hereto), as well as the countries of Australia **Certain portions of this exhibit have been omitted based upon a request for confidential treatment that has been filed with the Commission. The omitted portions have been filed separately with the Commission. 6 and New Zealand. 1.26 "US Program" shall refer to the research and development program through which TAP, as a licensee and collaborator of Cephalon, bears the primary responsibility and expenses of preclinical, clinical, regulatory and commercial development of certain Compounds in the United States, including, the Lead Compound, CEP-751, CEP-2563 and the Backup Compounds. 1.27 "Valid Claim" shall mean a claim of an issued or granted patent that has not lapsed or become abandoned or been declared invalid or unenforceable by a court or agency of competent jurisdiction from which no appeal can be or is taken. Article 2. Development Program 2.1 Responsibilities of Schwarz Pharma. (a) Schwarz Pharma agrees to conduct a Development Program using Reasonable Business Efforts as to the Lead Compound (or as to CEP-751 or CEP- 2563, or as to one or more Backup Compounds should Schwarz Pharma exercise its option hereunder), to treat diseases in the Field. Schwarz Pharma shall fund and conduct all necessary clinical trials of Compounds in the Field within the Territory and any additional preclinical trials (other than those performed by Cephalon and TAP in support of regulatory filings outside of the Territory) required for regulatory purposes in the Field in the Territory. All Know-How developed solely by or on behalf of Schwarz Pharma resulting from the conduct of the Development Program will be owned by Schwarz Pharma and made available to Cephalon as set forth in Article 8. All Know-How developed jointly by or on behalf of Schwarz Pharma and Cephalon resulting from the conduct of the Development Program will be jointly owned by Schwarz Pharma and Cephalon and made available to Cephalon as set forth in Article 8. All Know-How developed by or on behalf of Schwarz Pharma and a third party will be made available to Cephalon as set forth in Article 8. (b) Promptly, but in any event not more than ninety (90) days following the execution of this Agreement, Schwarz Pharma shall submit to Cephalon a written plan describing the overall strategy and objectives of the Development Program to the extent such plan has been formulated (the "Development Plan"). The Development Plan shall take full advantage of the expertise of Schwarz Pharma with respect to drug development, regulatory practices and commercialization of such Compounds in the Field. The Development Plan will define, at a minimum, the following items (to the extent possible consistent with the current stage of clinical development of any Compound): **Certain portions of this exhibit have been omitted based upon a request for confidential treatment that has been filed with the Commission. The omitted portions have been filed separately with the Commission. 7 (i) the labeling Schwarz Pharma will seek in the Territory; (ii) the preclinical and clinical studies reasonably expected to be necessary to support such labeling; (iii) an estimate of the schedule of planned preclinical and clinical studies; and (iv) synopses of critical clinical studies ( e.g., proof-of-principle and Pivotal Trials). Such study synopses shall include information that is appropriate and customary in the industry, including but not limited to, study design and duration of treatment, the primary endpoints of such studies, patient numbers, the criteria for selection and exclusion of such patients, and the power calculations for determining numbers of such study participants and the estimated primary and secondary analyses. The Development Plan shall also account for the reasonable expectation of Schwarz Pharma for receipt of primary data and analyses of the same from time- sensitive preclinical and clinical studies conducted by or on behalf of TAP and/or Cephalon in the US Program. It shall be the primary responsibility of Schwarz Pharma to identify and conduct any preclinical and clinical studies necessary, in addition to those supplied by Cephalon to Schwarz Pharma from the US Program, for approval of an MAA and commercialization of a Licensed Product in the Field in the Territory. Subject to the prior written consent of Cephalon with respect to the material items in the Development Plan, which consent shall not be unreasonably withheld or delayed, Schwarz Pharma shall finalize the Development Plan. Cephalon shall be deemed to have provided its consent if it has not responded to the material items in such Development Plan within ten (10) business days of its receipt of the Development Plan from Schwarz Pharma. The final Development Plan shall be attached to this Agreement as Exhibit E. (c) Concurrent with its submission of the Development Plan, Schwarz Pharma shall provide to Cephalon an estimate of its overall budget for implementation of the Development Plan (the "Development Budget"). The Development Budget will include fully burdened expenses and will detail the allocation of resources by Schwarz Pharma necessary for the preclinical and clinical activities performed by or on behalf of Schwarz Pharma as distributed over each calendar year before the anticipated first commercial sale of Licensed Product in the Territory. The Development Budget shall also account for Schwarz Pharma's sole responsibility for all incremental expenses incurred by or on behalf of Cephalon or TAP that may be needed for the Development Program, but which are not similarly needed for the US Program, such **Certain portions of this exhibit have been omitted based upon a request for confidential treatment that has been filed with the Commission. The omitted portions have been filed separately with the Commission. 8 incremental expenses including, but not limited to, different formulations, additional studies, study arms or study analyses conducted under the US Program by or on behalf of Cephalon or TAP. The fully burdened expenses of Schwarz Pharma to implement and complete the Development Program defined in the Development Plan will be consistent with a minimum investment by Schwarz Pharma of [**] dollars [**]. The Development Budget will be treated as Confidential Information of Schwarz Pharma and shall not be disclosed by Cephalon to any third party without the consent of Schwarz Pharma. (d) Schwarz Pharma shall implement the Development Plan consistent with the Development Budget not later than ninety (90) days following receipt by Schwarz Pharma of Cephalon's written consent described in Section 2.1(b) and all required regulatory approvals or expiration of required waiting periods. Subject to its obligations set forth in Section 5.2, Section 2.3, Section 16.3 and those set forth herein to update and meet with Cephalon, and further subject to Cephalon's right to consent to material modifications to the Development Plan and Development Budget pursuant to Section 2.1(e), Schwarz Pharma will manage and coordinate all development activities undertaken pursuant to the Development Program, including scheduling preclinical studies and clinical trials for Compounds; establishing milestones for the completion of Development Program objectives, including without limitation those relating to anticipated filing dates for a clinical trial authorization (or its equivalent) filing and an MAA filing; determining to end the development of a Compound in the Field, within the Territory; and generally exercising its Reasonable Business Efforts to undertake and complete in a timely manner the Development Program with respect to each Compound. (e) Schwarz Pharma shall periodically review, and modify as may be necessary and advisable, the preclinical, clinical and commercial objectives of its Development Program for each Compound. On or before October 1st of each year following the Effective Date (and for so long as the Development Program continues), Schwarz Pharma shall provide to Cephalon a written update of the Development Plan accounting for any proposed modifications in the Development Program, including but not limited to, alterations in schedule of studies, design and objectives of studies, and timing of analysis or final reporting of studies or of regulatory filings in the Territory for the Lead Compound and plans for clinical development of other Compounds, if appropriate. Any material modification to the Development Plan shall be subject to the prior written consent of Cephalon, which consent shall not be unreasonably withheld or delayed, prior to Schwarz Pharma's implementation of such material modification. Cephalon shall be deemed to have provided its consent if it has not responded to such material modifications to the Development Plan within ten (10) business days of its receipt of such material modifications from Schwarz Pharma. **Certain portions of this exhibit have been omitted based upon a request for confidential treatment that has been filed with the Commission. The omitted portions have been filed separately with the Commission. 9 2.2 Primary Responsibilities of Cephalon. (a) Under the terms and conditions of the TAP Agreement, as amended, Cephalon and TAP collaborate in the conduct of research, preclinical and clinical studies, regulatory and commercialization strategies for the Lead Compound, and, potentially, CEP-751, CEP 2563 or Backup Compounds, in the Field in the United States. Under terms and conditions of an existing Confidential Disclosure Agreement by and between Cephalon and Schwarz Pharma dated July 13, 1998 as amended on November 6, 1998, Schwarz Pharma has received the necessary protocols, plans, results, analyses and reports regarding the US Program in order to determine, using its Reasonable Business Efforts, those additional requirements that may be needed for development of Compounds within the Field and commercialization of a Licensed Product in the Territory. Accordingly, all Know-How resulting from the conduct of the US Program, whether developed by Cephalon or TAP or jointly by Cephalon and TAP will be provided to Schwarz Pharma as described in Article 8. (b) For purposes of generating preclinical and clinical data that will be mutually acceptable by the regulatory authorities responsible for approving a Compound under the US Program and under the Development Program, Cephalon shall facilitate the coordination of the US Program and the Development Program as follows. Thirty (30) days following receipt of the Development Plan from Schwarz Pharma or as soon thereafter as practicable, Cephalon shall host the first meeting of governing members of both the US Program and the Development Program at a mutually agreeable location. The purpose of such meeting will be to determine the optimal manner in which Cephalon can coordinate the development of Compounds in the respective territories. Cephalon's efforts shall include the following: coordinating the objective of utilizing all preclinical and clinical trial data for both the US Food and Drug Administration ("FDA") and EMEA approvals; coordinating the design, primary or secondary endpoints, treatment regimens, dosing, and indications in proof-of-principle and Pivotal Trials, and minimizing replication of such preclinical and clinical studies by TAP and Cephalon in the US Program and by Schwarz Pharma in the Development Program. In no case, however, shall either Party be required to conduct studies in its respective Program which would otherwise conflict with its reasonable business judgment. Cephalon shall be responsible for producing minutes of this meeting and shall distribute the meeting minutes to Schwarz Pharma as well as to TAP within thirty (30) days after the meeting. (c) After the first meeting described above, Cephalon shall continue to use its Reasonable Business Efforts under the TAP Agreement and under this Agreement to coordinate and, if possible, and if appropriate, economize the development efforts and expenditures by TAP **Certain portions of this exhibit have been omitted based upon a request for confidential treatment that has been filed with the Commission. The omitted portions have been filed separately with the Commission. 10 and Cephalon and by Schwarz Pharma in their respective programs. In order to achieve this objective, Cephalon will ensure that appropriate representatives of Schwarz Pharma (not more than three [3] individuals per meeting) shall be invited as non-voting participants to regular meetings (not less frequently than once every six [6] months) of the development committee jointly representing Cephalon and TAP in the US Program and at consultant or investigator meetings convened to support a Compound under the US Program; conversely, Schwarz Pharma will ensure that appropriate representatives of TAP and Cephalon (not more than three [3] individuals per company per meeting) shall be invited to regular meetings (not less frequently than once every six [6] months) of Schwarz Pharma's management team for any Compound under the Development Program and at consultant or investigator meetings convened to support a Compound under the Development Program. Regardless of the number of individual members of Schwarz Pharma that may attend and participate in any given meeting or proceeding organized by TAP and/or Cephalon relating to a Compound, Schwarz Pharma shall not be entitled to vote on matters relating to the US Program, provided, however, that Cephalon shall consult with Schwarz Pharma with respect to critical decisions relating to the development of Compounds under the US Program and shall give due consideration to the experience and perspective of Schwarz Pharma. Regardless of the number of individual members of TAP that may attend and participate in any given meeting or proceeding organized by Schwarz Pharma relating to a Compound, TAP shall not be entitled to vote on matters relating to the Development Program. Written minutes of all such meetings shall be prepared by the host of the meeting and approved by authorized signature of the parties to the respective agreements only, and copies of these minutes shall be distributed to the General Counsel of Cephalon, Schwarz Pharma and TAP not later than thirty (30) days after any such meeting(s). Schwarz Pharma shall have the right to review and comment upon design and protocols for preclinical and clinical studies to be conducted in the US Program. Notwithstanding such review and comment by Schwarz Pharma, but subject to Cephalon's covenants in Section 16.2 (h) and 2.3 of this Agreement, Cephalon and TAP shall have the final authority on design and implementation of such protocols for the US Program. 