-----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, OeA5q1CYf3krJ9jC4uEcue/wCh5eNmY9ZbHTVda4VUDrmoHA3rrjy5yAe9DZhAwm YpTPfkoIEE5vyrJ/9Oz/FQ== 0001036050-99-000414.txt : 19990305 0001036050-99-000414.hdr.sgml : 19990305 ACCESSION NUMBER: 0001036050-99-000414 CONFORMED SUBMISSION TYPE: 10-K405 PUBLIC DOCUMENT COUNT: 15 CONFORMED PERIOD OF REPORT: 19981231 FILED AS OF DATE: 19990304 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: 99557201 BUSINESS ADDRESS: STREET 1: 145 BRANDYWINE PKWY CITY: WEST CHESTER STATE: PA ZIP: 19380 BUSINESS PHONE: 2153440200 MAIL ADDRESS: STREET 1: 145 BRANDYWINE PARKWAY CITY: WEST CHESTER STATE: PA ZIP: 19380 10-K405 1 FORM 10-K405 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, 1998 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, 19380 WEST CHESTER, PENNSYLVANIA (Zip Code) (Address of principal executive offices) Registrant's telephone number, including area code: (610) 344-0200 Securities registered pursuant to Section 12(b) of the Act: Name of each exchange Title of each class 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 $201,828,095. Such aggregate market value was computed by reference to the closing price of the Common Stock as reported on the Nasdaq National Market on February 19, 1999. For purposes of making this calculation only, the registrant has defined affiliates as including all directors 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 February 19, 1999 was 28,820,542. DOCUMENTS INCORPORATED BY REFERENCE Portions of the registrant's definitive proxy statement for its 1999 annual meeting of stockholders are incorporated by reference into Part III. TABLE OF CONTENTS -----------------
PART I ITEM 1. Business................................................................................. 3 ITEM 2. Properties............................................................................... 21 ITEM 3. Legal Proceedings........................................................................ 21 ITEM 4. Submission of Matters to a Vote of Security Holders...................................... 21 PART II ITEM 5. Market for Registrant's Common Equity and Related Stockholder Matters.................... 22 ITEM 6. Selected Consolidated Financial Data..................................................... 23 ITEM 7. Management's Discussion and Analysis of Financial Condition and Results of Operations.... 24 ITEM 7A. Quantitative and Qualitative Disclosure About Market Risk................................ 37 ITEM 8. Financial Statements and Supplementary Data.............................................. 38 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......................................................................................... 62
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 the Company's current expectations or forecasts of future events. These may include statements regarding anticipated scientific progress in the Company's research programs, development of potential pharmaceutical products, prospects for regulatory approval, manufacturing capabilities, market prospects for the Company's 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. The Company's 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 discussed throughout this document. Given these risks and uncertainties, any or all of these forward-looking statements may prove to be incorrect. See "Management's Discussion and Analysis of Financial Condition and Results of Operations--Certain Risks Related to Cephalon's Business." Cephalon, Inc., headquartered in West Chester, PA, is an international biopharmaceutical company dedicated to the discovery, development and marketing of products to treat neurological disorders and cancer. Cephalon, Inc., together with its subsidiaries, is referred to herein as "Cephalon" or the "Company." In December 1998, the Company received approval from the U.S. Food and Drug Administration ("FDA") to market PROVIGIL(R) (modafinil) Tablets [C-IV] ("PROVIGIL Tablets" or "PROVIGIL"), its first approved product in the United States. PROVIGIL has been approved for treating excessive daytime sleepiness associated with narcolepsy. Sales of PROVIGIL were initiated in the U.S. in February 1999 by the Company's U.S. sales organization. Cephalon began marketing PROVIGIL in the United Kingdom in March 1998 and the Republic of Ireland in February 1999 through its United Kingdom-based sales organization. Additionally, Cephalon has rights to commercialize PROVIGIL in Austria, Italy, Mexico and Switzerland, and applications seeking marketing approval have been filed or are being prepared in these countries. The Company also has rights to PROVIGIL in Japan. The Company is highly dependent on the commercial success of PROVIGIL in the United States. See "Management's Discussion and Analysis of Financial Condition and Results of Operations--Certain Risks Related to Cephalon's Business." In February 1997, the Company and Chiron Corporation submitted a new drug application to the FDA for approval to market MYOTROPHIN(R) (mecasermin) Injection ("MYOTROPHIN Injection" or "MYOTROPHIN") in the United States for the treatment of amyotrophic lateral sclerosis ("ALS"). In May 1998, the FDA issued a letter stating that the new drug application was "potentially approvable," under certain conditions. The Company cannot predict whether these conditions can be met to the satisfaction of the FDA, and the prospects for regulatory approval of MYOTROPHIN continue to be very uncertain in the United States. Because they believed the application would not be approved, in September 1998, Cephalon and Chiron withdrew their joint marketing authorization application for MYOTROPHIN in Europe for the treatment of ALS. The Company has initiated clinical studies exploring the utility of PROVIGIL in treating excessive daytime sleepiness and fatigue associated with disorders other than narcolepsy, such as sleep apnea and multiple sclerosis. The Company has a significant discovery research program that focuses on discovering and developing treatments for neurological disorders such as Parkinson's disease, Alzheimer's disease and stroke, and oncological disorders such as prostate cancer, pancreatic cancer and a variety of other cancers. Cephalon and TAP Holdings Inc. have formed an alliance for the development of signal transduction modulators for the treatment of cancers and prostate disorders in the United States. TAP is conducting Phase I clinical studies of intravenously and orally administered compounds. 3 COMMERCIAL OPERATIONS - --------------------- BACKGROUND Under a 1993 agreement with Laboratoire L. Lafon, a French pharmaceutical company, Cephalon obtained an exclusive license to develop, market and sell PROVIGIL in Italy, Japan, the Republic of Ireland, Mexico, the United Kingdom and the United States. Under a sales and marketing agreement with Merckle GmbH, the Company obtained the exclusive right to market PROVIGIL in Austria and Switzerland. In the United States, the Company conducted preclinical and clinical studies, including two Phase III clinical studies necessary to obtain FDA approval, and filed a new drug application with the FDA in December 1996. In December 1998, the FDA granted clearance to market PROVIGIL for excessive daytime sleepiness associated with narcolepsy. Sales of PROVIGIL commenced in the United States in February 1999 upon the scheduling of modafinil, the active drug substance in PROVIGIL, in Schedule IV of the Controlled Substances Act by the Drug Enforcement Administration. The Company's U.S. sales organization markets PROVIGIL to sleep centers, sleep specialists and neurologists. The Company also has a small department marketing to managed care organizations in the United States. The U.S. sales organization is also engaged in the co- promotion of STADOL NS(R) (butorphanol tartrate), a product of Bristol-Myers Squibb Corporation. Cephalon's United Kingdom-based sales organization commenced sales of PROVIGIL tablets for use in treating narcolepsy in the United Kingdom in 1998 and in the Republic of Ireland in 1999. The Company intends to market PROVIGIL in Austria and Switzerland upon regulatory approval. Additionally, Cephalon has formed alliances with Dompe Biotech S.p.A. and Azwell, Inc. to develop and market PROVIGIL in Italy and Japan, respectively, and is seeking a development and marketing partner in Mexico. Under a sales and marketing agreement with Laboratoire Aguettant S.A., the Company is marketing APOKINON(R) (apomorphine hydrocloride) in France for the treatment of levadopa therapy fluctuations common in late-stage Parkinson's disease. Cephalon relies on third parties for the manufacture, distribution and customer service activities related to marketing PROVIGIL and has established a small commercial management staff to oversee these third parties. See "Manufacturing and Product Supply." 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 30,000-45,000 are believed to currently seek treatment from a physician. The Company believes that there is a proportionate incidence of narcolepsy in the other territories in which it has obtained a license, but the relative extent of diagnosis and treatment in those other countries varies and is not as high as it is in the United States. The Company conducted two Phase III, double-blind, placebo-controlled, nine-week multicenter 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 excess 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. 4 Excessive Daytime Sleepiness associated with disorders other than narcolepsy The Company believes that a significant number of people suffer from excessive daytime sleepiness and fatigue resulting from or associated with other disorders. For example, patients suffering from obstructive sleep apnea may be excessively sleepy because of disruption to their normal sleep cycle, even when the underlying disease is treated. Sleep apnea is the most common diagnosis in sleep centers. Patients suffering from multiple sclerosis and Parkinson's disease, which neurologist treat, may suffer from fatigue and sleepiness caused either by their disease or by the therapeutics currently used to treat it. Focusing on disorders treated by sleep specialists and neurologists would allow the Company to utilize its existing field sales force to market PROVIGIL if it were to obtain regulatory approval for such indications. Consequently, the Company has initiated clinical studies to explore the utility of PROVIGIL in other disorders, including sleep apnea and multiple sclerosis. Laboratoire L. Lafon Under a 1993 agreement with Laboratoire L. Lafon, a French pharmaceutical company, Cephalon obtained an exclusive license to develop, market and sell PROVIGIL in Italy, Japan, the Republic of Ireland, Mexico, the United Kingdom and the United States. Under the terms of the agreement, Lafon supplies bulk modafinil compound, the active drug substance in PROVIGIL, for the Company's commercial use at a purchase price equal to a percentage of net product sales. In addition, the agreement requires that the Company pay trademark and license royalties, which also are based on a percentage of net product sales. Azwell, Inc. In June 1998, the Company entered into an agreement with Nippon Shoji Kaisha Ltd. ("Nippon Shoji"), a Japanese pharmaceutical company, to develop and market PROVIGIL in Japan. Subsequently, Nippon Shoji merged with Showa Pharmaceutical Co., Ltd. to form Azwell Inc. ("Azwell"). Azwell is responsible for funding product development activities, including conducting the clinical trials for narcolepsy required by Japanese regulatory authorities to be included in an application seeking authorization to market PROVIGIL in Japan. The Company will supply PROVIGIL to Azwell for use in Japanese clinical trials. Upon product approval by the Japanese Ministry of Health and Welfare, Azwell will market and sell the product in Japan. The Company will receive a percentage of net product sales as a license royalty and in exchange for supplying bulk compound. The agreement also provides for payments to Cephalon upon the achievement of certain milestones. The agreement with Azwell has an initial ten-year term and the Company may terminate the agreement if (i) Azwell fails to file an investigational new drug application ("IND") by June 2000, or (ii) fails to file a marketing application by end of December 2002. Dompe Biotech S.p.A. In June 1998, Cephalon entered into an agreement with Dompe Biotech S.p.A. ("Dompe"), an Italian pharmaceutical company, in which Cephalon granted Dompe the right to market, sell and distribute PROVIGIL in Italy. The parties will jointly manage regulatory matters and an application for marketing approval of PROVIGIL has been filed with the Italian Ministry of Health. Upon product approval in Italy, Dompe will market and sell PROVIGIL and will be obligated to fund a minimum of promotional activities during the first two years of sales. The Company will 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 December 1998, Cephalon entered into an agreement with Merckle GmbH ("Merckle") under which Cephalon obtained the rights to promote and market PROVIGIL in Austria and Switzerland for the treatment of narcolepsy. Under the agreement, Cephalon is responsible for promoting and marketing the product while Merckle retains responsibility for all other activities. The Company will receive quarterly compensation from Merckle based 5 on sales levels achieved. A marketing application has been approved in Austria and the Company expects to initiate sales activities in Austria in 1999. The ten-year agreement with Merckle automatically renews for successive one-year periods unless terminated by either party upon 180 days notice prior to expiration. OTHER COMMERCIAL COLLABORATIONS Bristol-Myers Squibb Company In July 1994, the Company entered into a co-promotion agreement with Bristol-Myers Squibb Company 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. Cephalon receives compensation from BMS 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 1999, unless further extended by the parties. Medtronic, Inc. In April 1997, the Company entered into an agreement with Medtronic, Inc. to promote and market Intrathecal Baclofen Therapy (ITB(TM)), for the treatment of intractable spasticity, to neurologists and physiatrists in the United States. Quarterly compensation from Medtronic is based primarily on a payment per patient screen basis. This co-promotion agreement will terminate pursuant to it terms as of April 29, 1999. Laboratoire Aguettant S.A. In December 1997, the Company entered into an agreement with Laboratoire Aguettant S.A. to promote and market APOKINON(R) (apomorphine hydrocloride) 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, the Company makes annual payments to Aguettant during the first five years of the agreement. The Company receives 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 prior to expiration. RESEARCH AND DEVELOPMENT - ------------------------ The Company's research and development efforts focus primarily in two areas: neurodegenerative disorders and oncological disorders. Neurodegenerative disorders are characterized by the death of neurons, the specialized conducting cells of the nervous system. Oncological disorders are characterized by the uncontrolled proliferation of cells that form tumors. The Company utilizes its technical expertise in molecular biology, molecular pharmacology, biochemistry, cell biology, tumor biology and chemistry to develop products in both of these areas. The Company's research strategy has focused on understanding the cellular mechanisms of cell survival and cell death. This understanding may allow medicinal chemical approaches toward creating novel, small, orally active, synthetic molecules which would facilitate the death of tumor cells leading to new therapies in oncology or would cross the blood-brain barrier (which prevents the free passage of many molecules between the bloodstream and the central nervous system, "CNS") and enhance the survival of neurons, thereby intervening in the progression of neurodegenerative disorders. Cephalon believes that its multidisciplinary technology approach facilitates the development of a portfolio of potential products for the treatment of neurological disorders which involve neuronal death such as Parkinson's disease, Alzheimer's disease and stroke, and oncological disorders such as prostate cancer, pancreatic cancer and a variety of other cancers. The Company's research programs currently consist of four core technology areas: neurotrophic factors, gene transcription regulators, signal transduction modulators and protease inhibitors. 6 RESEARCH AND DEVELOPMENT PROGRAMS The following table outlines the Company's research and development programs.
- ------------------------------------------------------------------------------------------------------------------ -------------------------------------------------------------------------------------------------------------- COMPOUND INDICATION STATUS (1) COMMERCIAL RIGHTS (3) -------------------------------------------------------------------------------------------------------------- Neurotrophic Factors (MYOTROPHIN).. ALS NDA(2) Cephalon/Chiron/Kyowa Hakko Gene Transcription Regulators...... Alzheimer's Disease Development Cephalon/Leo Signal Transduction Modulators..... Alzheimer's Disease Development Cephalon/Kyowa Hakko Parkinson's Disease Development Cephalon/Kyowa Hakko Prostate and Phase I Cephalon/TAP/Kyowa Hakko pancreatic cancer Solid Tumors Research Cephalon Protease Inhibitors................ Alzheimer's Disease Research Cephalon Stroke Research Cephalon --------------------------------------------------------------------------------------------------------------
(1) "Research" includes the development of assay systems, discovery and evaluation of prototype compounds in vitro and in animals. "Development" includes product formulation, toxicology and additional animal testing of a lead compound. "Phase I" clinical trials involve administration of a product to a limited number of patients to assess safety and determine 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) The FDA stated the NDA was "potentially approvable" under certain conditions. The prospects for regulatory approval in the United States are very uncertain. Cephalon and Chiron have withdrawn the marketing application for MYOTROPHIN in Europe. See "Management's Discussion and Analysis of Financial Condition and Results of Operations--Certain Risks Related to Cephalon's Business." (3) Cephalon has entered into several collaborations under which the parties license technology to/from each other for research and development and marketing of the compounds. For further elaboration of commercial rights, see "Research and Development Collaborations." - -------------------------------------------------------------------------------- 7 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 which affect the survival of different types of neurons. However, neurotrophic factors cannot cross the blood-brain barrier. The Company's development efforts in this area focus on using the neurotrophic factor, MYOTROPHIN, in disorders such as amyotrophic lateral sclerosis 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 ("ALS") is a fatal disorder of the nervous system characterized by the chronic, progressive degeneration of motor neurons. The term "amyotrophic" refers to the loss of lower motor neurons that project from the spinal cord to the muscle, and "lateral sclerosis" refers to the loss of upper motor neurons that project from the brain to motor neurons in the spinal cord. Although both groups of motor neurons are affected in this disease, it is the loss of the spinal (lower) motor neurons that leads to muscle weakness, muscle atrophy and, eventually, to the patient's death. ALS affects approximately 15,000-20,000 people in the United States. The Company believes that there is a proportionate incidence of ALS in the populations of Europe and Japan. The first symptom of ALS is muscle weakness, which progresses to muscle atrophy and loss of muscle function. 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. The Company conducted clinical trials in North America and Europe. In February 1997, the Company and Chiron Corporation submitted a new drug application to the FDA for approval to market MYOTROPHIN in the United States for the treatment of amyotrophic lateral sclerosis. In May 1998, the FDA issued a letter stating that the new drug application was "potentially approvable," under certain conditions. The Company cannot predict whether these conditions can be met to the satisfaction of the FDA and the prospects for regulatory approval of MYOTROPHIN continue to be very uncertain in the United States. Cephalon and Chiron also filed jointly for regulatory approval of MYOTROPHIN in Europe. Because they believed the application would not be approved, in September 1998, Cephalon and Chiron withdrew their joint marketing authorization application for MYOTROPHIN in Europe for the treatment of ALS. A study of MYOTROPHIN in ALS patients is being conducted by Kyowa Hakko in Japan. For a complete discussion, see "Management's Discussion and Analysis of Financial Condition and Results of Operations--Certain Risks Related to Cephalon's Business." Other indications The Company has conducted pilot studies to explore the utility of MYOTROPHIN in indications other than ALS, such as multiple sclerosis and peripheral neuropathies. Any further studies to be conducted by the Company are contingent upon the regulatory outcome of the MYOTROPHIN NDA. GENE TRANSCRIPTION REGULATORS 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 where the neurons as well as their axonal projections lie within the blood brain barrier. The Company is developing proprietary molecules believed to influence gene transcription by binding to a specific receptor found in neurons in the central nervous system. In preclinical studies, these orally active small molecules cross the blood-brain barrier and initiate transcriptional events at the genes responsible for the production of certain neurotrophic factors within the CNS. 8 Alzheimer's Disease Alzheimer's disease is an intractable, chronic, and progressively incapacitating disease characterized by the presence of core neuritic plaques, neurofibrillary tangles and gliosis in the brain which is believed to result in the observed death of several types of neurons. Patients affected 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 four million individuals in the United States, 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. The focus of the Company's gene transcription regulator program is to develop molecules that would enhance the endogenous expression of neurotrophic factors in the CNS and promote neuronal survival in regions of the brain known to be affected by Alzheimer's disease. This program is being conducted in collaboration with Leo Pharmaceutical Products, Ltd. SIGNAL TRANSDUCTION MODULATORS Survival of cells, including neurons, is regulated and influenced by factors that promote cell survival or induce cell death. These factors exert differential effects on the cell (promotion of survival versus induction of death) through activation of intracellular signaling pathways. Once activated, these pathways result in the discrete biochemical events targeted at distinct intracellular kinases (proteins) that regulate molecular pathways of survival or death. The Company's signal transduction modulator program focuses on identifying small molecules that modulate these signal transduction events. Neurology In neurodegenerative disease, activation of death-promoting processes leads to neuronal death. Thus, inhibition of the signaling events in death-promoting pathways provides novel therapeutic targets for small molecules. The Company has developed an extensive proprietary library of small molecule modulators of the signal transduction processes which block the death process in isolated neurons in vitro and in vivo, where damage has been induced by a variety of harmful stimuli. The Company is pursuing the development of these small molecules for the treatment of Alzheimer's disease, Parkinson's disease and other neurodegenerative disorders. Alzheimer's Disease As previously mentioned, Alzheimer's disease is characterized by the death of neurons in the CNS. In addition to its work focused on gene transcription regulators, Cephalon has synthesized and identified a class of novel small molecules which are orally active and cell- and blood-brain barrier permeable and are inhibitors of the stress activated protein kinase pathway, which is believed to be the signaling pathway which may be linked to the death of neurons in this disease. One of these molecules, CEP-1347, has been shown to prevent neuronal death in vitro and in several models of neuronal death in vivo. CEP- 1347 is currently in preclinical development for use as a potential treatment for Alzheimer's disease. This program is being conducted under the terms of a license agreement with Kyowa Hakko Kogyo Co., Ltd. Parkinson's Disease Parkinson's disease is a progressive disorder of the central nervous system affecting over one million people in the United States. Clinically, the disease is characterized by a decrease in spontaneous movements, gait difficulty, postural instability, rigidity and tremor. Parkinson's disease is caused by the degeneration of the pigmented neurons in the Substantia Nigra of the brain, resulting in decreased dopamine availability. In preclinical models of Parkinson's disease, CEP-1347 and other proprietary compounds have indicated their potential utility in the treatment of this disease by demonstrating the ability to protect the dopamine neurons in the Substantia Nigra. 9 Oncology Cancer is a disease of uncontrolled proliferation of cells. As the cells proliferate, they aggregate into masses, demand neovascularization (the formation of new blood vessels), invade organs, and can eventually lead to death. In many instances, it is the growth factors that are normally involved in maintenance of cells which become the culprits in driving their abnormal proliferation. Many of these growth factors bind to specific receptors (or receptor kinases) and initiate intracellular signals that direct the cell to proliferate. Thus, inhibition of these kinases provides a unique therapeutic strategy for treating a variety of oncological disorders. The Company has developed small molecule inhibitors of specific kinases that have been demonstrated in preclinical models to inhibit tumor growth. This research provides the opportunity for selective inhibition of tumor growth without the undesirable effects on other organ systems produced by traditional chemotherapeutics. Other factors become involved as the tumor cells aggregate and promote the formation of new blood vessels which provide nutrients to the growing tumor. This latter process is called angiogenesis. The Company has a core of proprietary, orally active molecules targeted at preventing the development of new blood vessels required by a cancerous tissue to grow or spread. Selective inhibition of this new vessel formation would result in slowing tumor growth by basically starving the tumor of necessary nutrients. Prostate Cancer Prostate cancer is the most common form of cancer in men, affecting approximately one million men in the United States, and is the second leading cause of cancer death in men. Current therapy includes surgery to remove the cancer and treatment with anti-androgen agents such as leuprolide. If these treatments fail and the tumor becomes androgen-refractory, there are no effective treatments and death usually results. The Company has identified certain molecules which modulate signal transduction by blocking (antagonizing) the action of certain growth factors through the trk kinase. The Company believes these inhibitors may be useful in treating certain diseases such as prostate cancer, where tumor growth and development may be mediated by an uncontrolled activation of the endogenous growth factor. This approach has been demonstrated by the Company to be active against androgen-refractory prostate cancer tumors in preclinical models. Cephalon and TAP Holdings Inc. are parties to a licensing and research and development collaboration to develop trk kinase inhibitors for the treatment of human cancers and prostate disorders in the United States. In 1996, TAP initiated a Phase I clinical study of an intravenously administered compound which was completed in 1998. In March 1998, TAP initiated an ongoing multiple- dose study of an orally administered compound. The objective of these multi- center studies is to examine the drugs' pharmacokinetic and safety profiles in patients with advanced cancer. The molecules used by TAP in these studies were developed under the Company's agreement with Kyowa Hakko. Solid Tumors Angiogenesis, the natural process used by the human body to produce blood vessels, occurs as a pathological process in the development of solid tumors such as breast and lung cancers. The blood vessels created by this process provide the nutrients and oxygen the tumor needs to grow and spread. The process of angiogenesis is mediated by a number of factors including the polypeptide vascular endothelial growth factor ("VEGF"). As a result, the Company believes that inhibitors of the receptor kinase for VEGF has potential utility in the treatment of solid tumors. The Company has synthesized a number of proprietary orally active small molecules which, in in vitro studies, are potent and selective inhibitors of the receptor kinase for VEGF. The Company is currently evaluating these molecules in preclinical models for their potential utility in a variety of solid tumors. 10 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. These peptide fragments may threaten the survival of neurons. The Company has developed expertise in identifying, isolating and assaying specific types of proteases believed to be involved in certain neurodegenerative disorders. In addition, the Company's expertise in chemistry has enabled the synthesis of molecules that, in preclinical studies, specifically inhibit the action of these proteases. In the past, the Company has 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 and on other compounds that inhibit the protease sigma-secretase, which plays a pivotal role in the production of the toxic beta-Amyloid protein associated with the degeneration in Alzheimer's disease. The Company believes that this core technology can be applied to any number of proteases and disorders. RESEARCH AND DEVELOPMENT COLLABORATIONS NEUROTROPHIC FACTORS (MYOTROPHIN) Cephalon Clinical Partners, L.P. In August 1992, Cephalon exclusively licensed to Cephalon Clinical Partners, L.P. (the "Partnership"), rights to MYOTROPHIN for human therapeutic use within the United States, Canada and Europe (the "Territory"). The Company is performing the development and clinical testing of MYOTROPHIN on behalf of the Partnership under a research and development agreement with the Partnership. Under the agreement, the Partnership reimbursed the Company an aggregate $38,714,000 through 1995 for development costs incurred. Since that time, the Company has been funding the continued development of MYOTROPHIN from its own cash resources. The Partnership has granted an exclusive license to the Company to manufacture and market MYOTROPHIN for human therapeutic use within the Territory in return for royalty payments equal to 10.1% of sales and a payment of approximately $16,000,000 (the "Milestone Payment") that will be made if MYOTROPHIN receives regulatory approval in the United States or certain other countries within the Territory. The Company has a contractual option to purchase all of the limited partnership interests in the Partnership (the "Purchase Option"). To exercise the Purchase Option, Cephalon is required to make an advance payment of $40,275,000 in cash or, at Cephalon's election, $42,369,000 in shares of common stock, valued at the market price at the time the Purchase Option is exercised. The Purchase Option will become exercisable for a 45-day period commencing on the date which is the earlier of (a) the date which is the later of (i) the last day of the first month in which the Partnership shall have received Interim License payments equal to fifteen percent (15%) of the limited partners' capital contributions (excluding the Milestone Payment), and (ii) the last day of the 24th full month after the date of the Company's first commercial sale, if any, of MYOTROPHIN within the Territory that generates a payment to the Partnership, and (b) the last day of the 48th full month after the date of such first commercial sale, if any, in the Territory. If the Company does not exercise the Purchase Option, its license will terminate and all rights to manufacture or market MYOTROPHIN in the Territory will revert to the Partnership, which may then commercialize MYOTROPHIN itself or license or assign its rights to a third party. The Company would not receive any benefits from such commercialization, license or assignment of rights. Kyowa Hakko Kogyo Co., Ltd. In July 1993, the Company 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. In April 1995, Kyowa Hakko initiated a Phase III study in Japan, results of which may be available in late 1999. The Company is supplying MYOTROPHIN at its cost to Kyowa Hakko for use in Japanese clinical trials, and will supply MYOTROPHIN for 11 a percentage of any net product sales for commercial use. In addition, the Company is to receive certain licensing, milestone and royalty payments. Under certain circumstances, the Company has an option to co-promote MYOTROPHIN in Japan. The Company 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, the Company 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. Currently, the companies are funding their own program expenses. Profits, if any, 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 European countries ("Western Europe") generally will be shared equally by the Company and Chiron. In addition, the Company will receive a royalty on sales of MYOTROPHIN, if any, 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 the Company and Chiron. Either party may terminate the collaboration if there is no reasonable basis for developing any of the collaboration's compounds. If the Company is the non- terminating party, it 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 Cephalon does not exercise the Purchase Option. See "Cephalon Clinical Partners, L.P." Under the collaboration, Chiron has an option to obtain the Company's IGF-I technology outside the neurology field for compensation to be determined if such option is exercised. The Company's collaboration with Chiron is subject to the rights of Cephalon Clinical Partners, L.P., which has licensed the Company the right to develop MYOTROPHIN in North America and Europe in return for receiving certain payments. The Company is solely responsible for making any royalty and milestone payments owed to the Partnership and is responsible for funding the Purchase Option if it exercises the option. See "Cephalon Clinical Partners, L.P." GENE TRANSCRIPTION REGULATORS Leo Pharmaceutical Products, Ltd. In November 1996, the Company and Leo Pharmaceutical Products, Ltd. ("Leo") entered into an agreement to collaborate in the development of gene transcription regulators for use in the treatment of neurological disorders. Under this agreement, Cephalon will use its proprietary technology to evaluate molecules synthesized by Leo. The companies intend to jointly develop selected products and will share the cost of development. Leo is responsible for the cost of Phase I studies, Cephalon is responsible for the cost of Phase II, and the two companies will share equally in the cost of Phase III. Cephalon will have the exclusive rights to market and sell these jointly developed products in the United States and Mexico in the neurological field, and will pay Leo a percentage of net product sales as a royalty and for the supply of product. Cephalon will receive a royalty from Leo's net product sales of jointly developed products in other territories. 