10-Q 1 d10q.txt FORM 10-Q ================================================================================ SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-Q |X| Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 For the Quarterly Period Ended March 31, 2001 -------------- | | Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 For the Transition Period from to -------------- --------------- Commission File Number 0-19119 CEPHALON, INC. ------------------------------------------------------ (Exact Name of Registrant as Specified in its Charter) Delaware 23-2484489 --------------------------------------------- ------------------------ (State Other Jurisdiction of Incorporation or (I.R.S. Employer Organization) Identification Number) 145 Brandywine Parkway, West Chester, PA 19380-4245 --------------------------------------------- ------------------------ (Address of Principal Executive Offices) (Zip Code) Registrant's Telephone Number, Including Area Code (610) 344-0200 -------------- Not Applicable --------------------------------------------------- Former Name, Former Address and Former Fiscal Year, If Changed Since Last Report Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes X No ----- ------- Applicable only to corporate issuers: Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date. Class Outstanding as of May 7, 2001 ---------------------------- ----------------------------- Common Stock, par value $.01 49,562,313 Shares This Report Includes a Total of 23 Pages CEPHALON, INC. AND SUBSIDIARIES ------------------------------- INDEX ----- Page No. -------- PART I - FINANCIAL INFORMATION Item 1. Consolidated Financial Statements (Unaudited) Consolidated Balance Sheets - 3 March 31, 2001 and December 31, 2000 Consolidated Statements of Operations - 4 Three months ended March 31, 2001 and 2000 Consolidated Statements of Cash Flows - 5 Three months ended March 31, 2001 and 2000 Notes to Consolidated Financial Statements 6 Item 2. Management's Discussion and Analysis of 10 Financial Condition and Results of Operations Item 3. Quantitative and Qualitative Disclosure about Market Risk 21 PART II - OTHER INFORMATION Item 1. Legal Proceedings 22 Item 6. Exhibits and Reports on Form 8-K 22 SIGNATURES 23 2 CEPHALON, INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS --------------------------- (Unaudited)
March 31, December 31, 2001 2000 ------------- ------------- ASSETS ------ CURRENT ASSETS: Cash and cash equivalents ............................................... $ 56,180,000 $ 36,571,000 Investments ............................................................. 37,946,000 60,813,000 Receivables, net ........................................................ 23,058,000 21,905,000 Inventory (Note 2) ...................................................... 26,731,000 20,161,000 Other ................................................................... 3,183,000 1,579,000 ------------- ------------- Total current assets ............................................... 147,098,000 141,029,000 PROPERTY AND EQUIPMENT, net of accumulated depreciation and amortization of $19,507,000 and $18,905,000 ............... 30,776,000 29,730,000 INTANGIBLE ASSETS, net of accumulated amortization of $4,540,000 and $1,679,000 (Note 3) ......................... 132,933,000 135,794,000 OTHER ........................................................................ 1,894,000 1,882,000 ------------- ------------- $ 312,701,000 $ 308,435,000 ============= ============= LIABILITIES AND STOCKHOLDERS' EQUITY ------------------------------------ CURRENT LIABILITIES: Accounts payable ........................................................ $ 3,829,000 $ 3,590,000 Accrued expenses ........................................................ 29,966,000 32,758,000 Current portion of deferred revenues .................................... 2,795,000 1,469,000 Current portion of long-term debt (Note 4) .............................. 43,722,000 42,950,000 ------------- ------------- Total current liabilities .......................................... 80,312,000 80,767,000 DEFERRED REVENUES ............................................................ 8,062,000 7,151,000 LONG-TERM DEBT (Note 4) ..................................................... 55,029,000 55,138,000 OTHER ........................................................................ 170,000 186,000 ------------- ------------- Total liabilities .................................................. 143,573,000 143,242,000 ------------- ------------- COMMITMENTS AND CONTINGENCIES (Note 6) STOCKHOLDERS' EQUITY: Preferred stock, $.01 par value, 5,000,000 shares authorized, 2,500,000 shares issued and outstanding, liquidation preference of $126,133,000 at March 31, 2001 ........................... 25,000 25,000 Common stock, $.01 par value, 100,000,000 shares authorized, 43,124,178 and 42,478,225 shares issued and outstanding ................. 431,000 425,000 Additional paid-in capital ............................................... 697,846,000 683,004,000 Treasury stock, 138,183 shares outstanding ............................... (4,119,000) (4,119,000) Accumulated deficit ...................................................... (527,351,000) (515,543,000) Accumulated other comprehensive income ................................... 2,296,000 1,401,000 ------------- ------------- Total stockholders' equity ......................................... 169,128,000 165,193,000 ------------- ------------- $ 312,701,000 $ 308,435,000 ============= =============
3 CEPHALON, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS ------------------------------------- (Unaudited) Three Months Ended March 31, ---------------------------- 2001 2000 ------------ ------------ REVENUES: Product sales .................................................. $ 40,822,000 $ 16,211,000 Other revenues ................................................. 6,250,000 3,444,000 ------------ ------------ 47,072,000 19,655,000 ------------ ------------ COSTS AND EXPENSES: Cost of product sales .......................................... 8,298,000 2,068,000 Research and development ....................................... 19,269,000 14,581,000 Depreciation and amortization .................................. 3,489,000 503,000 Selling, general and administrative ............................ 24,707,000 17,656,000 ------------ ------------ 55,763,000 34,808,000 ------------ ------------ LOSS FROM OPERATIONS ................................................ (8,691,000) (15,153,000) ------------ ------------ OTHER: Income ......................................................... 1,507,000 4,039,000 Expense ........................................................ (2,358,000) (1,246,000) ------------ ------------ (851,000) 2,793,000 ------------ ------------ LOSS BEFORE DIVIDENDS ON PREFERRED STOCK AND CUMULATIVE EFFECT OF A CHANGE IN ACCOUNTING PRINCIPLE ............... (9,542,000) (12,360,000) Dividends on convertible exchangeable preferred stock ............... (2,266,000) (2,266,000) ------------ ------------ LOSS BEFORE CUMULATIVE EFFECT OF A CHANGE IN ACCOUNTING PRINCIPLE ............................................. (11,808,000) (14,626,000) Cumulative effect of adopting Staff Accounting Bulletin 101 (SAB 101) -- (7,434,000) ------------ ------------ LOSS APPLICABLE TO COMMON SHARES .................................... $(11,808,000) $(22,060,000) ============ ============ BASIC AND DILUTED LOSS PER COMMON SHARE: Loss per common share before cumulative effect of adopting SAB 101 $ (0.28) $ (0.37) Cumulative effect of adopting SAB 101 ............................. -- (0.19) ------------ ------------ $ (0.28) $ (0.56) ============ ============ WEIGHTED AVERAGE NUMBER OF COMMON SHARES OUTSTANDING ...................................... 42,732,000 39,141,000 ============ ============
4 CEPHALON, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS ------------------------------------- (Unaudited)