2.3 General Responsibilities of the Parties The Parties agree to cooperate with each other in good faith to work toward the success of the Development Program. No less frequently than once every six (6) months, the Parties shall meet at mutually agreed locations (or via videoconference) to update one another on the progress and any modifications, including Material Modifications, of the Development Program and the US Program. Each Party agrees that it will not conduct or allow to be conducted any development activities in its territory which in its reasonable business judgment would jeopardize regulatory approval of Licensed Products worldwide. The Parties agree to use Reasonable Business Efforts to perform their obligations pursuant to this Agreement, including without limitation the diligence requirements set forth in **Certain portions of this exhibit have been omitted based upon a request for confidential treatment that has been filed with the Commission. The omitted portions have been filed separately with the Commission. 11 Section 5.2. However, nothing in this Agreement shall give either Party the authority to control or direct the activities of any employees or agents of the other Party. 2.4 Term of the Development Program. The Development Program shall continue for so long as Schwarz Pharma continues development and seeks marketing approval for not less than one Compound. 2.5 Use of Compounds and Technology. The Parties agree that all compositions, biological materials and animals used in the Development Program shall be used in compliance with all applicable laws and regulations. Neither Party shall provide Lead Compound (or CEP-751, CEP-2563 if under development by Schwarz Pharma, or Backup Compounds if Schwarz Pharma has exercised its option to the Backup Compounds) to any third party in the Territory without the prior written consent of the other Party, which consent shall not be unreasonably withheld or delayed. ARTICLE 3. GRANT OF RIGHTS 3.1 SUBLICENSE TO KYOWA LICENSED PRODUCTS. Subject to the terms and conditions set forth herein, and pursuant to the Kyowa License, Cephalon hereby grants to Schwarz Pharma its rights under the Kyowa License, except the right to sublicense, solely to (a) use the Kyowa Technology for development of the Lead Compound, CEP-751 or CEP-2563 within the Field, and (b) use and sell the Kyowa Licensed Products in the Territory. Cephalon additionally hereby grants to Schwarz Pharma the exclusive right in the Territory, without the right to sublicense, to use the Cephalon Technology solely for the purposes of development, marketing and sale of Kyowa Licensed Products within the Field. Schwarz Pharma acknowledges that the rights of Cephalon with regard to Kyowa Licensed Products under the Kyowa License are exclusive in Europe, Mexico and Canada, and semi-exclusive as to Kyowa in the remainder of the Territory and, therefore, that the rights granted hereunder to Schwarz Pharma also are exclusive in Europe, Mexico and Canada and semi-exclusive as to Kyowa in all other parts of the Territory. Moreover, Schwarz Pharma hereby agrees to cooperate with Cephalon so as to ensure continued satisfaction of all those terms and conditions of the Kyowa License, a copy of which Kyowa License is attached hereto as Exhibit D. In the event that Cephalon determines to directly manufacture any of Lead Compound, CEP-751 or CEP-2563 rather than have such compounds manufactured by a third party manufacturer, then, if that compound is currently under development by Schwarz Pharma, Cephalon shall promptly notify Schwarz Pharma and, upon the request of Schwarz Pharma, the Parties shall discuss the possibility of Cephalon granting manufacturing rights to Schwarz Pharma to make Compounds for use in the Field within the **Certain portions of this exhibit have been omitted based upon a request for confidential treatment that has been filed with the Commission. The omitted portions have been filed separately with the Commission. 12 Territory. 3.2 Marketing and Distribution Rights to Kyowa Licensed Products. Subject to the terms and conditions set forth herein, Schwarz Pharma may market and distribute Kyowa Licensed Products developed hereunder through the channels normally used for the Schwarz Pharma product portfolio, including but not limited to, Affiliates, agents, distributors, joint venture partners and co- promotion and co-marketing partners (even if any such commercial contract between Schwarz Pharma and the applicable third party is formally described or structured as a license). Subject to the written consent of Cephalon, which consent shall not be unreasonably withheld, Schwarz Pharma may grant rights to other authorized third parties to market, promote, sell and distribute Kyowa Licensed Products in any country in the Territory where Schwarz Pharma does not itself or through its then existing ordinary channels, wish to market Kyowa Licensed Products. Cephalon shall be deemed to have provided consent if it has not responded to the suggested authorized third party(ies) within ten (10) business days after receiving the name of such authorized third parties from Schwarz Pharma. If Cephalon has established a commercial operation in any of the following countries: [**] and Schwarz Pharma is not then marketing, promoting, selling and distributing directly or through an Affiliate or other channel normally used for the Schwarz Pharma product portfolio in such countries, then prior to entering into any agreement with any other third party for such marketing, promotion, selling or distribution rights in such country, Schwarz Pharma hereby agrees to negotiate in good faith for a period not to exceed sixty (60) days to grant such rights to Cephalon under terms and conditions to be mutually agreed upon. If Schwarz Pharma and Cephalon fail to so reach agreement within such period, then Schwarz Pharma may discuss terms and conditions with such other third parties but it shall not, within twelve (12) months of the expiration of the sixty (60) day negotiation period, enter into any such agreement with a third party on terms and conditions more favorable in the aggregate to such third party than those offered to Cephalon without first offering such more favorable terms to Cephalon in accordance with the procedures set forth herein. If, after complying with the terms of this paragraph, Schwarz Pharma thereafter enters into such an agreement with a third party, with Cephalon's consent as described above in this Section 3.2, then such agreement shall contain terms and conditions customary in the pharmaceutical industry with respect to such commercial arrangements, including without limitation those relating to the prompt disclosure of adverse drug experiences, any adverse regulatory or other governmental actions, or Know-How relating to the Kyowa Licensed Products. 3.3 Option to Backup Compounds. Subject to the terms and conditions set forth herein, including payment of all upfront license payments in Section 4.1, Cephalon hereby grants to Schwarz Pharma a time-limited option to license exclusively (exclusive even as to Cephalon) under the Cephalon Technology (a) the right to use and develop the Backup Compounds in the **Certain portions of this exhibit have been omitted based upon a request for confidential treatment that has been filed with the Commission. The omitted portions have been filed separately with the Commission. 13 Field in the Territory; (b) the right to use and sell Cephalon Licensed Products in the Territory. The option must be exercised, if at all, in accordance with the terms and conditions of Section 3.4. 3.4 Option Exercise for Backup Compounds. Subject to the terms and conditions set forth herein, to exercise the option granted by Cephalon in section 3.3 for any Backup Compound: (a) Schwarz Pharma must, by the latter of the second anniversary of the Effective Date or one hundred eighty (180) days after the filing of an Investigational New Drug Application ("IND") for such Backup Compound provided such IND is filed on or before the second anniversary of the Effective Date: (i) give Cephalon not less than thirty (30) days written notice that it is exercising its option and (ii) provided Cephalon has filed patent applications for all Backup Compounds no later than thirty (30) days from receipt of such notice, pay Cephalon [**] dollars [**] within thirty (30) days of such notice, OR, in the alternative (b) Schwarz Pharma must (i) give Cephalon not less than thirty (30) days written notice on or before the second anniversary of the Effective Date that it is extending the time to exercise its option until the latter to occur of the fourth anniversary of the Effective Date or sixty (60) days after the filing of an IND for such Backup Compound, (ii) provided Cephalon has filed patent applications for all Backup Compounds no later than thirty (30) days from receipt of such notice, pay Cephalon an option period extension fee of [**] Dollars [**] within thirty days of such notice, and (iii) if Schwarz Pharma desires to exercise its option, Schwarz Pharma shall notify Cephalon in writing before the expiration of the extended option period that it is exercising its option and shall pay Cephalon [**] dollars [**] within thirty (30) days of such notice. If Schwarz Pharma does not exercise its option for any Backup Compound within the relevant time periods set forth above, then such option shall expire and shall be of no further force and effect. 3.5 Marketing and Distribution Rights to Cephalon Licensed Products. From and after the time Schwarz Pharma exercises its option to take an exclusive license to the Backup Compounds pursuant to Section 3.4, and subject to the terms and conditions set forth herein, Schwarz Pharma may market and distribute Cephalon Licensed Products developed hereunder in the Territory through the channels normally used for the Schwarz Pharma product portfolio including, but not limited to, Affiliates, agents, distributors, joint venture partners and co- promotion and co-marketing partners (even if any such commercial contract between Schwarz Pharma and the applicable third party is formally described or structured as a license). Subject to the written consent of Cephalon, which consent shall not be unreasonably withheld, Schwarz Pharma may grant rights to other authorized third parties to market, promote, sell and distribute Cephalon Licensed Products in any country in the Territory, where Schwarz Pharma does not itself or through its then-existing ordinary channels, wish to market Cephalon Licensed Products. Cephalon shall be deemed to have provided consent if it has not responded to the suggested **Certain portions of this exhibit have been omitted based upon a request for confidential treatment that has been filed with the Commission. The omitted portions have been filed separately with the Commission. 14 authorized third party(ies) within ten (10) business days after receiving the names of such authorized third parties from Schwarz Pharma. If Cephalon has established a commercial operation in any of the following countries: [**] and Schwarz Pharma is not marketing, promoting, selling and distributing directly or through an Affiliate or other channel normally used for the Schwarz Pharma product portfolio in such countries, then prior to entering into any agreement with any other third party for such marketing, promotion, selling or distribution rights in such country, Schwarz Pharma hereby agrees to negotiate in good faith for a period not to exceed sixty (60) days to grant such rights to Cephalon under terms and conditions to be mutually agreed upon. If Schwarz Pharma and Cephalon fail to so reach agreement within such period, then Schwarz Pharma may discuss terms and conditions with such other third parties but it shall not, within twelve (12) months of the expiration of the sixty (60) day negotiation period, enter into any such agreement with a third party on terms and conditions more favorable in the aggregate to such third party than those offered to Cephalon without first offering such more favorable terms to Cephalon in accordance with the procedures set forth herein. If , after complying with the terms of this paragraph, Schwarz Pharma thereafter enters into such an agreement with a third party, with Cephalon's consent as described above in this Section 3.5, then such agreement shall contain terms and conditions customary in the pharmaceutical industry with respect to such commercial arrangements, including without limitation those relating to the prompt disclosure of adverse drug experiences, any adverse regulatory or other governmental actions, or Know- How relating to the Cephalon Licensed Products. 