12 SIGNAL TRANSDUCTION MODULATORS TAP Holdings Inc. The Company and TAP Holdings Inc. are parties to a licensing and research and development collaboration to develop and commercialize certain compounds for the treatment of human cancers and prostate disorders in the United States. The compounds belong to a family of inhibitors from the Company's signal transduction modulator program. Under the terms of the agreement, the Company performs research and preclinical development of these compounds for which it is compensated quarterly by TAP, based on a contract rate per individual assigned to the program for that quarter and reimbursement of certain external costs, all subject to annual budgetary maximums. The research under the agreement may be extended for one- year periods. TAP may terminate the research under the agreement upon 90 days prior to the expiration. TAP is responsible for conducting and funding all U.S. clinical trials and additional activities for regulatory submissions for U.S. marketing approval. The agreement provides for TAP to make milestone payments to Cephalon upon the submission and approval of new drug applications, if any, that may emanate from the collaboration and to purchase commercial supplies of product from Cephalon at a price equal to a fixed percentage of sales plus royalties on product sales. Kyowa Hakko Kogyo Co., Ltd. In May 1992, the Company licensed from Kyowa Hakko Kogyo Co., Ltd. patent and other intellectual property rights to a class of small molecules which the Company has identified as signal transduction modulators; certain of these molecules are being developed for use in the treatment of neurological disorders and others are being developed for the treatment of cancer. The Company has exclusive marketing rights in North America and Europe with respect to certain of those compounds, which the Company is seeking to develop for the treatment of prostate and pancreatic cancer; Kyowa Hakko retains exclusive marketing rights to these compounds in Asia. The Company has exclusive marketing rights in the United States with respect to all other of these compounds, which the Company is seeking to develop for the treatment of neurological disorders; the Company and Kyowa Hakko each hold semi-exclusive marketing rights to these compounds throughout the rest of the world, including Europe and Japan. The Company will pay to Kyowa Hakko a royalty on all sales of pharmaceutical products containing the compounds. Under the terms of a related supply agreement, Kyowa Hakko is responsible for supplying the compounds under development. However, if Kyowa Hakko determines that it cannot or will not manufacture and supply the compounds, it must then arrange for a third party to manufacture and supply the compounds or allow the Company to assume responsibility for manufacturing and supply. The license and supply agreements will automatically terminate if the Company discontinues the development of pharmaceutical products containing the compounds due to lack of safety or efficacy. PATENTS AND PROPRIETARY TECHNOLOGIES An important part of Cephalon's product development strategy is to seek protection for its products and technologies through the use of U.S. and foreign patents and trademarks. As described below, Cephalon holds rights to and has filed applications for various U.S. and foreign patents, though Cephalon cannot be certain that any of these patent applications will issue, or if issued, that they will not be challenged by third parties or that Cephalon will not be found to have infringed upon the rights of others in any case. 13 PROVIGIL The particle size of the composition of modafinil as the active drug substance in PROVIGIL is included in claims of a U.S. patent of the Company which issued in 1997. Foreign patents claiming the particle size composition of modafinil are pending in Cephalon's other territories. 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. This patent was to have expired in 1998 in the United Kingdom and the United States; however, the Company has applied for an extension of the patent in the those countries. In the United States, if the Company 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 "DPC Act"), the composition of matter patent would expire on November 18, 2001. The Company cannot be certain that it will receive this patent extension or that it will be able to take advantage of any other patent benefits of the DPC Act. The Company does not believe that an extension of the modafinil composition patent is possible in any other of its licensed territories. Also included in the license from Lafon are 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 isomers of PROVIGIL. The FDA has granted orphan drug status to PROVIGIL for use in the treatment of excessive daytime sleepiness associated with narcolepsy, that provides for a seven-year period of marketing exclusivity for PROVIGIL in that indication. See "Government Regulation." MYOTROPHIN MYOTROPHIN(R) (mecasermin) Injection is the Company's trademark for recombinant human insulin-like growth factor-I ("rhIGF-I" or "IGF-I"). The Company believes that the composition of rhIGF-I is in the public domain and therefore cannot be patented under a composition-of-matter patent. However, Cephalon owns issued U.S., European 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. The Company also owns U.S. patents claiming the use of IGF-I in treating certain types of peripheral neuropathies, and the Company has filed similar applications in Canada, Europe and Japan. Cephalon also has filed patent applications in the United States, Canada, Europe and Japan covering the use of IGF-I in enhancing the survival of neuronal 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. The FDA has designated MYOTROPHIN as an orphan drug for use in the treatment of ALS. See "Government Regulation." Under an agreement with SIBIA Neurosciences, Inc. ("SIBIA"), the Company has obtained a license to use certain patent rights and other technology related to the manufacture of rhIGF-I in certain strains of yeast host cells. The issued patent and all patent applications relating to IGF-I in the United States, Canada and Europe have been licensed to the Partnership. Subject to the rights of the Partnership, the Company and Chiron cross- licensed all of their respective patents and patent applications related to IGF- I and certain other compounds (excluding the Company's rights under the SIBIA license, as to which Chiron has the option to sublicense) in the field of neurological diseases and disorders, including Chiron's rights under U.S. and foreign patents. The Company cannot be sure that any of its patent applications for IGF-I uses will issue, that any issued patents will be as broad in scope as such patent applications or that the claims of any issued patent will withstand challenge. Even in those jurisdictions where rhIGF-I (or the processes used in IGF-I manufacturing) may be covered by the claims of a use patent, "off-label" sales by a third party might occur, especially if another company markets rhIGF-I for other uses at a price that is less than the price of MYOTROPHIN, thereby potentially reducing sales of MYOTROPHIN. It is not always possible to detect "off-label" sales and therefore enforcement of use patents can be difficult. Furthermore, some jurisdictions outside of the United States restrict the manner in which patents claiming uses of a product may be enforced. 14 Under its collaboration with Chiron, Chiron has the primary responsibility for manufacturing commercial supplies of MYOTROPHIN. One of Chiron's issued patents related to certain methods for the manufacture of recombinant proteins, including rhIGF-I, is currently the subject of an interference proceeding before the U.S. Patent and Trademark Office ("USPTO") involving patent applications owned by Genentech, Inc. ("Genentech"). It is not known when or how the USPTO will ultimately conclude the interference proceeding. Another related patent application of Chiron, which may cover the current process for manufacturing rhIGF-I, was the subject of another interference proceeding with a Genentech patent. Chiron prevailed in the second interference proceeding and thereafter prevailed in a district court appeal brought by Genentech. That decision was appealed to the U.S. Court of Appeals for the Federal Circuit ("CAFC") by Genentech. In April, 1997, the CAFC reversed the District Court's judgment and remanded the case back to the District Court, which issued a judgment affirming the USPTO decision for Chiron. Genentech has the right to appeal to the CAFC. It is not possible to predict which party will obtain an issued patent or whether the issued claims will cover any portion of the current manufacturing process. The Company is aware of other patents and patent applications owned by third parties, which if issued with the claims as filed, may cover certain aspects of the current method of manufacturing rhIGF-I. The Company and Chiron intend to either seek licenses under any valid patents related to the manufacturing of rhIGF-I as required or, alternatively, modify the manufacturing process. There can be no assurance 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, the Company could be subject to a claim of patent infringement which, if successful, could prevent the Company from manufacturing or selling MYOTROPHIN in the United States. Even if patents issue on the pending applications owned or licensed by the Company, there can be no assurance that applications filed by others will not result in patents that would be infringed by the manufacture, use or sale of MYOTROPHIN. The Company is aware of a U.S. patent recently issued to Genentech and a granted European patent 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, by increasing the active concentration(s) of IGF-I or its analogues in the CNS. The Company has filed an opposition against the granted European patent. The Company cannot predict the outcome of this opposition 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, the Company could be prevented from selling MYOTROPHIN in the United States and Europe for uses of IGF-I claimed in the patents, unless it obtained a license to the patents. There can be no assurance that a license is available at all or on acceptable terms to the Company. The Company believes, based on a preliminary review, that the claims of the issued United States patent and the granted European patent would not be infringed by the use or sale of MYOTROPHIN for the treatment of ALS or peripheral neuropathies, and that the claims directed to the treatment of multiple sclerosis are invalid over the prior art. The Company is aware of a published application filed under the Paris Convention Treaty, designating the United States, that relates to the use of IGF-I in effecting a change in the CNS. The Company believes that even if the subject matter were deemed to overlap the subject matter of issued patents and pending patent applications filed by the Company in the United States, based on the filing date of the third party's application, it would not take priority over the Company's patents or applications. Another third party has been granted a U.S. patent claiming the use of IGF-I to treat diabetic neuropathy. This patent could prevent the Company from selling MYOTROPHIN in the United States for use in treating diabetic neuropathy unless it obtained a license to the patent. That third party may also be prosecuting a U.S. patent application that may contain a broader claim which, if issued, could generally cover the use of rhIGF-I to treat many neurological conditions, including ALS and peripheral neuropathies. The owner of such third- party patent application has asserted for several years that the subject matter claimed in its application interferes with claims of the Company's patent with respect to the use of rhIGF- I in treating ALS. If a broad claim were to issue, or an interference declared and the third party patent prevailed, the Company could be prevented from selling MYOTROPHIN in the United States for use in treating ALS and peripheral neuropathies unless it obtained a license to the patent. There can be no assurance that any such licenses could be obtained at all or on acceptable terms from any third parties holding a patent which covers any of the Company's commercial activities. Furthermore, one or more claims of the Company's existing patents could be declared invalid. 15 Other Cephalon also owns issued U.S. patents claiming compositions of inhibitors of certain proteases, compositions and uses of certain novel classes of small molecules for inhibition of calpain, compositions and uses of a novel class of small molecules for inhibition of the multicatalytic protease, and compositions and uses of a novel class of small molecules referred to as "fused pyrrolocarbazoles." Counterparts of these patents have been filed in other countries, as appropriate. Through collaborative agreements with researchers at several academic institutions, Cephalon has 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. The Company also has licensed U.S. composition-of-matter and use patents and various European patent applications for novel compositions under its collaborative agreement with Kyowa Hakko, including compositions and uses of certain indolocarbazoles in the treatment of pathological conditions of the prostate (including prostate cancer) and for the treatment of neurological disorders. No assurance can be given that any additional patents will be issued on any of the patent applications owned by the Company or licensed from third parties. Furthermore, even if such patents are issued, there can be no assurance that the validity of any issued patents will be upheld if challenged, that any issued patents will provide protection against competitive products or otherwise be commercially valuable, or that applications filed by others will not result in patents that would be infringed by the manufacture, use or sale of the Company's products. In addition, patent law relating to the scope of claims in the biotechnology field is still evolving and the biotechnology patent rights of the Company are subject to this additional uncertainty. There can be no assurance that others will not independently develop similar products, duplicate any of the Company's products, or, if patents are issued to the Company, design around any products developed by the Company. The products of the Company could infringe the patent rights of others. If licenses required under any such patents or proprietary rights of third parties are not obtained, the Company 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 the Company. In the event that the Company is a defendant in such litigation, an adverse outcome would subject the Company to significant liabilities to third parties, require the Company to license disputed rights from third parties, or require the Company to cease selling its products. The Company also relies upon trade secrets and other unpatented proprietary information in its product development activities. The Company's employees enter into agreements providing for confidentiality and the assignment of rights to inventions made by them while employed by the Company. The Company also has entered into non-disclosure agreements to protect its confidential information delivered to third parties in conjunction with possible corporate collaborations and other purposes. There can be no assurance that these types of agreements will effectively prevent disclosure of the Company's confidential information. MANUFACTURING AND PRODUCT SUPPLY The Company's ability to conduct clinical trials on a timely basis, to obtain regulatory approvals and to commercialize its products will depend in part upon its ability to manufacture its 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 ("cGMP") regulations. Cephalon has no manufacturing facilities of its own and relies on third parties for all of its manufacturing requirements. See "Management's Discussion and Analysis of Financial Condition and Results of Operations--Certain Risks Related to Cephalon's Business." 16 The Company relies on Lafon for all of its requirements of bulk modafinil compound and upon third party manufacturers to provide final formulation, tabletting and packaging of PROVIGIL. Cephalon relies on Chiron for all of its manufacturing requirements for MYOTROPHIN (including clinical and commercial supplies of MYOTROPHIN used by Kyowa Hakko in Japan). The Company is aware of patents and patent applications owned by third parties that may cover certain aspects of the collaboration's method of manufacturing MYOTROPHIN. See "Patents and Proprietary Technologies." Cephalon relies on Kyowa Hakko to supply bulk compounds for its signal transduction modulator research program, but if Kyowa Hakko determines that it cannot or will not manufacture and supply the compounds, it must then arrange for a third party to manufacture and supply the compounds or allow the Company to assume responsibility for manufacturing and supply. See "Research and Development Collaborations--Kyowa Hakko Kogyo Co., Ltd." Under the Company's agreement with TAP, the Company is obligated to provide finished product for use in clinical trials and ultimately for commercial purposes. See "Research and Development Collaborations--TAP Holdings Inc." COMPETITION Competition in the Company's fields of interest, from both large and small companies, is intense and is expected to increase. Furthermore, academic institutions, governmental agencies, and other public and private research organizations will continue to conduct research, seek patent protection, and establish collaborative arrangements for product development. Products developed by any of these entities may compete directly with those developed or sold by the Company. Many of these companies and institutions have substantially greater capital resources, research and development staffs and facilities than the Company, and substantially greater experience in conducting clinical trials, obtaining regulatory approvals and manufacturing and marketing pharmaceutical products. These entities represent significant competition for the Company. 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 being developed or sold by the Company or that would render its technology and products obsolete or noncompetitive. Competition and innovation from these or other sources potentially could materially adversely affect any sales of products which might be developed or are currently being sold by the Company or make them obsolete. Advances in current treatment methods may also adversely affect the market for such products. The approval and introduction of therapeutic products that compete with compounds being developed by the Company could also adversely affect the Company's ability to attract and maintain patients in clinical studies for the same indication or otherwise successfully complete its clinical studies. With respect to PROVIGIL, there are presently several products used in the United States and the Company's other licensed territories to treat narcolepsy. There can be no assurance that the Company 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. In the United States and elsewhere, PROVIGIL faces significant competition in the marketplace since 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. With respect to MYOTROPHIN, Rilutek(R) (riluzole) has been approved and is being marketed by Rhone-Poulenc Rorer in the United States and certain countries in Europe for the treatment of ALS. In addition, the Company believes that other companies are developing other therapeutic agents for the treatment of ALS. Because the potential patient population for ALS is limited, competition from other products may adversely affect potential sales of MYOTROPHIN. Other companies are developing rhIGF-I as a therapeutic product for diseases other than ALS or peripheral neuropathy, including Chiron. If another company markets rhIGF-I for other uses at a price lower than the price of MYOTROPHIN, potential sales of MYOTROPHIN, if any, may be reduced. See "Management's Discussion and Analysis of Financial Condition and Results of Operations--Certain Risks Related to Cephalon's Business." 17 Cephalon is marketing proprietary products of other pharmaceutical companies, including STADOL NS in the United States and APOKINON in France. All of these therapies compete directly or indirectly with other products on the market. In addition, in all cases, new products are under development by third parties which could compete, if approved for marketing, with the products currently being marketed by the Company. 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 in the United States under the U.S. Food, Drug and Cosmetic Act and by comparable agencies in most foreign countries. As an initial step in the FDA regulatory approval process, preclinical studies are typically conducted in animals to identify potential safety problems. The results of the preclinical studies are submitted to regulatory authorities as a part of an investigational new drug application ("IND"), which is filed with regulatory agencies prior to beginning studies in humans. For several of the Company's drug candidates, no animal model exists which is potentially predictive of results in humans. As a result, no in vivo indication of efficacy would be available until these candidates progress to human clinical trials. Clinical trials are typically conducted in three sequential phases, although the phases may overlap. In Phase I, which frequently begins with the initial introduction of the drug into healthy human subjects prior to introduction into patients, the compound is tested for safety (adverse effects), dosage tolerance, absorption, biodistribution, metabolism, excretion, clinical pharmacology and, 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, to determine dose tolerance and the optimal dose range as well as to gather additional information relating to safety and potential adverse effects. Phase III trials are undertaken to further evaluate clinical safety and efficacy in an expanded patient population, often at multiple study sites, in order 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, each clinical study must be evaluated by an independent Institutional Review Board ("IRB") at the institution at which the study will be conducted. The IRB considers, among other things, ethical factors, the safety of an 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. Data from preclinical and clinical trials are submitted to the FDA in a new drug application ("NDA") for marketing approval and to foreign health authorities in Europe as a marketing authorization application ("MAA"). 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. Preparing an NDA or MAA involves considerable data collection, verification, analyses and expense, and there can be no assurance that the FDA or any foreign health authority will grant an approval on a timely basis, or at all. The approval process is affected by a number of factors, primarily the risks and benefits demonstrated in clinical trials as well as the severity of the disease and the availability of alternative treatments. The FDA or foreign health authorities may deny an NDA or MAA, in their sole discretion, if that authority determines that its regulatory criteria have not been satisfied or may require additional testing or information. Among the conditions for marketing approval is the requirement that the prospective manufacturer's quality control and manufacturing procedures conform to the cGMP regulations of the health authority. In complying with standards set forth in these regulations, manufacturers 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 FDA or foreign health authority approval has been obtained, further studies, including Phase IV post-marketing studies, may be required to provide additional data on safety and will be required to gain 18 approval for the use of a product as a treatment for clinical indications other than those for which the product was initially tested. Also, the FDA or foreign regulatory authority will require post-marketing reporting to monitor the side effects of the drug. 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, an application seeking approval of such changes may be required to be submitted to the FDA or foreign regulatory authority. 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 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 product for the orphan indication. While the marketing exclusivity of an orphan drug would prevent other sponsors from obtaining approval of the same compound for the same indication, it would not prevent approval of the compound for other indications. In addition, other types of drugs may be approved for the same use. 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 of the market exclusivity of an orphan drug and, thus, there can be no assurance 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 (the "DPC Act"), 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 a new drug application (NDA) for a new chemical entity ("NCE"). 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 filing of an IND and the filing of the corresponding NDA plus the complete 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 14 years following FDA approval. Additionally, under this statute, five years of marketing exclusivity is granted for the first approval of a NCE. During this period of exclusivity, a third party would be prevented from filing an Abbreviated New Drug Application ("ANDA") or a 505(b)(2) application for a modafinil drug product equivalent or identical to PROVIGIL. 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 for any non-exclusive indication(s) if any five-year exclusivity granted to the NCE has expired, but would be prohibited from marketing a generic version of the new chemical entity for the subsequent approved indication until the expiration of three years from marketing authorization for such subsequent approved indication. The Company intends to seek the benefits of this statute as applicable, but there can be no assurance that the Company will be able to obtain any such benefits. 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 at this time 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 U.S. and, in some circumstances, may prohibit the export even if such products are approved for sale in other countries. The Controlled Substances Act (the "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 19 particular CSA requirements, if any, applicable to a product is its actual or potential abuse profile. A pharmaceutical product may be "scheduled" 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, such as modafinil, 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 which, in some cases, may be more restrictive than the CSA. In 1997, STADOL NS was classified as a Schedule IV controlled substance at the request of Bristol-Myers Squibb. 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, the Company also is 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 The Company maintains a Scientific Advisory Board consisting of individuals with expertise in neuroscience and related fields. Members of the Scientific Advisory Board advise the Company concerning long-term scientific planning, research and development, and also periodically evaluate the Company's research programs. The members are compensated by the Company for their services. The current members of the Company's Scientific Advisory Board are as follows: Stanley H. Appel, M.D., Baylor College of Medicine Stanley Cohen, Ph.D., Vanderbilt University School of Medicine Gordon Guroff, Ph.D., National Institute of Child Health and Human Development, NIH 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 The Company also maintains a Medical Advisory Board consisting of individuals with expertise in clinical development who periodically review and evaluate the Company's clinical development plans and clinical trials. The members are compensated by the Company for their services. The current members of the Company's 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 20 EMPLOYEES As of December 31, 1998, the Company had a total of 295 full-time employees, of which 227 were employed at the Company's main facility in West Chester, Pennsylvania, 18 were located at the Company's facilities in Europe, and approximately 50 were engaged in sales and marketing activities throughout the United States. The Company believes that it has been successful in attracting skilled and experienced personnel; however, competition for such personnel is intense. None of the Company's employees are covered by collective bargaining agreements. Management considers relations with its employees to be good. ITEM 2. PROPERTIES The Company owns its administrative offices and research facilities, which currently occupy approximately 156,000 square feet of space in West Chester, Pennsylvania. The Company also leases approximately 4,950 square feet of office space in Surrey, England, which serves as the Company's European headquarters. The annual cost of the lease is approximately $193,000. The Company also leases offices in France and Germany at an aggregate annual cost of approximately $45,000. The Company believes that its current facilities are adequate for its present purposes. ITEM 3. LEGAL PROCEEDINGS The Company, a current director and officer, and a former officer have been named as defendants in a number of civil actions filed in the U.S. District Court for the Eastern District of Pennsylvania, which have been consolidated into a single class action. The plaintiff class is comprised of those persons and entities who purchased Cephalon common stock, or traded in options to buy or sell Cephalon common stock, during the period June 12, 1995 through and including June 7, 1996. Plaintiffs seek to hold defendants liable for stock trading losses that stem from alleged violations of the U.S. securities laws and alleged common law negligent misrepresentation. More specifically, plaintiffs have alleged that statements by the Company and the named defendants relating to the results of certain clinical studies of MYOTROPHIN were misleading. A judgment in this matter could materially exceed the coverage which may be available under its directors' and officers' liability insurance. The Company is vigorously defending this lawsuit and believes that there are valid defenses against the claims, but the defense of the action is expensive, and the costs of defense will reduce the available insurance coverage that might otherwise be available to satisfy the claims. In an effort to resolve this dispute, in January 1999, the Company engaged a mediator to initiate a non-binding mediation process and commenced discussions with counsel for the lead plaintiffs. At this time, the Company is not able to determine with any certainty the outcome of this action or its potential liability. Due to the Company's involvement in promoting STADOL NS(R) (butorphanol tartrate) Nasal Spray, a product of Bristol-Myers Squibb, the Company is a co- defendant in a product liability action brought against BMS. Although the Company cannot predict with certainty the outcome of this litigation, it believes that any expenses or damages that are incurred will be paid by BMS under the indemnification provisions of the co-promotion agreement. As such, the Company does not believe that these actions will have a negative effect on the Company's financial condition or results of operations. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS No matters were submitted to the vote of security holders during the fourth quarter of fiscal 1998. 21 PART II ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS The Common Stock of Cephalon, Inc. 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 ---- --- 1997 First Quarter...................................... 28.50 17.38 Second Quarter..................................... 21.88 11.00 Third Quarter...................................... 12.63 9.50 Fourth Quarter..................................... 13.88 9.75 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 (through February 19, 1999).......... 10.69 8.00 As of February 19, 1999 there were 757 holders of record and approximately 18,000 beneficial holders of the Company's Common Stock. On February 19, 1999, the last reported sale price of the Common Stock as reported on the NASDAQ National Market was $8.06 per share. Cephalon has never declared or paid cash dividends on its capital stock and does not anticipate paying any cash dividends in the foreseeable future. 22 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, 1998 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 notes thereto, and "Management's Discussion and Analysis of Financial Condition and Results of Operations" included elsewhere herein.