Three Months Ended March 31, ---------------------------- 2001 2000 ------------ ------------ CASH FLOWS FROM OPERATING ACTIVITIES: Loss ......................................................... $ (9,542,000) $(19,794,000) Adjustments to reconcile loss to net cash used for operating activities: Cumulative effect of adoption of SAB 101 ............... -- 7,434,000 Depreciation and amortization .......................... 3,489,000 503,000 Non-cash interest expense .............................. 1,073,000 -- Non-cash compensation expense .......................... 1,711,000 1,499,000 Other .................................................. (10,000) (500,000) (Increase) decrease in operating assets: Receivables ........................................ (1,915,000) 1,388,000 Inventory .......................................... (6,570,000) (7,489,000) Other current assets ............................... (1,604,000) (2,327,000) Other long-term assets ............................. (12,000) 14,000 Increase (decrease) in operating liabilities: Accounts payable ................................... 239,000 (3,051,000) Accrued expenses ................................... (2,792,000) (4,096,000) Deferred revenues .................................. 2,237,000 (404,000) Other long-term liabilities ........................ (16,000) -- ------------ ------------ Net cash used for operating activities ............. (13,712,000) (26,823,000) ------------ ------------ CASH FLOWS FROM INVESTING ACTIVITIES: Purchases of property and equipment .......................... (1,389,000) (906,000) Acquistion of intangible assets .............................. -- (5,000,000) Sales and maturities (purchases) of investments, net ......... 22,972,000 70,032,000 ------------ ------------ Net cash provided by investing activities .......... 21,583,000 64,126,000 ------------ ------------ CASH FLOWS FROM FINANCING ACTIVITIES: Proceeds from exercises of common stock options and warrants . 13,883,000 11,835,000 Payments to acquire treasury stock ........................... -- (34,000) Preferred dividends paid ..................................... (2,266,000) (2,266,000) Principal payments on and retirements of long-term debt ...... (669,000) (30,480,000) ------------ ------------ Net cash provided by (used for) financing activities 10,948,000 (20,945,000) ------------ ------------ EFFECT OF EXCHANGE RATE CHANGES ON CASH AND CASH EQUIVALENTS ...... 790,000 142,000 ------------ ------------ NET INCREASE IN CASH AND CASH EQUIVALENTS ......................... 19,609,000 16,500,000 CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD .................... 36,571,000 24,898,000 ------------ ------------ CASH AND CASH EQUIVALENTS, END OF PERIOD .......................... $ 56,180,000 $ 41,398,000 ============ ============ Supplemental disclosure of non-cash investing activities: Capital lease additions ........................................ $ 259,000 $ --
5 1. NATURE OF BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES Business Cephalon, Inc. is an international biopharmaceutical company focused on the discovery, development and marketing of products to treat sleep disorders, neurological disorders, cancer and pain. In addition to an active research and development program, we market three products in the United States and eight products in various countries in Europe. In the United States, we maintain our corporate and research and development headquarters and market three products: PROVIGIL(R) (modafinil) Tablets [C-IV] for treating excessive daytime sleepiness associated with narcolepsy, ACTIQ(R) (oral transmucosal fentanyl citrate) [C-II] for the management of breakthrough cancer pain in opioid tolerant patients and GABITRIL(R) (tiagabine hydrochloride) for the treatment of partial seizures associated with epilepsy. We market these products through our two specialty sales forces: the first, numbering approximately 130 representatives, details PROVIGIL and GABITRIL to neurologists, psychiatrists and sleep specialists; the second, numbering approximately 50 representatives, details ACTIQ to oncologists and pain specialists. In the United Kingdom, we market PROVIGIL and five other products, including TEGRETOL(R) (carbamazepine), a treatment for epilepsy and RITALIN(R) (methylphenidate), a treatment for attention deficit hyperactivity disorder (ADHD). We also market other products in France, Germany, Austria and Switzerland. In support of our European sales and marketing efforts, we have established a European sales and marketing organization comprised of approximately 30 persons. Basis of Presentation The accompanying unaudited consolidated financial statements have been prepared in accordance with generally accepted accounting principles for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnote disclosures required by generally accepted accounting principles for complete financial statements. In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation have been included. These financial statements should be read in conjunction with the consolidated financial statements and notes thereto included in our annual report on Form 10-K, filed with the Securities and Exchange Commission, which includes financial statements as of December 31, 2000 and 1999 and for each of the three years in the period ended December 31, 2000. The results of our operations for any interim period are not necessarily indicative of the results of our operations for any other interim period or for a full year. Merger On October 10, 2000, we completed a merger with Anesta Corp. under which we acquired all of the outstanding shares of Anesta in a tax-free, stock-for-stock transaction. Under the terms of the merger agreement, each stockholder of Anesta received 0.4765 shares of our common stock for each share of Anesta common stock. The merger has been accounted for as a pooling-of-interests and, accordingly, all of our prior period consolidated financial statements have been restated to include the results of operations, financial position, and cash flows of Anesta. Information concerning common stock, employee stock plans, and per share data has been restated on an equivalent share basis. There were no material adjustments required to conform the accounting policies of the two companies. Certain amounts of Anesta have been reclassified to conform to our reporting practices. 6 SAB 101 During 2000, we adopted the SEC's Staff Accounting Bulletin No. 101 (SAB 101) on revenue recognition for use in recording revenues from collaborative research and development agreements and similar sources of other revenue. Results for the first quarter of 2000 have been restated to give effect for the implementation of SAB 101 in the fourth quarter of 2000 retroactively to January 1, 2000. The impact of the change resulted in an increase in total revenues and a corresponding decrease in loss before cumulative effect of a change in accounting principle of $29,000 for the quarter ended March 31, 2000 as compared to amounts previously reported. 2. INVENTORY Inventory is stated at the lower of cost or market value using the first-in, first-out method: March 31, December 31, 2001 2000 ----------- ----------- Raw material ....................... $13,762,000 $ 6,401,000 Work-in-process .................... 4,840,000 5,325,000 Finished goods ..................... 8,129,000 8,435,000 ----------- ----------- $26,731,000 $20,161,000 =========== =========== 3. INTANGIBLE ASSETS Intangible assets consisted of the following: March 31, December 31, 2001 2000 ------------- ------------- GABITRIL product rights .............. $ 71,982,000 $ 71,982,000 Novartis CNS product rights .......... 41,641,000 41,641,000 ACTIQ marketing rights ............... 23,850,000 23,850,000 ------------- ------------- 137,473,000 137,473,000 Less amortization .................... (4,540,000) (1,679,000) ------------- ------------- $ 132,933,000 $ 135,794,000 ============= ============= 4. LONG-TERM DEBT Long-term debt consisted of the following: March 31, December 31, 2001 2000 ------------ ------------ Capital lease obligations .................. $ 2,213,000 $ 2,342,000 Mortgage and building improvement loans .... 14,618,000 14,900,000 Abbott/Novartis obligations ................ 81,920,000 80,846,000 ------------ ------------ Total debt ................................. 