3.6 Licensed Products in the United States. If, during the term of this Agreement, the TAP Agreement is terminated for any reason, Cephalon shall immediately (and no later than ten [10] business days thereafter) inform Schwarz Pharma and, provided that Cephalon does not decide to unilaterally assume all responsibilities and costs of the US Program, then Cephalon shall grant Schwarz Pharma an exclusive right, exercisable within ninety (90) days of Cephalon's notification to Schwarz Pharma that the TAP agreement has terminated, upon the payment of additional consideration to be negotiated in good faith, to share responsibilities, costs and commercial opportunities, to be agreed upon, of the US Program. In any event there shall be no such expansion of the Territory hereunder unless Schwarz Pharma shall have, within ninety (90) days of said notification to Schwarz Pharma, successfully negotiated additional terms and conditions with Cephalon concerning said expansion. If in such negotiation Schwarz Pharma receives exclusive commercialization rights in the United States then the additional terms set forth below shall be included in any agreement for territorial expansion: (a) negotiation of additional reasonable terms giving due regard to the stage of development of any Compounds in the US Program; **Certain portions of this exhibit have been omitted based upon a request for confidential treatment that has been filed with the Commission. The omitted portions have been filed separately with the Commission. 15 (b) deletion of all references hereunder to the US Program and to TAP; (c) diligent conduct of a program for registration and commercialization of Licensed Product in the US; (d) payment to Cephalon of a transfer price in the amount of between [**] percent [**] and [**] percent [**] of the annual Net Sales of such Licensed Product(s) in the United States; and (e) payment to Cephalon of the following additional milestone payments not later than 30 days following completion of each milestone: (i) [**] dollars [**] upon the submission of the first New Drug Application ("NDA") for a Licensed Product in the United States; and (ii) [**] dollars [**] upon the approval of the first NDA for a Licensed Product in the United States. If Schwarz Pharma and Cephalon fail to so reach agreement within such ninety-day period, then Cephalon may discuss terms and conditions with third parties but it shall not, within twelve (12) months of the expiration of the ninety (90) day negotiation period, enter into any such agreement with a third party on terms and conditions more favorable in the aggregate to such third party than those offered to Schwarz Pharma without first offering such more favorable terms to Schwarz Pharma in accordance with the procedures set forth herein. Article 4. License fees, Transfer Pricing and Milestone Payments 4.1 Upfront License Fees and Fees for Option to License to Backup Compounds. In consideration of Cephalon granting Schwarz Pharma the sublicense to the Kyowa License to Kyowa Licensed Products (as set forth in Section 3.1) and in consideration of Cephalon granting Schwarz Pharma the option to exercise an exclusive license to the Backup Compounds (as set forth in Section 3.3), Schwarz Pharma shall pay Cephalon (i) on the Effective Date, by wire transfer (or as otherwise agreed upon by the Parties), an amount equal to [**] dollars [**]; and (ii) on or before the first anniversary of the Effective Date, by wire transfer (or as otherwise agreed upon by the Parties) an amount equal to [**] dollars [**]. 4.2 TRANSFER PRICING. Schwarz Pharma shall pay the following amounts to Cephalon as transfer prices on Net Sales: **Certain portions of this exhibit have been omitted based upon a request for confidential treatment that has been filed with the Commission. The omitted portions have been filed separately with the Commission. 16 (a) Subject to Section 4.2(e), Schwarz Pharma shall pay to Cephalon (i) a transfer price in the amount of [**] percent [**] of the annual Net Sales of Kyowa Licensed Products in the Territory for all annual Net Sales less than [**] dollars [**]; and (ii) a transfer price in the amount of [**] percent [**] of the annual Net Sales of Kyowa Licensed Products in the Territory for all annual Net Sales equal to or greater than [**] dollars [**]. (b) If Schwarz Pharma exercises its option in Section 3.3 to take an exclusive license to Cephalon Licensed Products in the Territory, subject to Section 4.2(e), Schwarz Pharma shall pay to Cephalon a transfer price in the amount of [**] percent [**] of the annual Net Sales of Cephalon Licensed Products in the Territory. (c) Notwithstanding the provisions of Sections 4.2(a) and 4.2(b), while the parties fully expect that the transfer pricing that Cephalon will charge Schwarz Pharma hereunder for the supply of Licensed Products, which is dependent upon the price for which Schwarz Pharma will be able to sell Licensed Products in the Territory, is reasonable and will allow each Party to make an acceptable return for their efforts, the Parties acknowledge and agree that because the Licensed Products are still in development and the competitive situation in the marketplace could change unexpectedly, the transfer pricing hereunder may result in an undue hardship on one or both of the Parties. Therefore, the parties agree that if the transfer pricing hereunder results in a situation where Cephalon is unable to make a fair profit [**] on the sale of Licensed Products to Schwarz Pharma, and/or in a situation where Schwarz Pharma is unable to make a fair profit (transfer prices in the ranges set forth in Section 4.2(a), above, as a percentage of annual Net Sales) on the sale of Licensed Products in the Territory, the parties agree to renegotiate the transfer price terms in good faith to allow each party to make an acceptable return. (d) Schwarz Pharma shall maintain (and shall require its Affiliates, sublicensees and third party marketers to maintain, if applicable) such records as it creates in the ordinary course of its business of all sales of Licensed Products pursuant to the licenses granted hereunder, for a period of not less than five (5) years from the date of the applicable Net Sales. Cephalon shall have the right, upon no less than two (2) weeks prior written notice to Schwarz Pharma, and at its own expense and through a certified public accountant or like person reasonably acceptable to Schwarz Pharma, to examine such records during regular business hours during the life of this Agreement and for twelve (12) months after the later of its termination or the last sale of Licensed Products by Schwarz Pharma subject to the transfer pricing obligations outlined above; provided, however, that such examination shall not take place more often than once a year and shall not cover such records for more than the preceding five (5) years and provided further that such certified public accountant shall be subject to the confidentiality provisions of this **Certain portions of this exhibit have been omitted based upon a request for confidential treatment that has been filed with the Commission. The omitted portions have been filed separately with the Commission. 17 Agreement, shall not retain or make copies of any Schwarz Pharma records, and shall report to Cephalon only as to the accuracy of said transfer price statements and payments. (e) Upon shipment of Licensed Products to Schwarz Pharma, Cephalon shall immediately invoice Schwarz Pharma in the amount of a provisional transfer price for the Licensed Products, which amount shall equal the transfer price as set forth in Sections 4.2(a) and 4.2(b) based upon Schwarz Pharma's Net Sales during the immediately preceding calendar quarter. With respect to shipments prior to the first commercial sale of Licensed Products and during the first two calendar quarters after such first commercial sale only, the provisional transfer price shall be based upon Schwarz Pharma's best estimates in accordance with its most recent sales forecasts. Within six (6) months after the first commercial sale of said Licensed Products, Schwarz Pharma shall conduct an accounting to determine the actual Net Sales for the first two calendar quarters, and Schwarz Pharma shall pay to Cephalon within sixty (60) days any understated amounts, or Cephalon shall pay to Schwarz Pharma any overstated amounts. Thereafter, within sixty (60) days after the end of each calendar quarter during the pendency of this Agreement, Schwarz Pharma shall deliver to Cephalon a true accounting of all Licensed Products sold by Schwarz Pharma (and by its Affiliates, sublicensees and third party marketers, if applicable) during such calendar quarter and shall, at the same time, Schwarz Pharma shall pay all additional transfer prices in excess of the current provisional transfer price due Cephalon on the basis of the Net Sales attributable thereto or Cephalon shall, within thirty days after receiving such accounting pay to Schwarz Pharma any overpayment and the provisional transfer price shall be adjusted accordingly. Such accounting shall show sales on a country-by country and Licensed Product- by-Licensed Product basis, and such accounting shall state the Net Sales subject to transfer pricing under this Article 4, the calculation of transfer pricing with respect thereto, and shall separately show the calculation of all adjustments thereto. 4.3 Milestone Payments. (a) In consideration of the rights granted pursuant to this Agreement and for so long as this Agreement has not been terminated, Schwarz Pharma shall pay to Cephalon those amounts set forth below (subject to Section 4.3(b), Section 4.3(c) and Section 4.4 hereof) by wire transfer (or as otherwise agreed by the parties) not later than thirty (30) days following the completion of the milestones set forth below: (i) [**] (ii) [**] **Certain portions of this exhibit have been omitted based upon a request for confidential treatment that has been filed with the Commission. The omitted portions have been filed separately with the Commission. 18 (iii) [**] (iv) [**] (v) [**] (b) For each of the milestones set forth in Sections 4.3(a)(i)- (v), above, Cephalon shall receive payment for any one of the Lead Compound, CEP-751 or CEP-2563 which achieves the individual milestone, and any one of the Backup Compounds which achieves the individual milestone, without regard to whether the milestone is achieved in the US Program or the Development Program. (c) With respect to unpaid milestones under 4.3 (a) (ii) and 4.3 (a) (iv) relating to any Pivotal Trial(s) the design of which was not accepted in writing by Schwarz Pharma, but for which Schwarz Pharma receives notice from the EMEA accepting such MAA, such milestones shall be due and payable immediately (and no later than thirty [30] days subsequent to the notice from the EMEA of the validation of such MAA). 4.4 Credits Against Milestone Payments. Milestone payments made by Schwarz Pharma under the terms of Section 4.3 hereof in connection with the Lead Compound, CEP-751, CEP-2563 or a Backup Compound that subsequently "fails in development" (as defined below), or for which Schwarz Pharma otherwise fails to obtain approval of the applicable MAA, and is subsequently replaced by a Backup Compound that is so designated by Schwarz Pharma for the same indication, shall be credited against milestone payments for such Backup Compound. Failure in development shall mean a) any failure to reach the defined success criteria in the clinical program of the US Program or the Development Program with respect to safety and/or efficacy, b) any failure to fulfill clinical or preclinical regulatory requirements established by the EMEA; c) any failure to meet CMC standards; and/or d) failure of the Compound to demonstrate a sufficient competitive profile of safety, efficacy or price to support commercialization. 4.5 Development Budget Variances. Schwarz Pharma shall provide to Cephalon, upon Cephalon's reasonable request, documentation that supports the expenses incurred by Schwarz Pharma under the Development Budget. Cephalon shall have the right, at its own expense and through a certified public accountant or like person reasonably acceptable to Schwarz Pharma, to audit the records supporting the Development Budget during regular business hours during the life of this Agreement and for twelve (12) months after the later of its termination or the last sale of Licensed Products by Schwarz Pharma. If Schwarz Pharma fails to spend at least [**]of the **Certain portions of this exhibit have been omitted based upon a request for confidential treatment that has been filed with the Commission. The omitted portions have been filed separately with the Commission. 19 [**] dollar [**] Development Budget under the Development Plan, then Schwarz Pharma agrees to pay Cephalon [**] percent [**] of the difference between [**] dollars [**] and the actual amount Schwarz Pharma spends on the Development Plan, but in no case more than [**] dollars [**], by the date of the first commercial sale of Licensed Product. Such payment shall be made by Schwarz Pharma to Cephalon on or before the date of the first anniversary of the first commercial sale. If, based on European regulatory requirements or state-of-the- art medical practice, Schwarz Pharma spends in excess of [**] of the [**] dollar [**] Development Budget under the Development Plan, then Cephalon agrees to pay Schwarz Pharma [**] percent [**] of the difference between [**] dollars [**] and the actual amount Schwarz Pharma spends on the Development Plan, but in no case more than [**] dollars [**], by the date of the first commercial sale of Licensed Product, provided, however, that in no event shall Schwarz Pharma charge any costs to the Development Budget to the extent that such costs were incurred by Schwarz Pharma because of Schwarz Pharma's gross negligence in the conduct of the Development Program. Such payment shall be made either as direct payment or credits against Schwarz Pharma milestone payments, at Schwarz Pharma's option. 