Year Ended December 31, ----------------------------------------------------------------------------- 1998 1997 1996 1995 1994 ---- ---- ---- ---- ---- Statement of Operations Data: Revenues............................................ $ 15,655,000 $ 23,140,000 $ 21,366,000 $ 46,999,000 $ 21,681,000 Operating Expenses: Research and development........................... 43,649,000 51,587,000 62,096,000 73,994,000 51,613,000 Selling, general and administrative................ 30,947,000 36,744,000 28,605,000 15,762,000 9,180,000 ------------- ------------- ------------- ------------- ------------ Total operating expenses............................ 74,596,000 88,331,000 90,701,000 89,756,000 60,793,000 Interest income, net................................ 3,534,000 4,772,000 6,205,000 9,754,000 3,047,000 Gain on sale of assets.............................. -- -- 9,845,000 -- -- ------------- ------------- ------------- ------------- ------------ Loss................................................ $ (55,407,000) $ (60,419,000) $ (53,285,000) $ (33,003,000) $(36,065,000) ============= ============= ============= ============= ============ Basic and diluted loss per share.................... $ (1.95) $ (2.36) $ (2.19) $ (1.63) $ (2.13) Weighted average number of shares outstanding....... 28,413,220 25,637,508 24,319,163 20,262,071 16,928,516 As of December 31, ----------------------------------------------------------------------------- 1998 1997 1996 1995 1994 ---- ---- ---- ---- ---- Balance Sheet Data: Cash, cash equivalents and investments(1)........... $ 67,346,000 $ 119,471,000 $ 146,848,000 $ 178,067,000 $114,458,000 Total assets........................................ 94,673,000 151,208,000 177,891,000 221,330,000 140,173,000 Long-term debt...................................... 15,096,000 27,587,000 16,974,000 21,668,000 16,088,000 Accumulated deficit(2).............................. (273,793,000) (218,386,000) (157,967,000) (104,682,000) (71,679,000) Stockholders' equity(2)............................. 57,602,000 100,338,000 137,326,000 180,205,000 112,767,000
(1) Maintenance of certain cash and investment balances is required by specific agreements. (2) No cash dividends have been declared on the capital stock since the inception of the Company. 23 ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS CERTAIN RISKS RELATED TO CEPHALON'S BUSINESS In addition to historical facts or statements of current condition, this report contains forward-looking statements. Forward-looking statements provide our current expectations or forecasts of future events. These may include statements regarding anticipated scientific progress in our research programs, development of potential pharmaceutical products, prospects for regulatory approval, manufacturing capabilities, market prospects for our products, sales and earnings projections, and other statements regarding matters that are not historical facts. Some of these forward-looking statements may be identified by the use of words in the statements such as "anticipate," "estimate," "expect," "project," "intend," "plan," "believe" or other words and terms of similar meaning. Our performance and financial results could differ materially from those reflected in these forward-looking statements due to general financial, economic, regulatory and political conditions affecting the biotechnology and pharmaceutical industries as well as more specific risks and uncertainties such as those set forth below. Given these risks and uncertainties, any or all of these forward-looking statements may prove to be incorrect. Therefore, you are cautioned not to place too much reliance on any such forward-looking statements. Furthermore, we do not intend (and we are not obligated) to update publicly any forward-looking statements, whether as a result of new information, future events or otherwise. This discussion is permitted by the Private Securities Litigation Reform Act of 1995. Dependence on the Commercial Success of PROVIGIL(R) (modafinil) Tablets [C-IV] During the next several years we will be very dependent on the commercial success of PROVIGIL(R) (modafinil) Tablets [C-IV] ("PROVIGIL Tablets" or "PROVIGIL"), especially in the United States. In December 1998, the FDA approved PROVIGIL for use by those suffering from excessive daytime sleepiness associated with narcolepsy. 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 between 30,000 and 45,000 currently are seeking treatment from a physician. At our present level of operations, we will not be able to attain profitability if physicians prescribe PROVIGIL only for those who are diagnosed narcoleptics and, we may not promote PROVIGIL outside of this approved use. We have initiated clinical studies to examine whether or not PROVIGIL is effective and safe when used in connection with disorders other than narcolepsy, but we do not know whether 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 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 and limit the commercial success of the product. Even if the results of these studies are positive, the impact on PROVIGIL may be negligible until we are able to obtain FDA approval to expand the authorized use of PROVIGIL to include treatment for conditions other than excessive daytime sleepiness associated with narcolepsy. FDA regulations restrict our ability to communicate the results of additional clinical studies to patients and physicians without first obtaining from the FDA approval to expand the authorized uses for this product. As a result, it may be several years, if ever, before we have 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 the Federal, state and foreign government agencies; . the occurrence of any side effects or adverse reactions (or unfavorable publicity relating thereto) stemming from the use of PROVIGIL; 24 We have described these and other factors in more detail below: . Effectiveness of our Marketing and Selling Efforts We must effectively market and sell PROVIGIL in the United States. In the United States and elsewhere, PROVIGIL faces significant competition in the marketplace since 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, and the related health care benefits to the patient. During the past few years, we have developed a specialty sales organization focused on marketing, promoting and detailing the products of other companies to neurologists. However, we have no experience in marketing, selling or distributing our own products in the United States, and we lack the more substantial experience held by major pharmaceutical companies in developing, training and managing a sales organization over an extended period of time. More recently, we have established a managed care sales force to market our products to health maintenance organizations, prescription benefit management firms, and other third party payors; we also lack substantial experience in this area and we cannot be certain that we will be successful in our efforts to market our products to these groups. . Uncertainty Associated with Third Party Payor Reimbursement Levels The continuing efforts of government and third party payors to contain or reduce the costs of health care through various means may affect our sales. 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 adoption by Federal or state governments of any such proposals could limit the commercial success of PROVIGIL. In addition, in both the United States and elsewhere, sales of pharmaceutical products are dependent in part on the availability of reimbursement to the consumer from third party payors, such as government and private insurance plans. Third party payors are increasingly challenging the prices charged for products, and are limiting reimbursement levels offered to consumers for such products. To the extent that third party payors direct such efforts toward PROVIGIL, the commercial success of the product could be impaired. . Uncertainty as to the Occurrence of Unexpected Adverse Events The usage of PROVIGIL has been limited to date to clinical trial patients under controlled conditions and under the care of expert physicians. We cannot predict whether the commercial use of PROVIGIL will produce undesirable or unintended side effects that have not been demonstrated in our clinical trials. . No Assurance of Market Exclusivity for PROVIGIL 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 run through November 18, 2001. In addition, we own a U.S. patent covering the particle size of modafinil which issued in 1997. 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. 25 The FDA has granted orphan drug status to PROVIGIL for its use in the treatment of excessive daytime sleepiness associated with narcolepsy, which 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), 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 and Distribution Uncertainties Associated with PROVIGIL 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, and a non-active ingredient used in the manufacture of PROVIGIL is no longer available. We maintain an inventory of modafinil compound to protect against supply disruptions and, at anticipated levels of demand, we also have several years supply of the ingredient that is no longer available. We are preparing a new formulation of PROVIGIL that would not include the now unavailable ingredient, and could enable us to qualify additional tablet manufacturers with regulatory authorities. However, the introduction of any such new formulation requires that we establish that the new formulation is bioequivalent to the current one, and also requires regulatory approval. If we are unable to develop and obtain approval for a new formulation, or if demand for the product were to greatly 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 must comply with all applicable regulatory requirements of the FDA and foreign authorities, including current Good Manufacturing Practice regulations ("cGMP"). The facilities used to manufacture, store and distribute our products are subject to inspection by the FDA and other regulatory authorities at any time to determine compliance with cGMP and other regulatory requirements. 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. We rely on several third parties in the United States to formulate, tablet, package, 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 reduce sales revenue. Risk Associated with Revenue-Sharing Notes In February 1999, we completed the sale of $30,000,000 of revenue-sharing notes due February 2002 (the "Notes"). The Notes are secured by our licenses, patents and FDA rights relating to PROVIGIL (collectively, the "Pledged Assets"). The Notes contain a number of covenants including a requirement to maintain cash and cash equivalent balances of $40,000,000 through December 31, 1999 and $30,000,000 during the remainder of the term of the Notes. If we fail to maintain such cash balances or violate the other covenants, the holders of the Notes can declare a default and increase the royalty percentage to 25% of U.S. PROVIGIL sales and, if the default is not cured within one year, can accelerate the due date of the Notes and foreclose on the Pledged Assets. The holders of the Notes can also foreclose on the Pledged Assets if we fail to pay principal and interest when due. Need for Additional Funds Since our inception we have had negative cash flow from operations. As of December 31, 1998, we had sufficient cash resources to fund our operations at their current level for at least twelve months. However, beyond 1999, we will need to raise substantial additional funds to continue our operations at their current level, continue to meet our minimum cash balance requirements during the period prior to the repayment of the Notes and pay the Notes at maturity. We expect that it will be at least several years, if ever, before our level of commercial sales and other revenue will 26 provide enough funds to generate positive cash flow from operations. Therefore, if we cannot raise additional funds, we will have to reduce our present level of spending which may involve curtailing or restructuring our operations, including the sale of certain assets of the company. Even after taking these steps, we would not be able to eliminate all of our existing fixed costs, such as occupancy expenses and debt service. Most of the funds we have raised to date have been through the sale of equity in the company; our ability to raise money through the sale of additional equity in the company, as well as the price at which such equity may be sold, are difficult to predict. If we issue common stock or securities convertible into common stock in order to raise such funds, the existing shareholders' percentage ownership of Cephalon necessarily would be reduced. Volatility of Stock Price The market price and trading volume of shares of our common stock is volatile, and we expect it to continue to be volatile for the foreseeable future. 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, news concerning certain external events, such as that concerning our competitors or changes in government regulations that may impact the biotechnology or pharmaceutical industries, also could affect the price of our common stock. Potential for Product Liability 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. Legal Proceedings Cephalon, a current director and officer, and a former officer, have been named as defendants in a number of civil actions filed in the U.S. District Court for the Eastern District of Pennsylvania, all of which have been consolidated into a single class action. The plaintiff class is comprised of those persons and entities who purchased Cephalon common stock, or traded in options to buy or sell Cephalon common stock, during the period June 12, 1995 through and including June 7, 1996. Plaintiffs seek to hold defendants liable for stock trading losses that stem from alleged violations of the U.S. securities laws and alleged common law negligent misrepresentation. More specifically, plaintiffs have alleged that statements made by Cephalon and the named defendants relating to the results of certain clinical studies of MYOTROPHIN were misleading. A judgment in this matter could materially exceed the coverage that may be available under our directors' and officers' liability insurance. We are vigorously defending this lawsuit and believe that there are valid defenses against the claims, but the defense of the action is expensive, and the costs of defense will reduce the amount of insurance coverage that might otherwise be available to satisfy the claims. In an effort to resolve this dispute, in January 1999, we engaged a mediator to initiate a non-binding mediation process and commenced discussions with counsels for the lead plaintiffs. However, at this time we are not able to determine with any certainty the results of these discussions, the outcome of this action or our potential liability. 27 Due to our involvement in promoting STADOL NS(R) (butorphanol tartrate) Nasal Spray, a product of Bristol-Myers Squibb, we are a co-defendant in a product liability action brought against BMS. 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 BMS under the indemnification provisions of our co-promotion agreement. As such, we do not believe that these actions will have a negative effect on our financial condition or results of operations. Risks Inherent in Research and Development of Pharmaceutical Products We are highly focused on the research and development of potential pharmaceutical products. Research and development of potential pharmaceutical products is a very risky and speculative activity that is extremely time consuming and expensive. 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 major 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 unlikely 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. Uncertain Ability to Protect Patents and Other Proprietary Technology and Information Our ability to compete effectively depends, in part, on our ability to protect our proprietary technology, both in the United States and abroad. As such, 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 similar 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 ("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. See "Business-- Patents and Proprietary Technologies." Dependence on Key Executives and Scientists 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 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 28 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. Uncertainties Related to MYOTROPHIN(R) (mecasermin) Injection Cephalon and Chiron have withdrawn the joint marketing authorization application for MYOTROPHIN(R) (mecasermin) Injection ("MYOTROPHIN Injection" or "MYOTROPHIN") in Europe for the treatment of ALS. We made this decision because of comments we received from the reviewer concerning the results of our two pivotal ALS studies. These comments led us to believe that our application would not be approved. The withdrawal of our marketing authorization application for MYOTROPHIN in Europe may negatively affect the FDA approval process for MYOTROPHIN in the United States. In May 1998, the FDA issued a letter stating that the new drug application submitted jointly by Cephalon and Chiron Corporation to market MYOTROPHIN in the United States for the treatment of amyotrophic lateral sclerosis (ALS) was "potentially approvable," contingent, however, upon the submission of additional information from ongoing clinical studies that demonstrates to the satisfaction of the FDA that MYOTROPHIN is effective in the treatment of ALS. Cephalon and Chiron have had discussions with the FDA regarding safety and efficacy data and have submitted information from the ongoing treatment investigational new drug program ("T-IND"). The T-IND is a compassionate use program that is neither placebo-controlled nor blinded, and therefore is not designed to produce evidence of efficacy. No additional data will be submitted to the FDA at this time. The study of MYOTROPHIN in ALS patients being conducted by Kyowa Hakko in Japan is not under our control. Results from that study may be available in late 1999 but may not satisfy the FDA's request for additional information. The prospects for regulatory approval of MYOTROPHIN continue to be very uncertain in the United States. We will continue to evaluate the prospects of receiving regulatory approval and, based on communications with the FDA, may determine to withdraw the new drug application. If the information that has been submitted to the FDA to date does not prove to be sufficient for approval, a new study would be necessary, which would be expensive and would take years to complete. We are not sure whether the potential profits from sales of MYOTROPHIN would make an additional study cost- effective to conduct. Even if an additional study were conducted, the results of a new study may not be sufficient to obtain regulatory approval. Dependence on Corporate Collaborators Because we have limited resources, we have entered into a number of agreements with other pharmaceutical companies to support our efforts to develop and market potential products. 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 research and commercial interests may not be supported fully 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 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. If we learn from any of them that they will not, or cannot, continue to produce and supply compounds or products under the terms of our agreement(s), we would attempt to identify and obtain a commitment from another manufacturer. We cannot be certain that we would be able to locate an appropriate manufacturer or that a new manufacturer will be able to 29 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. Other Risks We face other risks and uncertainties in our business that are characteristic of a company operating in the biotechnology and pharmaceutical industries, including intense competition and the failure to keep pace with rapid technological developments; environmental risks associated with the materials used in research and development activities; and the failure of third-party vendors and suppliers to be Year 2000 compliant in a timely manner. LIQUIDITY AND CAPITAL RESOURCES Cash, cash equivalents, reverse repurchase agreements and investments at December 31, 1998 were $67,346,000, representing 71% of total assets, and at December 31, 1997 were $119,471,000, representing 79% of total assets. Cash equivalents, reverse repurchase agreements and investments consisted primarily of short to intermediate-term corporate obligations, overnight investments that are backed by collateral in the form of government securities with a value equal to at least 102% of such investments and short to intermediate-term obligations of the United States government. The following is a summary of selected cash flow information for each of the years ended December 31:
1998 1997 1996 ---- ---- ---- Net cash used for operating activities................ $(50,198,000) $(54,677,000) $(53,215,000) Net cash provided by investing activities............. 45,253,000 31,154,000 45,886,000 Net cash (used for) provided by financing activities.. (1,351,000) 28,123,000 6,435,000
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:
1998 1997 1996 ---- ---- ---- TAP Holdings................... $8,059,000 $6,957,000 $5,889,000 Bristol-Myers Squibb........... 2,005,000 4,682,000 4,879,000 Chiron......................... 1,962,000 5,242,000 4,100,000 Medtronic...................... 1,922,000 553,000 -- Kyowa Hakko.................... 902,000 2,210,000 1,700,000 SmithKline Beecham............. -- 3,083,000 2,856,000 Schering-Plough................ -- 88,000 3,000,000 Interest....................... 4,734,000 8,260,000 8,489,000
We have a licensing and research and development collaboration with TAP Holdings Inc. to develop and commercialize certain compounds for the treatment of human cancers and prostate disorders 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 reimbursement of certain external costs, all subject to annual budgetary maximums. At December 31, 1998, $2,178,000 was receivable from TAP. We market STADOL NS(R) (butorphanol tartrate) Nasal Spray, a Bristol-Myers Squibb proprietary product, 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 30 amount. The decrease in amounts received from BMS in the twelve months ended December 31, 1998 is due to a reduction in the total amount of STADOL NS sales from the comparable 1997 period. Additionally, the 1997 period reflects four quarterly BMS payments while the corresponding 1998 period includes only three payments. At December 31, 1998, $630,000 was receivable from BMS. Cephalon has been developing MYOTROPHIN in collaboration with Chiron Corporation for the treatment of ALS and other neurological disorders. Under the collaboration, the costs of the program through June 30, 1998 had generally been shared equally by the two companies. The amounts we received generally represent reimbursement from Chiron for MYOTROPHIN program costs incurred in excess of our fifty percent share of program costs. Receipt of cash from Chiron in the twelve months ended December 31, 1998 has decreased from prior year's levels due to an overall reduction in our expenditures associated with the MYOTROPHIN program and because as of June 30, 1998, each party has agreed to fund their own MYOTROPHIN expenditures. Under an April 1997 agreement with Medtronic, Inc., we are co-promoting Intrathecal Baclofen Therapy (ITB(TM)) to neurologists and physiatrists in the United States for the treatment of intractable spasticity. Compensation is earned primarily on a payment per patient screen basis with the amount per patient screen increasing if annual volume targets are achieved. The increase in cash receipts from 1997 to 1998 is due to an increase in the number of patient screens performed. At December 31, 1998, $470,000 was receivable from Medtronic. The agreement with Medtronic will terminate pursuant to its terms as of April 29, 1999. In May 1992, we entered into an agreement with Kyowa Hakko Kogyo Co., Ltd. under which Kyowa Hakko is to provide us with bulk supplies of the substance K252a and certain of its derivatives for manufacture into certain of our neurology and oncology compounds. In July 1993, we entered into an agreement with Kyowa Hakko to develop and market MYOTROPHIN in Japan. The payments received from Kyowa Hakko primarily represent reimbursement of MYOTROPHIN supplies for clinical trials conducted by Kyowa Hakko in Japan and reimbursement of certain expenditures related to the K252a program. Also included in the payments received from Kyowa Hakko in 1997 is a non-recurring $900,000 milestone payment that was paid upon our filing of the MYOTROPHIN NDA in the United States. At December 31, 1998, $266,000 was receivable from Kyowa Hakko. Our research agreements with SmithKline Beecham and Schering-Plough concluded in 1997. The decrease in interest received in 1998 compared to 1997 and 1996 was primarily due to lower investment balances. --Operating Cash Outflows A summary of the cash outflows reflected in net cash used for operating activities for the year ended December 31 is as follows:
1998 1997 1996 ---- ---- ---- $(71,261,000) $(85,790,000) $(83,098,000)
Cash used in the selling, general and administrative area decreased in 1998 as compared to the corresponding 1997 period because of reductions in expenditures 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 used for selling, general and administrative activities increased in 1997 as compared to 1996 due to increased funding of sales and marketing activities, including increases in pre-marketing efforts to support products in development. The funding of research and development decreased in 1997 as compared to 1996 31 primarily due to the reduction in clinical trial expenses, including cost reductions due to the November 1996 sale of our Beltsville, Maryland pilot-scale manufacturing facility and the completion of certain clinical studies. The decrease was partially offset by the cost in 1997 of purchasing bulk modafinil compound. --Cash and Funding Requirements Outlook We believe that our cash and investment balance as of December 31, 1998 was adequate to fund the then-current level of operations for at least twelve months. We expect cash flow from operating activities to continue to be negative for the next several years. The major source of our cash inflows in 1998 was derived from our collaborative research and development agreement with TAP and from co-promotion agreements. The continuation of funding under the agreement with TAP is subject to the achievement of certain development milestones and periodic review by TAP and may be terminated without cause with prior notice. As of June 30, 1998, Cephalon and Chiron have agreed to fund their own ongoing MYOTROPHIN expenditures. We will not receive any future payments from Chiron for reimbursement of the Company's MYOTROPHIN program costs. Future receipts from Kyowa Hakko are dependent upon shipment of MYOTROPHIN to supply Kyowa Hakko's clinical trials in Japan. Additional receipts from Kyowa Hakko may be received for reimbursement of certain expenditures associated with the K252a program. The levels of potential payments to be received under our co-promotion agreements with BMS and Medtronic are subject to a number of uncertainties related to product sales, including competition from new and existing products. The agreement with BMS has been extended through December 31, 1999. The agreement with Medtronic will terminate pursuant to its terms as of April 29, 1999. Although we initiated sales of PROVIGIL in the United States in February 1999, we expect it will be at least several years, if ever, before sales from PROVIGIL will provide enough funds to generate cash inflows in excess of the present level of cash outflows from operations. In addition to the uncertainty surrounding the degree of market acceptance for a recently introduced product, factors such as competition, the effectiveness of our sales and marketing efforts and the ability to demonstrate the utility of PROVIGIL in disorders other than narcolepsy will all have an impact on PROVIGIL sales that are not predictable at this point in time. The Company expects its cash requirements for PROVIGIL to increase significantly for the next several years due to efforts associated with the commercial launch of PROVIGIL in the United States, including building PROVIGIL inventory and conducting clinical studies of PROVIGIL in disorders other than narcolepsy. Additionally, we expect to continue to expend substantial funds on research and development activities for our other products in development. We intend to seek sources of funding for these research programs through collaborative arrangements with third parties. If additional funds are unavailable, we may have to reduce our present level of spend which may involve curtailing or restructuring some of our programs. We will require substantial additional funds to continue our operations at their current level. We will need to obtain additional funding through debt and/or equity financings, collaborative arrangements or through other financing vehicles. The amount of capital needed to fund operations will depend upon many factors, including the scope of our research and development programs and the extent of any funding under collaborative research arrangements, the cost of conducting clinical studies, the cost of defending and enforcing patent claims and other legal proceedings, and the level of sales of PROVIGIL in the United States. We can not be sure that additional funds can be obtained on acceptable terms, if at all. If additional funds cannot be obtained, we will have to reduce our present level of spending which may involve curtailing or restructuring operations, including the sale of certain assets of the company. Even with such curtailment, we would not be able to eliminate fixed costs, such as occupancy expenses and debt service. 32 Net Cash Provided by Investing Activities A summary of net cash provided by investing activities for each of the years ended December 31 is as follows:
1998 1997 1996 ---- ---- ---- Purchases of property and equipment............. $ (576,000) $ (823,000) $(2,058,000) Sale leaseback of property and equipment........ -- -- 427,000 Proceeds from sale of assets.................... -- -- 17,192,000 Sales and maturities of investments, net........ 45,829,000 31,977,000 30,325,000 ----------- ----------- ----------- Net cash provided by investing activities.... $45,253,000 $31,154,000 $45,886,000 =========== =========== ===========
In November 1996, we sold the assets of our Beltsville, Maryland pilot-scale manufacturing facility for a total purchase price of $24,864,000. In the transaction, we received $17,192,000 in cash, and transferred $7,712,000 of equipment lease obligations to the purchaser. Sales and maturities of investments, net, represent the liquidation of investments. Net Cash (Used for) Provided by Financing Activities A summary of net cash (used for) provided by financing activities for each of the years ended December 31 is as follows:
1998 1997 1996 ---- ---- ---- Proceeds from exercises of common stock options and warrants.... $ 410,000 $ 3,458,000 $ 8,516,000 Proceeds from issuance of long-term debt........................ -- 30,000,000 1,838,000 Principal payments on long-term debt ........................... (1,761,000) (5,335,000) (3,919,000) ----------- ----------- ----------- Net cash (used for) provided by financing activities.......... $(1,351,000) $28,123,000 $ 6,435,000 =========== =========== ===========