98,751,000 98,088,000 Less current portion ....................... (43,722,000) (42,950,000) ------------ ------------ Total long-term debt ....................... $ 55,029,000 $ 55,138,000 ============ ============ 7 5. LEGAL PROCEEDINGS In August 1999, the U.S. District Court for the Eastern District of Pennsylvania entered a final order approving the settlement of a class action alleging that statements made about the results of certain clinical studies of MYOTROPHIN(R) (mecasermin) Injection were misleading. A related complaint has been filed with the Court by a small number of plaintiffs who decided not to participate in the settlement. This related complaint alleges that we are liable under common law for misrepresentations concerning the results of the MYOTROPHIN clinical trials, and that we and certain of our current and former officers and directors are liable for the actions of persons who allegedly traded in our common stock on the basis of material inside information. We believe that we have valid defenses to all claims raised in this action. Moreover, even if there is a judgment against us in this case, we do not believe it will have a material negative effect on our financial condition or results of operations. Due to our past involvement in promoting STADOL NS(R) (butorphanol tartrate) Nasal Spray, a product of Bristol-Myers Squibb Company, we are co-defendants in several product liability actions brought against Bristol-Myers. Although we cannot predict with certainty the outcome of this litigation, we believe that any expenses or damages that we may incur will be paid by Bristol-Myers under the indemnification provisions of our co-promotion agreement. As such, we do not believe that these actions will have a material negative effect on our financial condition or results of operations. In February 2001, a complaint was filed in Utah state court by Zars, Inc. and one of its research scientists, against us and our subsidiary Anesta Corp. The plaintiffs are seeking a declaratory judgment to establish their right to develop transdermal or other products containing fentanyl and other pharmaceutically active agents under a royalty and release agreement between Zars and Anesta. The complaint also asks for unspecified damages for breach of contract and interference with economic relations. We have filed a motion to dismiss this complaint that is currently pending before the court. We believe that we have valid defenses to all claims raised in this action. In any event, we do not believe any judgment against us will have a material negative effect on our financial condition or results of operations. 6. 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 Cephalon Clinical Partners, L.P., or CCP. Development and clinical testing of MYOTROPHIN is performed 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. 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, shares of common stock with a value of $42,369,000 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. 8 7. REVENUES Revenues consisted of the following: Three months ended March 31, 2001 2000 ----------- ----------- Product sales: PROVIGIL .......................... $27,024,000 $13,463,000 ACTIQ ............................. 6,582,000 908,000 GABITRIL .......................... 7,216,000 1,840,000 ----------- ----------- Total product sales .................. 40,822,000 16,211,000 Other revenues ....................... 6,250,000 3,444,000 ----------- ----------- Total revenues ....................... $47,072,000 $19,655,000 =========== =========== 8. OTHER COMPREHENSIVE INCOME Statement of Financial Accounting Standards No. 130, "Reporting Comprehensive Income," requires presentation of the components of comprehensive income (loss). Our comprehensive loss includes net loss, unrealized gains and losses from foreign currency translation adjustments, and unrealized investment gains and losses. Our total comprehensive loss is as follows: Three months ended March 31, 2001 2000 ------------ ------------ Loss applicable to common shares ............. $(11,808,000) $(22,060,000) Other comprehensive income (loss): Foreign currency translation adjustment .... 790,000 142,000 Unrealized investment gains (losses) ....... 105,000 (692,000) ------------ ------------ Other comprehensive loss ..................... $(10,913,000) $(22,610,000) ============ ============ 9. SUBSEQUENT EVENTS In May 2001, we completed a private placement of $300,000,000 of 5.25% convertible subordinated notes due 2006. In connection with this private placement, we granted the initial purchasers a 45-day option to purchase an additional $100,000,000 in aggregate principal amount of notes. Interest on the notes is payable each May 1 and November 1, beginning November 1, 2001. The notes are convertible into our common stock at a conversion price of $74.00 per share, subject to adjustment in certain circumstances. We may redeem the notes on or after May 5, 2003. Prior to that date, we may redeem the notes if our common stock price exceeds 150% of the conversion price for a specified period of time. Upon early redemption, we are required to pay interest which would have been due up through May 5, 2003. In May 2001, the holders of 2,344,586 shares of the 2,500,000 shares outstanding of our convertible exchangeable preferred stock converted their preferred shares into an aggregate of 6,541,752 shares of our common stock, in accordance with the terms of the preferred stock. As an inducement to the holders to convert their preferred stock prior to August 2001, when we are initially permitted to redeem the preferred stock, we agreed to pay immediately all dividends accrued through the date of conversion as well as all dividends that would have accrued through the August 2001 redemption date in the aggregate amount of $4,390,000, which will result in a charge of $3,257,000 in the second quarter of 2001. As of May 11, 2001, 155,414 shares of preferred stock remained outstanding. 9 ITEM 2. 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 identified by the use of words in the statements such as "anticipate," "estimate," except," project," "intend," "plan," "believe" or other words and terms of similar meaning. Our performance and financial results could differ materially from those reflected in these forward-looking statements due to general financial, economic, regulatory and political conditions affecting the biotechnology and pharmaceutical industries as well as more specific risks and uncertainties such as those set forth below and in our reports to the SEC on Forms 8-K and 10-K. Given these risks and uncertainties, any or all of these forward-looking statements may prove to be incorrect. Therefore, you should not rely on any such forward-looking statements. Furthermore, we do not intend (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 upon the commercial success of our products, especially PROVIGIL, and we may not be able to consistently and meaningfully increase sales of these products during this period, or to attain profitability on the basis of such sales. The commercialization of our pharmaceutical products involves a number of significant challenges. In particular, our ability to meaningfully increase sales depends, in large part, on the success of our clinical development programs, and our sales and marketing efforts to physicians, patients and third- party payors. A number of factors could impact these efforts, including our ability to demonstrate clinically that our products have utility beyond current indications, our limited financial resources and sales and marketing experience relative to our competitors, perceived differences between our products and those of our competitors, the availability and level of reimbursement of our products by third-party payors, incidents of adverse reactions, side effects or misuse of our products and the unfavorable publicity that could result, or the occurrence of manufacturing, supply or distribution disruptions. Ultimately, our efforts may not prove to be as effective as the efforts of our competitors. In the United States and elsewhere, our products face significant competition in the marketplace. The conditions that our products treat, and some of the other disorders for which we are conducting additional studies, are currently treated with several drugs, many of which have been available for a number of years or are available in inexpensive generic forms. Thus, we will