4.6 Taxes. If Schwarz Pharma is required by law to withhold any taxes or other governmental obligations from the milestone or transfer price obligations to be paid to Cephalon under the terms of this Article 4, then Schwarz Pharma shall provide notice to Cephalon of any such requirement. In such event, Schwarz Pharma may withhold and pay such taxes or obligations on behalf of Cephalon, provided that Schwarz Pharma sends to Cephalon original receipts of such payments (or if it is not possible to obtain an original receipt, other official written confirmation thereof). 4.7 Payments (a) Currency: All payments due under this agreement shall be payable in -------- U.S. dollars. Any conversion of Net Sales from local currencies shall be made at the average rate prevailing for the applicable calendar quarter as published in The Wall Street Journal. (b) Other Payments: Cephalon shall invoice Schwarz Pharma for any -------------- incremental At Cost expenses in the US Program incurred by or on behalf of Cephalon at Schwarz Pharma's request for support of the Development Program in the Territory, and such incremental expenses shall be due and payable within sixty (60) days of invoicing. (c) Late Payments: Each party agrees to pay interest at the lower of the ------------- rate of i) one percent (1%) per month compounded daily, or ii) the highest rate allowable under applicable law, accruing from the due date of such payment, on any payment due to the other party which is **Certain portions of this exhibit have been omitted based upon a request for confidential treatment that has been filed with the Commission. The omitted portions have been filed separately with the Commission. 20 more than thirty (30) days overdue. Article 5. Regulatory Matters 5.1 Regulatory Approvals. Schwarz Pharma shall be responsible for obtaining and shall own all necessary regulatory and marketing approvals for the use and sale of Licensed Products in the Territory, unless otherwise agreed to by the Parties. 5.2 Diligence in Regulatory Submissions and Product Launch. Schwarz Pharma agrees to prepare and file MAAs for Licensed Products in the Territory using resources as if said Licensed Products were of Schwarz Pharma origin and have the same commercial potential. Unless otherwise agreed upon by the Parties, Schwarz Pharma agrees to file a MAA with the EMEA (or with a regulatory authority in one of the following countries: [**] within [**] following successful completion of the Development Program (including all related activities) for any Kyowa Licensed Products and Cephalon Licensed Products, and to launch such Licensed Products in the Territory as soon as practicable following the date of marketing (and, if applicable, pricing and reimbursement) approval in each country in the Territory, and in a manner at least consistent with the launch of other products having the same or similar commercial potential that are marketed and sold by Schwarz Pharma in such country. Notwithstanding anything to the contrary in this Section 5.2, Schwarz Pharma agrees to use Reasonable Business Efforts to: (a) launch the first clinical study(ies) in the Territory within [**] of the Effective Date of this Agreement and the fulfillment of all applicable requirements of a competent regulatory authority in the Territory and in accordance with the Development Plan; (b) complete the analysis and report on the first proof-of-principle clinical study(ies) in the Territory within [**] of the Effective Date; (c) initiate the first Pivotal Trial within [**] of the Effective Date; and (d) file a MAA with the EMEA (or with a regulatory authority in one of the following countries: [**] within [**] after the filing by or on behalf of Cephalon of a NDA with the US Food and Drug Administration for any Licensed Products, provided that the US NDA filing meets EMEA regulatory requirements, or otherwise within [**] after completion by Schwarz Pharma of the Pivotal Trial(s) required to support an EMEA filing. 5.3 Cooperation. Both Parties hereby agree to: (i) cooperate with each other and render **Certain portions of this exhibit have been omitted based upon a request for confidential treatment that has been filed with the Commission. The omitted portions have been filed separately with the Commission. 21 assistance in connection with the filing of a MAA (or other application for regulatory approval) with any governmental authority or agency which may be required, whether in or outside the Territory, to obtain approval to market Licensed Products or to obtain pricing and reimbursement approval; and (ii) execute documents, and provide a letter of authorization or other documentation to the appropriate regulatory authorities or to any other governmental authority or agency, as necessary or advisable, to enable either Party to file, refer to or incorporate by reference all technical information including data on file with any such agency or authority concerning Licensed Products that may be contained in a drug master file or otherwise. In the event that any such drug master file is supplemented or modified, each Party agrees to notify the other Party promptly that supplements or modifications have been made. 5.4 Product Recalls. If (i) any governmental or regulatory authority issues a request, directive, or order that any Licensed Product be recalled or withdrawn from the market, (ii) a court of competent jurisdiction in a final, nonappealable judgment orders a recall or withdrawal of any Licensed Product, or (iii) following discussion between the Parties, and giving due consideration to the views of the other Party, the Party holding the MAA (or analogous marketing application outside the Territory) for the applicable Licensed Product determines in its sole discretion that said Licensed Product should be recalled or withdrawn from one or more countries within its respective territory, then the Parties together shall take all appropriate corrective actions to effect the recall or withdrawal. The costs and expenses of notification and destruction or return of the recalled or withdrawn Licensed Product in the Territory shall be borne by Schwarz Pharma, provided, however, that in the case of recalls due to latent defects in a manufacturing lot of Licensed Products which Schwarz Pharma would not have been reasonably able to detect and reject, Cephalon shall bear such costs and expenses. Article 6. Manufacture and Supply of Compounds and Licensed Products 6.1 Supply AgreementS. (a) Definitive Supply Agreements. The Parties agree to negotiate in good faith the terms of a definitive supply agreement with regard to pre-commercial and commercial supply of Compounds (and their associated Licensed Products) under which Cephalon will manufacture and supply Compounds and Licensed Products to Schwarz Pharma, which supply agreement shall contain terms and conditions customary in the industry, including without limitation those relating to GMP compliance, compliance with product specifications, quality control, records, storage, inspection, product delivery and acceptance, lead times, firm orders, forecasts, quantity, inventory requirements, and assurance of supply [**], and audit rights in favor of Schwarz Pharma. The supply agreement will provide that Schwarz Pharma shall purchase exclusively **Certain portions of this exhibit have been omitted based upon a request for confidential treatment that has been filed with the Commission. The omitted portions have been filed separately with the Commission. 22 from Cephalon all of Schwarz Pharma's requirements for Licensed Products during the term of this Agreement and such supply agreement shall have a term not less than the term of this Agreement . Schwarz Pharma will be responsible for packaging and labeling the finished dosage form Licensed Products to be marketed and sold in the Territory. Schwarz Pharma shall provide to Cephalon samples of the label, package insert, packaging, advertising and promotional materials for each Licensed Product, and Cephalon shall, if it has any concerns regarding compliance of such samples with applicable law as such law relates to Cephalon's responsibilities as a manufacturer, it shall notify Schwarz Pharma within thirty (30) days after receipt of the samples. (b) Preclinical and Clinical Supply. Until the definitive supply agreement described in Section 6.1(a) has been executed by the parties, Cephalon agrees to use its Reasonable Business Efforts to supply Schwarz Pharma and Schwarz Pharma agrees to purchase from Cephalon sufficient quantities of preclinical and clinical supplies of GMP quality Compounds in order to permit Schwarz Pharma to conduct the Development Program hereunder. Schwarz Pharma acknowledges that Cephalon may engage new third party manufacturers (other than those in existence as of the Effective Date), subject to the prior written approval of Schwarz Pharma not to be unreasonably withheld or delayed, to produce the Compounds. Schwarz Pharma shall purchase exclusively from Cephalon all of Schwarz Pharma's requirements for Compounds during the term of this Agreement. Cephalon shall provide pre-clinical and clinical supply At Cost. All such supplies shall be provided in finished dosage form, packaged in bulk containers, ready for final packaging and labeling. Cephalon shall use its Reasonable Business Efforts to provide Phase III clinical supplies that either i) consist of final drug product in the dosage form specified by Schwarz Pharma to be utilized in its applicable regulatory filing, or, ii) consist of supplies that are bioequivalent to the final commercial dosage form, provided, however, that if such Phase III clinical supplies do not consist of final drug product, then Cephalon shall bear any additional development costs which may be incurred as a result. Cephalon shall be responsible for timely compliance with all CMC requirements in the Territory, including, without limitation, development and manufacturing of drug substance and drug product and qualification and maintenance of manufacturing facilities. (c) Commercial Supply. Cephalon agrees to use its Reasonable Business Efforts to supply Schwarz Pharma and Schwarz Pharma agrees to purchase from Cephalon sufficient quantities of commercial supplies of GMP quality finished dosage form Licensed Products in the Territory, to be packaged in bulk containers. Schwarz Pharma acknowledges that Cephalon has engaged and may engage additional third party manufacturers to produce bulk drug substance and/or finished dosage form. Schwarz Pharma shall pay Cephalon a transfer price for finished dosage form as described in Section 4.2. Such finished dosage form shall in all cases be **Certain portions of this exhibit have been omitted based upon a request for confidential treatment that has been filed with the Commission. The omitted portions have been filed separately with the Commission. 23 provided in a product format specified by Schwarz Pharma to meet then current European regulatory requirements specified by the EMEA. Schwarz Pharma shall purchase exclusively from Cephalon all of Schwarz Pharma's requirements for the Licensed Products during the term of this Agreement. Schwarz Pharma hereby grants to Cephalon a right of first negotiation to obtain from Schwarz Pharma the right to supply Schwarz Pharma with Licensed Products after the expiration of the term of this Agreement. In the event Schwarz Pharma requires supply of Licensed Products after the termination of this Agreement, then not less than [**] prior to the expiration or termination of this Agreement and prior to negotiating with any third party manufacturer, or manufacturing itself, Schwarz Pharma shall notify Cephalon of its supply requirements. Cephalon shall have thirty (30) days thereafter to notify Schwarz Pharma in writing that it is interested in supplying Schwarz Pharma. If Cephalon so notifies Schwarz Pharma then the parties shall proceed in good faith to negotiate a supply agreement for Licensed Products. If Cephalon notifies Schwarz Pharma that it is not interested in such a supply arrangement, or fails to notify Schwarz Pharma within such thirty-day period, or fails to reach agreement with Schwarz Pharma on the terms of such supply arrangement within ninety (90) days after such notification, then Schwarz Pharma shall be free to negotiate with any third party for supply. In the event that Cephalon determines to directly manufacture Licensed Products, or to contract with a new or additional third party manufacturer for supplies of Licensed Product at any time, then, if that Licensed Product is either currently under development or being commercialized by Schwarz Pharma, Cephalon shall promptly notify Schwarz Pharma and, upon the request of Schwarz Pharma, the parties shall discuss the possibility of Cephalon granting manufacturing rights to Schwarz Pharma to make Licensed Product for sale in the Territory. Article 7. Marketing, Promotion and Sale of Product 7.1 MARKETING. Schwarz Pharma agrees to use its Reasonable Business Efforts to promote the sale of Kyowa Licensed Products and Cephalon Licensed Products in the Territory and to maximize the Net Sales thereof. In connection with these efforts, Schwarz Pharma shall regularly prepare and update a commercialization plan (the "Marketing Plan") for review by Cephalon not less than once per calendar year following the filing of the first MAA, which Marketing Plan will set forth the Licensed Product marketing and selling strategies, and will include an estimated promotional budget, detailing objectives, planned training and educational programs for its sales force, upcoming symposia, seminars and professional relations events in the Territory, and other matters appropriate and customary in the industry for such a Marketing Plan, all of which shall give due consideration to the experience and perspective of Cephalon with respect to optimal marketing and selling practices in the Territory. With respect to Licensed Products, Schwarz Pharma agrees to provide that level of sales and promotional support which is, in the aggregate, at a level comparable to that incurred in the industry for pharmaceutical **Certain portions of this exhibit have been omitted based upon a request for confidential treatment that has been filed with the Commission. The omitted portions have been filed separately with the Commission. 