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. Proceeds from the issuance of long-term debt in the year ended December 31, 1997 consists of a $30,000,000 private placement of senior convertible notes. As of December 31, 1998, the principal on the notes had been fully converted into 3,148,000 shares of Cephalon's common stock. Proceeds from the issuance of long- term debt in 1996 represent additional borrowings provided by the Commonwealth of Pennsylvania in connection with the 1995 West Chester building purchase. For all periods presented, principal payments on long-term debt include payments on mortgage loans and payments on capital lease obligations. Additionally, we paid $2,500,000 in 1996 on an unsecured bank loan and, in March 1997, repaid in full the $3,750,000 balance due on that same unsecured bank loan. Commitments and Contingencies --Related Party Cephalon Clinical Partners, L.P. (the "Partnership") granted Cephalon an exclusive license (the "Interim License") to manufacture and market MYOTROPHIN within the United States, Canada and Europe (the "Territory") in return for royalty payments equal to 10.1% of MYOTROPHIN sales and a payment of approximately $16,000,000 (the "Milestone Payment") that is to be made if MYOTROPHIN receives regulatory approval in the United States or certain other countries within the Territory. We have the option to pay the Milestone Payment in cash, common stock, or a combination thereof. 33 We have a contractual option to purchase all of the limited partnership interests in the Partnership (the "Purchase Option") in specified circumstances following the initiation of commercial sales, if any, of MYOTROPHIN. To exercise the 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 Cephalon's common stock, valued at the market price at the time the Purchase Option is exercised. In addition to the advance payment, the exercise of the Purchase Option requires us to make royalty payments to the former limited partners for a period of eleven years after exercise at a royalty rate of 10.1% (subject to reduction under certain circumstances) of MYOTROPHIN sales in the Territory. If we do not exercise the Purchase Option prior to its expiration date the Interim License will terminate and all development and marketing rights to MYOTROPHIN in the Territory would revert to the Partnership, which may commercialize MYOTROPHIN itself or license or assign its rights to a third party. We would not receive any benefits from any such commercialization, license or assignment of rights. Late in 1995, the Partnership depleted all of its available funding and has not provided further funding of MYOTROPHIN development costs. The amount of additional funding required for further development is determined by the Partnership's general partner in advance of each quarter, and each quarter, we have the right, but not the obligation, to contribute such funds. If we decide to discontinue funding of the MYOTROPHIN program, the Purchase Option and Interim License will terminate and commercialization rights to MYOTROPHIN will revert back to the Partnership, as described in the preceding paragraph. The January 1994 collaboration between Cephalon and Chiron is subject to the rights of the Partnership. We are solely responsible for making any royalty and milestone payments owed to the Partnership and for funding any exercises of the Purchase Option. The general partner of the Partnership is a wholly-owned subsidiary of Cephalon, which owns 1% of the Partnership. --Shareholder Litigation Cephalon, a current director and officer, and a former officer have been named as defendants in a number of civil actions, which have been consolidated into a single class action, alleging that statements made about the results of certain clinical studies of MYOTROPHIN were misleading. Due to our involvement in promoting STADOL NS, a product of Bristol-Myers Squibb, we are a co-defendant in a recent product liability action brought against BMS. 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." A summary of revenues and expenses for each of the years ended December 31 is as follows:
% CHANGE % CHANGE 1998 VS. 1997 VS. 1998 1997 1996 1997 1996 ---- ---- ---- ---- --------- Revenues....................................... $15,655,000 $23,140,000 $21,366,000 (32)% 8% Research and development expenses.............. 43,649,000 51,587,000 62,096,000 (15) (17) Selling, general and administrative expenses... 30,947,000 36,744,000 28,605,000 (16) 28 Interest income, net........................... 3,534,000 4,772,000 6,205,000 (26) (23) Gain on sale of assets......................... -- -- 9,845,000 -- (100)
34 Year ended December 31, 1998 compared to year ended December 31, 1997 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. These decreases were partially offset by revenue from initial sales of PROVIGIL in the United Kingdom although such sales were not material. 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. 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 expenses related to a certain co-promotion agreement. Net interest income decreased in 1998 due primarily to lower investment balances throughout the year as compared to the corresponding 1997 period. Year ended December 31, 1997 compared to year ended December 31, 1996 The increase in revenues for 1997 as compared to 1996 resulted primarily from increases in revenue recognized under the Chiron collaboration, the Kyowa Hakko MYOTROPHIN agreement and the TAP agreement, and revenue recognized from the initiation of a co-promotion agreement with Medtronic. The increases in revenues were partially offset by a decrease in revenue in 1997 from Schering-Plough due to the conclusion of its funding of a research program. Research and development expenses decreased in 1997 as compared to 1996 primarily due to the reduction in clinical trial expenses, including cost reductions due to the November 1996 sale of our Beltsville, Maryland pilot-scale manufacturing facility and the completion of certain clinical studies. The decrease was partially offset by an increase in expenditures due to the purchase of bulk modafinil compound, the active drug substance in PROVIGIL Tablets, an increase in expenditures in our research programs and certain license fees payable in accordance with third-party agreements. The increase in selling, general and administrative expenses in 1997 as compared to 1996 was primarily due to increases in expenses incurred in our U.S. and European sales and marketing organizations including increases in pre- marketing efforts in support of the products in development and expenses associated with a co-promotion agreement. The decrease in net interest income in 1997 as compared to 1996 was primarily due to an increase in interest expense associated with senior convertible notes. In 1996, we realized a $9,845,000 gain in connection with the sale of assets at our Beltsville, Maryland pilot-scale manufacturing facility. Results of Operations Outlook We initiated sales of PROVIGIL for narcolepsy in the U.S. in February 1999. We expect that sales of PROVIGIL may be limited since we can only market the product to treat excessive daytime sleepiness associated with narcolepsy. As a result, we expect to continue to incur operating losses for at least several years. We may never be able to achieve profitability solely through sales of PROVIGIL even if we obtain approval to market the product to treat other disorders. We do not expect sales of PROVIGIL in the United Kingdom to provide a significant source of revenue for at least several years. 35 The major source of our current revenue is derived 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. Additionally, all agreements have termination clauses allowing either party to end the funding under those agreements. Without these sources of revenue, operating losses would increase. In the next several years, we expect our expenditures associated with PROVIGIL to increase including expenses related to marketing and selling a commercial product and expenses incurred in conducting clinical studies of PROVIGIL in disorders other than narcolepsy. Additionally, we expect to continue to incur substantial expenses on research and development activities for our other products in development. We intend to seek sources of funding for these programs through collaborative arrangements with third parties. We do not believe that inflation has had a material impact on the results of its operations since inception. SUBSEQUENT EVENT On February 25, 1999, we completed a debt offering totaling $30,000,000, raised through the private sale of revenue-sharing notes (the "Notes"). The Notes are repayable in cash in February 2002. The Notes are secured by our U.S. rights to PROVIGIL (the "Pledged Assets") and bear an annual interest rate of 11%. Investors in the Notes also will receive a royalty of 6% on U.S. sales of PROVIGIL for up to five years. We have the right to redeem the Notes at a premium prior to maturity, which would reduce the royalty period to four years and may extend the maturity and the royalty by one year under certain circumstances. The Notes contain a number of covenants including a requirement to maintain a minimum level of cash and investments equal to $40,000,000 during 1999 and $30,000,000 thereafter as long as the principal remains outstanding. If we fail to maintain such cash balances or violate the other covenants, the holders of the Notes can declare a default and increase the royalty percentage to 25% of U.S. PROVIGIL sales and, if the default is not cured within one year, can accelerate the due date of the Notes and foreclose on the Pledged Assets. The holders of the Notes can also foreclose on the Pledged Assets if we fail to pay principal and interest when due. The Notes are not convertible into common stock. The offering also includes the issuance of five-year warrants to purchase 1,920,000 shares of Cephalon common stock with an exercise price of $10.08. The investors will forfeit 480,000 warrants if specified PROVIGIL sales levels are achieved. In addition, we may redeem up to 720,000 of the remaining warrants after three years if the market value of Cephalon common stock exceeds certain thresholds. IMPACT OF YEAR 2000 The "Year 2000 Issue" is typically the result of software and firmware being written using two digits rather than four to define the applicable year. If our software and firmware with date-sensitive functions are not Year 2000 compliant, these systems may recognize a date using "00" as the year 1900 rather than the year 2000. This could result in a system failure or miscalculations causing disruptions of operations, including, among other things, interruptions in research and development operations or the inability to engage in normal business activities. We have developed a multi-step Year 2000 readiness plan for its internal systems. The plan includes development of corporate awareness, assessment of internal systems, project planning, project implementation (including remediation, upgrading and replacement where necessary), validation testing and contingency planning. We are currently conducting a review of our information technology systems to identify the systems that could be adversely affected by the Year 2000 problem. We believe that, with minor modifications and testing of our systems, the Year 2000 issue will not pose a significant operational problem. We are using our internal resources to reprogram or replace and test our software for Year 2000 modifications. If we are unable to make the required modifications to existing software or convert to new software in a timely manner, the Year 2000 Issue could have an impact on operations, although we do not believe this impact will be material. 36 We have initiated formal communication with significant suppliers and third party vendors to determine the extent to which operations are vulnerable to those third parties' failure to remediate their own Year 2000 hardware and software issues. Our primary focus to date has been on research and development activities that do not rely heavily on third-party systems. However, third parties perform certain activities related to commercialization of our products, including product manufacturing and distribution, order entry, shipping and billing, and sales tracking. We have asked our suppliers and vendors to inform us of the status of the Year 2000 compliance of their products and we are aware that certain of our suppliers and vendors are not currently Year 2000 compliant. These parties have communicated to us that they are taking appropriate remediation steps, and we intend to monitor their progress. We will continue to seek information from non-responsive suppliers and vendors and we plan to contact additional suppliers. In addition, in all new contract negotiations, we are asking suppliers to warrant that products sold or licensed to us are Year 2000 compliant. In the event that any of our significant suppliers are unable to become Year 2000 compliant, our business or operations could be adversely affected. We cannot be sure that the systems of other companies on which we rely will be compliant on or before January 1, 2000 and will not have an adverse effect on our operations. We do not expect the total cost associated with required modifications to become Year 2000 compliant to be material. We are funding the minimal expenditures of the Year 2000 project through existing cash on hand. We anticipate completing the critical Year 2000 issues by the first half of 1999, which is prior to any anticipated impact on our operating systems, and expect the Year 2000 project to continue beyond January 1, 2000 with respect to resolution of non-critical issues. We have not yet fully developed a comprehensive contingency plan addressing situations that may result if we are unable to achieve Year 2000 readiness of our critical operations. We can not be sure that we will be able to develop a contingency plan that will adequately address issues that may arise in the year 2000. Finally, the Company we are also vulnerable to external forces that might generally affect industry and commerce, such as utility or transportation company Year 2000 compliance failures and related service interruptions. The costs of the project and the completion date of the Year 2000 modifications are based on our best estimates. These estimates were derived utilizing numerous assumptions of future events, including the continued availability of certain resources, third-party modification plans and other factors. We can not be sure that these estimates will be achieved and actual results could differ materially from those anticipated. ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK We do not hold any investments in market risk sensitive instruments. Accordingly, we believe that we are not subject to any material risks arising from changes in interest rates, foreign currency exchange rates, commodity prices, equity prices or other market changes that affect market risk sensitive instruments. 37 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, 1998 and 1997, and the related consolidated statements of operations, stockholders' equity and cash flows for each of the three years in the period ended December 31, 1998. 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 generally accepted auditing standards. 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, 1998 and 1997, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 1998, in conformity with generally accepted accounting principles. Arthur Andersen LLP Philadelphia, Pennsylvania February 25, 1999 38 CEPHALON, INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS
December 31, December 31, 1998 1997 -------------- -------------- ASSETS CURRENT ASSETS: Cash and cash equivalents (Note 2) $3,975,000 $10,271,000 Reverse repurchase agreements (Note 2) 3,509,000 27,414,000 Short-term investments (Note 2) 59,862,000 81,786,000 Accounts receivable - contract 3,887,000 5,039,000 Other 1,361,000 2,641,000 -------------- -------------- Total current assets 72,594,000 127,151,000 PROPERTY AND EQUIPMENT, net of accumulated depreciation and amortization of $13,439,000 and $11,099,000 (Note 3) 20,505,000 21,853,000 OTHER 1,574,000 2,204,000 -------------- -------------- $94,673,000 $151,208,000 ============== ============== LIABILITIES AND STOCKHOLDERS' EQUITY CURRENT LIABILITIES: Accounts payable $3,558,000 $2,724,000 Accrued expenses (Note 4) 13,298,000 16,075,000 Current portion of long-term debt (Note 5) 1,624,000 1,734,000 -------------- -------------- Total current liabilities 18,480,000 20,533,000 LONG-TERM DEBT (Note 5) 15,096,000 27,587,000 OTHER (Note 6) 3,495,000 2,750,000 -------------- -------------- Total liabilities 37,071,000 50,870,000 -------------- -------------- COMMITMENTS AND CONTINGENCIES (Note 7) STOCKHOLDERS' EQUITY: (Note 8) Preferred stock, $.01 par value, 5,000,000 shares authorized, none issued -- -- Common stock, $.01 par value, 100,000,000 shares authorized, 28,802,323 and 27,395,254 shares issued and outstanding 288,000 274,000 Additional paid-in capital 331,673,000 318,753,000 Treasury stock (487,000) (259,000) Accumulated deficit (273,793,000) (218,386,000) Cumulative translation adjustment (79,000) (44,000) -------------- -------------- Total stockholders' equity 57,602,000 100,338,000 -------------- -------------- $94,673,000 $151,208,000 ============== ============== The accompanying notes are an integral part of these financial statements.
39 CEPHALON, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS
Year Ended December 31, -------------------------------------------------- 1998 1997 1996 --------------- --------------- --------------- REVENUES: (Note 9) $15,655,000 $23,140,000 $21,366,000 OPERATING EXPENSES: Research and development 43,649,000 51,587,000 62,096,000 Selling, general and administrative 30,947,000 36,744,000 28,605,000 -------------- -------------- -------------- 74,596,000 88,331,000 90,701,000 -------------- -------------- -------------- LOSS FROM OPERATIONS (58,941,000) (65,191,000) (69,335,000) INTEREST: Income 5,408,000 7,973,000 8,491,000 Expense (Note 5) (1,874,000) (3,201,000) (2,286,000) -------------- -------------- -------------- 3,534,000 4,772,000 6,205,000 -------------- -------------- -------------- GAIN ON SALE OF ASSETS -- -- 9,845,000 -------------- -------------- -------------- LOSS (Note 10) $(55,407,000) $(60,419,000) $(53,285,000) ============= ============= ============= BASIC AND DILUTED LOSS PER SHARE (Note 1) $(1.95) $(2.36) $(2.19) ============= ============= ============= WEIGHTED AVERAGE NUMBER OF SHARES OUTSTANDING 28,413,220 25,637,508 24,319,163 ============= ============= ============= The accompanying notes are an integral part of these financial statements.
40 CEPHALON, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
Accumulated Total Other Comprehensive Accumulated Comprehensive Common Loss Total Deficit Income/(Loss) Stock --------------- -------------- ----------------- --------------- ------------- BALANCE, JANUARY 1, 1996 $ 180,205,000 $ (104,682,000) $ 14,000 $ 238,000 Loss $(53,285,000) (53,285,000) (53,285,000) Foreign currency (57,000) translation -------------- Other comprehensive loss (57,000) (57,000) (57,000) -------------- Comprehensive loss $(53,342,000) ============== Stock options and warrants exercised 8,152,000 -- 8,000 Restricted stock award plan 2,073,000 -- -- Employee benefit plan 529,000 -- -- Treasury stock acquired (291,000) -- -- --------------- ---------------- ----------- ------------- BALANCE, DECEMBER 31, 1996 $ 137,326,000 $ (157,967,000) $ (43,000) $ 246,000 Loss $(60,419,000) (60,419,000) (60,419,000) Foreign currency (1,000) translation -------------- Other comprehensive loss (1,000) (1,000) (1,000) -------------- Comprehensive loss $(60,420,000) ============== Stock options and warrants exercised 4,023,000 -- 3,000 Restricted stock award plan 1,164,000 -- 1,000 Employee benefit plan 605,000 -- -- Conversion of convertible debentures 17,695,000 -- 20,000 Issuance of warrants in connection 400,000 -- -- with convertible debentures transactions Expired call option (1,973,000) -- 5,000 Treasury stock acquired (455,000) -- -- Treasury stock retirement 1,973,000 -- (1,000) --------------- ----------------- ----------- ------------- BALANCE, DECEMBER 31, 1997 $ 100,338,000 $ (218,386,000) $ (44,000) $ 274,000 Loss $(55,407,000) (55,407,000) (55,407,000) Foreign currency (35,000) translation --------------- Other comprehensive loss (35,000) (35,000) (35,000) --------------- Comprehensive loss $(55,442,000) =============== Stock options and warrants exercised 216,000 -- -- Restricted stock award plan 1,500,000 -- 1,000 Employee benefit plan 583,000 -- 1,000 Conversion of convertible debentures 10,635,000 -- 12,000 Treasury stock acquired (228,000) -- -- ---------------- --------------- ----------- ------------- BALANCE, DECEMBER 31, 1998 $57,602,000 $(273,793,000) ($79,000) $288,000 ================ =============== =========== ============= Additional Paid-in Treasury Capital Stock ------------ ------------ BALANCE, JANUARY 1, 1996 $286,122,000 $ (1,487,000) Loss Foreign currency translation Other comprehensive loss Comprehensive loss Stock options and warrants exercised 8,144,000 -- Restricted stock award plan 2,073,000 -- Employee benefit plan 529,000 -- Treasury stock acquired -- (291,000) ------------ ------------ BALANCE, DECEMBER 31, 1996 $296,868,000 $ (1,778,000) Loss Foreign currency translation Other comprehensive loss Comprehensive loss Stock options and warrants exercised 4,020,000 -- Restricted stock award plan 1,163,000 -- Employee benefit plan 605,000 -- Conversion of convertible debentures 17,675,000 -- Issuance of warrants in connection 400,000 with convertible debentures transactions Expired call option (1,978,000) -- Treasury stock acquired -- 455,000 Treasury stock retirement -- 1,974,000 ------------ ------------ BALANCE, DECEMBER 31, 1997 $318,753,000 $ (259,000) Loss Foreign currency translation Other comprehensive loss Comprehensive loss Stock options and warrants exercised 216,000 -- Restricted stock award plan 1,499,000 -- Employee benefit plan 582,000 -- Conversion of convertible debentures 10,623,000 -- Treasury stock acquired -- (228,000) ------------ ------------ BALANCE, DECEMBER 31, 1998 $331,673,000 $ (487,000) ============ ============ 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, -------------------------------------------------------------------- 1998 1997 1996 ------------------------ -------------------- -------------------- CASH FLOWS FROM OPERATING ACTIVITIES: Loss $(55,407,000) $(60,419,000) $(53,285,000) Adjustments to reconcile loss to net cash used for operating activities: Depreciation and amortization 2,340,000 2,247,000 4,198,000 Gain on sale of assets -- -- (9,845,000) Non-cash compensation expense 1,854,000 1,811,000 2,602,000 Other 47,000 157,000 -- (Increase) decrease in operating assets: Accounts receivable - contract 1,152,000 247,000 (2,262,000) Other current assets 1,157,000 (186,000) 4,102,000 Other long-term assets (109,000) (1,656,000) 121,000 Increase (decrease) in operating liabilities: Accounts payable 874,000 1,086,000 (2,741,000) Accrued liabilities (2,851,000) 1,289,000 2,947,000 Other long-term liabilities 745,000 747,000 948,000 ------------------- -------------------- -------------------- Net cash used for operating activities (50,198,000) (54,677,000) (53,215,000) ------------------- -------------------- -------------------- CASH FLOWS FROM INVESTING ACTIVITIES: Purchases of property and equipment (576,000) (823,000) (2,058,000) Sale leaseback of property and equipment -- -- 427,000 Proceeds from sale of assets -- -- 17,192,000 Sales and maturities of investments, net 45,829,000 31,977,000 30,325,000 ------------------- -------------------- -------------------- Net cash provided by investing activities 45,253,000 31,154,000 45,886,000 ------------------- -------------------- -------------------- CASH FLOWS FROM FINANCING ACTIVITIES: Proceeds from exercises of common stock options and warrants 410,000 3,458,000 8,516,000 Proceeds from issuance of long-term debt -- 30,000,000 1,838,000 Principal payments on long-term debt (1,761,000) (5,335,000) (3,919,000) ------------------- -------------------- -------------------- Net cash (used for) provided by financing activities (1,351,000) 28,123,000 6,435,000 ------------------- -------------------- -------------------- NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS (6,296,000) 4,600,000 (894,000) CASH AND CASH EQUIVALENTS, BEGINNING OF YEAR 10,271,000 5,671,000 6,565,000 ------------------- -------------------- -------------------- CASH AND CASH EQUIVALENTS, END OF YEAR $3,975,000 $10,271,000 $5,671,000 =================== ==================== ==================== 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, PA, is an international biopharmaceutical company dedicated to the discovery, development and marketing of products to treat neurological disorders and cancer. The Company has had negative cash flow from operations since inception and has funded its operations primarily from the proceeds of public and private placements of its equity securities. The Company has only recently initiated sales of its first approved product, PROVIGIL(R) (modafinil) Tablets [C-IV] ("PROVIGIL Tablets" or "PROVIGIL"), in the United States for use by those suffering from excessive daytime sleepiness associated with narcolepsy. The Company's business is subject to a number of significant risks, including the risks inherent in pharmaceutical research and development activities. The Company is highly dependent upon the successful commercialization of PROVIGIL and there is no assurance that the Company will achieve profitability solely on sales of PROVIGIL in the United States. PRINCIPLES OF CONSOLIDATION The consolidated financial statements include the results of operations of the Company and its wholly owned subsidiaries. Intercompany transactions have been eliminated. 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 reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. FIXED ASSETS AND DEPRECIATION Buildings, property and equipment are stated at cost and depreciated using the straight-line method over the estimated 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. The Company's 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, 1998. Expenditures for maintenance and repairs are charged to expense as incurred, while major renewals and betterments are capitalized. REVENUE RECOGNITION On contracts in which the Company receives payments based upon the level of its 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 the Company's co-promotion agreements, revenue is recognized upon the achievement of the stipulated sales activity and performance 43 CEPHALON, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) targets. Under agreements to supply product for clinical trials, the Company recognizes revenue upon shipment. (See Note 9). RESEARCH AND DEVELOPMENT All research and development costs are expensed as incurred. 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 the Company's debt instruments that are outstanding as of December 31, 1998 have readily ascertainable market values; however, the carrying values are considered to approximate their respective fair values. LOSS PER SHARE Statement of Financial Standards No. 128 "Earning per Share" requires dual presentation of basic and diluted earnings per share ("EPS") for complex capital structures on the face of the income statement. Basic EPS is computed by dividing net income by the weighted-average number of common shares outstanding during the period. Diluted EPS is similar to basic EPS except that the effect of converting or exercising all potential dilutive securities also is included in the denominator. For the years ended December 31, 1998, 1997 and 1996, the Company's calculation of diluted EPS excludes stock options, restricted stock awards, warrants and the conversion of convertible notes since their inclusion would be antidilutive. 2. CASH, CASH EQUIVALENTS AND INVESTMENTS At December 31, cash, cash equivalents and investments consisted of the following:
1998 1997 ---- ---- Cash and cash equivalents.......................... $ 3,975,000 $ 10,271,000 Reverse repurchase agreements collateralized by U.S. Treasury securities......................... 3,509,000 27,414,000 Short-term investments U.S. government obligations...................... 49,830,000 76,789,000 Commercial paper................................. 10,032,000 -- Other corporate obligations...................... -- 4,997,000 ----------- ------------ 59,862,000 81,786,000 $67,346,000 $119,471,000 =========== ============
The Company considers all highly liquid instruments purchased with an original maturity of three months or less to be cash equivalents. The Company's short-term investments consisted primarily of short to intermediate-term corporate obligations, overnight investments that are backed by collateral in the form of government securities with a value equal to at least 102% of such investments and short to intermediate-term obligations of the United States government. These securities are held in a trust account with a commercial bank on behalf of the Company. The Company believes that the quantity and quality of the collateral are sufficient to secure its investment in these instruments. All of the Company's investments in debt securities at December 31, 1998 mature in 1999. 44 CEPHALON, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) In accordance with SFAS No. 115, "Accounting for Certain Investments in Debt and Equity Securities," the Company considers its investments as being "available for sale." The Company classifies these investments as short-term and records them at fair market value. The unrealized gains and losses in each of the three years ended December 31, 1998 were immaterial. Certain of the Company's lease agreements contain covenants that obligate the Company to maintain certain minimum cash and investment balances (see Note 5). 3. PROPERTY AND EQUIPMENT: At December 31, property and equipment consisted of the following:
1998 1997 ---- ---- Land and buildings...................................... $ 20,046,000 $ 19,629,000 Laboratory and office equipment......................... 13,898,000 13,323,000 ------------ ------------ 33,944,000 32,952,000 Less allowances for depreciation and amortization....... (13,439,000) (11,099,000) ------------ ------------ Property and equipment, net............................. $ 20,505,000 $ 21,853,000 ============ ============
4. ACCRUED EXPENSES At December 31, accrued expenses consisted of the following:
1998 1997 ---- ---- Accrued compensation and benefits.................... $ 876,000 $ 964,000 Accrued professional and consulting fees............. 2,556,000 1,258,000 Accrued clinical trial fees and related expenses..... 2,177,000 2,320,000 Accrued license fees and royalties................... 2,096,000 2,627,000 Accrued co-promotion expenses........................ 118,000 2,491,000 Accrued litigation-related costs..................... 4,838,000 4,896,000 Other accrued expenses............................... 637,000 1,519,000 ----------- ----------- $13,298,000 $16,075,000 =========== ===========
5. LONG-TERM DEBT At December 31, long-term debt consisted of the following:
1998 1997 ---- ---- Capital lease obligations...... $ 1,335,000 $ 1,682,000 Mortgage loans................. 15,385,000 16,313,000 Senior convertible notes....... -- 11,326,000 ----------- ----------- 16,720,000 29,321,000 Less current portion........... (1,624,000) (1,734,000) ----------- ----------- Long-term debt................. $15,096,000 $27,587,000 =========== ===========
Aggregate maturities of long-term debt for the next five years are as follows: 1999--$1,624,000; 2000--$1,642,000; 2001--$1,374,000; 2002--$1,212,000; 2003--$1,258,000; 2004 and thereafter--$9,610,000. The current portion of long- term debt consists of payments due on the capital lease obligations and mortgage loans. The Company paid interest related to debt instruments of $1,170,000, $2,242,000, and $1,388,000 in 1998, 1997 and 1996, respectively. 45 CEPHALON, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) SENIOR CONVERTIBLE NOTES In April 1997, the Company completed a $30,000,000 private placement of senior convertible notes. As of December 31, 1997, $18,674,000 in principal of the notes had been converted into 1,938,000 shares of common stock. As of December 31, 1998, the remaining balance of $11,326,000 in principal of the notes was converted into 1,210,000 shares of common stock. CAPITAL LEASE OBLIGATIONS The Company currently leases laboratory, production and computer equipment with a cost of $3,352,000 under lease agreements. Under the terms of the agreements, the Company must maintain a minimum balance in unrestricted cash and 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, 1998, the balance due under the lease agreements was $1,335,000. Both agreements provide the Company with an option to purchase the leased equipment. MORTGAGE LOANS In March 1995, the Company purchased the buildings housing its administrative offices and research facilities in West Chester, Pennsylvania for $11,000,000. The Company financed the purchase through the assumption of an existing $6,900,000 first mortgage and from $11,600,000 in mortgage loans provided by the Commonwealth of Pennsylvania (the "State Funding"), a portion of which was used to finance building improvements and $2,700,000 was held in escrow to fund future improvements. At December 31, 1998, the remaining escrow balance, including earned interest, was $1,404,000. The first mortgage has a 15- year term with an annual interest rate of 95/8%. The State Funding has a 15-year term with an annual interest rate of 2%. The 2% interest rate is subject to increase to prime plus 2% if the Company fails to hire a specified number of new employees in Chester County, Pennsylvania by the end of 1999. The Company is presently paying interest at the 2% rate and is accruing interest at the higher rate. The mortgage loans require annual aggregate principal and interest payments of $1,800,000. The mortgage loans are secured by the buildings and fixtures therein and a portion of the State Funding is also secured by all Company equipment located in Pennsylvania that is otherwise unsecured. 6. OTHER LIABILITIES At December 31, other liabilities consisted of the following:
1998 1997 ---- ---- Accrued long-term interest..... $3,210,000 $2,372,000 Deferred compensation.......... 285,000 378,000 ---------- ---------- $3,495,000 $2,750,000 ========== ==========
7. COMMITMENTS AND CONTINGENCIES LEASES The Company leases certain of its offices and automobiles under operating leases. The Company does not consider its future annual minimum payments under these leases to be material. In November 1996, the remaining operating lease obligations of the Company's former manufacturing facility were transferred to the purchaser of the 46 CEPHALON, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) facility. Lease expense under all operating leases totaled $866,000, $725,000, and $3,423,000 in 1998, 1997, and 1996, respectively. RELATED PARTY In August 1992, Cephalon exclusively licensed to Cephalon Clinical Partners, L.P. (the "Partnership") rights to manufacture and market MYOTROPHIN(R) (mecasermin) Injection ("MYOTROPHIN Injection" or "MYOTROPHIN") for human therapeutic use within the United States, Canada and Europe (the "Territory") Through a concurrent offering of 900 limited partnership interests, the Partnership raised approximately $38,714,000 in net proceeds. In August 1995, the Company purchased 67 limited partnership interests and recorded the acquisition cost as in-process research and development expense in accordance with SFAS No. 2 "Accounting for Research and Development Costs." A total of 27 1/2 limited partnership interests were canceled following default on payments due to the Partnership. There are currently 805 1/2 limited partnership interests held by third parties. The Company is performing the development and clinical testing of MYOTROPHIN on behalf of the Partnership and the Company's costs incurred to develop MYOTROPHIN in the Territory were reimbursed by the Partnership to the extent of its available funds and subject each year to the Partnership Development Agreement budget for that year. Late in 1995, the Partnership depleted all of its available funding and will not provide further funding of MYOTROPHIN development costs to the Company. The amount of additional funding required for further development will be determined by the Partnership's general partner in advance of each quarter, and each quarter, the Company will have the right, but not the obligation, to contribute such funds. In exchange for the exclusive license to MYOTROPHIN, Cephalon is obligated to make royalty payments equal to 10.1% of MYOTROPHIN sales and a payment of approximately $16,000,000 (the "Milestone Payment") that is to be made if MYOTROPHIN receives regulatory approval in the United States or certain other countries within the Territory. The Company has the option to pay the Milestone Payment in cash, common stock, or a combination thereof. The Company has a contractual option to purchase all of the limited partnership interests in the Partnership (the "Purchase Option"). To exercise the Purchase Option, Cephalon is required to make an advance payment of $40,275,000 in cash or, at Cephalon's election, $42,369,000 in shares of the Company's Common Stock, valued at the market price at the time the Purchase Option is exercised. The Purchase Option will become exercisable for a 45-day period commencing on the date which is the earlier of (a) the date which is the later of (i) the last day of the first month in which the Partnership shall have received Interim License payments equal to fifteen percent (15%) of the limited partners' capital contributions (excluding the Milestone Payment), and (ii) the last day of the 24th full month after the date of the Company's first commercial sale, if any, of MYOTROPHIN within the Territory that generates a payment to the Partnership, and (b) the last day of the 48th full month after the date of such first commercial sale, if any, in the Territory. In addition to the advance payment, the exercise of the Purchase Option requires the Company to make future payments to the former limited partners for a period of eleven years after exercise at a royalty rate of 10.1% (reducing to 5.0% after a specified return is earned by the former limited partners) of MYOTROPHIN sales in the Territory, provided that royalties on MYOTROPHIN sales in Europe will only be paid to the extent necessary to meet specified sales targets. If the Company does not exercise the Purchase Option prior to its expiration date the Interim License will terminate and all development and marketing rights to MYOTROPHIN in the Territory would revert to the Partnership, which may commercialize MYOTROPHIN itself or license or assign its rights to a third party. The Company would not receive any benefits from any such commercialization, license or assignment of rights. The current general partner of the Partnership is a wholly-owned subsidiary of the Company, which owns 1% of the Partnership. The board of directors of the Partnership is 50% controlled by a third-party investor. The 47 CEPHALON, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) general partner cannot adversely modify the economic terms of the Partnership without a vote of the limited partners. The general partner may be removed at any time by a vote of the limited partners. The obligations of the general partner include enforcing agreements entered into by the Partnership, prosecuting and defending the intellectual property owned by the Partnership and entering into loan agreements and other transactions on behalf of the Partnership. No such borrowings, commitments, or obligations are outstanding. The January 1994 collaboration between the Company and Chiron Corporation ("Chiron") is subject to the rights of the Partnership. The Company is solely responsible for making any royalty and milestone payments owed to the Partnership and is responsible for funding the Purchase Option if it exercises the option. LEGAL PROCEEDINGS The Company, a current director and officer, and a former officer have been named as defendants in a number of civil actions filed in the U.S. District Court for the Eastern District of Pennsylvania, which have been consolidated into a single class action. The plaintiff class is comprised of those persons and entities who purchased Cephalon common stock, or traded in options to buy or sell Cephalon common stock, during the period June 12, 1995 through and including June 7, 1996. Plaintiffs seek to hold defendants liable for stock trading losses that stem from alleged violations of the U.S. securities laws and alleged common law negligent misrepresentation. More specifically, plaintiffs have alleged that statements by the Company and the named defendants relating to the results of certain clinical studies of MYOTROPHIN were misleading. A judgment in this matter could materially exceed the coverage which may be available under its directors' and officers' liability insurance. The Company is vigorously defending this lawsuit and believes that there are valid defenses against the claims, but the defense of the action is expensive, and the costs of defense will reduce the available insurance coverage that might otherwise be available to satisfy the claims. In an effort to resolve this dispute, in January 1999 the Company engaged a mediator to initiate a non-binding mediation process and commenced discussions with counsel for the lead plaintiffs. At this time, the Company is not able to determine with any certainty the outcome of this action or its potential liability. Due to the Company's involvement in promoting STADOL NS(R) (butorphanol tartrate) Nasal Spray, a product of Bristol-Myers Squibb, the Company is a co- defendant in a product liability action brought against BMS. Although the Company cannot predict with certainty the outcome of this litigation, it believes that any expenses or damages that are incurred will be paid by BMS under the indemnification provisions of the co-promotion agreement. As such, the Company does not believe that these actions will have a negative effect on the Company's financial condition or results of operations. 8. STOCKHOLDERS' EQUITY EQUITY COMPENSATION PLANS The Company 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 the Company's Board of Directors. The Company may grant either non-qualified or incentive stock options under both plans, and may also 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. 48 CEPHALON, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) The following tables summarize the aggregate option activity under both plans:
1998 1997 1996 ------------------- -------------------- ------------------- WEIGHTED WEIGHTED WEIGHTED AVERAGE AVERAGE AVERAGE EXERCISE EXERCISE EXERCISE SHARES PRICE SHARES PRICE SHARES PRICE ------ ----- ------ ----- ------ ----- Outstanding, January 1, 3,518,258 $13.96 3,181,020 $14.07 2,942,697 $17.72 Granted 1,009,000 8.18 873,520 12.94 583,835 19.27 Exercised (57,379) 10.21 (223,493) 8.27 (140,574) 7.83 Canceled (435,580) 16.20 (312,789) 19.16 (204,938) 19.83 --------- ------ --------- ------ --------- ------ Outstanding, December 31, 4,034,299 $12.42 3,518,258 $13.96 3,181,020 $14.07 ========= ====== ========= ====== ========= ====== Exercisable at end of year 2,279,718 $13.31 1,961,945 $12.93 1,722,378 $11.88 Weighted average fair value of $ 4.75 $ 7.67 $11.48 options granted during the year
OPTIONS OUTSTANDING OPTIONS EXERCISABLE ---------------------------------------------------- ------------------------------ WEIGHTED AVERAGE WEIGHTED WEIGHTED REMAINING AVERAGE AVERAGE RANGE OF EXERCISE PRICE OPTIONS CONTRACTUAL LIFE EXERCISE PRICE OPTIONS EXERCISE PRICE - ----------------------- ------- ---------------- -------------- ------- -------------- $ .30 - $ 9.00 1,651,060 7.9 years $ 7.49 722,825 $ 7.12 $ 9.01 - $14.00 1,167,761 6.8 $11.24 645,904 $11.31 $14.01 - $31.00 1,215,478 6.0 $20.26 910,989 $19.64 --------- --------- 4,034,299 7.0 $12.42 2,279,718 $13.31 ========= =========
At December 31, 1998, 569,012 shares were available for future grants under the plans. During 1998, 1997 and 1996, the Company received proceeds of $410,000, $2,205,000 and $1,127,000, respectively, from the exercise of stock options. The following table summarizes restricted stock award activity for the years ended December 31:
RESTRICTED STOCK AWARDS --------------------------------------------------------------------------------- 1998 1997 1996 ---- ---- ---- Outstanding, January 1, 237,825 190,700 140,000 Granted 142,450 113,450 85,700 Vested (77,100) (54,325) (35,000) Canceled (9,400) (12,000) -- ---------- ---------- ---------- Outstanding, December 31, 283,775 237,825 190,700 Compensation expense recognized $1,494,000 $1,679,000 $2,073,000
49 CEPHALON, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED) Effective in 1996, Cephalon adopted the disclosure requirements of Statement of Financial Accounting Standards No. 123 ("SFAS 123"), "Accounting for Stock-Based Compensation." As permitted under SFAS 123, the Company applies APB No. 25 and related interpretations. All options granted under the plans to date have been with exercise prices equal to the fair market value of the stock on the date of grant. Accordingly, under APB No. 25, no compensation expense for employees has been recognized for its stock-based compensation plans other than for its restricted stock awards. If the Company had elected to recognize compensation cost based on the fair value of the options as prescribed by SFAS 123, pro forma loss and loss per share amounts would have been reflected as set forth below:
1998 1997 1996 ---- ---- ---- As reported Loss $(55,407,000) $(60,419,000) $(53,285,000) Basic and diluted loss per share $ (1.95) $ (2.36) $ (2.19) Pro forma Loss $(60,659,000) $(62,315,000) $(58,885,000) Basic and diluted loss per share $ (2.13) $ (2.43) $ (2.42)
The effects of applying SFAS 123 in this pro forma disclosure are not indicative of future amounts since SFAS 123 does not apply to awards prior to 1995, and additional awards in future years are anticipated. The fair value of the options granted during 1998, 1997 and 1996 were estimated on the date of grant using the Black-Scholes option-pricing model based on the following assumptions:
1998 1997 1996 ---- ---- ---- Risk free interest rate 5.23% 6.35% 6.11% Expected life 6 years 6 years 6 years Expected volatility 56% 56% 56% Expected dividend yield 0% 0% 0%
QUALIFIED SAVINGS AND INVESTMENT PLAN The Company has 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 the Company in cash or a combination of cash and shares of the Company's common stock. For the years 1998, 1997 and 1996, the Company contribution was 100% of the first 6% of employee salaries contributed in the ratio of 50% cash and 50% Company stock. The Company contributed $1,155,000, $1,090,000, and $1,106,000 in cash and common stock to the plan for the years 1998, 1997, and 1996, respectively. WARRANTS AND OTHER OPTIONS In April 1997, the Company issued warrants to purchase 84,000 shares of the Company's common stock at an exercise price of $24.77 per share to the placement agent in connection with the private placement of the Company's senior convertible notes (see Note 5). In February 1994, the Company issued to Chiron a warrant to purchase 750,000 shares of common stock with an exercise price of $18.50 per share. 50 CEPHALON, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED) In August 1992, the Company and Cephalon Clinical Partners, L.P. completed a private placement of 900 units. Each unit consists of a limited partnership interest in the Partnership and warrants to purchase 4,500 shares of the Company's common stock, resulting in the aggregate issuance of warrants to purchase 4,050,000 shares of common stock. In connection with the offering, including the sale of a Class B limited partnership interest, the Company issued warrants to purchase an additional 144,000 shares of common stock. At December 31, 1998, warrants to purchase shares of the Company's common stock were outstanding as follows:
NUMBER OF SHARES ISSUABLE UPON EXERCISE EXERCISE PRICE OF WARRANTS EXPIRATION DATE PER SHARE ----------- --------------- --------- 1,661,277 August 31, 1999 $ 13.82 352,900 August 31, 1999 $ 13.70 17,963 August 31, 1999 $ 11.77 750,000 February 8, 2002 $ 18.50 84,000 April 7, 2000 $ 24.77 --------- 2,886,140 =========
During 1998, no warrants were exercised. In 1997, 102,004 warrants were exercised for an aggregate exercise price of $1,183,000. In exchange for 490,000 shares of common stock, in May 1997, the Company acquired options from Swiss Bank Corporation ("SBC") to purchase 2,500,000 shares of the Company's common stock. The options expired unexercised. The transaction related to the options was recorded in stockholders' equity. PREFERRED SHARE PURCHASE RIGHTS In November 1993, the Board of Directors of the Company declared a dividend distribution of one right ("Right") for each outstanding share of common stock. In addition, a Right attaches to and trades with each new issue of the Company's common stock. Each Right entitles each registered holder, upon the occurrence of certain events, to purchase from the Company a unit consisting of one one- hundredth of a share (a "Unit") of the Series A Junior Participating Preferred Stock of the Company (the "Preferred Shares"), or a combination of securities and assets of equivalent value, at a purchase price of $90.00 per Unit, subject to adjustment. 9. REVENUES At December 31, revenues consisted of the following:
1998 1997 1996 ---- ---- ---- Commercial collaborations.................... $5,598,000 $ 5,228,000 $ 4,305,000 Research and development collaborations....... 9,085,000 17,912,000 17,061,000 Other......................................... 972,000 -- --
COMMERCIAL COLLABORATIONS Cephalon has entered into several agreements under which its sales organization markets the proprietary products of third parties. The Company focuses their sales efforts on neurologists and other neurological specialists. Under these agreements, the Company receives payments generally for achievement of the stipulated sales activity and performance targets, and may also be responsible for payment of fees to the third party 51 CEPHALON, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED) collaborator and funding promotional activities. In the United States, Cephalon is promoting and marketing STADOL NS(R) (butorphanol tartrate) for Bristol-Myers Squibb Company. In France, Cephalon is promoting and marketing APOKINON(R) (apomorphine hydrochloride) for Laboratoire Aguettant S.A. The agreement with Medtronic Inc. to co-promote Intrathecal Baclofen Thererapy (ITB(TM)) will terminate pursuant to its terms as of April 29, 1999. RESEARCH AND DEVELOPMENT COLLABORATIONS The Company has entered into several collaborative research and development agreements under which the Company is reimbursed generally for its research efforts, product supply, development milestones and license fees. Under these agreements, the Company may also be responsible for the payment of milestone and license fee payments to its collaborators. Under a collaborative agreement with TAP, the Company performs research and development for which it is compensated quarterly by TAP for both internal and external expenses. Under collaborative agreements with Kyowa Hakko, the Company is reimbursed for its cost to supply MYOTROPHIN in Japanese clinical trials, the achievement of certain milestones and certain expenditures related to the Company's K252a research and development program. 10. INCOME TAXES At December 31, 1998, the Company had net operating loss carryforwards for federal income tax purposes of approximately $174,000,000, 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. 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 cumulative change in ownership of more than 50% occurred within a three year period. The Company does not believe that such limitation will have a material adverse impact on the utilization of its carryforwards. Significant components of the Company's deferred tax assets for federal and state income taxes as of December 31, are as follows:
1998 1997 ---- ---- Net operating loss carryforwards ..................... $ 59,240,000 $ 54,051,000 Capitalized research and development expenditures .... 32,357,000 16,478,000 Other--net ........................................... 9,300,000 6,657,000 ------------- ------------ Total deferred tax assets ............................ 100,897,000 77,186,000 Valuation allowance for deferred tax assets .......... (100,897,000) (77,186,000) ------------- ------------ Net deferred tax assets .............................. $ -- $ -- ============= ============
A valuation allowance was established for 100% of the deferred tax assets as realization of the tax benefits is not assured. 11. SUBSEQUENT EVENT On February 25, 1999, the Company completed a debt offering totaling $30,000,000, raised through the private sale of revenue-sharing notes (the "Notes"). The notes are repayable by the Company in cash in February 2002. The Notes are secured by the Company's U.S. rights to PROVIGIL (the "Pledged Assets") and bear an annual interest rate of 11%. Investors in the 52 CEPHALON, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED) Notes also will receive a royalty of 6% on U.S. sales of PROVIGIL for up to five years. The Company has the right to redeem the Notes at a premium prior to maturity, which would reduce the royalty period to four years and may extend the maturity and the royalty by one year under certain circumstances. The Notes contain a number of covenants including a requirement to maintain a minimum level of cash and investments equal to $40,000,000 during 1999 and $30,000,000 thereafter as long as the principal remains outstanding. If the Company fails to maintain such cash balances or violates the other covenants, the holders of the Notes can declare a default and increase the royalty percentage to 25% of U.S. PROVIGIL sales and, if the default is not cured within one year, can accelerate the due date of the Notes and foreclose on the Pledged Assets. The holders of the Notes can also foreclose on the Pledged Assets if the Company fails to pay principal and interest when due. The Notes are not convertible into common stock. The offering also includes the issuance of five-year warrants to purchase 1,920,000 shares of the Company's common stock with an exercise price of $10.08. The investors will forfeit 480,000 warrants if specified PROVIGIL sales levels are achieved. In addition, the Company may redeem up to 720,000 of the remaining warrants after three years if the market value of the Company's common stock exceeds certain thresholds. 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 the directors and executive officers of the Company are as follows:
NAME Age POSITION - ---- --- -------- Frank Baldino, Jr., Ph.D...... 45 Director, President and Chief Executive Officer and founder of the Company Bruce A. Peacock.............. 47 Director, Executive Vice President, Chief Operating Officer and Treasurer William P. Egan(1)............ 54 Director Robert J. Feeney, Ph.D.(2).... 73 Director Martyn D. Greenacre(1)........ 57 Director Kevin E. Moley(1)............. 52 Director Horst Witzel, Dr.-Ing.(2)..... 71 Director Jeffry L. Vaught, Ph.D........ 48 President, Research and Development J. Kevin Buchi................ 43 Senior Vice President, Finance and Chief Financial Officer Peter E. Grebow, Ph.D......... 52 Senior Vice President, Worldwide Business Development Earl W. Henry, M.D............ 51 Senior Vice President, Worldwide Clinical Research and Regulatory Affairs John E. Osborn................ 41 Senior Vice President, General Counsel and Secretary
(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 the next annual meeting of the stockholders of the Company 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, the founder of the Company, has served as President, Chief Executive Officer and a director since its inception. Dr. Baldino received his Ph.D. degree from Temple University and holds several adjunct academic appointments. Dr. Baldino currently serves as a director of ViroPharma, Inc., a biopharmaceutical company, First Consulting Group, Inc., which provides consulting services for information processing, and Pharmacopeia, Inc., a developer of proprietary technology platforms for pharmaceutical companies. 54 Mr. Peacock has served as a director, Executive Vice President and Chief Operating Officer since February 1994. For the previous two years, Mr. Peacock served as Executive Vice President and Chief Financial Officer and Treasurer of the Company. From 1982 to January 1992, Mr. Peacock was employed by Centocor, Inc., a biopharmaceutical company, most recently as Senior Vice President, Chief Financial Officer and Treasurer. Mr. Peacock holds a B.A. degree from Villanova University and is a Certified Public Accountant. Mr. Egan was elected to the Board of Directors in 1988. Since 1979, Mr. Egan has served as President of Burr, Egan, Deleage & Co., a venture capital company. He also is a general partner of ALTA Communications VI, L.P., and ALTA Communications VII, L.P., both venture capital firms. Dr. Feeney was elected to the Board of Directors in 1988. Since October 1987, Dr. Feeney has 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. Mr. Greenacre was appointed to the Board of Directors in October 1992. Mr. Greenacre has been President, Chief Executive Officer and Director of Delsys Pharmaceutical Corp. since June 1997. From 1993 to 1996, Mr. Greenacre served with Zynaxis Inc., a biopharmaceutical company, as President, Chief Executive Officer and a director. From 1989 to 1992, 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. Moley was appointed to the Board of Directors in 1994. Mr. Moley has been Chairman of the Board of Patient Care Dynamics since November 1998. From January 1996 to February 1998, Mr. Moley was President and CEO of Integrated Medical Systems, where he had 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 to 1992 Mr. Moley served in the Bush administration as an Assistant Secretary of the U.S. Department of Health and Human Services ("HHS"), and in 1992 and 1993 as the Deputy Secretary of HHS. Mr. Moley also serves as a director of Merge Technologies, Inc., a medical imaging software company, and Pfymatrix, Inc., a physician practice management company. Dr. Witzel was appointed to the Board of Directors in January 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. Dr. Vaught has headed the Company's research operations since joining the Company in August 1991 and currently serves as Senior Vice President and President, Research and Development. Prior to joining the Company, 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 to 1991. Dr. Vaught received his Ph.D. degree from the University of Minnesota. Mr. Buchi joined the Company as Controller in March 1991 and held several financial positions with the Company prior to being appointed Senior Vice President, Finance 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 M.M. degree from the J.L. Kellogg Graduate School of Management, Northwestern University in 1982 and is a Certified Public Accountant. Dr. Grebow joined the Company in January 1991 and was Senior Vice President, Drug Development prior to his current position as Senior Vice President, Worldwide Business Development. From 1988 to 1990, Dr. Grebow 55 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 the Company in August 1997 as Vice President, Clinical Operations, and was appointed Senior Vice President, Worldwide Clinical Research and Regulatory Affairs in October 1998. Prior to Cephalon, Dr. Henry served as Vice President, Clinical Research for Guilford Pharmaceuticals. From 1992 to 1995, he was Executive Director, Clinical Research at Sandoz, Inc. and spent five years at Pfizer Central Research. Dr. Henry received his doctor of medicine 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 the Company in March 1997 and has served as Senior Vice President, General Counsel and Secretary of the Company since January 1999. He was appointed Senior Vice President of the Company in September 1998, and prior to that served as Vice President, Legal Affairs. From 1992 to March 1997, Mr. Osborn was employed by The DuPont Merck Pharmaceutical Company, most recently as Vice President, Associate General Counsel and Assistant Secretary. From 1989 to 1992, he served as special assistant to the legal adviser at the U.S. Department of State. Prior to that, he was associated with the law firms of Hale and Dorr, Boston and Dechert Price & Rhoads, Philadelphia. 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. 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 the Company's definitive proxy statement for the 1999 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 the Company's definitive proxy statement for the 1999 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 the Company's definitive proxy statement for the 1999 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 the consolidated financial statements of the Company and its subsidiaries and supplementary data included in this report under Item 8: Report of Independent Public Accountants. Consolidated Balance Sheets as of December 31, 1998 and 1997. Consolidated Statements of Operations for the years ended December 31, 1998, 1997 and 1996. Consolidated Statements of Stockholders' Equity for the years ended December 31, 1998, 1997 and 1996. Consolidated Statements of Cash Flows for the years ended December 31, 1998, 1997 and 1996. Notes to Consolidated Financial Statements. SCHEDULES All schedules 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, 1998, the Company filed a Current Report on Form 8-K on December 28, 1998 announcing approval from the U.S. Food and Drug Administration to market PROVIGIL(R) (modafinil) Tablets for the treatment of excessive daytime sleepiness associated with narcolepsy. 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. -- 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) (22). *4.3(a) Form of Notc Purchase Agreement dated as of February 24, 1999 by and between Cephalon and Investor. *4.3(b) Form of Revenue Sharing Senior Secured Note due 2002 dated March 1, 1999. (21) *4.3(c) Form of Class A Warrant. *4.3(d) Form of Class B Warrant.
57
EXHIBIT NO. -- *4.3(e) Security Agreement dated March 1, 1999 between Cephalon, Inc. and Delta Opportunity Fund, Ltd., as collateral agent. *4.3(f) Patent and Trademark Agreement dated March 1,1999 between Cephalon, Inc. and Delta Opportunity Fund, Ltd., as collateral agent. 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)(20). 10.4(b) Letter agreement dated March 6, 1995 amending License Agreement between Cephalon, Inc. and Kyowa Hakko Kogyo Co., Ltd. (Exhibit 10.4(6))(14)(20). 10.5(a) Supply Agreement, dated January 20, 1993, between Cephalon, Inc. and Laboratoire L. Lafon (Exhibit 10.1)(7)(20). 10.5(b) License Agreement, dated January 20, 1993, between Cephalon, Inc. and Laboratoire L. Lafon (Exhibit 10.2)(7)(20). 10.5(c) Trademark Agreement, dated January 20, 1993, between Cephalon, Inc. and Genelco S.A. (Exhibit 10.3)(7)(20). 10.5(d) Amendment to License Agreement and Supply Agreement, dated July 21, 1993, between Cephalon, Inc. and Laboratoire L. Lafon (Exhibit 10.1)(10)(11). 10.5(e) Amendment to Trademark Agreement, dated July 21, 1993, between Cephalon, Inc. and Genelco S.A. (Exhibit 10.2)(11)(20). 10.5(f) Amendment No. 3 to License Agreement dated June 8, 1995, between Cephalon, Inc. and Laboratoire L. Lafon (Exhibit 99.2)(15). 10.5(g) Amendment No. 4 to License Agreement and Supply Agreement dated August 23, 1995, between Cephalon, Inc. and Laboratoire L. Lafon (Exhibit 10.5(g))(17)(20). *10.5(h) Amendment No. 5 to License Agreement and Supply Agreement dated January 21, 1998 between Cephalon, Inc. and Laboratoire L. Lafon. (21) *10.5(i) Amendment No. 6 to License Agreement and Supply Agreement dated February 2, 1998 between Cephalon, Inc. and Laboratoire L. Lafon. (21) *10.5(j) Amendment No. 3 to Trademark Agreement dated January 21, 1998 between Cephalon, Inc. and Genelco S.A. (21) *10.5(k) Amendment No. 4 to Trademark Agreement dated February 9, 1998 between Cephalon, Inc. and Genelco S.A. (21)
58
EXHIBIT No. -- +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 (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 the Registrant and Cephalon Clinical Partners, L.P. (Exhibit 10.2)(6)(20). 10.8(c) Purchase Agreement, dated as of August 11, 1992, by and between the Registrant and each of the limited partners of Cephalon Clinical Partners, L.P. (Exhibit 10.3)(6)(20). 10.8(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). 10.8(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). 10.8(f) Incentive Warrant to purchase 115,050 shares of Common Stock of the Registrant issued to PaineWebber Incorporated (Exhibit 10.6)(6). 10.8(g) Fund Warrant to purchase 19,950 shares of Common Stock of the Registrant issued to PaineWebber R&D Partners III, L.P. (Exhibit 10.7)(6). 10.8(h) Pledge Agreement, dated as of August 11, 1992, by and between Cephalon Clinical Partners, L.P. and the Registrant (Exhibit 10.8)(6). 10.8(i) Promissory Note, dated as of August 11, 1992, issued by Cephalon Clinical Partners, L.P. to the Registrant (Exhibit 10.9)(6). 10.8(j) 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)(20). 10.10(a) Agreement between Cephalon, Inc. and Chiron Corporation dated as of January 7, 1994 (Exhibit 10.1)(12)(20). 10.10(b) Letter agreement dated January 13, 1995 amending Agreement between Cephalon, Inc. and Chiron Corporation (Exhibit 10.12(b))(14). 10.10(c) Letter agreement dated May 23, 1995 amending Agreement between Cephalon, Inc. and Chiron Corporation (17)(20).