need to demonstrate to physicians, patients and third party payors that the cost of our products is reasonable and appropriate in the light of their safety and efficacy, the price of competing products and the related health care benefits to the patient. Even if we are able to increase sales over the next several years, we cannot be sure that such sales and other revenue will reach a level at which we will attain profitability. We may be unsuccessful in our efforts to expand the number and scope of authorized uses of PROVIGIL, which would hamper sales growth and make it more difficult to attain profitability. PROVIGIL is approved for sale in the United States and abroad for use by those suffering from excessive daytime sleepiness associated with narcolepsy. Under current FDA regulations, we are limited in our ability to promote the use of PROVIGIL outside of this approved indication. The market for the 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 50,000 seek 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, additional studies in these disorders will be necessary before we can apply to expand the authorized uses of PROVIGIL. We do not know whether these studies will demonstrate safety and efficacy, or if they do, whether we will succeed in receiving regulatory approval to market PROVIGIL 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, limit the commercial success of the product and diminish the acceptance of PROVIGIL in the narcolepsy market. Even if the results of these studies are positive, the 10 impact on sales of PROVIGIL may be minimal 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 our products are used commercially, unintended side effects, adverse reactions or incidents of misuse may occur which could result in additional regulatory controls, and reduce sales of our products. Prior to 1999, the use of our products had been limited principally to clinical trial patients under controlled conditions and under the care of expert physicians. We cannot predict whether the widespread commercial use of our products will produce undesirable or unintended side effects that have not been evident in our clinical trials or the relatively limited commercial use to date. In addition, in patients who take multiple medications, drug interactions could occur which can be difficult to predict. Additionally, incidents of product misuse may occur. These events, among others, could result in additional regulatory controls that could limit the circumstances under which the product is prescribed or even lead to the withdrawal of the product from the market. More specifically, ACTIQ has been approved under regulations concerning drugs with certain safety profiles, under which the FDA has established special restrictions to ensure safe use. Any violation of these special restrictions could lead to the imposition of further restrictions or withdrawal of the product from the market. We may not be able to maintain adequate patent protection or market exclusivity for our products and therefore potential competitors may develop competing products, which could result in a decrease in sales and market share, cause us to reduce prices to compete successfully, and limit our commercial success. We place considerable importance on obtaining patent protection for new technologies, products and processes. To that end, we file applications for patents covering the composition of matter or uses of our drug candidates or our proprietary processes. We could incur substantial costs in asserting our patent rights, including those licensed to us by third parties, and in defending patent infringement suits against us or our employees relating to ownership of, or rights to, patents and other intellectual property of third parties. Such disputes could substantially delay our drug development or commercialization. The Patent 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 could be forced to either seek a license to intellectual property rights of others, which may not be available to us on acceptable terms, if at all, or alter our products or processes so that they no longer infringe on the proprietary rights of others. 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. PROVIGIL We hold exclusive license rights to a composition-of-matter patent covering modafinil, 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 2001. In addition, we own a U.S. patent covering the particle size of modafinil that was 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 challenged by a third party. Additionally, we cannot be sure that a potential competitor will not develop a competing product or product formulation that would avoid infringement of these patents or any patent owned or licensed by us. 11 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 same compound for other indications that otherwise are non-exclusive, or approval of other compounds for the same indication. ACTIQ We hold exclusive worldwide licenses to U.S. and foreign patents covering this product that are held by the University of Utah and its assignee, the UURF. Specifically, we have U.S. patents covering the currently approved formulation, methods for administering fentanyl via this formulation and a method of producing the approved product. These patents are currently set to expire in 2005. Corresponding patents in foreign countries are set to expire between 2009 and 2010. Other issued patents and pending patent applications in the U.S. and foreign countries that are owned or licensed by us are directed to various processes of manufacturing the product as well as to a child-resistant disposal container required by the FDA to be provided as part of the product. We cannot guarantee that any of these patents will be held to be valid if challenged by a third party. In any event, we cannot be sure that a potential competitor will not develop a competing product or product formulation that would avoid infringement of these patents or any patent owned or licensed by us. In the United States, ACTIQ is considered a new formulation of fentanyl by the FDA, and accordingly, has been granted a three-year period of marketing exclusivity under FDA regulations, which expires in 2001. This marketing exclusivity runs concurrently with the patent protection described above and should also prevent other sponsors from obtaining approval of the same formulation for the same indication unless the sponsor obtains such approval on the basis of a full NDA. GABITRIL The issued U.S. composition-of-matter patent claiming tiagabine, the active drug substance in GABITRIL, is exclusively sublicensed to us and is currently set to expire in 2008. An extension of this patent in the United States under the terms of the U.S. Drug Price Competition and Patent Term Restoration Act of 1984, as amended, to extend the term of this patent until 2011 is being sought. We cannot be certain that this patent extension will be obtained or that we will be able to take advantage of any other patent benefits of the patent restoration act. In addition, this product is covered by another issued U. S. patent directed to crystalline tiagabine hydrochloride monohydrate and its use as an anti-epileptic agent, which is currently set to expire in 2012. We cannot guarantee that any of these patents will be held to be valid if challenged by a third party. In any event, we cannot be sure that a potential competitor will not develop a competing product or product formulation that would avoid infringement of these patents or any patent owned or licensed by us. Manufacturing, supply and distribution problems may create supply disruptions that could result in a reduction of product sales revenue, and damage commercial prospects for PROVIGIL, ACTIQ, GABITRIL and other products. We must comply with all applicable regulatory requirements of the FDA and foreign authorities, including current Good Manufacturing Practice, or cGMP, regulations. In addition, we must comply with all applicable regulatory requirements of the DEA, and foreign authorities for PROVIGIL (Schedule IV controlled substance) and ACTIQ (Schedule II controlled substance). 