24 products of comparable market potential. All Know-How resulting from implementation of the Marketing Plan will be owned by Schwarz Pharma and made available to Cephalon as set forth in Article 8 Notwithstanding Cephalon's review of the Marketing Plan, Schwarz Pharma shall have the final authority to determine product positioning, pricing [subject to Section 4.2(c)] and all other marketing and promotional issues, expenditures and activities. If Schwarz Pharma determines in good faith that it would not be in the mutual best interests of the Parties for it to commence (or to continue, as the case may be) marketing and selling Kyowa Licensed Products or Cephalon Licensed Products in any given country in the Territory for which it has received marketing approval, then it will promptly notify Cephalon of such determination and the Parties will discuss appropriate resolution, which may include the forfeiture of territorial rights in such countries to Cephalon under terms and conditions to be mutually agreed upon; provided however, that Schwarz Pharma shall be deemed to be marketing and selling the applicable Licensed Product in all countries of the European Union if it is marketing and selling said Licensed Product in each of the following countries: [**]. 7.2 Compliance. Schwarz Pharma shall have obtained and shall maintain in good standing all required permits, licenses and regulatory approvals necessary or advisable to market, promote, sell and distribute Licensed Products in the Territory. Schwarz Pharma shall comply with all local laws, rules, regulations, and reporting requirements in force in the Territory covering, among other things, the marketing, promotion and sale, and the payment for, the Licensed Products. 7.3 Sale of Product. Prior to filing the initial MAA for a Licensed Product in the Territory, Schwarz Pharma will provide to Cephalon in writing its good faith non-binding forecast of aggregate Net Sales to be obtained in the Territory for at least the first three calendar years after the first commercial sale hereunder, and thereafter shall provide to Cephalon its sales forecasts for such Licensed Product as generated in the ordinary course of its business ("Annual Sales Forecasts"). In the event that a Licensed Product has more than one indication, the Annual Sales Forecasts may include separate minimum Annual Sales Forecasts for each Licensed Product indication. If, despite its Reasonable Business Efforts, Schwarz Pharma fails to meet its most recent Annual Sales Forecasts , then the Parties shall meet to discuss whether such shortfall is due principally to market conditions beyond the control of Schwarz Pharma, or whether certain marketing and sales initiatives or other actions should be taken. Article 8. Rights to Data and Regulatory Compliance 8.1 Sharing of Data. Subject to the license grants set forth in Article 3, the Parties shall provide to each other and have reciprocal rights to use, in connection with the development and **Certain portions of this exhibit have been omitted based upon a request for confidential treatment that has been filed with the Commission. The omitted portions have been filed separately with the Commission. 25 commercialization of Compounds, all Know-How generated either by or for either Party, or jointly by or for the Parties, under the Development Program or the US Program in each of its respective territories. Such Know-How may be used by Cephalon inside or outside the Territory and inside or outside the Field subject to the rights of Schwarz Pharma to use all such Know-How set forth herein. Schwarz Pharma agrees to use Cephalon's Know-How and any other Know-How, to the extent such Know-How is directly related to Compounds or Licensed Products, solely for the development of Compounds within the Field and the commercialization of Licensed Products within the Territory . The Parties shall agree on a format to be used to enable the Parties to have prompt, electronic access to all data generated (whether generated jointly or by or on behalf of either Party separately), subject to appropriate electronic encryption and other confidentiality requirements to preserve the integrity of each party's proprietary data. 8.2 Adverse Drug Events. The Parties hereby agree that, not later than sixty (60) days after the Effective Date, they will establish procedures for the handling and reporting of adverse events ("AEs"), and that such procedures shall require that the Parties inform each other in an appropriate and efficient manner of any such AEs with respect to Compounds and the Licensed Products, taking into account those procedures used regularly by the Parties and those requirements of the EMEA, the FDA and other relevant regulatory authorities. Details of the AE exchange with respect to e.g. form, content, timelines, etc. will be agreed and documented by the Parties respective drug safety departments. Notwithstanding the above, Cephalon shall be allowed to retain copies in electronic or other formats of all information relating to adverse drug events for any Compound recorded in the Development Program and in the US Program. 8.3 Notice of Governmental Action. During the term of this Agreement, each Party further agrees to immediately notify the other Party about any information such Party received regarding any threatened or pending action by a governmental agency which may involve the safety and efficacy claims of Compounds or Licensed Products or the continued clinical testing or marketing thereof. Upon receipt of any such information, Cephalon shall consult with Schwarz Pharma in an effort to arrive at a mutually acceptable procedure for taking appropriate action; provided, however, that nothing contained herein shall be construed as restricting the right of either Party to make a timely report of such matter to any government agency or take other action that it deems to be appropriate or required by applicable law or regulation. Article 9. Limited Liability OTHER THAN THOSE WARRANTIES SET FORTH IN SECTION 16 BELOW, CEPHALON MAKES NO WARRANTY (EXPRESS OR IMPLIED) AS TO THE **Certain portions of this exhibit have been omitted based upon a request for confidential treatment that has been filed with the Commission. The omitted portions have been filed separately with the Commission. 26 COMPOUNDS OR THE LICENSED PRODUCTS. EXCEPT AS OTHERWISE PROVIDED HEREIN, THE SOLE AND EXCLUSIVE REMEDY OF SCHWARZ PHARMA FOR ANY LIABILITY OF ANY KIND, INCLUDING LIABILITY BASED ON WARRANTY FOR COMPOUND SUPPLIED TO SCHWARZ PHARMA BY CEPHALON (EXPRESS OR IMPLIED, WHETHER CONTAINED HEREIN OR ELSEWHERE), NEGLIGENCE, STRICT LIABILITY, CONTRACT OR OTHERWISE IS LIMITED TO THE REPLACEMENT OF COMPOUND OR LICENSED PRODUCT (AS THE CASE MAY BE) OR THE REFUND OF THE SUPPLY PRICE THERFOR. CEPHALON SHALL IN NO CASE BE LIABLE FOR SPECIAL, INCIDENTAL, OR CONSEQUENTIAL DAMAGES OF ANY KIND, INCLUDING LOST PROFITS. Article 10. Trademark for Licensed Products 10.1 Selection of Trademarks. The Parties acknowledge that it may be in their mutual best interests to attempt to develop a single trademark for use within and outside the Territory for a given Licensed Product, and agree to discuss the choice and selection of the trademark at an appropriate time prior to commercial launch. Any single trademark for use within the Territory and within the United States for a given Licensed Product shall be made in accordance with Section 4.3 of the TAP Agreement. In the event that such trademark is licensed by TAP to Cephalon, then Cephalon shall grant to Schwarz Pharma a royalty-free, exclusive sublicense to such trademark for use with the Licensed Products in the Territory for the term of this Agreement. All other such trademarks in the Territory shall be owned by, and registered in the name of Schwarz Pharma. Cephalon agrees that Cephalon will select for its own marketed products trademarks not confusingly similar to the trademarks chosen for the Licensed Products. Article 11. Inventions 11.1 Disclosure of Inventions. During the pendency of this Agreement, the Parties agree to disclose to each other any and all inventions, discoveries and improvements that may be conceived, reduced to practice, or made by either Party while engaged in the performance of this Agreement and that are within the scope of the licenses granted under Article 3 hereof,]whether patentable or unpatentable including without limitation any new compositions, formulations, uses, dosages, methods of formulating, processes, methods of manufacture or the administration thereof (collectively, "Improvements"). The Parties further agree to exchange any Know-How related to or covered by the Improvements that is reasonably necessary in order to utilize such Improvements. 11.2 Inventorship. Inventorship and ownership with respect to all patentable Improvements **Certain portions of this exhibit have been omitted based upon a request for confidential treatment that has been filed with the Commission. The omitted portions have been filed separately with the Commission. 27 shall be determined in accordance with U.S. patent law. 11.3 Ownership. All Improvements to the extent directly related to the Compounds, whether discovered or developed by Cephalon, by Schwarz Pharma or jointly by Cephalon and Schwarz Pharma in collaboration hereunder, shall be owned by Cephalon. Cephalon shall grant Schwarz Pharma an option for an exclusive, royalty-free license to use and sell such Improvements in the Territory, but only to use and sell Compounds in the Field or Licensed Products in the Territory. All Improvements discovered or developed solely by Schwarz Pharma during the performance of this Agreement to the extent that they are not directly related to the Compounds, shall be owned by Schwarz Pharma. Schwarz Pharma shall grant Cephalon an option for an exclusive, royalty-free license to such Improvements outside the Territory , but only to make, have made, use and sell Compounds or Licensed Products outside the Territory. All Improvements discovered or developed jointly by Cephalon and Schwarz Pharma during the performance of this Agreement that are not directly related to the Compounds, shall be owned jointly by Cephalon and Schwarz Pharma. Each party shall grant to the other party an option for an exclusive, royalty-free license to such jointly owned Improvements that are not directly related to the Compounds, outside the Territory as to Cephalon, and in the Territory as to Schwarz Pharma, but in each case only to make, have made, use and sell Compounds and Licensed Products. Article 12. Patent Rights. Each Party, at its own expense, shall prepare, file, prosecute and maintain all patents and patent applications for Improvements that it owns. Each Party shall keep the other Party fully advised of the status of all such patents and patent applications. In addition, each party shall make Reasonable Business Efforts to send the other Party advance drafts of any papers to be filed relating to such patents and patent applications and shall consider the suggestions of the other Party and its patent counsel with respect to the prosecution and maintenance of such patents and patent applications. If a Party fails to prepare, file, prosecute or maintain such patents and patent applications as required by this Agreement, it shall immediately notify the other Party and the other Party shall have the right to assume responsibility and control at its own expense for said preparation, filing, prosecution and maintenance of such patents and patent applications in the name and on the account of the original party. Each Party shall cooperate reasonably with the other upon request in promptly executing any and all such patent applications, or other instruments deemed necessary or useful by either or both Parties in connection with the application prosecution or maintenance of such patents or patent applications. Cephalon, at its own expense, shall prepare, file, prosecute and maintain all Patent Rights for Cephalon Technology in the Territory. Cephalon shall keep Schwarz Pharma fully advised of **Certain portions of this exhibit have been omitted based upon a request for confidential treatment that has been filed with the Commission. The omitted portions have been filed separately with the Commission. 