59
Exhibit No. -- 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)(20). 10.11(b) Amendment dated June 28, 1996 amending Agreement between Cephalon, Inc. and TAP Holdings Inc. (Exhibit 10.13(b))(19)(21) *10.12 Toll Manufacturing and Packaging Agreement dated February 24, 1998 between Cephalon, Inc. and Circa Pharmaceuticals, Inc. (21) *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. (20) 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. (21) 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. (22) Filed as an Exhibit to the Company's Form 8-A/A (12G) filed on January 20, 1999. 60 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 4, 1999 Cephalon, Inc. By: /s/ Frank Baldino, Jr., Ph.D. --------------------------------------- Frank Baldino, Jr., Ph.D. President 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. or Bruce A. Peacock, and each of them acting alone, 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 --------- ----- ---- By: /s/ Frank Baldino, Jr., Ph.D. President, Chief Executive Officer March 4, 1999 ------------------------------ and Director Frank Baldino, Jr., Ph.D. (Principal executive officer) By: /s/ Bruce A. Peacock Executive Vice President, March 4, 1999 ------------------------------ Bruce A. Peacock Chief Operating Officer and Director By: /s/ J. Kevin Buchi Sr. Vice President, Finance March 4, 1999 ------------------------------ J. Kevin Buchi and Chief Financial Officer (Principal financial and accounting officer) By: /s/ William P. Egan Director March 4, 1999 ------------------------------ William P. Egan By: /s/ Robert J. Feeney, Ph.D. Director March 4, 1999 ------------------------------ Robert J. Feeney, Ph.D. By: /s/ Martyn D. Greenacre Director March 4, 1999 ------------------------------ Martyn D. Greenacre By: /s/ Kevin E. Moley Director March 4, 1999 ------------------------------- Kevin E. Moley By: /s/ Horst Witzel, Dr.-Ing. Director March 4, 1999 ------------------------------ Horst Witzel, Dr.-Ing
61 EX-4.3(A) 2 FORM OF NOTE PURCHASE AGREEMENT DATED 02/24/99 EXHIBIT 4.3A ================================================================================ ================================================================================ ================================================================================ ================================================================================ ================================================================================ NOTE PURCHASE AGREEMENT ================================================================================ ================================================================================ ================================================================================ ================================================================================ DATED AS OF FEBRUARY 24, 1999 ================================================================================ ================================================================================ ================================================================================ ================================================================================ BY AND BETWEEN ================================================================================ ================================================================================ ================================================================================ ================================================================================ CEPHALON, INC. ================================================================================ ================================================================================ ================================================================================ ================================================================================ AND ================================================================================ ================================================================================ ================================================================================ ================================================================================ [NAME OF INVESTOR] ================================================================================ ================================================================================ ================================================================================ ================================================================================ ================================================================================ ================================================================================ DIAZ & ALTSCHUL CAPITAL, LLC ================================================================================ ================================================================================ ================================================================================ CEPHALON, INC. NOTE PURCHASE AGREEMENT 11% REVENUE SHARING SENIOR SECURED NOTES DUE 2002 AND COMMON STOCK PURCHASE WARRANTS TABLE OF CONTENTS
PAGE ---- 1. DEFINITIONS 1 2. PURCHASE AND SALE; PURCHASE PRICE 6 (a) Purchase 6 (b) Form of Payment 7 (c) Closing 7 3. REPRESENTATIONS, WARRANTIES, COVENANTS, ETC. OF THE BUYER (a) Purchase for Investment 7 (b) Accredited Investor 7 (c) Reoffers and Resales 7 (d) Company Reliance 7 (e) Information Provided 8 (f) Absence of Approvals 8 (g) Note Purchase Agreement 8
-4- (h) Buyer Status 8 4. REPRESENTATIONS, WARRANTIES, COVENANTS, ETC. OF THE COMPANY 8 (a) Organization and Authority 8 (b) Qualifications 9 (c) Capitalization 9 (d) Concerning the Shares and the Common Stock 10 (e) Corporate Authorization 10 (f) Non-contravention 10 (g) Approvals, Filings, Etc 11 (h) Information Provided 11 (i) Conduct of Business 11 (j) SEC Filings 11 (k) Absence of Certain Proceedings 12 (l) Financial Statements; Liabilities 12 (m) Material Losses 12 (n) Absence of Certain Changes 12 (o) Intellectual Property 12 (p) Internal Accounting Controls 13 (q) Compliance with Law 13 (r) Properties 13 -5- (s) Labor Relations 13 (t) Insurance 13 (u) Tax Matters 13 (v) Investment Company 14 (w) Absence of Brokers, Finders, Etc. 14 (x) No Solicitation 14 (y) ERISA Compliance 14 (z) Concerning the Collateral 14 5. CERTAIN COVENANTS 14 (a) Transfer Restrictions 14 (b) Restrictive Legends 14 (c) Nasdaq Listing; Reporting Status 16 (d) Form D 16 (e) State Securities Laws 16 (f) Limitation on Certain Actions 16 (g) Security Agreement; Financing Statements, Etc. 16 (h) Use of Proceeds 17 (i) Best Efforts 17 (j) Debt Obligation 17 6. CONDITIONS TO THE COMPANY'S OBLIGATION TO SELL 17 -6- 7. CONDITIONS TO THE BUYER'S OBLIGATION TO PURCHASE 17 8. REGISTRATION RIGHTS 18 (a) Mandatory Registration 18 (b) Obligations of the Company 19 (c) Obligations of the Buyer and other Investors 22 (d) Rule 144 24 9. INDEMNIFICATION AND CONTRIBUTION 24 (a) Indemnification 24 (b) Contribution 25 (c) Other Rights 26 10. MISCELLANEOUS 26 (a) Governing Law 26 (b) Headings 26 (c) Severability 26 (d) Notices 26 (e) Counterparts 26 (f) Entire Agreement; Benefit 26 (g) Waiver 27 (h) Amendment 27 (i) Further Assurances 27 -7- (j) Assignment of Certain Rights and Obligations 27 (k) Expenses 27 (l) Termination 28 (m) Survival 28 (n) Public Statements, Press Releases, Etc. 28 (o) Construction 29 SCHEDULES - --------- Schedule 4(a) Certain Equity Investments Schedule 4(c) Certain Antidilution Adjustments Schedule 4(r) Certain Mortgages, Liens, Security Interests, Encumbrances, Etc. ANNEXES - ------- ANNEX I Form of 11% Revenue Sharing Senior Secured Note due 2002 ANNEX II Form of Common Stock Purchase Warrant, Class A ANNEX III Form of Common Stock Purchase Warrant, Class B ANNEX IV Form of Security Agreement ANNEX V Form of Patent and Trademark Security Agreement ANNEX VI Form of Opinion of Morgan, Lewis & Bockius, LLP to Be Delivered on the Closing Date ANNEX VII Form of Opinion of Law Offices of Brian W Pusch to Be Delivered on the Closing Date ANNEX VIII Form of Instruction to the Company's Transfer Agent ANNEX IX Form of Opinion of Morgan, Lewis & Bockius, LLP to Be Delivered in Connection with Effectiveness of each Registration Statement ANNEX X Form of Opinion of the Company's General Counsel to Be Delivered in Connection with Effectiveness of each Registration Statement ANNEX XI Form of Investor Questionnaire -8- NOTE PURCHASE AGREEMENT THIS NOTE PURCHASE AGREEMENT, dated as of February 24, 1999 (this "Agreement"), by and between CEPHALON, INC., a Delaware corporation (the "Company"), with headquarters located at 145 Brandywine Parkway, West Chester, Pennsylvania 19380, and [NAME OF BUYER], a ____________________ (the "Buyer"). W I T N E S S E T H: WHEREAS, the Buyer wishes to purchase from the Company and the Company wishes to sell to the Buyer, upon the terms and subject to the conditions of this Agreement, a promissory note of the Company having the principal amount set forth on the signature page of this Agreement and in connection with which the Company shall issue to the Buyer warrants to purchase shares of Common Stock (such capitalized term and all other capitalized terms used in this Agreement having the meanings provided in Section 1); WHEREAS, on or before the Closing Date the Company and the Collateral Agent shall execute and deliver, one to the other, a Security Agreement, in the form referred to herein, which provides, among other things, for the grant to the Collateral Agent for the ratable benefit of the holders from time to time of the Note and the Other Notes of a first priority security interest in certain collateral, upon the terms and with the effect as provided therein; and WHEREAS, on or before the Closing Date, the Company and the Collateral Agent shall execute and deliver, one to the other, a Patent and Trademark Security Agreement, in the form referred to herein, which provides, among other things, for the grant to the Collateral Agent for the ratable benefit of the holders from time to time of the Note and the Other Notes of a first priority perfected security interest in certain collateral upon the terms and with the effect as provided therein; NOW THEREFORE, in consideration of the premises and the mutual covenants contained herein and other good and valuable consideration, the receipt and sufficiency of which are hereby acknowledged, the parties agree as follows: 1. DEFINITIONS. (a) As used in this Agreement, the terms "Agreement", "Buyer" and "Company" shall have the respective meanings assigned to such terms in the introductory paragraph of this Agreement. (b) All the agreements or instruments herein defined shall mean such agreements or instruments as the same may from time to time be supplemented or amended or the terms thereof waived or modified to the extent permitted by, and in accordance with, the terms -9- thereof and of this Agreement. (c) The following terms shall have the following meanings (such meanings to be equally applicable to both the singular and plural forms of the terms defined): "Affiliate" means, with respect to any Person, any other Person that directly, or indirectly through one or more intermediaries, controls, is controlled by or is under common control with the subject Person. For purposes of this definition, "control" (including, with correlative meaning, the terms "controlled by" and "under common control with"), as used with respect to any Person, shall mean the possession, directly or indirectly, of the power to direct or cause the direction of the management and policies of such Person, whether through the ownership of voting securities or by contract or otherwise. "Blackout Period" means the period of up to 15 consecutive Trading Days after the date the Company notifies the Investors that they are required, pursuant to Section 8(c)(4), to suspend offers and sales of Registrable Securities pursuant to a Registration Statement as a result of an event or circumstance described in Section 8(b)(5)(A) relating to or affecting such Registration Statement, during which period, by reason of Section 8(b)(5)(B), the Company is not required to amend such Registration Statement or supplement the related Prospectus. "Business Day" means any day other than a Saturday, Sunday or a day on which commercial banks in The City of New York are authorized or required by law or executive order to remain closed. "Claims" means any losses, claims, damages, liabilities or expenses (joint or several), incurred by a Person to or in respect of any other Person who is not a party to this Agreement. "Class A Warrants" means Common Stock Purchase Warrants, Class A in the form attached hereto as ANNEX II initially entitling the holder to purchase the number of shares of Common Stock (and related Preferred Share Purchase Rights) determined in accordance with Section 2(a). "Class B Warrants" means Common Stock Purchase Warrants, Class B in the form attached hereto as ANNEX III initially entitling the holder to purchase the number of shares of Common Stock (and related Preferred Share Purchase Rights) determined in accordance with Section 2(a). "Closing Date" means 10:00 a.m., New York City time, on February 26, 1999 or such other mutually agreed to time. "Code" means the Internal Revenue Code of 1986, as amended, and the regulations -10- thereunder and published interpretations thereof. "Collateral" shall have the meanings provided in any of the Security Agreement and the Patent and Trademark Security Agreement. "Collateral Agent" means Delta Opportunity Fund, Ltd., as collateral agent pursuant to the Security Agreement and the Patent and Trademark Security Agreement, and from time to time its duly appointed and acting successor or successors. "Common Stock" means the Common Stock, par value $.01 per share, of the Company. "ERISA" means the Employee Retirement Income Security Act of 1974, as amended, and the regulations thereunder and published interpretations thereof. "Event of Default" shall have the meaning provided in the Note. "Indemnified Party" means the Company, each of its directors, each of its officers who signs the Registration Statement, each Person, if any, who controls the Company within the meaning of the 1933 Act or the 1934 Act, any underwriter and any other stockholder selling securities pursuant to the Registration Statement or any of its directors or officers or any Person who controls such stockholder or underwriter within the meaning of the 1933 Act or the 1934 Act. "Indemnified Person" means the Buyer and each other Investor who owns or holds any Securities and each Investor who sells Registrable Securities in the manner permitted under this Agreement, the directors, if any, of the Buyer and any such Investor, the officers, if any, of the Buyer and any such Investor, each Person, if any, who controls the Buyer or any such Investor within the meaning of the 1933 Act or the 1934 Act, any underwriter (as defined in the 1933 Act) acting on behalf of an Investor who participates in the offering of Registrable Securities of such Investor in accordance with the plan of distribution contained in the Prospectus, the directors, if any, of such underwriter and the officers, if any, of such underwriter, and each Person, if any, who controls any such underwriter within the meaning of the 1933 Act or the 1934 Act. "Inspector" means any attorney, accountant or other agent retained by an Investor for the purposes provided in Section 8(b)(9). "Interest Shares" means the shares of Common Stock and the related Preferred Share Purchase Rights issuable in payment of interest on the Note. "Investor" means the Buyer and any transferee or assignee who agrees to become bound by the provisions of Sections 5(a), 5(b), 8, 9, and 10 of this Agreement. -11- "Lafon" means Laboratoire L. Lafon, a French corporation. "Lafon Agreements" means (1) the License Agreement, dated January 20, 1993, by and between Lafon and the Company, as amended, (2) the Trademark Agreement, dated January 20, 1993, by and between Genelco S.A. and the Company, as amended, and (3) the Supply Agreement, dated January 20, 1993, between the Company and Lafon, as amended. "Margin Stock" shall have the meaning provided in Regulation U of the Board of Governors of the Federal Reserve System (12 C.F.R. Part 221). "Nasdaq" means the Nasdaq National Market. "NASD" means the National Association of Securities Dealers, Inc. "1997 10-K" means the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1997. "1934 Act" means the Securities Exchange Act of 1934, as amended. "1933 Act" means the Securities Act of 1933, as amended. "Non-Responsive Investor" means an Investor who does not provide the Requested Information to the Company at least one Business Day prior to the filing of the Purchase Share Registration Statement. "Note" means the 11% Revenue Sharing Senior Secured Note due 2002 of the Company in the form attached hereto as ANNEX I. "Optional Redemption Price" shall have the meaning to be provided or provided in the Note. "Other Note Purchase Agreements" means the several Note Purchase Agreements relating to the Other Notes. "Other Notes" shall have the meaning to be provided or provided in the Note. "Patent and Trademark Security Agreement" means the Patent and Trademark Security Agreement by and between the Company and the Collateral Agent, in the form attached hereto as ANNEX V. "Payment Share Registration Statement" means a registration statement on Form -12- S-3 (or the comparable form at the time of filing with the SEC) of the Company under the 1933 Act relating to the Payment Shares and which names the Investors as selling stockholders. "Payment Shares" means the shares of Common Stock and the related Preferred Share Purchase Rights issuable in partial payment of principal or the Optional Redemption Price of the Note. "Person" means any natural person, corporation, partnership, limited liability company, trust, incorporated organization, unincorporated association or similar entity or any government, governmental agency or political subdivision. "Placement Agent" means Diaz & Altschul Capital, LLC. "Preferred Share Purchase Rights" means the Preferred Share Purchase Rights issued or issuable pursuant to the Rights Agreement (or any similar rights issued by the Company with respect to the Common Stock after the date of this Agreement). "Products" means all pharmaceutical compositions containing modafinil or any compound based on or derived therefrom as an active ingredient, whether alone or in combination with any other substance, which are developed, marketed or sold by the Company or any Subsidiary or Affiliate of the Company, including, without limitation, that pharmaceutical composition marketed by the Company on the Closing Date under the name Provigil(R). "Prospectus" means the prospectus forming part of the Registration Statement at the time the Registration Statement is declared effective and any amendment or supplement thereto (including any information or documents incorporated therein by reference). "PTO" means the United States Patent and Trademark Office. "Purchase Price" means the purchase price for the Note set forth on the signature page of this Agreement. "Questionnaire" means the Prospective Purchaser Questionnaire completed by the Buyer. "Record" means all pertinent financial and other records, pertinent corporate documents and properties of the Company subject to inspection for the purposes provided in Section 8(b)(9). "register," "registered," and "registration" refer to a registration effected by preparing and filing a Registration Statement or Statements in compliance with the 1933 Act and pursuant to Rule 415, and the declaration or ordering of effectiveness of such Registration Statement by the -13- SEC. "Registrable Securities" means the Shares and any stock or other securities into which or for which the Common Stock may hereafter be changed, converted or exchanged by the Company or its successor, as the case may be, and any other securities issued to holders of such Common Stock (or such shares into which or for which such Shares are so changed, converted or exchanged) upon any reclassification, share combination, share subdivision, share dividend, merger, consolidation or similar transaction or event. "Registration Period" means: (1) with respect to the Warrant Share Registration Statement, the period from the SEC Effective Date for the Warrant Share Registration Statement to the earlier of (A) the date which is two years after the end of the Exercise Period (as defined in the Warrants) (or, if (x) the Warrants shall have been exercised in full for shares of Common Stock or (y) the Warrants shall no longer remain outstanding, such date after which each Investor may sell all of its Registrable Securities relating to the Warrants or that are Interest Shares without registration under the 1933 Act pursuant to Rule 144, free of any limitation on the volume of such securities which may be sold in any period) and (B) the date on which the Investors no longer own any Registrable Securities relating to the Warrants or that are Interest Shares; and (2) with respect to the Payment Share Registration Statement, the period from the SEC Effective Date for the Payment Share Registration Statement to the earlier of (A) the date which is two years after the Payment Shares are issued and (B) the date on which the Investors no longer own any Registrable Securities that are Payment Shares or derive from Payment Shares. "Registration Statement" means the Payment Share Registration Statement or the Warrant Share Registration Statement, or either of them. "Regulation D" means Regulation D under the 1933 Act. "Repurchase Event" shall have the meaning provided in the Note. "Required Information" means, with respect to each Investor, all information regarding such Investor, the Registrable Securities held by such Investor or which such Investor has the right to acquire and the intended method of disposition of the Registrable Securities held by such Investor or which such Investor has the right to acquire as shall be required by the 1933 Act to effect the registration of the resale by such Investor of such Registrable Securities. "Rights Agreement" means the Rights Agreement, dated as of January 1, 1999, by -14- and between the Company and Stocktrans, Inc., as Rights Agent. "Rule 415" means Rule 415 under the 1933 Act or any successor rule providing for offering securities on a delayed or continuous basis. "Rule 144" means Rule 144 promulgated under the 1933 Act or any other similar rule or regulation of the SEC that may at any time provide a "safe harbor" exemption from registration under the 1933 Act so as to permit a holder to sell securities of the Company to the public without registration under the 1933 Act. "SEC" means the Securities and Exchange Commission. "SEC Effective Date" means with respect to any Registration Statement the date such Registration Statement is declared effective by the SEC. "SEC Filing Date" means with respect to any Registration Statement the date such Registration Statement is first filed with the SEC pursuant to Section 8. "SEC Reports" means (1) the 1997 10-K, (2) the Company's definitive Proxy Statement for its 1998 Annual Meeting of Stockholders, (3) the Company's Quarterly Reports on Form 10-Q for the quarters ended March 31, 1998, June 30, 1998 and September 30, 1998, and (4) the Company's Current Reports on Form 8-K, dated September 15, 1998 and December 28, 1998, in each case as filed with the SEC and including the information and documents (other than exhibits) incorporated therein by reference. "Securities" means, collectively, the Note, the Shares and the Warrants. "Security Agreement" means the Security Agreement by and between the Company and the Collateral Agent, in the form attached hereto as ANNEX IV. "September 10-Q" means the Company's Quarterly Report on Form 10-Q for the quarter ended September 30, 1998. "Shares" means the Payment Shares, the Interest Shares and the Warrant Shares. "Subsidiary" means any corporation or other entity of which a majority of the capital stock or other ownership interests having ordinary voting power to elect a majority of the board of directors or other persons performing similar functions are at the time directly or indirectly owned by the Company. "Territory" means the United States, its territories and possessions. -15- "Trading Day" means at any time a day on which any of a national securities exchange, Nasdaq or such other securities market as at such time constitutes the principal securities market for the Common Stock is open for general trading of securities. "Trading Price" shall have the meaning provided in the Note. "Transaction Documents" means, collectively, this Agreement, the Securities, the Security Agreement, the Patent and Trademark Security Agreement and the other agreements, instruments and documents contemplated hereby and thereby. "Transfer Agent" means Stocktrans, Inc., as transfer agent and registrar for the Common Stock, or its successor. "Violation" means (i) any untrue statement or alleged untrue statement of a material fact contained in the Registration Statement or any post-effective amendment thereof or the omission or alleged omission to state therein a material fact required to be stated therein or necessary to make the statements therein not misleading, (ii) any untrue statement or alleged untrue statement of a material fact contained in any Prospectus (as amended or supplemented, if the Company files any amendment thereof or supplement thereto with the SEC) or the omission or alleged omission to state therein any material fact necessary to make the statements made therein, in light of the circumstances under which the statements therein were made, not misleading, (iii) any violation or alleged violation by the Company of the 1933 Act, the 1934 Act, any state securities law or any rule or regulation under the 1933 Act, the 1934 Act or any state securities law, or (iv) any breach or alleged breach by any Person other than the Buyer of any representation, warranty, covenant, agreement or other term of any of the Transaction Documents. "Warrants" means the Class A Warrants and the Class B Warrants. "Warrant Share Registration Statement" means a registration statement on Form S-3 of the Company under the 1933 Act relating to the Warrant Shares which names the Investors as selling stockholders. "Warrant Shares" means the shares of Common Stock and the related Preferred Share Purchase Rights issuable upon exercise of the Warrants. -16- 2. PURCHASE AND SALE; PURCHASE PRICE. (A) PURCHASE. Upon the terms and subject to the conditions of this Agreement, the Buyer hereby agrees to purchase from the Company, and the Company hereby agrees to sell to the Buyer, on the Closing Date, the Note in the principal amount set forth on the signature page of this Agreement and having the terms and conditions as set forth in the form of the Note attached hereto as ANNEX I for the Purchase Price. In connection with the purchase of the Note by the Buyer, the Company shall issue to the Buyer at the closing on the Closing Date (x) Class A Warrants initially entitling the holder to purchase 48 shares of Common Stock for each $1,000 principal amount of the Note and (y) Class B Warrants initially entitling the holder to purchase 16 shares of Common Stock for each $1,000 principal amount of the Note. (B) FORM OF PAYMENT. Payment by the Buyer of the Purchase Price to the Company on the Closing Date shall be made by wire transfer of funds to: First Union National Bank 5th & Market Streets Philadelphia, Pennsylvania 19101 ABA# 031000503 For credit to account# 200200254913 For credit to the account of Cephalon, Inc. (C) CLOSING. The issuance and sale of the Note and the issuance of the Warrants shall occur on the Closing Date at the Law Offices of Brian W Pusch, Penthouse Suite, 29 West 57th Street, New York, New York. At the closing, upon the terms and subject to the conditions of this Agreement, the Company shall issue and deliver to the Buyer the Note and the Warrants against payment by the Buyer to the Company of an amount equal to the Purchase Price, and the Buyer shall pay to the Company an amount equal to the Purchase Price against delivery of the Note and the Warrants to the Buyer. 3. REPRESENTATIONS, WARRANTIES, COVENANTS, ETC. OF THE BUYER. The Buyer represents and warrants to, and covenants and agrees with, the Company as follows: (A) PURCHASE FOR INVESTMENT. The Buyer is purchasing the Note and acquiring the Warrants for its own account for investment and not with a view towards the public sale or distribution thereof within the meaning of the 1933 Act; and the Buyer will acquire any Shares issued to the Buyer prior to the SEC Effective Date of a Registration Statement covering the resale of such Shares by the Buyer for its own account for investment and not with a view towards the -17- public sale or distribution thereof within the meaning of the 1933 Act prior to the SEC Effective Date; (B) ACCREDITED INVESTOR. The Buyer is an "accredited investor" as that term is defined in Rule 501 of Regulation D under the 1933 Act by reason of Rule 501(a)(3) thereof; (C) REOFFERS AND RESALES. The Buyer will not, directly or indirectly, offer, sell, pledge, transfer or otherwise dispose of (or solicit any offers to buy, purchase or otherwise acquire or take a pledge of) any of the Securities unless registered under the 1933 Act, pursuant to an exemption from registration under the 1933 Act or in a transaction not requiring registration under the 1933 Act; (D) COMPANY RELIANCE. The Buyer understands that (1) the Note is being offered and sold and the Warrants are being issued to the Buyer, (2) the Shares are being offered to the Buyer, (3) the Interest Shares, if any, will be issued to the Buyer, (4) the Payment Shares, if any, will be issued to the Buyer, and (5) upon exercise of the Warrants, the Warrant Shares will be sold to the Buyer, in each such case in reliance on one or more exemptions from the registration requirements of the 1933 Act, including, without limitation, Regulation D, and exemptions from state securities laws and that the Company is relying upon the truth and accuracy of, and the Buyer's compliance with, the representations, warranties, agreements, acknowledgments and understandings of the Buyer set forth herein and in the Questionnaire, a true and accurate copy of which has been delivered by the Buyer to the Company, in order to determine the availability of such exemptions and the eligibility of the Buyer to acquire or receive an offer to acquire the Securities; and the information with respect to the Buyer set forth in the Questionnaire is accurate and complete in all material respects; (E) INFORMATION PROVIDED. The Buyer and its advisors, if any, have requested, received and considered all information relating to the business, properties, operations, condition (financial or other), results of operations or prospects of the Company and information relating to the offer and sale of the Note and the offer of the Interest Shares and the Payment Shares deemed relevant by them (assuming the accuracy and completeness of the SEC Reports and of the Company's responses to the Buyer's requests); the Buyer and its advisors, if any, have been afforded the opportunity to ask questions of the Company concerning the terms of the offering of the Securities and the business, properties, operations, condition (financial or other), results of operations and prospects of the Company and its Subsidiaries and have received satisfactory answers to any such inquiries; without limiting the generality of the foregoing, the Buyer has had the opportunity to obtain and to review the SEC Reports; in connection with its decision to purchase the Note and to acquire the Warrants, the Buyer has relied solely upon the SEC Reports, the representations, warranties, covenants and agreements of the Company set forth in this Agreement and to be contained in the other Transaction Documents, as well as any investigation of the Company completed by the Buyer or its advisors; the Buyer understands that its investment in the Securities involves a high degree of risk; and the Buyer understands that the offering of the Note is being made to the Buyer as part of an offering without any minimum or maximum amount of the -18- offering (subject, however, to the right of the Company at any time prior to execution and delivery of this Agreement by the Company, in its sole discretion, to accept or reject an offer by the Buyer to purchase the Note and to acquire the Warrants); (F) ABSENCE OF APPROVALS. The Buyer understands that no United States federal or state agency or any other government or governmental agency has passed on or made any recommendation or endorsement of the Securities; (G) NOTE PURCHASE AGREEMENT. The Buyer has all requisite power and authority, corporate or otherwise, to execute, deliver and perform its obligations under this Agreement and the other agreements executed by the Buyer in connection herewith and to consummate the transactions contemplated hereby and thereby; and this Agreement has been duly and validly authorized, duly executed and delivered by the Buyer and, assuming due execution and delivery by the Company, is a valid and binding agreement of the Buyer enforceable in accordance with its terms, except as the enforceability hereof may be limited by bankruptcy, insolvency, reorganization, moratorium, fraudulent conveyance or other similar laws now or hereafter in effect relating to or affecting creditors' rights generally and general principles of equity, regardless of whether enforcement is considered in a proceeding in equity or at law; and (H) BUYER STATUS. The Buyer is not a "broker" or "dealer" as those terms are defined in the 1934 Act which is required to be registered with the SEC pursuant to Section 15 of the 1934 Act. 4. REPRESENTATIONS, WARRANTIES, COVENANTS, ETC. OF THE COMPANY. The Company represents and warrants to, and covenants and agrees with, the Buyer as follows: (A) ORGANIZATION AND AUTHORITY. The Company and each of the Subsidiaries is a corporation duly organized, validly existing and in good standing under the laws of the jurisdiction of its incorporation, and (i) each of the Company and the Subsidiaries has all requisite corporate power and authority to own, lease and operate its properties and to carry on its business as described in the SEC Reports and as currently conducted, and (ii) the Company has all requisite corporate power and authority to execute, deliver and perform its obligations under this Agreement and the other Transaction Documents to be executed and delivered by the Company in connection herewith, and to consummate the transactions contemplated hereby and thereby; and the Company does not have any equity investment in any other Person other than (x) the Subsidiaries listed in Exhibit 21 to the 1997 10-K, (y) as set forth on SCHEDULE 4(A) and (z) Subsidiaries which do not, individually or in the aggregate, have any material revenue, assets or liabilities. (B) QUALIFICATIONS. The Company and each of the Subsidiaries are duly -19- qualified to do business as foreign corporations and are in good standing in all jurisdictions where such qualification is necessary and where failure so to qualify could have a material adverse effect on the business, properties, operations, condition (financial or other), results of operations or prospects of the Company and the Subsidiaries, taken as a whole. (C) CAPITALIZATION. (1) The authorized capital stock of the Company consists of (A) 100,000,000 shares of Common Stock, of which 28,820,542 shares were outstanding at the close of business on February 19, 1999 and (B) 5,000,000 shares of Preferred Stock, $.01 par value, of which 1,000,000 shares have been designated Series A Junior Participating Preferred Stock, and none of which is outstanding; from February 19, 1999 to the Closing Date there will be (x) no material increase in the number of shares of Common Stock outstanding (except for shares issued upon exercise of options and warrants outstanding on the date hereof or options or similar rights granted subsequent to