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 and controlled substance regulations are complex, and any failure to comply with them could lead to remedial action, civil and criminal penalties and delays in production of material. Except for the in-house manufacture of ACTIQ for international markets, we rely on third parties to manufacture our products. Abbott is required to supply us with ACTIQ for the United States for up to 36 months from March 2000. After that date, we will have to make other arrangements for supply, which could include the manufacture of ACTIQ 12 in-house for the United States, or establishing supply arrangements with third parties. We also rely on third parties to distribute, provide customer service activities and accept and process returns. In addition, we depend upon sole suppliers for active drug substances contained in our products, and we depend upon single manufacturers that are qualified to manufacture finished commercial products. 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. We maintain inventories of active drug substances and finished products to protect against supply disruptions, and are qualifying an additional manufacturer of finished product for PROVIGIL. Nevertheless, any disruption in these activities could impede our ability to sell our products and could reduce sales revenue. 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 our new formulation, 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. The efforts of government entities and third party payors to contain or reduce the costs of health care may adversely affect our sales and limit the commercial success of our products. In certain foreign markets, pricing or profitability of pharmaceutical products is subject to various forms of direct and indirect governmental control. In the United States, there have been, and we expect there will continue to be, various federal and state proposals to implement similar government controls. The commercial success of our products could be limited if federal or state governments adopt any such proposals. In addition, in the United States 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. Third party payors could focus their cost control efforts on our products, thereby limiting the commercial success of the products. We experience intense competition in our fields of interest, which may adversely affect our business. Large and small companies, academic institutions, governmental agencies, and other public and private research organizations conduct research, seek patent protection, and establish collaborative arrangements for product development in competition with us. Products developed by any of these entities may compete directly with those we develop or sell. Competing products may provide greater therapeutic benefits for a specific indication, or may offer comparable performance at a lower cost. Many of these companies and institutions have substantially greater capital resources, research and development staffs and facilities than we have, and substantially greater experience in conducting clinical trials, obtaining regulatory approvals and manufacturing and marketing pharmaceutical products. These entities represent significant competition for us. In addition, competitors who are developing products for the treatment of neurological or oncological disorders might succeed in developing technologies and products that are more effective than any that we develop or sell or that would render our technology and products obsolete or noncompetitive. Competition and innovation from these or other sources potentially could negatively affect sales of our products or make them obsolete. Advances in current treatment methods also may adversely affect the market for such products. In addition, we may be at a competitive marketing disadvantage against companies that have broader product lines and whose sales personnel are able to offer more complementary products than we can. Our products contain controlled substances. The active ingredients in PROVIGIL and ACTIQ are controlled substances regulated by the U.S. Drug Enforcement Administration, or DEA. As controlled substances, the manufacture, shipment, sale and use of these products is subject to a high degree of regulation and accountability. These regulations also are imposed on prescribing physicians and other third parties, making the use of such products relatively complicated and expensive. Future products also may contain substances regulated by the DEA. In some cases, products containing controlled substances have generated public controversy which, in extreme cases, have resulted in further restrictions on marketing or even withdrawal of regulatory approval. In addition, negative publicity may bring about rejection of the product by the medical community. If the DEA or FDA withdrew the approval of, or placed additional significant restrictions on, the marketing of any of our products, our business could be materially and adversely affected. 13 We face significant product liability risks, which may have a negative effect on our financial performance. The administration of drugs to humans, whether in clinical trials or commercially, can result in product liability claims whether or not the drugs are actually at fault for causing an injury. Furthermore, our products may cause, or may appear to have caused, serious adverse side effects (including death) or potentially dangerous drug interactions that we may not learn about or understand fully until the drug has been administered to patients for some time. As our products are used more widely and in patients with varying medical conditions, the likelihood of an adverse drug reaction may increase. Product liability claims can be expensive to defend and may result in large judgments or settlements against us, which could have a negative effect on our financial performance. We maintain product liability insurance in amounts we believe to be commercially reasonable, but claims could exceed our coverage limits. 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. The results and timing of our research and development activities, including future clinical trials are difficult to predict, subject to future setbacks and, ultimately, may not result in any additional pharmaceutical products, which may adversely affect our business. We are focused on the search for new pharmaceutical products. These activities include engaging in discovery research and process development, conducting preclinical and clinical studies, and seeking regulatory approval in the United States and abroad. In all of these areas, we have relatively limited resources and compete against larger multinational pharmaceutical companies. Moreover, even if we undertake these activities in an effective and efficient manner, regulatory approval for the sale of new pharmaceutical products remains highly uncertain since, in our industry, the majority of compounds discovered do not enter clinical studies and the majority of therapeutic candidates fail to show the human safety and efficacy necessary for regulatory approval and successful commercialization. Preclinical testing and clinical trials must demonstrate that a product candidate is safe and efficacious. The results from preclinical testing and early clinical trials may not be predictive of results obtained in subsequent clinical trials, and we cannot be sure that these clinical trials will demonstrate the safety and efficacy necessary to obtain regulatory approval for any product candidates. A number of companies in the biotechnology and pharmaceutical industries have suffered significant setbacks in advanced clinical trials, even after obtaining promising results in earlier trials. In addition, certain clinical trials are conducted with patients having the most advanced stages of disease. During the course of treatment, these patients often die or suffer other adverse medical effects for reasons that may not be related to the pharmaceutical agent being tested. Such events can have a negative impact on the statistical analysis of clinical trial results. The completion of clinical trials of our product candidates may be delayed by many factors. Once 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 or at all. 