28 the status of all Patent Rights. In addition, Cephalon shall make commercially reasonable efforts to send Schwarz Pharma advance drafts of any papers to be filed relating to Patent Rights in the Territory and shall consider the suggestions of Schwarz Pharma and its patent counsel with respect to the prosecution and maintenance of Patent Rights in the Territory. If Cephalon fails to prepare, file, prosecute or maintain Patent Rights in the Territory as required by this Agreement, it shall immediately notify Schwarz Pharma and then Schwarz Pharma shall have the right to assume responsibility and control at its own expense for said preparation, filing, prosecution and maintenance of any such Patent Rights in the name and on the account of Cephalon. Each Party shall cooperate reasonably with the other upon request in promptly executing any and all patent applications, or other instruments deemed necessary or useful by either or both Parties in connection with the application, prosecution or maintenance of Patent Rights in the Territory. Article 13. Infringement 13.1 Notice Regarding and Authority to Take Action Against Infringers. Each Party shall promptly notify the other Party of any identified infringement by third parties of the proprietary rights of either Party with regard to Compounds and Licensed Products. If any of the Patent Rights are infringed in the any of the following countries[**], then Cephalon shall have the obligation to commence appropriate legal action to enjoin such infringement at its sole expense, and Schwarz Pharma shall provide its complete cooperation to Cephalon in doing so, at Schwarz Pharma's expense. If any of the Patent Rights are infringed in any of the remaining countries in the Territory, Cephalon shall have the right but not the obligation to commence appropriate legal action to enjoin such infringement at its sole expense, and Schwarz Pharma shall provide its complete cooperation to Cephalon in doing so, at Schwarz Pharma's expense. If, in the latter case, Cephalon fails to initiate such action within ninety (90) days after being notified of the infringement, Schwarz Pharma shall have the right, but not the obligation, to undertake such action at its own expense, in the name of Cephalon, and Cephalon agrees to provide its complete cooperation to Schwarz Pharma, at Cephalon's expense. Any damages or awards resulting from the prosecution of such claim shall be applied first, to reimburse the parties pro-rata for their costs and expenses, with any balance to be shared by the Parties in proportion to their respective economic losses from such infringement. Notwithstanding the foregoing, the Parties acknowledge that the Kyowa License, which is attached hereto as Exhibit D, establishes all applicable procedures and responsibilities for enforcement of rights relating to the Kyowa Technology. 13.2 Notice of Infringement of Third Party Proprietary Rights. Each Party shall promptly notify the other Party of any notification received or claim against it asserting infringement of third party proprietary rights by Licensed Products, Compounds, Know-How or Improvements. **Certain portions of this exhibit have been omitted based upon a request for confidential treatment that has been filed with the Commission. The omitted portions have been filed separately with the Commission. 29 13.3 Infringement of Third Party Proprietary Rights. If a claim alleging infringement of third party proprietary rights in the Territory is made against Schwarz Pharma, then Cephalon may elect to defend against such a claim on behalf of Schwarz Pharma at the cost and expense (including, without limitation, attorneys fees) of Cephalon, but Schwarz Pharma may be represented in such event by legal counsel in an advisory capacity at its own expense. However, if Cephalon does not elect to defend against such a claim within one hundred twenty (120) days after receiving notice (whether from Schwarz Pharma or otherwise) of such claim, Schwarz Pharma has the right, but not the obligation, to defend against such claim at its own expense. The Party assuming said defense shall keep the other Party informed of the status of the case. If the Party assuming said defense determines to file a counterclaim against the third party claiming infringement, and subsequently prevails in obtaining damages or awards, then such award or damages shall be divided on the same basis as set forth in Section 13.1, above. Regardless of which Party assumes the defense of any such claim, if damages are awarded based upon said claim, then the Parties shall allocate the responsibility for paying said damages in proportion to their respective economic interests in the country or countries within the Territory as to which such damage award is based. Notwithstanding the foregoing, the Parties acknowledge that the Kyowa License, which is attached hereto as Exhibit D, establishes all applicable procedures and responsibilities for the defense of infringement claims raised with respect to Kyowa Licensed Products. Article 14. Term and Termination 14.1 Term of the Agreement. This Agreement shall commence as of the Effective Date, and will terminate by mutual agreement of the Parties, or otherwise in accordance with the provisions of this Article 14. The parties obligations with respect to Sections 4.2 and 4.6 and Article 6 shall expire upon the last to occur of (i) the expiration date of the last to expire of Valid Claims of Patent Rights to any Licensed Product; (ii) the end of any period of market exclusivity under any MAA for any Licensed Product (or under the terms of applicable laws and regulations); or (iii) that date which is the tenth (10th) anniversary of the first commercial sale of a Licensed Product by Schwarz Pharma in the Territory. 14.2 Termination of Development Program for a Compound. All rights to any Compounds for which development has been discontinued in its entirety by Schwarz Pharma, including any rights of use to Kyowa Technology and Cephalon Technology related to such Compound, automatically shall revert to Cephalon, subject to the terms of this Agreement.. 14.3 Termination for Breach by Either Party. Upon breach of any material provision of **Certain portions of this exhibit have been omitted based upon a request for confidential treatment that has been filed with the Commission. The omitted portions have been filed separately with the Commission. 30 this Agreement, the breaching Party will be given written notice and ninety (90) days within which to remedy such breach. Failure to remedy any such breach within this time period (or if the breach is not capable of remedy in such time period, to undertake continuous and diligent efforts to remedy such breach) will constitute sufficient grounds for termination by the other Party without any further notice. Upon termination of this Agreement due to unremedied breach by either Party, the breaching Party shall have no liability to the other Party (or to any third party)for any damages, losses, indemnity, compensation, costs or expenses of any kind for lost profits or prospective sales, investments made or expenses incurred in connection with the establishment, development or maintenance of its business, markets or customers, fees for transferring Compounds, product registrations, or any similar claims, damages, fees or payments. 14.4 Termination by Schwarz Pharma. Schwarz Pharma shall have the right to terminate this Agreement at any time upon no less than (i) six (6) months prior written notice to Cephalon up until commercial launch of the first Licensed Product in the Territory or upon (ii) twelve (12) months prior written notice to Cephalon at any time thereafter. 14.5 Termination for Product Failure. Either Party shall have the right to terminate this Agreement with respect to a particular Compound or Licensed Product upon thirty (30) days written notice if nonclinical or clinical evidence about that Licensed Product demonstrates a sufficiently serious adverse risk/benefit profile that further development or commercialization of such Compound or Licensed Products permanently suspended a regulatory authority or other authority of competent jurisdiction in any Major Country of the Territory. 14.6 Effects of Termination. Upon termination of this Agreement due to unremedied breach by Schwarz Pharma, unilateral termination by Schwarz Pharma, or upon termination of this Agreement by the mutual agreement of the Parties, the following provisions shall apply: (a) Schwarz Pharma acknowledges that except as provided herein, upon any such termination it shall have no further rights with respect to the Cephalon Technology, the Kyowa Technology, the Compounds and the Licensed Products. All rights granted to Schwarz Pharma under this Agreement shall immediately revert to Cephalon, except as provided below, and Schwarz Pharma shall immediately cease its use of Cephalon Technology and Kyowa Technology. To the extent necessary or advisable, at the request of Cephalon Schwarz Pharma immediately will grant to Cephalon a perpetual, exclusive (exclusive even as to Schwarz Pharma), fully-paid, royalty-free license under any Patent Rights, Know-How, Improvements, trademarks or any other proprietary rights whatsoever held by Schwarz Pharma necessary to enable Cephalon to make, have made, use and sell Licensed Products in the Territory, and Schwarz Pharma will execute any documents necessary to facilitate the intent of this paragraph; **Certain portions of this exhibit have been omitted based upon a request for confidential treatment that has been filed with the Commission. The omitted portions have been filed separately with the Commission. 31 (b) Any outstanding unpaid invoices shall become due and payable immediately in lieu of any payment terms previously agreed upon by the Parties; (c) Schwarz Pharma shall cease use of all Compounds in the Territory, and shall cease all marketing, sales and distribution of Licensed Products in the Territory; provided, however, that Schwarz Pharma shall have the right to sell in accordance with the terms of this Agreement all unsold inventories of any such Licensed Products in its possession unless Cephalon, at its sole discretion, shall exercise the option, by written notice to Schwarz Pharma on or before the effective date of such expiration or termination, to repurchase all remaining inventory then held by Schwarz Pharma at a purchase price equal to the cost of Products of such inventory; and (d) Schwarz Pharma will provide Cephalon with all copies of any MAA (or its equivalent outside the Territory) for Compounds or Licensed Product and any accompanying documentation (including without limitation all regulatory agency correspondence) in its possession or, if such registration application has not yet been filed in the Territory prior to the date of said termination or expiration, with all Know-How relating to all Compounds in its possession on such date. At the request of Cephalon, Schwarz Pharma shall take all steps as may be required by applicable law to transfer any such registration for Licensed Products to Cephalon, or otherwise to enable Cephalon to market and sell Licensed Products in the Territory, and also shall provide full support to Cephalon to facilitate the prompt execution of such legal transfer. In no event shall Cephalon be obligated to pay any fee or to make any other payment to Schwarz Pharma, to the local government in the Territory, or to any third party, to effect such legal transfer. Except for termination due to unremedied breach by Schwarz Pharma, the costs incurred in connection with such transfer or enabling activities shall be shared equally between Schwarz Pharma and Cephalon. 14.7 Bankruptcy. All rights and licenses granted under or pursuant to this Agreement by Cephalon to Schwarz Pharma, or by Schwarz Pharma to Cephalon are, and shall otherwise be deemed to be, for purposes of Section 365(n) of the Bankruptcy Code, licenses of rights to "intellectual property" as defined under Section 101(52) of the Bankruptcy Code. The parties agree that each of them, as licensees of such rights under this Agreement, shall retain and may fully exercise all of its rights and elections under the Bankruptcy Code. The parties further agree that, in the event of the commencement of a bankruptcy proceeding by or against either party under the Bankruptcy Code, the party not in bankruptcy shall be entitled to a complete duplicate of, or complete access to, as appropriate, any such intellectual property and all embodiments of such intellectual property, and same, if not already in its possession, shall be promptly delivered to such party not in bankruptcy (i) upon any such commencement of a bankruptcy proceeding **Certain portions of this exhibit have been omitted based upon a request for confidential treatment that has been filed with the Commission. The omitted portions have been filed separately with the Commission. 32 upon written request therefore by the party not in bankruptcy , unless the party in bankruptcy elects to continue to perform all of its obligations under this Agreement, or (ii) if not delivered under (i) above, upon the rejection of this Agreement by or on behalf of the party in bankruptcy upon written request therefore by the party not in bankruptcy 14.9 Survival of Obligations. All terms and conditions of this Agreement which the Parties intend to survive the expiration or termination hereof shall so survive, and shall include without limitation, those terms and conditions relating to confidentiality, indemnification, intellectual property rights generally, and rights to payment. More specifically, the termination of this Agreement shall not relieve the Parties of any obligations accruing prior to such termination, and any such termination shall be without prejudice to the rights of either Party against the other, including without limitation the obligation to pay for Compounds purchased, or transfer prices for Licensed Products sold prior to said termination. Article 15. Confidentiality. 15.1 Confidential Information. During the term of this Agreement, and for ten (10) years after its termination or expiration, each Party shall maintain in confidence any information concerning the subject matter hereof provided by the other Party (the "Providing Party"), and that is considered to be confidential by the Providing Party, regardless of whether provided prior to or after the Effective Date. Such information, collectively the "Confidential Information" shall be in writing and includes but is not limited to Know-How, Patent Rights, Improvements, Cephalon Technology and Kyowa Technology, documentation, business plans, cost and operational information, whether or not related to Compounds or Licensed Products. Confidential Information shall not be used or disclosed to others except for carrying out the purpose of this Agreement. The foregoing obligation of confidentiality shall not apply to any portion of the Confidential Information that a Party ("Receiving Party") can demonstrate by written documentation: (a) was already known to the Receiving Party; (b) was generally available to the public or otherwise part of the public domain at the time of its disclosure; (c) became generally available to the public or otherwise part of the public domain after its disclosure to the Receiving Party, other than through any act or omission of the Receiving Party in breach of this Agreement; **Certain portions of this exhibit have been omitted based upon a request for confidential treatment that has been filed with the Commission. The omitted portions have been filed separately with the Commission. 