the date of this Agreement pursuant to the Company's stock option plans in effect on the date of this Agreement) and (y) no issuance of securities convertible into, exchangeable for, or otherwise entitling the holder to acquire, shares of Common Stock (except for securities issued pursuant to the Other Note Purchase Agreements and Preferred Share Purchase Rights issued in connection with shares Common Stock issued in accordance with the immediately preceding clause (x)). The 1997 10-K discloses as of December 31, 1997 all outstanding options or warrants for the purchase of, or rights to purchase or subscribe for, or securities convertible into, exchangeable for, or otherwise entitling the holder to acquire, Common Stock or other capital stock of the Company, or any contracts or commitments to issue or sell Common Stock or other capital stock of the Company or any such options, warrants, rights or other securities; and from such date to the date hereof there has been, and to the Closing Date there will be, no material change in the amount or terms of any of the foregoing except for the grant or exercise of options to purchase shares of Common Stock pursuant to the Company's stock option plans in effect on the date of this Agreement. (2) The Company has duly reserved from its authorized and unissued shares of Common Stock the full number of shares required for (A) all options, warrants, convertible securities, exchangeable securities, and other rights to acquire shares of Common Stock which are outstanding and (B) all shares of Common Stock and options and other rights to acquire shares of Common Stock which may be issued or granted under the stock option and similar plans which have been adopted by the Company or any Subsidiary; and, immediately following the Closing Date, after giving effect to any antidilution or similar adjustment arising by reason of issuance of the Note, the Other Notes, the Warrants and the warrants issuable to the purchasers of the Other Notes, the total number of shares of Common Stock reserved and required to be reserved from the authorized and unissued shares of Common Stock for purposes of all such options, warrants, convertible securities, other rights, and stock option and similar plans (excluding the Note, the Other Notes, the Warrants and the warrants issuable to the purchasers of the Other Notes) will be 7,844,603. Each outstanding class or series of securities of the Company for which any such antidilution adjustment will occur is identified on SCHEDULE 4(C) attached hereto, together with the amount of such antidilution adjustment for each such class or series. The o utstanding shares of Common Stock of the Company and outstanding options, warrants, rights, and other securities -20- entitling the holders to purchase or otherwise acquire Common Stock have been duly and validly authorized and issued. None of the outstanding shares of Common Stock or options, warrants, rights, or other such securities has been issued in violation of the preemptive rights of any securityholder of the Company. The offers and sales of the outstanding shares of Common Stock of the Company and options, warrants, rights, and other securities were at all relevant times either registered under the 1933 Act and applicable state securities laws or exempt from such requirements. No holder of any of the Company's securities has any rights, "demand," "piggy-back" or otherwise, to have such securities registered by reason of the intention to file, filing or effectiveness of the Registration Statement. (D) CONCERNING THE SHARES AND THE COMMON STOCK. The Shares have been duly authorized and the Payment Shares, when issued in payment of a portion of the Company's obligation to repay principal of the Note or the Optional Redemption Price, the Interest Shares, when issued in payment of interest on the Note, and the Warrant Shares, when issued upon exercise of the Warrants, will be duly and validly issued, fully paid and non-assessable and will not subject the holder thereof to personal liability by reason of being such holder. There are no preemptive or similar rights of any stockholder of the Company or any other Person to acquire any of the Shares or the Warrants. The Company has duly reserved 1,920,000 shares of Common Stock as the Warrant Shares and for issuance upon exercise of the warrants issuable to the purchasers of the Other Notes, and such shares shall remain so reserved, and the Company shall from time to time reserve such additional shares of Common Stock as shall be required to be reserved pursuant to the Warrants, so long as the Warrants are outstanding. The Common Stock is listed for trading on Nasdaq and (1) the Company and the Common Stock meet the criteria for continued listing and trading on Nasdaq; (2) the Company has not been notified since January 1, 1996 by the NASD or the Nasdaq Stock Market of any failure or potential failure to meet the criteria for continued listing and trading on Nasdaq and (3) no suspension of trading in the Common Stock is in effect. The Company knows of no reason that the Shares will be ineligible for listing on Nasdaq. (E) CORPORATE AUTHORIZATION. This Agreement and the other Transaction Documents to which the Company is or will be a party have been duly and validly authorized by the Company; this Agreement has been duly executed and delivered by the Company and, assuming due execution and delivery by the Buyer, this Agreement is, and the Note, and the Warrants will be, when executed and delivered by the Company, valid and binding obligations of the Company enforceable in accordance with their respective terms, except as the enforceability hereof or thereof may be limited by bankruptcy, insolvency, reorganization, moratorium or other similar laws now or hereafter in effect relating to or affecting creditors' rights generally and general principles of equity, regardless of whether enforcement is considered in a proceeding in equity or at law. (F) NON-CONTRAVENTION. The execution and delivery of the Transaction Documents by the Company and the consummation by the Company of the issuance of the Securities as contemplated by this Agreement and consummation by the Company of the other -21- transactions contemplated by the Transaction Documents do not and will not, with or without the giving of notice or the lapse of time, or both, (i) result in any violation of any term or provision of the certificate of incorporation or bylaws of the Company or any Subsidiary, (ii) conflict with or result in a breach by the Company or any Subsidiary of any of the terms or provisions of, or constitute a default under, or result in the modification of, or result in the creation or imposition of any lien, security interest, charge or encumbrance (other than pursuant to the Security Agreement and the Patent and Trademark Security Agreement) upon any of the properties or assets of the Company or any Subsidiary pursuant to, any indenture, mortgage, deed of trust or other agreement or instrument to which the Company or any Subsidiary is a party or by which the Company or any Subsidiary or any of their respective properties or assets are bound or affected, in any such case which (x) relates to or affects the Collateral or (y) would be reasonably likely to have a material adverse effect on the business, properties, operations, condition (financial or other), results of operations or prospects of the Company and the Subsidiaries, taken as a whole, or the validity or enforceability of, or the ability of the Company to perform its obligations under, the Transaction Documents, (iii) conflict with or result in a breach by the Company or any Subsidiary of the terms or provisions of, or constitute a default under, or result in the modification of, or entitle any party other than the Company to terminate, or require any consent or approval of any such party with respect to, any of the Lafon Agreements, (iv) violate or contravene any applicable law, rule or regulation or any applicable decree, judgment or order of any court, United States federal or state regulatory body, administrative agency or other governmental body having jurisdiction over the Company or any Subsidiary or any of their respective properties or assets, in any such case which (x) relates to or affects the Collateral or (y) would be reasonably likely to have a material adverse effect on the business, properties, operations, condition (financial or other), results of operations or prospects of the Company and the Subsidiaries, taken as a whole, or the validity or enforceability of, or the ability of the Company to perform its obligations under, the Transaction Documents, or (v) have any material adverse effect on any permit, certification, registration, approval, consent, license or franchise necessary for the Company or any Subsidiary to own or lease and operate any of its properties and to conduct any of its business or the ability of the Company or any Subsidiary to make use thereof. (G) APPROVALS, FILINGS, ETC. No authorization, approval or consent of, or filing with, any court, governmental body, regulatory agency, self-regulatory organization, or stock exchange or market or the stockholders of the Company is required to be obtained or made by the Company or any Subsidiary for (x) the execution, delivery and performance by the Company of the Transaction Documents, (y) the issuance and sale of the Securities as contemplated by this Agreement and the terms of the Note and the Warrants and (z) the performance by the Company of its obligations under the Transaction Documents, other than (1) listing of the Shares on Nasdaq, (2) registration of the resale of the Shares under the 1933 Act as contemplated by Section 8, (3) as may be required under applicable state securities or "blue sky" laws, (4) filing of one or more Forms D with respect to the Securities as required under Regulation D, (5) filing by the Company of financing statements under the provisions of applicable state Uniform Commercial Codes, and (6) filing of the Patent and Trademark Security Agreement with the PTO. -22- (H) INFORMATION PROVIDED. The SEC Reports, the Transaction Documents and the instruments delivered by the Company to the Buyer in connection with the closing on the Closing Date do not and will not on the date of execution and delivery of this Agreement, the date of delivery thereof to the Buyer and on the Closing Date contain any untrue statement of a material fact or omit to state any material fact necessary in order to make the statements therein, in the light of the circumstances under which they are made, not misleading, it being understood that for purposes of this Section 4(h), any statement contained in such information shall be deemed to be modified or superseded for purposes of this Section 4(h) to the extent that a statement in any document included in such information which was prepared and furnished to the Buyer on a later date or filed with the SEC on a later date modifies or replaces such statement, whether or not such later prepared or filed statement so states. (I) CONDUCT OF BUSINESS. Except as set forth in the SEC Reports, since September 30, 1998, neither the Company nor any Subsidiary has (i) incurred any material obligation or liability (absolute or contingent) other than in the ordinary course of business; (ii) canceled, without payment in full, any material notes, loans or other obligations receivable or other debts or claims held by it other than in the ordinary course of business; (iii) sold, assigned, transferred, abandoned, mortgaged, pledged or subjected to lien any of its material properties, tangible or intangible, or rights under any material contract, permit, license, franchise or other agreement; (iv) conducted its business in a manner materially different from its business as conducted on such date; (v) declared, made or paid or set aside for payment any cash or non-cash distribution on any shares of its capital stock; or (vi) consummated, or entered into any agreement with respect to, any transaction or event which would constitute a Repurchase Event. Except as disclosed in the SEC Reports, the Company and each Subsidiary owns, possesses or has obtained all governmental, administrative and third party licenses, permits, certificates, registrations, approvals, consents and other authorizations necessary to own or lease (as the case may be) and operate its properties, whether tangible or intangible, and to conduct its business or operations as currently conducted, except such licenses, permits, certificates, registrations, approvals, consents and authorizations the failure of which to obtain would not have a material adverse effect on the business, properties, operations, condition (financial or other), results of operations or prospects of the Company and the Subsidiaries, taken as a whole. (J) SEC FILINGS. The Company has timely filed all reports required to be filed under the 1934 Act and any other material reports or documents required to be filed with the SEC since January 1, 1997. All of such reports and documents complied, when filed, in all material respects, with all applicable requirements of the 1933 Act and the 1934 Act. The Company meets the requirements for the use of Form S-3 for the registration of the resale of the Shares by the Buyer and any other Investor. The Company has not filed any reports with the SEC under the 1934 Act since December 31, 1997 other than the SEC Reports. (K) ABSENCE OF CERTAIN PROCEEDINGS. Except as disclosed in the SEC Reports, there is no action, suit, proceeding, inquiry or investigation before or by any court, public board or body or governmental agency pending or, to the knowledge of the Company or any Subsidiary, -23- threatened against or affecting the Company or any Subsidiary, in any such case wherein an unfavorable decision, ruling or finding is reasonably likely and would reasonably be expected to have a material adverse effect on the business, properties, operations, condition (financial or other), results of operations or prospects of the Company and the Subsidiaries, taken as a whole, or the transactions contemplated by the Transaction Documents or which could adversely affect the validity or enforceability of, or the authority or ability of the Company to perform its obligations under, the Transaction Documents; the Company does not have pending before the SEC any request for confidential treatment of information and, to the best of the Company's knowledge, no such request will be made by the Company prior to the SEC Effective Date for the Warrant Share Registration Statement; and to the best of the Company's knowledge there is not pending or contemplated any, and there has been no, investigation by the SEC involving the Company or any current or former director or officer of the Company. (L) FINANCIAL STATEMENTS; LIABILITIES. The financial statements included in the September 10-Q present fairly the financial position, results of operations and cash flows of the Company and the Subsidiaries, at the dates and for the periods covered thereby, have been prepared in conformity with generally accepted accounting principles applied on a consistent basis throughout the periods covered thereby and on a basis consistent with the audited financial statements appearing in the 1997 Form 10-K, and include all adjustments (consisting only of normal recurring adjustments) necessary to present fairly the financial position, results of operations and cash flows of the Company and the Subsidiaries at the dates and for the periods covered thereby. Except as and to the extent disclosed, reflected or reserved against in the financial statements of the Company and the notes thereto included in the SEC Reports, neither the Company nor any Subsidiary has any liability, debt or obligation, whether accrued, absolute, contingent or otherwise, and whether due or to become due which, individually or in the aggregate, are material to the Company and the Subsidiaries, taken as a whole. Subsequent to September 30, 1998, neither the Company nor any Subsidiary has incurred any liability, debt or obligation of any nature whatsoever which, individually or in the aggregate are material to the Company and the Subsidiaries, taken as a whole, other than those incurred in the ordinary course of their respective businesses. (M) MATERIAL LOSSES. Since September 30, 1998, neither the Company nor any Subsidiary has sustained any loss or interference with its business or properties from fire, flood, hurricane, accident or other calamity, whether or not covered by insurance, or from any labor dispute or court or governmental action, order or decree, which loss or interference could be material to the business, properties, operations, condition (financial or other), results of operations or prospects of the Company and the Subsidiaries, taken as a whole. (N) ABSENCE OF CERTAIN CHANGES. Since September 30, 1998, there has been no material adverse change and no material adverse development in the business, properties, operations, condition (financial or other), results of operations or prospects of the Company and the Subsidiaries, taken as a whole, except as disclosed in the SEC Reports and except for operating losses incurred since such date at a rate consistent with the rate thereof during the nine -24- months ended September 30, 1998. (O) INTELLECTUAL PROPERTY. Except as disclosed in the SEC Reports, each of the Company and each Subsidiary owns, or possesses adequate rights to use, all patents, patent rights, inventions, trade secrets, know-how, proprietary techniques, including processes and substances, trademarks, service marks, trade names and copyrights described or referred to in the SEC Reports or owned or used by it or which are necessary for the conduct of its business as it is presently conducted or proposed to be conducted, except for where the failure to own or possess adequate rights to use such patents, patent rights, inventions, trade secrets, service marks, trade names and copyrights would not have a material adverse effect on (x) the business, properties, operations, condition (financial or other), results of operations or prospects of the Company and the Subsidiaries, taken as a whole, or (y) the Company's ability to manufacture, market and sell the Products. Except as disclosed in the SEC Reports, neither the Company nor any Subsidiary has received any notice of infringement of or conflict with asserted rights of others with respect to, any patents, patent rights, inventions, trade secrets, know-how, proprietary techniques, including processes and substances, trademarks, service marks, trade names or copyrights which, singly or in the aggregate, if the subject of an unfavorable decision, ruling or finding, could have a material adverse effect on the business, properties, operations, condition (financial or other), results of operations or prospects of the Company and the Subsidiaries, taken as a whole. (P) INTERNAL ACCOUNTING CONTROLS. The Company maintains a system of internal accounting controls for the Company and the Subsidiaries which meets the requirements of Section 13(b)(2) of the 1934 Act in all material respects. (Q) COMPLIANCE WITH LAW. Neither the Company nor any Subsidiary is in violation of or has any liability under any statute, law, rule, regulation, ordinance, decision or order of any governmental agency or body or any court, domestic or foreign, including, without limitation, those relating to the use, operation, handling, transportation, disposal or release of hazardous or toxic substances or wastes or relating to the protection or restoration of the environment or human exposure to hazardous or toxic substances or wastes, except where such violation or liability would not individually or in the aggregate have a material adverse effect on the business, properties, operations, condition (financial or other), results of operations or prospects of the Company and the Subsidiaries, taken as a whole; and neither the Company nor any Subsidiary is aware of any pending investigation which would reasonably be expected to lead to such a claim. (R) PROPERTIES. Each of the Company and the Subsidiaries has good title to all property, real and personal (tangible and intangible), and other assets owned by it, free and clear of all security interests, charges, mortgages, liens or other encumbrances, except such as are described in the SEC Reports or such as do not materially interfere with the use of such property made, or proposed to be made, by the Company or any Subsidiary. The leases, licenses or other contracts or instruments under which the Company and each Subsidiary leases, holds or is entitled to use any property, real or personal, which individually or in the aggregate are material to the Company and the Subsidiaries, taken as a whole, are valid, subsisting and enforceable with only -25- such exceptions as do not materially interfere with the use of such property made, or proposed to be made, by the Company or such Subsidiary or have expired or terminated in accordance with their terms or have been superseded by other classes, contracts or agreements. Neither the Company nor any Subsidiary has received notice of any material violation of any applicable law, ordinance, regulation, order or requirement relating to its owned or leased properties. Neither the Company nor any Subsidiary has any mortgage, lien, pledge, security interest or other charge or encumbrance on any of its assets or properties except as listed in SCHEDULE 4(R) attached hereto. (S) LABOR RELATIONS. No material labor problem exists or, to the knowledge of the Company or any Subsidiary, is imminent with respect to any of the employees of the Company or any Subsidiary. (T) INSURANCE. The Company and the Subsidiaries maintain insurance against loss or damage by fire or other casualty and such other insurance, including but not limited to, product liability insurance, in such amounts and covering such risks as the Company believes are commercially reasonable. (U) TAX MATTERS. Each of the Company and the Subsidiaries has filed all federal, state and local income and franchise tax returns required to be filed and has paid all material taxes shown by such returns to be due, and no tax deficiency has been determined adversely to the Company or any Subsidiary which has had (nor does the Company or any Subsidiary have any knowledge of any tax deficiency which, if determined adversely to the Company or any Subsidiary, might have) a material adverse effect on the business, properties, operations, condition (financial or other), results of operations, or prospects of the Company and the Subsidiaries, taken as a whole. (V) INVESTMENT COMPANY. Neither the Company nor any Subsidiary is an "investment company" within the meaning of such term under the Investment Company Act of 1940, as amended, and the rules and regulations of the SEC thereunder. (W) ABSENCE OF BROKERS, FINDERS, ETC. No broker, finder or similar Person other than the Placement Agent is entitled to any commission, fee or other compensation by reason of action taken by or on behalf of the Company in connection with the transactions contemplated by this Agreement, and the Company shall pay, and indemnify and hold harmless the Buyer from, any claim made against the Buyer by any Person for any such commission, fee or other compensation. (X) NO SOLICITATION. No form of general solicitation or general advertising was used by the Company or, to the best of its knowledge, any other Person acting on behalf of the Company, in respect of the Securities or in connection with the offer and sale of the Securities. Neither the Company nor, to its knowledge, any Person acting on behalf of the Company has, either directly or indirectly, sold or offered for sale to any Person any of the Securities (other than -26- the Placement Agent) or, within the six months prior to the date hereof, any other similar security of the Company except as contemplated by this Agreement and the Other Note Purchase Agreements; and neither the Company nor any Person authorized to act on its behalf will sell or offer for sale any promissory notes, warrants, shares of Common Stock or other securities to, or solicit any offers to buy any such security from, any Person so as thereby to cause the issuance or sale of any of the Securities to be in violation of any of the provisions of Section 5 of the 1933 Act. (Y) ERISA COMPLIANCE. Each of the Company and the Subsidiaries is in compliance in all material respects with all presently applicable provisions of ERISA; no "reportable event" (as defined in ERISA) has occurred with respect to any "pension plan" (as defined in ERISA) for which the Company or any Subsidiary would have any liability; neither the Company nor any Subsidiary has incurred or expects to incur liability under (i) Title IV of ERISA with respect to termination of, or withdrawal from, any "pension plan" or (ii) Sections 412 or 4971 of the Code; and each "pension plan" for which the Company or any Subsidiary would have any liability that is intended to be qualified under Section 401(a) of the Code is so qualified in all material respects and nothing has occurred, whether by action or by failure to act, which would cause the loss of such qualification. (Z) CONCERNING THE COLLATERAL. Upon execution and delivery of the Security Agreement and the Patent and Trademark Security Agreement by the Company and the Collateral Agent and completion of the filings referred to in Schedule I to ANNEX VI attached hereto, the Collateral Agent will have a perfected first priority security interest and will have all of the rights currently held by the Company to manufacture, market, use and sell the Products in the Territory, and to obtain supplies of modafinil, including, without limitation, requisite rights under the Company's licenses, patents, patent applications, manufacturing and supply agreements and requisite governmental authorizations, approvals, permits and licenses. 5. CERTAIN COVENANTS. (A) TRANSFER RESTRICTIONS. The Buyer acknowledges and agrees that (1) the Note and the Warrants have not been and are not being registered under the provisions of the 1933 Act or any state securities laws and, except as provided in Section 8, the Shares have not been and are not being registered under the 1933 Act or any state securities laws, and that the Note and the Warrants may not be transferred unless the Buyer shall have delivered to the Company an opinion of counsel, reasonably satisfactory in form, scope and substance to the Company, to the effect that the Note or the Warrants to be transferred may be transferred without such registration; (2) no sale, assignment or other transfer of the Note or the Warrants or any interest therein may be made except in accordance with the terms hereof and thereof; (3) the Shares may not be resold by the Buyer unless the resale has been registered under the 1933 Act or is made pursuant to an applicable exemption from such registration and the Company shall have received the opinion of counsel provided for in the final sentence of this Section 5(a); (4) any sale of Shares under a Registration Statement shall be made only in compliance with the terms of this -27- Section 5(a) and Section 8 (including, without limitation, Section 8(c)(5)); (5) any sale of the Securities made in reliance on Rule 144 may be made only in accordance with the terms of Rule 144 and further, if the exemption provided by Rule 144 is not available, any resale of the Securities under circumstances in which the seller, or the Person through whom the sale is made, may be deemed to be an underwriter, as that term is used in the 1933 Act, may require compliance with some other exemption under the 1933 Act or the rules and regulations of the SEC thereunder; and (6) the Company is under no obligation to register the Securities (other than registration of the resale of the Shares in accordance with Section 8) under the 1933 Act or, except as provided in Section 5(d) and Section 8, to comply with the terms and conditions of any exemption thereunder. The Buyer may not transfer the Shares in a transaction which does not constitute a transfer thereof pursuant to the applicable Registration Statement in accordance with the plan of distribution set forth therein or in any supplement to the related Prospectus unless the Buyer shall have delivered to the Company an opinion of counsel, reasonably satisfactory in form, scope and substance to the Company, that such Shares may be so transferred without registration under the 1933 Act. (B) RESTRICTIVE LEGENDS. (1) The Buyer acknowledges and agrees that the Note shall bear a restrictive legend in substantially the following form (and a stop-transfer order may be placed against transfer of the Note): This Note has not been registered under the Securities Act of 1933, as amended (the "1933 Act"), or any state securities laws. The issuance to the holder of this Note of the shares of Common Stock issuable in payment of a portion of this Note and in payment of interest on this Note are not covered by a registration statement under the 1933 Act or registration under state securities laws. This Note has been acquired, and such shares must be acquired, for investment only and may not be sold, transferred or assigned in the absence of registration of the resale thereof under the 1933 Act or an opinion of counsel reasonably satisfactory in form, scope and substance to the Company that such registration is not required. (2) The Buyer further acknowledges and agrees that the Warrants shall bear a restrictive legend in substantially the following form (and a stop- transfer order may be placed against transfer of the Warrants): The securities represented by this certificate have not been registered under the Securities Act of 1933, as amended (the "1933 Act"). The securities have been acquired for investment and may not be resold, transferred or assigned in the absence of an effective registration statement for the securities under the 1933 Act or an opinion of counsel that registration is not required under the 1933 Act. (3) The Buyer further acknowledges and agrees that until such time as the Warrant Shares have been registered for resale under the 1933 Act as contemplated by Section 8, the certificates for the Shares, may bear a restrictive legend in substantially the following form -28- (and a stop-transfer order may be placed against transfer of the certificates for the Shares): The securities represented by this certificate have not been registered under the Securities Act of 1933, as amended (the "1933 Act"). The securities have been acquired for investment and may not be resold, transferred or assigned in the absence of an effective registration statement for the securities under the 1933 Act or an opinion of counsel that registration is not required under the 1933 Act. (4) Once the Registration Statement required to be filed by the Company pursuant to Section 8 relating to the Warrant Shares has been declared effective, thereafter (1) upon request of the Buyer the Company will substitute certificates without restrictive legend for certificates for any Warrant Shares issued prior to the SEC Effective Date which bear such restrictive legend and remove any stop-transfer restriction relating thereto promptly, but in no event later than three days after surrender of such certificates by the Buyer and (2) the Company shall not place any restrictive legend on certificates for any Warrant Shares issued upon exercise of the Warrants or impose any stop-transfer restriction thereon. (C) NASDAQ LISTING; REPORTING STATUS. Prior to the Closing Date, the Company will file with Nasdaq an application or other document required by Nasdaq for the listing of the Warrant Shares with Nasdaq and shall provide evidence of such filing to the Buyer. So long as the Buyer beneficially owns any portion of the Note or the Warrants or any Shares, the Company will use its best efforts to maintain the listing of the Common Stock on Nasdaq or a registered national securities exchange. The Company shall use its best efforts to obtain the listing, subject to official notice of issuance, of the Warrant Shares on the Nasdaq prior to the Closing Date. During the Registration Period, the Company shall timely file all reports required to be filed with the SEC pursuant to Section 13 or 15(d) of the 1934 Act, and the Company shall not terminate its status as an issuer required to file reports under the 1934 Act even if the 1934 Act or the rules and regulations thereunder would permit such termination. (D) FORM D. The Company agrees to file one or more Forms D with respect to the Securities as required under Regulation D to claim the exemption provided by Rule 506 of Regulation D and to provide a copy thereof to the Buyer promptly after such filing. (E) STATE SECURITIES LAWS. On or before the Closing Date, the Company shall take such action as shall be necessary to qualify, or to obtain an exemption for, the Note for sale to the Buyer pursuant to this Agreement, the Warrants for issuance to the Buyer pursuant to this Agreement and the Warrant Shares for sale upon exercise of the Warrants under such of the securities laws of jurisdictions in the United States as shall be applicable to the sale of the Note to the Buyer pursuant to this Agreement and issuance of the Warrant Shares upon exercise of the Warrants. Notwithstanding the foregoing obligations of the Company in this Section 5(e), the Company shall not be required (1) to qualify to do business in any jurisdiction where it would not otherwise be required to qualify but for this Section 5(e), (2) to subject itself to general taxation in -29- any such jurisdiction, (3) to file a general consent to service of process in any such jurisdiction, (4) to provide any undertakings that cause more than nominal expense or burden to the Company or (5) to make any change in its charter or by-laws which the Company determines to be contrary to the best interests of the Company and its stockholders. The Company shall furnish the Buyer with copies of all filings, applications, orders and grants or confirmations of exemptions relating to such securities laws on or before the Closing Date. (F) LIMITATION ON CERTAIN ACTIONS. From the date of execution and delivery of this Agreement by the parties hereto to the date of issuance of the Note, the Company (1) shall comply with Article III of the Note as if the Note were outstanding, (2) shall not take any action which, if the Note were outstanding, (A) would constitute an Event of Default or, with the giving of notice or the passage of time or both, would constitute an Event of Default or (B) would constitute a Repurchase Event or, with the giving of notice or the passage of time or both, would constitute a Repurchase Event. (G) SECURITY AGREEMENT; FINANCING STATEMENTS, ETC. The Company agrees to execute and deliver to the Collateral Agent on or before the Closing Date the Security Agreement in the form attached hereto as ANNEX IV and the Patent and Trademark Security Agreement in the form attached hereto as ANNEX V. The Company shall prepare and on or before the Closing Date file (x) with the appropriate officials, Uniform Commercial Code financing statements on Form UCC-1 relating to the Collateral in which the Company is granting a security interest to the Collateral Agent for the benefit of the holder of the Note pursuant to the Security Agreement, and (y) with the PTO copies of the Patent and Trademark Security Agreement. Prior to the Closing Date, the Company shall provide to the Buyer evidence of such filings and customary search reports of the relevant Uniform Commercial Code filing offices and the PTO. (H) USE OF PROCEEDS. The Company represents and agrees that: (1) it does not own or have any present intention of acquiring any "margin stock" as defined in Regulation U (12 CFR Part 221) of the Board of Governors of the Federal Reserve System ("margin stock"); (2) the proceeds of sale of the Note will be used for general working capital purposes and in the operation of the Company's business; (3) none of such proceeds will be used, directly or indirectly (A) to make any loan to or investment in any other Person or (B) for the purpose, whether immediate, incidental or ultimate, of purchasing or carrying any margin stock or for the purpose of maintaining, reducing or retiring any indebtedness which was originally incurred to purchase or carry any stock that is currently a margin stock or for any other purpose which might constitute the transactions contemplated by this Agreement a "purpose credit" within the meaning of such Regulation U; and (4) neither the Company nor any agent acting on its behalf has taken or will take any action which might cause this Agreement or the transactions contemplated hereby to violate Regulation T, Regulation U or any other regulation of the Board of Governors of the Federal Reserve System or to violate the 1934 Act, in each case as in effect now or as the same may hereafter be in effect. (I) BEST EFFORTS. Each of the parties shall use its best efforts timely to satisfy each of the conditions to the other party's obligations to sell and purchase the Note set forth in -30- Section 6 or 7, as the case may be, of this Agreement on or before the Closing Date. (J) DEBT OBLIGATION. So long as any portion of the Note is outstanding, the Company shall cause its books and records to reflect the Note as a debt of the Company in its unpaid principal amount, shall cause its financial statements to reflect the Note as a debt of the Company in such amount as shall be the greatest amount permitted in accordance with generally accepted accounting principles and, whenever appropriate, as a valid senior, secured debt obligation of the Company for money borrowed. 