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 and marketing efforts are often dependent on corporate collaborators and other third parties who may not devote sufficient time, resources and attention to our programs, which may limit our efforts to successfully develop and market potential products. Because we have limited resources, we have entered into a number of collaboration agreements with other pharmaceutical companies. These agreements call for our partner to control the supply of bulk or formulated drugs 14 for commercial use or for use in clinical trials; design and execution of clinical studies; process of obtaining regulatory approval to market the product; and/or marketing and selling of any approved product. In each of these areas, our partners may not support fully our research and commercial interests since our program may compete for time, attention and resources with the internal programs of our corporate collaborators. As such, 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 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. We also rely on several of these collaborators and other third parties for the production of compounds and the manufacture and supply of pharmaceutical products. Additionally, we may find it necessary from time to time to seek new or additional partners to assist us in commercializing our products. It is uncertain whether we would be successful in establishing any such new or additional relationships. Our product sales and related financial results will fluctuate and these fluctuations may cause our stock price to fall, especially if they are not anticipated by investors. A number of analysts and investors who follow our stock have developed models to attempt to forecast future product sales and have established earnings expectations based upon those models. Forecasting revenue growth 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 also may adversely affect our stock price. Other factors which cause our financial results to fluctuate unexpectedly include the cost of product sales, achievement and timing of research and development milestones, co-promotion and other collaboration revenues, cost and timing of clinical trials, marketing and other expenses and manufacturing or supply disruption. We may incur additional losses. To date, we have not been profitable and our accumulated deficit was approximately $527 million at March 31, 2001. 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. While we seek to attain profitability, we cannot be sure that we will ever achieve product and other revenue sufficient for us to attain this objective. We cannot be sure that we will obtain required regulatory approvals, or successfully develop, commercialize, manufacture and market any other product candidates. The price of our common stock has been and may continue to be highly volatile. The market price of our common stock is volatile, and we expect it to continue to be volatile for the foreseeable future. For example, during the period January 1, 2000 through May 7, 2001, our common stock traded at a high price of $83.625 and a low price of $29.875. Negative announcements (such as adverse regulatory decisions, disappointing clinical trial results, disputes concerning patent or other proprietary rights, or operating results that fall below the market's expectations) could trigger significant declines in the price of our common stock. In addition, external events, such as news concerning our competitors, changes in government regulations that may impact the biotechnology or pharmaceutical industries or the movement of capital into or out of our industry, also are likely to affect the price of our common stock. 15 We are involved in legal proceedings that, if adversely adjudicated or settled, could materially impact our financial condition. 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. Even if there is a judgment against us in this case, we do not believe it will have a material negative effect on our financial condition or results of operations. Due to our past involvement in promoting STADOL NS(R) (butorphanol tartrate) Nasal Spray, a product of Bristol-Myers Squibb Company, we are co-defendants in several product liability actions brought against Bristol-Myers. Although we cannot predict with certainty the outcome of this litigation, we believe that any expenses or damages that we may incur will be paid by Bristol-Myers under the indemnification provisions of our co-promotion agreement. As such, we do not believe that these actions will have a material negative effect on our financial condition or results of operations. In February 2001, a complaint was filed in Utah state court by Zars, Inc. and one of its research scientists, against us and our subsidiary Anesta Corp. The plaintiffs are seeking a declaratory judgment to establish their right to develop transdermal or other products containing fentanyl and other pharmaceutically active agents under a royalty and release agreement between Zars and Anesta. The complaint also asks for unspecified damages for breach of contract and interference with economic relations. We have filed a motion to dismiss this complaint that is currently pending before the court. We believe that we have valid defenses to all claims raised in this action. In any event, we do not believe any judgment against us will have a material negative effect on our financial condition or results of operations. 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. We do not believe that the conditions for regulatory approval of MYOTROPHIN imposed by the FDA can be met without conducting an additional Phase 3 study, and we have no plans to conduct such a study at this time. However, we have had discussions with certain physicians who are seeking to obtain governmental and non-governmental funding to be used to conduct such a study. If this funding is obtained and the study is undertaken, we may allow reference to our Investigational New Drug Application (IND), and supply MYOTROPHIN in quantities sufficient to conduct the study in exchange for the rights to use any clinical data generated by such study in support of FDA approval of our pending New Drug Application (NDA). Even if an additional study is undertaken, the results will not be available for several years and may not be sufficient to obtain regulatory approval to market the product. If MYOTROPHIN is not approved for the treatment of Amyotrophic Lateral Sclerosis, or ALS, then it is unlikely 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 Cephalon Clinical Partners, L.P., or CCP. Our dependence on key executives and scientists could impact the development and management of our business. We are highly dependent upon our ability to attract and retain qualified scientific, technical and managerial personnel. There is intense competition for qualified personnel in the pharmaceutical and biotechnology industries, and we cannot be sure that we will be able to continue to attract and retain the qualified personnel necessary for the development and management of our business. 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. 16 We may be required to incur significant costs to comply with environmental laws and regulations and our compliance may limit any future profitability. Our research and development activities involve the controlled use of hazardous, infectious and radioactive materials that could be hazardous to human health, safety or the environment. We store these materials and various wastes resulting from their use at our facility pending ultimate use and disposal. We are subject to a variety of federal, state and local laws and regulations governing the use, generation, manufacture, storage, handling and disposal of these materials and wastes, and we may be required to incur significant costs to comply with both existing and future environmental laws and regulations. We believe that our safety procedures for handling and disposing of these materials comply with 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, which could adversely affect our financial condition or results of operations. 