33 (d) was subsequently lawfully disclosed to the Receiving Party by a third party; or (e) the Receiving Party was compelled to disclose by governmental administrative agency or judicial requirements; provided however, that any disclosure under this subsection 15.1(e) shall neither relieve the Receiving Party from attempting to impose confidentiality obligations on the governmental administrative agency or judicial body, to the extent feasible, nor shall it relieve the Receiving Party from maintaining the confidentiality of the Confidential Information with respect to third parties other than the agency or body as to which such compelled disclosure has been made. 15.2 Protection of Confidential Information. The Parties shall take all reasonable steps to eliminate the risk of disclosure of Confidential Information, including, without limitation, ensuring that only employees, agents, consultants, and representatives with a need to know the Confidential Information have access thereto. The Parties acknowledge by the signing of this Agreement that such employees, agents, and representatives are to be bound by substantially similar obligations of confidentiality as are established under this Article 15. 15.3 Presumptive Confidentiality of Information Exchanged. All information exchanged by the Parties under the terms and conditions of this Agreement shall be considered Confidential Information and treated as such unless otherwise specified and agreed upon by the Parties. 15.4 Use for Development Purposes and Following Termination For Breach. During the term of this Agreement or in the event that this Agreement is terminated for breach under the terms of Article 14, nothing herein shall be construed so as to preclude a party (during the Agreement term) or the non-breaching Party (after termination) from disclosing to a competent regulatory authority or to a third party, under appropriate confidentiality provisions, any, Know-How, Improvements or other Confidential Information, that it may deem necessary or advisable in order to support the further development or commercialization of Compounds or Licensed Products. Article 16. Representations, Warranties and Covenants 16.1 General Representations. Each Party hereby represents and warrants to the other as follows: (a) Duly Organized. It is a corporation duly organized, validly existing and in good standing under the laws of the jurisdiction of its incorporation, is qualified to do business and is in good standing as a foreign corporation in each jurisdiction in which the conduct of its business or **Certain portions of this exhibit have been omitted based upon a request for confidential treatment that has been filed with the Commission. The omitted portions have been filed separately with the Commission. 34 the ownership of its properties requires such qualification and has all requisite power and authority, corporate or otherwise, to conduct its business as now being conducted, to own, lease and operate its properties and to execute, deliver and perform this Agreement; (b) Due Execution. The execution, delivery and performance by it of this Agreement have been duly authorized by all necessary corporate action and do not and will not (i) require any consent or approval of its stockholders, (ii) violate any provision of any law, rule, regulation, order, writ, judgment, injunction, decree, determination or award presently in effect having applicability to it or any provision of its charter or by-laws, or (iii) result in a breach of or constitute a default under any agreement, mortgage, lease, license, permit, patent or other instrument or obligation to which it is a Party or by which it or its assets may be bound or affected; (c) No Third Party Approval. No authorization, consent, approval, license, exemption of, or filing or registration with, any court or governmental authority or regulatory body is required for the due execution, delivery or performance by it of this Agreement; (d) Binding Agreement. This Agreement is a legal, valid and binding obligation of such Party, enforceable against it in accordance with its terms and conditions, except as may be limited by bankruptcy laws or other laws affecting the rights of creditors generally, and rules of law governing equitable remedies. Each is not under any obligation to any person, contractual or otherwise, that is conflicting or inconsistent in any respect with the terms of this Agreement or that would impede the diligent and complete fulfillment of its obligations hereunder; (e) Inventions. It will take all steps reasonably necessary to ensure that its employees, agents, consultants and representatives convey to it all rights in and to any and all Improvements, trademark rights or any other proprietary rights that may be conceived or reduced to practice by said employees, agents, consultants and representatives; (f) Debarment. It is not debarred or suspended from receiving contracts from the United States or German government or other governmental authority or agency; (g) Full Disclosure. It has disclosed in good faith any and all material information related to the subject matter hereof and to the performance of its obligations hereunder. 16.2 Cephalon Representations, Warranties and Covenants. Cephalon hereby represents, warrants and covenants to Schwarz Pharma that, as of the Effective Date: (a) Cephalon is the sole owner of the entire right, title and interest in and to those Patent **Certain portions of this exhibit have been omitted based upon a request for confidential treatment that has been filed with the Commission. The omitted portions have been filed separately with the Commission. 35 Rights which include a Valid Claim for Compounds and the same are free of any liens, encumbrances, restrictions, licenses and other legal or equitable claims of any kind or nature; (b) Cephalon is the sole licensee of the entire right, title and interest in the part of the Kyowa Technology, which is sublicensed to Schwarz Pharma under this Agreement and the same are free of any liens, encumbrances, restrictions, licenses and other legal or equitable claims of any kind or nature; (c) It has the right to grant to Schwarz Pharma the licenses provided for in this Agreement; (d) To the best of its knowledge and belief, there are no third Party rights, licenses or patents, other than those granted to Schwarz Pharma hereunder, which are necessary for Schwarz Pharma's use and enjoyment of the licenses granted to Schwarz Pharma; (e) Cephalon has not received any notices from any third party alleging that Licensed Products or Compounds infringe or would infringe any third party rights within the Territory. To the best of Cephalon's knowledge, the manufacture, use and sale of Licensed Product in the Territory will not infringe any such third party rights; (f) If Schwarz Pharma has exercised its option to a Backup Compound, and provided Schwarz Pharma is not in breach of the terms of this Agreement, for the term of this Agreement, Cephalon shall not [**]. If Schwarz Pharma does not exercise its option to the Backup Compounds under Section 3.4 herein, and provided Schwarz Pharma is not in breach of the terms of this Agreement, for a period of [**], Cephalon shall [**], Cephalon shall [**]; (g) For so long as Schwarz Pharma is undertaking the Development Program or commercializing a Licensed Product, Cephalon shall [**]; and, (h) It shall use its Reasonable Business Efforts to: (i) Conduct outside of the Territory at least one Pivotal Trial with the Lead Compound (or CEP-751 or CEP-2563 if such Compounds are under development by Schwarz Pharma in the Territory) in either hormone-dependent or hormone-independent prostate cancer, the design and execution of which shall be coordinated with Schwarz Pharma such that the results of such Pivotal Trials may be used to support marketing approval of an EMEA regulatory approval under the Development Program;. (ii) Not conduct or allow to be conducted any development activities outside the **Certain portions of this exhibit have been omitted based upon a request for confidential treatment that has been filed with the Commission. The omitted portions have been filed separately with the Commission. 36 Territory which in its reasonable business judgment would jeopardize regulatory approval of Licensed Products worldwide; (iii) Install electronic encryption and other confidentiality requirements to preserve the integrity of Schwarz Pharma's proprietary data; and (iv) Amend the TAP Agreement to include the representations set forth in 16.2(h)(i), (ii) and (iii), above, and to provide to Schwarz Pharma, no later than the Effective Date of this Agreement, a copy of such amendment. 16.3 Schwarz Pharma Representations and Covenants. Schwarz Pharma hereby represents and covenants to Cephalon that: (a) Schwarz Pharma is acknowledged by the authorities in parts of the Territory as an approved manufacturer and marketer of drugs, and is as such under the inspection of the competent authorities; (b) During the term of this Agreement, it will not [**]. (c) It shall use its Reasonable Business Efforts in the Territory to conduct at least one Pivotal Trial with the Lead Compound (or CEP-751 or CEP- 2563 if such Compounds are under development by Schwarz Pharma in the Territory) in either hormone-dependent or hormone-independent prostate cancer, the design and execution of which shall be coordinated with Cephalon and TAP such that the results of such Pivotal Trials may be used to support marketing approval of an NDA under the US Program. 16.4 Warranty Disclaimers. Nothing in this Agreement shall be construed as: (a) a warranty or representation by Cephalon as to the validity or scope of the Cephalon Technology, other than as specifically provided to the contrary herein; (b) a warranty or representation that anything made, used, sold or otherwise disposed of under this Agreement is or will be free from infringement of patents, copyrights and trademarks of third Parties; (c) an obligation to bring or prosecute actions or suits against third parties for infringement, except as set forth in Section 13.1; **Certain portions of this exhibit have been omitted based upon a request for confidential treatment that has been filed with the Commission. The omitted portions have been filed separately with the Commission. 37 (d) except as otherwise provided herein, conferring rights to use in advertising, publicity or otherwise any trademark or the name of Cephalon or Schwarz Pharma; (e) any representation by either Party, express or implied, other than as specifically set forth herein, including representations of merchantability or fitness for a particular purpose, or that the use, manufacture, sale or distribution of Licensed Products will not infringe upon any third party patent, copyright, trademark or other rights. Article 17. Indemnification 17.1 Schwarz Pharma Indemnitees. Cephalon shall indemnify and hold Schwarz Pharma, its parent companies, Affiliates and subsidiaries, and the officers, directors and employees of each of them (the "Schwarz Pharma Indemnitees") harmless from any and all liability, loss, damages, costs or expenses (including reasonable attorneys' fees) stemming from third party claims or actions (or the threat thereof) that are based upon (i) the breach of any material covenant, representation or warranty of Cephalon contained in this Agreement; (ii) the manufacture by Cephalon (or any Affiliate, assignee, subcontractor or sublicensee thereof) of any Compounds or Licensed Products; and (iii) the costs incurred by Schwarz Pharma in the successful enforcement of its rights under this Section 17.1. Notwithstanding anything to the contrary herein, Cephalon shall have no obligation to so indemnify the Schwarz Pharma Indemnitees to the extent that such losses, liabilities, obligations, claims, fees or expenses are based upon the conduct of the Schwarz Pharma Indemnitees. 17.2 Cephalon Indemnitees. Schwarz Pharma shall indemnify and hold Cephalon, its parent companies, Affiliates and subsidiaries, and the officers, directors and employees of each of them (the "Cephalon Indemnitees") harmless from any and all liability, loss, damages, costs or expenses (including reasonable attorneys' fees) stemming from third party claims or actions (or the threat thereof) that are based upon (i) the breach of any material covenant, representation or warranty of Schwarz Pharma contained in this Agreement; (ii) the manufacture, use, marketing, promotion, sale or distribution by Schwarz Pharma (or any Affiliate, assignee, subcontractor or sublicensee thereof) of any Compounds or Licensed Products; (iii) the use by any person of any Licensed Products that were manufactured, marketed, sold or distributed by Schwarz Pharma (or any Affiliate, assignee, subcontractor or sublicensee thereof), including without limitation, any claim that said use resulted in personal injury or death; and (iv) the costs incurred by Cephalon in the successful enforcement of its rights under this Section 17.2. Notwithstanding anything to the contrary herein, Schwarz Pharma shall have no obligation to so indemnify the Cephalon Indemnitees to the extent that such losses, liabilities, obligations, claims, fees or expenses are **Certain portions of this exhibit have been omitted based upon a request for confidential treatment that has been filed with the Commission. The omitted portions have been filed separately with the Commission. 38 based upon the conduct of the Cephalon Indemnitees. 17.3 Indemnification Procedures. In the event that one Party receives notice of a claim, lawsuit, or liability for which it is entitled to indemnification by the other Party, the Party receiving notice shall give prompt notification to the indemnifying Party. The Party being indemnified shall cooperate fully with the indemnifying Party throughout the pendency of the claim, lawsuit or liability, and the indemnifying Party shall have complete control over the conduct and disposition of the claim, lawsuit, or liability, except that indemnifying Party shall have no obligation to provide indemnity with respect to any amounts paid in settlement of any claims if such settlement is effected without the prior written consent of the indemnifying Party. Article 18. General. 18.1 Headings. The headings and captions used herein are for the convenience of the Parties only and are not to be construed to define, limit, or affect the construction or interpretation thereof. 18.2 Severability. The provisions of this Agreement are separate and divisible, and the invalidity or unenforceability of any part shall not affect the validity or enforceability of any remaining part or parts, all of which shall remain in full force and effect. However, the Parties agree to substitute, any invalid or unenforceable provision, by a valid and enforceable provision which maintains, to the greatest extent possible, the respective interests of the Parties otherwise established hereunder. 18.3 Entire Agreement. This Agreement contains the entire agreement of the Parties regarding the subject matter hereof and supersedes all prior agreements, understandings or conditions (whether oral or written) regarding the same. This Agreement may not be changed, modified, amended or supplemented except by a written instrument signed by both Parties. 18.4 Assignability and Sublicenses. Except as otherwise provided herein, this Agreement shall not be assignable, sublicensable or transferable, either in whole or in part, by either Party without the prior written consent of the other, except to an Affiliate or in connection with a merger, consolidation or sale of all or substantially all of the line of business to which this Agreement relates. In any event, no such assignment, sublicense or transfer shall relieve any Party of responsibility for the performance of any accrued obligation which such Party has then hereunder. 18.5 Publications. The Parties to this Agreement are free to make presentations and **Certain portions of this exhibit have been omitted based upon a request for confidential treatment that has been filed with the Commission. The omitted portions have been filed separately with the Commission. 39 publications relating to the results of any activities conducted pursuant to this Agreement prior to marketing of Cephalon Licensed Product or Kyowa Licensed Product, but with due regard to the protection of Confidential Information and proprietary rights and always provided that the other Party has approved the scientific content of any such presentation or publication. For that purpose, the Parties agree to provide the other with a copy of any proposed written presentation, abstract and/or publication relating to the results of such activities at least thirty (30) days prior to submission thereof for publication or presentation thereof. Each Party will take due note of any comment by the other Party and shall respect the response of the other Party. The parties agree, whenever possible, to mutually develop and adhere to a single uniform publication policy. In the event that a Party notifies the other Party that it intends to file patent applications on any of the subject matter of the presentation or publication, the Party publishing such publication or presentation shall delay such publication or presentation for a reasonable period as requested by the notifying party and not to exceed ninety (90) days to allow the notifying Party to file such applications. 18.6 Public Announcements. Each Party agrees that, except as may be required by law, it shall not disclose the existence, substance or details of this Agreement without the prior written consent of the other Party. In cases in which disclosure is proposed or required by law, the disclosing Party, prior to such disclosure, will notify the non-disclosing Party of the contents of the proposed disclosure, provided however, that subsequent disclosure(s) of the same or substantially similar contents shall not require further consent. The non- disclosing Party shall have the right to make reasonable changes to the disclosure to protect its interests. The disclosing Party shall not unreasonably refuse to include such changes in its disclosure. The parties will agree upon the text of a joint announcement of this Agreement and, once agreed, the information contained in that announcement may be used by either party in subsequent announcements. 18.7 Further Assurances. Each Party hereto agrees to execute, acknowledge and deliver such further instruments, and to take such other actions, as may be necessary to appropriate in order to carry out the purposes and intent of this Agreement. 18.8 Notices and Reports. All notices, consents or approvals required by this Agreement shall be in writing and sent by courier or by certified or registered air mail, postage prepaid or by facsimile or courier (confirmed by such certified or registered mail) to the Parties at the following addresses or such other addresses as may be designated in writing the respective Parties. Notices shall be deemed effective on the date of mailing. If to Cephalon: **Certain portions of this exhibit have been omitted based upon a request for confidential treatment that has been filed with the Commission. The omitted portions have been filed separately with the Commission. 40 Senior Vice President & General Counsel Cephalon, Inc. 145 Brandywine Parkway West Chester, PA 19380-4245 USA Telephone: (610) 738-6337 Facsimile (610) 738-6590 If to Schwarz Pharma: Schwarz Pharma AG Alfred-Nobel-Str. 10 Monheim am Rhein D-40789 Germany Telephone: (02173) 48.13.69 Telefax: (02173) 48.10.64 Attn: Head of Legal Affairs 18.9 Waiver. The waiver by either Party of a breach of any provisions contained herein shall be effective only if made in writing and shall in no way be construed as a waiver of any succeeding breach of such provision or the waiver of the provision itself. 18.10 Dispute Resolution. Any dispute concerning or arising out of this Agreement or concerning the existence or validity hereof, shall be determined by the following procedure. (a) Both Parties understand and appreciate that their long term mutual interest will be best served by affecting a rapid and fair resolution of any claims or disputes which may arise out of services performed under this contract or from any dispute concerning the terms of this Agreement. Therefore, both Parties agree to use their best efforts to resolve all such disputes as rapidly as possible on a fair and equitable basis. Toward this end both Parties agree to develop and follow a process for presenting, rapidly assessing, and settling claims on a fair and equitable basis which takes into account the precise subject and nature of the dispute. (b) If any dispute or claim arising under this Agreement cannot be readily resolved by the Parties pursuant to the process described above, the Parties agree to refer the matter to a panel consisting of the Chief Executive Officer ("CEO") of each Party for review and resolution. A copy of the terms of this Agreement, agreed upon facts (and areas of disagreement), and concise summary of the basis for the contentions of each Party will be provided to both such CEOs who shall review the same, confer, and attempt to reach a mutual resolution of the issue. **Certain portions of this exhibit have been omitted based upon a request for confidential treatment that has been filed with the Commission. The omitted portions have been filed separately with the Commission. 41 (c) Any dispute controversy or claim arising out of or relating to the validity, construction, enforceability or performance of this Agreement, including disputes relating to an alleged breach or to termination of this Agreement and including any claim of inducement by fraud or otherwise, but excluding any dispute, controversy or claim arising out of or relating to the validity, enforceability, or infringement of any Patent Rights , which cannot be resolved by good faith negotiation between the parties as set forth in paragraph 18.10(b), above, shall be resolved by arbitration conducted in the English language in New York, New York before a panel of three arbitrators under the then current rules and procedures of the International Chamber of Commerce, or other rules and procedures as the parties may agree. The prevailing party in any such proceeding shall be entitled to an award of its reasonable attorneys' fees and other costs, including the fees and expenses of the arbitrators, provided that the same may be apportioned between the parties by the arbitrators if they determine that each party has prevailed in part. The arbitral award shall be binding and conclusive on both parties and may be enforced in any court of competent jurisdiction. Notwithstanding the foregoing, either party may, on good cause shown, seek a temporary restraining order and/or a preliminary injunction from a court of competent jurisdiction, to be effective pending the institution of the arbitration process and the deliberation and award of the arbitration panel (d) This Agreement shall be governed by and construed in accordance with the substantive laws of the State of New York and of the United States of America, without regard to the conflicts of laws provision thereof. Judgment upon any award rendered in such event may be entered in any court having jurisdiction and the Parties hereby consent to the said jurisdiction and venue, and further irrevocably waive any objection which either Party may have now or hereafter to the laying of venue of any proceedings in said courts and to any claim that such proceedings have been brought in an inconvenient forum, and further irrevocably agrees that a judgment or order in any such proceedings shall be conclusive and binding upon the Parties and may be enforced in the courts of any other jurisdiction thereof. 18.11 Force Majeure. A Party shall not be liable for nonperformance or delay in performance (other than of obligations regarding any payments or of confidentiality) caused by any event reasonably beyond the control of such Party including, without limitation, wars, hostilities, revolutions, riots, civil disturbances, national emergencies, strikes, lockouts, unavailability of supplies, epidemics, fires, floods, earthquakes, other forces of nature, explosions, embargoes, or any other Acts of God, or any laws, proclamations, regulations, ordinances, or other acts or orders of any court, government or governmental agency. Any occurrence of Force Majeure shall be reported promptly to the other Party. **Certain portions of this exhibit have been omitted based upon a request for confidential treatment that has been filed with the Commission. The omitted portions have been filed separately with the Commission. 42 IN WITNESS THEREOF, the Parties have executed this Agreement by their duly authorized representatives, as of the day and year first above written. SCHWARZ PHARMA AG CEPHALON, INC. By:__________________________ By:__________________________ Patrick Schwarz-Schutte Peter E. Grebow,Ph.D. Chairman of the Executive Board Senior Vice President Worldwide Business Development By:__________________________ Lars Ekman, M.D., Ph.D. Member of the Executive Board Research & Development **Certain portions of this exhibit have been omitted based upon a request for confidential treatment that has been filed with the Commission. The omitted portions have been filed separately with the Commission. 43 EX-21 4 SUBSIDIARIES OF CEPHALON, INC. EXHIBIT 21 SUBSIDIARIES OF CEPHALON, INC.
Place of NAME Incorporation ---- ------------- Cephalon Development Corporation................................ Delaware Cephalon International Holdings, Inc............................ Delaware Cephalon Investments, Inc....................................... Delaware Cephalon Technology, Inc........................................ Delaware Cephalon (U.K.) Limited......................................... England and Wales
EX-23.1 5 CONSENT OF ARTHUR ANDERSON LLP EXHIBIT 23 CONSENT OF INDEPENDENT PUBLIC ACCOUTANTS As independent public accountants, we hereby consent to the incorporation of our report included in this Form 10-K, into the Company's previously filed Registration Statement File No. 33-43716, No. 33-71920, No. 33-74320, No. 333-02888, No. 333-20321, No. 333-69591, No. 333-89909, No. 333-75281, No. 333-87421 and No. 333-88985. ARTHUR ANDERSEN LLP Philadelphia, Pennsylvania March 29, 2000 EX-27 6 FINANCIAL DATA SCHEDULE
5 THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM CEPHALON, INC.'S FORM 10-K FOR THE YEAR ENDED DECEMBER 31, 1999 AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS. 0000873364 CEPHALON, INC. 12-MOS DEC-31-1999 JAN-01-1999 DEC-31-1999 13,152,000 188,410,000 5,578,000 0 4,258,000 212,386,000 35,193,000 15,192,000 234,053,000 57,455,000 14,034,000 0 25,000 326,000 158,006,000 234,053,000 25,370,000 44,919,000 3,250,000 3,250,000 46,420,000 0 8,253,000 (58,757,000) 0 (58,757,000) 0 (11,187,000) 0 (73,342,000) (2.48) (2.48)
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