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 General Corporation Law, which prohibits us from engaging in a "business combination" with an "interested stockholder" for a period of three years after the date of the transaction in which the person becomes an interested stockholder, unless the business combination is approved in a prescribed manner. The application of Section 203 could have the effect of delaying or preventing a change of control of Cephalon. We also have adopted a "poison pill" rights plan that will dilute the stock ownership of an acquirer of our stock upon the occurrence of certain events. Section 203, the rights plan, and the provisions of our certificate of incorporation, our bylaws and Delaware corporate law, may have the effect of deterring hostile takeovers or delaying or preventing changes in control of our management, including transactions in which stockholders might otherwise receive a premium for their shares over then current market prices. RESULTS OF OPERATIONS Three months ended March 31, 2001 compared to three months ended March 31, 2000 Revenues--Total revenues increased 139% to $47,072,000 in the first quarter of 2001 as compared to $19,655,000 in the first quarter of 2000. This increase was primarily due to a $24,611,000, or 152%, increase in product sales, of which $13,561,000 was attributed to a PROVIGIL sales increase, $5,674,000 was attributed to an ACTIQ sales increase, and $5,376,000 was attributed to a GABITRIL sales increase. In addition, other revenues increased by $2,806,000, or 81%, due primarily to $2,325,000 of revenues recognized in the current period under our collaboration with Novartis Pharma AG. Cost of Product Sales--The cost of product sales in the first quarter of 2001 increased to 20% of net product sales from 13% in the first quarter of 2000 due primarily to PROVIGIL. A significant portion of the PROVIGIL sold in the United States during the first quarter of 2000 was produced prior to its December 1998 FDA approval and the costs of producing that material were recorded as research and development expense at the time the material was produced. Research and Development Expenses--For the quarter ended March 31, 2001, research and development expenses increased 32% to $19,269,000 from $14,581,000 in the first quarter of 2000. This change primarily resulted from an increase in expenditures associated with clinical development studies of PROVIGIL in areas other than 17 narcolepsy and clinical development studies of GABITRIL, and an increase in drug development and manufacturing costs for our compounds that have progressed into later stages of development. Depreciation and Amortization Expenses--The increase in depreciation and amortization expenses from $503,000 in the first quarter of 2000 to $3,489,000 in the first quarter of 2001 is due primarily to amortization expense of $2,861,000 for intangibles acquired during 2000 relating to contracts with Novartis and Abbott. Selling, General and Administrative Expenses--Selling, general and administrative expenses increased 40% to $24,707,000 for the quarter ended March 31, 2001 from $17,656,000 for the first quarter of 2000 primarily due to an increase in selling and marketing expenses associated with the promotion and support of our three major products: PROVIGIL, ACTIQ and GABITRIL. Other Income and Expense, Net--Other income and expense, net, decreased by $3,644,000 from the first quarter of 2000 to the first quarter of 2001 due to a decrease in interest income resulting from a lower level of cash and investments during the first quarter of 2001 as compared to the first quarter of 2000, offset by a decrease in interest expense associated with the revenue sharing notes that were repaid in the first quarter of 2000. In addition, the foreign currency exchange loss we recognized in the first quarter of 2001 increased as compared to the first quarter of 2000 due to a decline in currency exchange value of the pound Sterling (GBP) relative to both the U.S. dollar and to our other foreign operations' currencies that are remeasured into the GBP for financial reporting purposes. Cumulative Effect of a Change in Accounting Principle--We adopted the U.S. Securities and Exchange Commission's Staff Accounting Bulletin No. 101 (SAB 101) on Revenue Recognition and, as a result, we recorded a charge of $7,434,000 in the fourth quarter of 2000 to defer upfront license fees associated with our collaborative alliances that were previously recognized in revenues. Under guidance from SAB 101, results for the first quarter of 2000 have been restated to give effect for the implementation of SAB 101 retroactively to January 1, 2000. LIQUIDITY AND CAPITAL RESOURCES Cash, cash equivalents and investments at March 31, 2001 were $94,126,000, representing 30% of total assets, and at December 31, 2000 were $97,384,000, representing 32% of total assets. Net Cash Used for Operating Activities Net cash used for operating activities decreased to $13,712,000 in the first quarter of 2001 as compared to $26,823,000 in the first quarter of 2000, a decrease of $13,111,000. The decrease in the net cash used for operating activities is due primarily to the following: o An increase in product sales of $24,611,000, including $13,561,000 from PROVIGIL product sales, $5,674,000 from ACTIQ product sales, and $5,376,000 from GABITRIL product sales. o An increase in selling, general and administrative expenses of $7,051,000 due principally to marketing expenses associated with ACTIQ and an increase in the size of our sales force to fully support our three major products: PROVIGIL, ACTIQ and GABITRIL. o An increase in research and development expenses of $4,688,000 resulting primarily from an increase in expenditures associated with clinical development studies of PROVIGIL in areas other than narcolepsy and clinical development studies of GABITRIL, and an increase in drug development and manufacturing costs for our compounds that have progressed into later stages of development. 18 Net Cash Provided by Investing Activities A summary of net cash provided by investing activities is as follows: Three months ended March 31, 2001 2000 ------------ ------------ Purchases of property and equipment .......... $ (1,389,000) $ (906,000) Acquisition of intangible assets ............. -- (5,000,000) Sales and maturities of investments, net ..... 22,792,000 70,032,000 ------------ ------------ Net cash provided by investing activities .... $ 21,583,000 $ 64,126,000 ============ ============ --Purchases of property and equipment The increase in purchases of property and equipment in 2001 is primarily the result of the ongoing expansion and renovation of our Salt Lake City facility. --Acquisition of intangible assets The acquisition of intangible assets in the three months ended March 31, 2000 represents a payment made in connection with our agreement with Abbott Laboratories to reacquire the marketing rights to ACTIQ. Net Cash Provided by (Used for) Financing Activities A summary of net cash provided by (used for) financing activities is as follows:
Three months ended March 31, 2001 2000 ------------ ------------ Proceeds from exercises of common stock options and warrants $ 13,883,000 $ 11,835,000 Payments to acquire treasury stock ......................... -- (34,000) Preferred dividends paid ................................... (2,266,000) (2,266,000) Principal payments on and retirement of long-term debt ..... (669,000) (30,480,000) ------------ ------------ Net cash provided by (used for) financing activities ....... $ 10,948,000 $(20,945,000) ============ ============
--Proceeds from exercises of common stock options and warrants During the three months ended March 31, 2001, we received proceeds of $13,883,000 from the exercise of approximately 643,000 common stock options. At March 31, 2001, warrants to purchase 265,800 shares of our common stock at an exercise price of $10.08 per share and options to purchase approximately 4,525,000 shares of our common stock at various exercise prices were outstanding. The extent and timing of future warrant and option exercises, if any, are primarily dependent upon the market price of our common stock and general financial market conditions, as well as the exercise prices and expiration dates of the warrants and options. --Payments to acquire treasury stock Under the Equity Compensation Plan, we may grant restricted stock awards to employees. Upon vesting, shares of Cephalon common stock are withheld from the employee's stock award and returned to the treasury for the corresponding dollar value of payroll-related taxes. 19 --Principal payments on long-term debt In the first quarter of 2000, we retired $30,000,000 of revenue sharing notes issued in a private placement in 1999. In addition, for all periods presented, principal payments on long-term debt include payments on mortgage and building improvements loans and payments on capital lease obligations. Commitments and Contingencies --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. Development and clinical testing of MYOTROPHIN is performed 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. 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, shares of common stock with a value of $42,369,000 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 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. Even if there is a judgment against us in this case, we do not believe it will have a material negative effect on our financial condition or results of operations. Due to our past involvement in promoting STADOL NS/R/ (butorphanol tartrate) Nasal Spray, a product of Bristol-Myers Squibb Company, we are co-defendants in several product liability actions brought against Bristol-Myers. Although we cannot predict with certainty the outcome of this litigation, we believe that any expenses or damages that we may incur will be paid by Bristol-Myers under the indemnification provisions of our co-promotion agreement. As such, we do not believe that these actions will have a material negative effect on our financial condition or results of operations. In February 2001, a complaint was filed in Utah state court by Zars, Inc. and one of its research scientists, against us and our subsidiary Anesta Corp. The plaintiffs are seeking a declaratory judgment to establish their right to develop transdermal or other products containing fentanyl and other pharmaceutically active agents under a royalty and release agreement between Zars and Anesta. The complaint also asks for unspecified damages for breach of contract and interference with economic relations. We have filed a motion to dismiss this complaint that is currently pending before the court. We believe that we have valid defenses to all claims raised in this action. In any event, we do not believe any judgment against us will have a material negative effect on our financial condition or results of operations. Outlook Cash, cash equivalents and investments at March 31, 2001 were $94,126,000. Since inception, we have had negative cash flows from operations and have used the proceeds of public and private placements of our securities to fund operations. We currently believe that projected increases in sales of our three marketed products, PROVIGIL, ACTIQ and GABITRIL, in combination with other revenues, will allow us to achieve profitability in 2001. If our expectations for product sales in 2001 are not realized, it may be difficult or impossible to achieve profitability. At this time, we cannot accurately predict the effect of certain developments on product sales such as the degree of market acceptance of our products, competition, the effectiveness of our sales and marketing efforts and our ability to demonstrate the utility of our products in indications beyond those already included in the FDA approved labels. Other revenues include receipts from collaborative research and development agreements and co-promotion agreements. The continuation of any of these agreements is subject to the achievement of certain milestones and to periodic review by the parties involved. We expect to continue to incur significant expenditures associated with PROVIGIL, ACTIQ and GABITRIL. These expenditures include the costs associated with manufacturing, selling and marketing our products and costs associated with conducting additional clinical studies to explore the utility of these products in treating disorders beyond those currently approved in their respective labels. We also expect to continue to incur significant expenditures to fund research and development activities for our other products in development. We may seek sources of funding for a portion of these research programs through collaborative arrangements with third parties. However, because we intend to retain a portion of the commercial rights to these programs, we still expect to spend significant funds on our share of the cost of these programs. We pay dividends on our convertible exchangeable preferred stock. In May 2001, the holders of 2,344,586 shares of the 2,500,000 shares outstanding of our convertible exchangeable preferred stock converted their preferred shares 20 into an aggregate of 6,541,752 shares of our common stock, in accordance with the terms of the preferred stock. As an inducement to the holders to convert their preferred stock prior to August 2001, when we are initially permitted to redeem the preferred stock, we agreed to pay immediately all dividends accrued through the date of conversion as well as all dividends that would have accrued through the August 2001 redemption date in the aggregate amount of $4,390,000, which will result in a charge of $3,257,000 in the second quarter of 2001. As of May 11, 2001, 155,414 shares of preferred stock remained outstanding. Pending any use of the net proceeds, the funds have bee invested in accordance with our investment guidelines and interest income earned will be used to offset, to the extent possible the interest payments on the notes. In May 2001, we completed a private placement of $300,000,000 of 5.25% convertible subordinated notes due 2006. In connection with this private placement, we granted the initial purchasers a 45-day option to purchase an additional $100,000,000 in aggregate principal amount of notes. Interest on the notes is payable each May 1 and November 1, beginning November 1, 2001. The annual interest payments on the notes will be $15,750,000 ($21,000,000 if the initial purchasers' option is exercised in full). We expect to use the net proceeds of the offering for working capital and general corporate purposes, which may include the acquisition of businesses, products, product rights or technologies. Additionally, we may also use the net proceeds to pay contractual obligations including those incurred in connection with the Abbott and Novartis transactions. Pending any use of the net proceeds, the funds have been invested in accordance with our investment guidelines and interest income earned will be used to offset, to the extent possible, the interest payments on the notes. Based on our current level of operations and projected sales of our products combined with other revenues, we believe that we will be able to meet our anticipated debt service, capital expenditure and working capital requirements for the next several years. However, we cannot be sure that our anticipated revenue growth will be realized or that we will generate positive cash flow from operations. We may need to obtain additional funding for our operational needs, or for future significant strategic transactions, and we cannot be certain that funding will be available on terms acceptable to us, or at all. ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK There have been no material changes in quantitative and qualitative market risk from the disclosure included in the Annual Report on Form 10-K for the fiscal year ended December 31, 2000. 21 PART II - OTHER INFORMATION Item 1. Legal Proceedings The information set forth in Footnote 5 to the Notes to Consolidated Financial Statements included herein is hereby incorporated by reference. Item 6. Exhibits and Reports on Form 8-K (a) Exhibits: Exhibit No. 21 Subsidiaries of Cephalon, Inc. (b) Reports on Form 8-K: No reports on Form 8-K were filed during the quarter ended March 31, 2001. 22 SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. CEPHALON, INC. (Registrant) May 14, 2001 By /s/ Frank Baldino, Jr. ------------------------------------ Frank Baldino, Jr., Ph.D. Chairman and Chief Executive Officer (Principal executive officer) By /s/ J. Kevin Buchi ------------------------------------ J. Kevin Buchi Senior Vice President and Chief Financial Officer (Principal financial and accounting officer) 23