6. CONDITIONS TO THE COMPANY'S OBLIGATION TO SELL. The Buyer understands that the Company's obligation to sell the Note and issue the Warrants to the Buyer pursuant to this Agreement is conditioned upon satisfaction of the following conditions precedent on or before the Closing Date (any or all of which may be waived by the Company in its sole discretion): (a) On the Closing Date, no legal action, suit or proceeding shall be pending or threatened which seeks to restrain or prohibit the transactions contemplated by this Agreement; and (b) The representations and warranties of the Buyer contained in this Agreement and in the Questionnaire shall have been true and correct on the date of this Agreement and on the Closing Date as if made on the Closing Date and on or before the Closing Date the Buyer shall have performed all covenants and agreements of the Buyer required to be performed by the Buyer on or before the Closing Date. 7. CONDITIONS TO THE BUYER'S OBLIGATION TO PURCHASE. The Company understands that the Buyer's obligation to purchase the Note and acquire the Warrants is conditioned upon satisfaction of the following conditions precedent on or before the Closing Date (any or all of which may be waived by the Buyer in its sole discretion): (a) The Collateral Agent shall have executed and delivered to the Company the Security Agreement and the Patent and Trademark Security Agreement and copies thereof duly executed and delivered by the Company, shall have been furnished to the Buyer; (b) On the Closing Date, no legal action, suit or proceeding shall be pending or threatened which seeks to restrain or prohibit the transactions contemplated by this Agreement; (c) The representations and warranties of the Company contained in this Agreement shall have been true and correct on the date of this Agreement and, except for the approvals and filings referred to in clauses (3) (to the extent action is required by applicable law -31- to be taken on or prior to the Closing Date), (5) and (6) of Section 4(g), which shall have been obtained or made, shall be true and correct on the Closing Date as if made on and as of the Closing Date, the representations and warranties of the Company contained in the Transaction Documents other than this Agreement shall have been true and correct on the Closing Date as if made on and as of the Closing Date, and on or before the Closing Date the Company shall have performed all covenants and agreements of the Company contained herein or in any of the other Transaction Documents required to be performed by the Company on or before the Closing Date; (d) No event which, if the Note were outstanding, (1) would constitute an Event of Default or which, with the giving of notice or the passage of time, or both, would constitute an Event of Default shall have occurred and be continuing or (2) would constitute a Repurchase Event or which, with the giving of notice or the passage of time, or both, would constitute a Repurchase Event shall have occurred and be continuing; (e) The Company shall have delivered to the Buyer a certificate, dated the Closing Date, duly executed by its Chief Executive Officer or Chief Financial Officer to the effect set forth in subparagraphs (b), (c), and (d) of this Section 7; (f) The Company shall have delivered to the Buyer a certificate, dated the Closing Date, of the Secretary of the Company certifying (1) the Certificate of Incorporation and By-Laws of the Company as in effect on the Closing Date, (2) all resolutions of the Board of Directors (and committees thereof) of the Company relating to this Agreement and the Transaction Documents and the transactions contemplated hereby and thereby and (3) such other matters as reasonably requested by the Buyer; (g) On the Closing Date, the Buyer shall have received an opinion of Morgan, Lewis & Bockius, LLP, counsel for the Company, dated the Closing Date, addressed to the Buyer, in form, scope and substance reasonably satisfactory to the Buyer, substantially in the form of ANNEX VI attached hereto; (h) On the Closing Date, the Buyer shall have received an opinion of the Law Offices of Brian W Pusch, dated the Closing Date, addressed to the Buyer substantially in the form of ANNEX VII attached hereto; and (i) On the Closing Date, (i) trading in securities on the New York Stock Exchange, Inc., the American Stock Exchange, Inc. or Nasdaq shall not have been suspended or materially limited and (ii) a general moratorium on commercial banking activities in the State of New York or the Commonwealth of Pennsylvania shall not have been declared by either federal or state authorities. 8. REGISTRATION RIGHTS. -32- (A) MANDATORY REGISTRATION. (1) The Company shall prepare and as expeditiously as possible, but in no event later than the date which is 45 days after the Closing Date, file with the SEC the Warrant Share Registration Statement covering as Registrable Securities the resale by the Buyer of a number of shares of Common Stock equal to (A) the Warrant Shares issuable to the Buyer and (B) such additional number of shares of Common Stock as the Company shall in its discretion determine to register in connection with the issuance of the Interest Shares. (2) If, in accordance with the terms of the Note, the Company elects to issue Payment Shares in partial payment of the principal amount of the Note or in partial payment of the Optional Redemption Price and any Investor who holds the Note, or any portion thereof, consents to such election, then the Company shall prepare, and on or prior to the date which is 15 days after the Company so elects, file with the SEC a Payment Share Registration Statement covering the resale by each Investor who so consents to such election of a number of shares of Common Stock equal to the number of Payment Shares to be issued to such Investor in connection therewith. (3) From the date the Company files a Payment Share Registration Statement with the SEC to the SEC Effective Date for such Payment Share Registration Statement and, if during any time subsequent to the SEC Effective Date for any Registration Statement, any Registration Statement for any reason is not available for use by any Investor for the resale of any Registrable Securities when such Registration Statement is required to be so available for use, the Company shall not file any other registration statement or any amendment thereto with the SEC under the 1933 Act or request the acceleration of the effectiveness of any other registration statement previously filed with the SEC, other than (A) any registration statement on Form S-8 and (B) any registration statement or amendment which the Company is required to file or as to which the Company is required to request acceleration pursuant to any obligation in effect on the date of execution and delivery of this Agreement. (B) OBLIGATIONS OF THE COMPANY. In connection with the registration of the Registrable Securities, the Company shall: (1) use its best efforts to cause each Registration Statement referred to in Section 8(a) to become effective as promptly as possible after the date it is required to be filed with the SEC, and keep such Registration Statement effective pursuant to Rule 415 at all times during the Registration Period. The Company shall submit to the SEC, within three Business Days after the Company learns that no review of a particular Registration Statement will be made by the staff of the SEC or that the staff of the SEC has no further comments on such Registration Statement, as the case may be, a request for acceleration of effectiveness of such Registration Statement to a time and date not later than 48 hours after the submission of such request. The Company shall notify the Investors of the effectiveness of each Registration Statement on the SEC Effective Date for such Registration Statement. The Company represents and warrants to the Investors that (a) each Registration Statement (including any amendments or supplements thereto and prospectuses contained therein), at the time it is first filed with the SEC, at the time it is ordered effective by the -33- SEC and at all times during which it is required to be effective hereunder (and each such amendment and supplement at the time it is filed with the SEC and at all times during which it is available for use in connection with the offer and sale of the Registrable Securities) shall not contain any untrue statement of a material fact or omit to state a material fact required to be stated therein or necessary to make the statements therein not misleading and (b) each Prospectus, at the time the related Registration Statement is declared effective by the SEC and at all times that such Prospectus is required by this Agreement to be available for use by any Investor, shall not contain any untrue statement of a material fact or omit to state a material fact required to be stated therein, or necessary to make the statements therein, in light of the circumstances in which they were made, not misleading; (2) prepare and file with the SEC such amendments (including post- effective amendments) and supplements to each Registration Statement and Prospectus as may be necessary to keep such Registration Statement effective, and such Prospectus current, at all times during the Registration Period (other than during any Blackout Period during which the provisions of Section 8(b)(5)(B) are applicable), and, during the Registration Period, comply with the provisions of the 1933 Act applicable to the Company in order to permit the disposition by the Investors of all Registrable Securities covered by such Registration Statement; (3) furnish to Delta Opportunity Fund, Ltd., as representative for Investors whose Registrable Securities are included in any Registration Statement, and a single firm of counsel selected by all such Investors (1) promptly after the same is prepared and publicly distributed, filed with the SEC or received by the Company, five copies of such Registration Statement and any amendment thereto, each related Prospectus and each amendment or supplement thereto, (2) one copy of each letter written by or on behalf of the Company to the SEC or the staff of the SEC and each item of correspondence from the SEC or the staff of the SEC relating to such Registration Statement (other than any portion of any such letter or item which contains information for which the Company has sought confidential treatment), each of which the Company hereby determines to be confidential information and which each Investor hereby agrees to keep confidential as a confidential Record in accordance with Section 8(b)(9), and (3) such number of copies of each Prospectus and all amendments and supplements thereto and such other documents, as such Investor may reasonably request in order to facilitate the disposition of the Registrable Securities owned by such Investor; (4) subject to Section 8(b)(5), use its best efforts (i) to register and qualify the Registrable Securities covered by each Registration Statement under the securities or blue sky laws of such jurisdictions as any Investor who holds any Registrable Securities reasonably requests, (ii) to prepare and to file in those jurisdictions such amendments (including post-effective amendments) and supplements to such registrations and qualifications as may be necessary to maintain the effectiveness thereof at all times during the Registration Period and (iii) to take all other actions reasonably necessary or advisable to qualify the Registrable Securities for sale by the Investors in such jurisdictions; provided, however, that the Company shall not be required in connection therewith or as a condition thereto (I) to do business in any jurisdiction where -34- it would not otherwise be required to qualify but for this Section 8(b)(4), (II) to subject itself to general taxation in any such jurisdiction, (III) to file a general consent to service of process in any such jurisdiction, (IV) to provide any undertakings that cause more than nominal expense or burden to the Company or (V) to make any change in its charter or by-laws which the Company determines to be contrary to the best interests of the Company and its stockholders; (5) (A) as promptly as practicable after becoming aware of such event or circumstance, notify each Investor of the occurrence of any event or circumstance of which the Company has knowledge (x) as a result of which the Prospectus relating to any Registration Statement, as then in effect, includes an untrue statement of a material fact or omits to state a material fact required to be stated therein or necessary to make the statements therein, in light of the circumstances under which they were made, not misleading or (y) which requires the Company to amend or supplement any Registration Statement due to the receipt from an Investor or any other selling stockholder named in the related Prospectus of new or additional information about such Investor or selling stockholder or its intended plan of distribution of its Registrable Securities or other securities covered by such Registration Statement, and use its best efforts promptly to prepare a supplement or amendment to such Registration Statement and the related Prospectus to correct such untrue statement or omission or to add any new or additional information, and deliver a number of copies of such supplement or amendment to each Investor as such Investor may reasonably request; (B) notwithstanding Section 8(b)(5)(A) above, if at any time the Company notifies the Investors as contemplated by Section 8(b)(5)(A) the Company also notifies the Investors that the event giving rise to such notice relates to a development involving the Company which occurred subsequent to the later of (x) the SEC Effective Date for the particular Registration Statement and (y) the latest date prior to such notice on which the Company has amended or supplemented such Registration Statement, then the Company shall not be required to use best efforts to make such amendment during a Blackout Period; provided, however, that in any period of 365 consecutive days the Company shall not be entitled to avail itself of its rights under this Section 8(b)(5)(B) with respect to more than (i) two Blackout Periods; and provided further, however, that no Blackout Period may commence sooner than 90 days after the end of another Blackout Period; and provided, further, however, that if the Company issues Payment Shares to any Investor, no portion of any Blackout Period shall occur during the period of 30 days commencing on the date such Payment Shares are required by the terms of the Note to be delivered by the Company to such Investor. (6) as promptly as practicable after becoming aware of such event, notify each Investor who holds Registrable Securities being offered or sold of the issuance by the SEC of any stop order or other suspension of effectiveness of the Registration Statement relating thereto at the earliest possible time; (7) permit the Investors who hold Registrable Securities being included in a particular Registration Statement (or their designee) and a single firm of counsel designated as -35- selling stockholders' counsel by the Investors who hold a majority in interest of the Registrable Securities being offered for sale in such Registration Statement (and identified in writing to the Company by such Investors prior to the Closing Date, subject to change by notice to the Company from Investors who hold a majority in interest of the Registrable Securities being offered for sale) at such Investors' sole expense to review and have a reasonable opportunity to comment on such Registration Statement and all amendments and supplements thereto at least two Business Days (or such shorter period as may reasonably be specified by the Company) prior to their filing with the SEC; provided, however, that the Investors shall coordinate the exercise of their rights under this Section 8(b)(7) through Delta Opportunity Fund, Ltd. (8) make generally available to its security holders as soon as practical, but not later than 90 days after the close of the period covered thereby, an earning statement (in form complying with the provisions of Rule 158 under the 1933 Act) covering a 12-month period beginning not later than the first day of the Company's fiscal quarter next following the effective date of each Registration Statement; (9) make available for inspection by any Investor and any Inspector retained by any such Investor, at such Investor's sole expense, all Records as shall be reasonably necessary to enable such Investor to exercise its due diligence responsibility and cause the Company's and the Subsidiaries' officers, directors and employees to supply all information which such Investor or such Inspector may reasonably request for purposes of such due diligence; provided, however, that such Investor shall hold in confidence and shall not make any disclosure of any Record or other information which the Company determines in good faith to be confidential, and of which determination such Investor is so notified, unless (i) the disclosure of such Record is necessary to avoid or correct a misstatement or omission in any Registration Statement and a reasonable time prior to such disclosure the Investor shall have informed the Company of the need to so correct such misstatement or omission and the Company shall have failed to correct such misstatement or omission, (ii) the release of such Record is ordered pursuant to a subpoena or other order from a court or government body of competent jurisdiction or (iii) the information in such Record has been made generally available to the public other than by disclosure in violation of this or any other agreement. The Company shall not be required to disclose any confidential information in such Records to any Inspector until and unless such Inspector shall have entered into a confidentiality agreement with the Company with respect thereto, substantially in the form of this Section 8(b)(9), which agreement shall permit such Inspector to disclose Records to the Investor who has retained such Inspector. Each Investor agrees that it shall, upon learning that disclosure of such Records is sought in or by a court or governmental body of competent jurisdiction or through other means, give prompt notice to the Company and allow the Company, at the Company's expense, to undertake appropriate action to prevent disclosure of, or to obtain a protective order for, the Records deemed confidential. The Company shall hold in confidence and shall not make any disclosure of information concerning an Investor provided to the Company pursuant to this Agreement unless (i) the disclosure of such information is necessary to comply with federal or state securities laws, (ii) the disclosure of such information is necessary to avoid or correct a misstatement or omission in any Registration Statement, (iii) the release of such information is -36- ordered pursuant to a subpoena or other order from a court or governmental body of competent jurisdiction, or (iv) such information has been made generally available to the public other than by disclosure in violation of this or any other agreement. The Company agrees that it shall, upon learning that disclosure of such information concerning an Investor is sought in or by a court or governmental body of competent jurisdiction or through other means, give prompt notice to such Investor and allow such Investor, at such Investor's expense, to undertake appropriate action to prevent disclosure of, or to obtain a protective order for, such information; (10) use its best efforts to cause all the Registrable Securities covered by the Registration Statement as of each SEC Effective Date to be listed on Nasdaq (in the case of the Payment Shares, prior to the issuance thereof) or such other principal securities market on which securities of the same class or series issued by the Company are then listed or traded; (11) provide a transfer agent and registrar, which may be a single entity, for the Registrable Securities at all times; (12) cooperate with the Investors who hold Registrable Securities being offered to facilitate the timely preparation and delivery of certificates (not bearing any restrictive legends) representing Registrable Securities to be offered pursuant to the applicable Registration Statement and enable such certificates to be in such denominations or amounts as the Investors may reasonably request and registered in such names as the Investors may request; and, not later than the applicable SEC Effective Date, the Company shall (i) in the case of the Warrant Share Registration Statement, deliver to the Transfer Agent (with copies to the Investors whose Registrable Securities are included in such Registration Statement) an instruction substantially in the form attached hereto as ANNEX VIII and (ii) cause legal counsel selected by the Company to deliver to the Investors whose Registrable Securities are included in such Registration Statement and to the Transfer Agent opinions of counsel, in the forms attached hereto as ANNEX IX and ANNEX X; (13) during the Registration Period, the Company shall not bid for or purchase any Common Stock or any right to purchase Common Stock or attempt to induce any Person to purchase any such security or right if such bid, purchase or attempt would in any way limit the right of the Investors to sell Registrable Securities by reason of the limitations set forth in Regulation M under the 1934 Act; and (14) take all other reasonable actions necessary to expedite and facilitate disposition by the Investors of the Registrable Securities pursuant to the Registration Statement relating thereto. (C) OBLIGATIONS OF THE BUYER AND OTHER INVESTORS. In connection with the registration of the Registrable Securities, the Investors shall have the following obligations: -37- (1) It shall be a condition precedent to the obligations of the Company to complete the registration pursuant to this Agreement with respect to the Registrable Securities of a particular Investor that such Investor shall furnish to the Company the Required Information and shall execute such documents in connection with such registration as the Company may reasonably request. Prior to the execution and delivery of this Agreement, the Buyer shall complete and deliver to the Company an Investor Questionnaire in the form attached hereto as ANNEX XI, which shall be deemed to provide all Required Information for purposes of the preparation and filing of the Warrant Share Registration Statement. At least ten Business Days prior to the first anticipated filing date of a Payment Share Registration Statement, the Company shall notify each Investor of the Required Information for inclusion of such Investor's Registrable Securities in such Registration Statement. If at least four Business Days prior to the SEC Filing Date for such Payment Share Registration Statement the Company has not received the Required Information from an Investor, the Company shall so notify such Investor at least three Business Days prior to the SEC Filing Date for such Payment Share Registration Statement and if at least one Business Day prior to the SEC Filing Date for such Payment Share Registration Statement the Company still has not received the Required Information from such Investor, then the Company may file such Registration Statement without including Registrable Securities of such Non-Responsive Investor; provided, however, that nothing herein shall constitute a waiver of the requirements of Section 1.4 of the Note; (2) Each Investor by such Investor's acceptance of the Registrable Securities agrees to cooperate with the Company as reasonably requested by the Company in connection with the preparation and filing hereunder of the Registration Statement relating thereto, unless such Investor has notified the Company in writing of such Investor's election to exclude all of such Investor's Registrable Securities from such Registration Statement; (3) Each Investor agrees that it will not effect any disposition of the Registrable Securities except as contemplated in the Registration Statement relating thereto or as otherwise is in compliance with the registration requirements of applicable securities laws and that it will promptly notify the Company of any material changes in the information set forth in any Registration Statement regarding such Investor or its plan of distribution; and each Investor agrees (a) to notify the Company in writing in the event that such Investor enters into any material agreement with a broker or a dealer for the sale of the Registrable Securities through a block trade, special offering, exchange distribution or a purchase by a broker or dealer and (b) in connection with such agreement, to provide to the Company in writing the information necessary to prepare any supplemental prospectus pursuant to Rule 424(c) under the 1933 Act which is required with respect to such transaction; (4) Each Investor acknowledges that there may occasionally be times as specified in Section 8(b)(5) or 8(b)(6) when the Company must suspend the use of the Prospectus until such time as an amendment to a particular Registration Statement has been filed by the Company and declared effective by the SEC, the Company has prepared a supplement to the Prospectus relating to such Registration Statement or the Company has filed an appropriate report -38- with the SEC pursuant to the 1934 Act. Each Investor hereby covenants that it will not sell any Registrable Securities pursuant to the Prospectus relating thereto during the period commencing at the time at which the Company gives such Investor notice of the suspension of the use of such Prospectus in accordance with Section 8(b)(5) or 8(b)(6) and ending at the time the Company gives such Investor notice that such Investor may thereafter effect sales pursuant to such Prospectus, or until the Company delivers to such Investor an amended or supplemented Prospectus; and (5) In connection with any sale of Registrable Securities which is made by an Investor pursuant to the Registration Statement relating thereto (A) if such sale is made through such Investor's broker, such Investor shall instruct such broker to deliver the applicable Prospectus to the purchaser (or the broker therefor) in connection with such sale and shall supply copies of such Prospectus to such broker; (B) if such sale is made in a transaction directly with a purchaser and not through the facilities of any securities exchange or market, such Investor shall deliver, or cause to be delivered, the applicable Prospectus to such purchaser; and (C) if such sale is made by any means other than those described in the immediately preceding clauses (A) and (B), such Investor shall otherwise use its reasonable best efforts to comply with the prospectus delivery requirements of the 1933 Act applicable to such sale. (D) RULE 144. With a view to making available to the Investors the benefits of Rule 144, the Company agrees: (1) so long as any Investor owns Registrable Securities, promptly upon request, to furnish to such Investor such information as may be necessary and otherwise reasonably to cooperate with such Investor to permit such Investor to sell Registrable Securities pursuant to Rule 144 without registration; and (2) if at any time the Company is not required to file reports with the SEC pursuant to Sections 13 or 15(d) of the 1934 Act, to use its best efforts to, upon the request of an Investor, to make publicly available other information so long as is necessary to permit publication by brokers and dealers of quotations for the Common Stock and sales of the Registrable Securities in accordance with Rule 15c2-11 under the 1934 Act. 9. INDEMNIFICATION AND CONTRIBUTION. (A) INDEMNIFICATION. (1) To the extent not prohibited by applicable law, the Company will indemnify and hold harmless each Indemnified Person against any Claims to which any of them may become subject under the 1933 Act, the 1934 Act or otherwise, insofar as such Claims (or actions or proceedings, whether commenced or threatened, in respect thereof) arise out of or are based upon any Violation or any of the transactions contemplated by this Agreement. Subject to the restrictions set forth in Section 9(a)(3) with respect to the number of legal counsel, the Company shall reimburse the Investors and each such controlling Person, promptly as such expenses are incurred and are due and payable, for any documented reasonable legal fees or -39- other documented and reasonable expenses incurred by them in connection with investigating or defending any such Claim. Notwithstanding anything to the contrary contained herein, the indemnification agreement contained in this Section 9(a)(1) shall not apply to: (I) a Claim arising out of or based upon a Violation which occurs in reliance upon and in conformity with information relating to an Indemnified Person furnished in writing to the Company by such Indemnified Person or an underwriter for such Indemnified Person expressly for use in connection with the preparation of any Registration Statement or any such amendment thereof or supplement thereto; (II) any Claim arising out of or based on any statement or omission in any Prospectus, which statement or omission was corrected in any subsequent Prospectus that was delivered to the Indemnified Person prior to the pertinent sale or sales of Registrable Securities by such Indemnified Person; and (III) amounts paid in settlement of any Claim if such settlement is effected without the prior written consent of the Company. Such indemnity shall remain in full force and effect regardless of any investigation made by or on behalf of the Indemnified Person and shall survive the transfer of the Registrable Securities by the Investors. (2) In connection with each Registration Statement, each Investor agrees to indemnify and hold harmless, to the same extent and in the same manner set forth in Section 9(a)(1), each Indemnified Party against any Claim to which any of them may become subject, under the 1933 Act, the 1934 Act or otherwise, insofar as such Claim arises out of or is based upon any Violation, in each case to the extent (and only to the extent) that such Violation occurs in reliance upon and in conformity with written information furnished to the Company by such Investor expressly for use in connection with such Registration Statement or any amendment thereof or supplement thereto; and such Investor will reimburse any legal or other expenses reasonably incurred by them in connection with investigating or defending any such Claim; provided, however, that the indemnity agreement contained in this Section 9(a)(2) shall not apply to amounts paid in settlement of any Claim if such settlement is effected without the prior written consent of such Investor; provided, further, however, that the Investor shall be liable under this Section 9(a)(2) for only that amount of all Claims in the aggregate as does not exceed the amount by which the proceeds to such Investor as a result of the sale of Registrable Securities pursuant to such Registration Statement exceeds the amount paid by such Investor for such Registrable Securities. Such indemnity shall remain in full force and effect regardless of any investigation made by or on behalf of such Indemnified Party and shall survive the transfer of the Registrable Securities by the Investors. Notwithstanding anything to the contrary contained herein, the indemnification agreement contained in this Section 9(a)(2) with respect to any preliminary prospectus shall not inure to the benefit of any Indemnified Party if the untrue statement or omission of material fact contained in such preliminary prospectus was corrected on a timely basis in the related Prospectus, as then amended or supplemented. (3) Promptly after receipt by an Indemnified Person or Indemnified Party under this Section 9(a) of notice of the commencement of any action (including any governmental action), such Indemnified Person or Indemnified Party shall, if a Claim in respect thereof is to be made against any indemnifying party under this Section 9(a), deliver to the indemnifying party a notice of the commencement thereof and the indemnifying party shall have the right to participate in, and, -40- to the extent the indemnifying party so desires, jointly with any other indemnifying party similarly noticed, to assume control of the defense thereof with counsel reasonably satisfactory to the Indemnified Person or the Indemnified Party, as the case may be; provided, however, that an Indemnified Person or Indemnified Party shall have the right to retain its own counsel with the fees and expenses to be paid by the indemnifying party, if, in the reasonable opinion of counsel retained by the indemnifying party, the representation by such counsel of the Indemnified Person or Indemnified Party and the indemnifying party would be inappropriate due to actual or potential differing interests between such Indemnified Person or Indemnified Party and any other party represented by such counsel in such proceeding, in which case the indemnifying party shall not be responsible for more than one such separate counsel, and one local counsel in each jurisdiction in which an Action is pending, for all Indemnified Persons or Indemnified Parties, as the case may be. The failure to deliver notice to the indemnifying party within a reasonable time of the commencement of any such action shall not relieve such indemnifying party of any liability to the Indemnified Person or Indemnified Party under this Section 9(a), except to the extent that the indemnifying party is prejudiced in its ability to defend such action. The indemnification required by this Section 9(a) shall be made by periodic payments of the amount thereof during the course of the investigation or defense, as such expense, loss, damage or liability is incurred and is due and payable. (B) CONTRIBUTION. To the extent any indemnification by an indemnifying party as set forth in Section 9(a) above is applicable by its terms but is prohibited or limited by law, the indemnifying party agrees to make the maximum contribution with respect to any amounts for which it would otherwise be liable under Section 9(a) to the fullest extent permitted by law. In determining the amount of contribution to which the respective parties are entitled, there shall be considered the relative fault of each party, the parties' relative knowledge of and access to information concerning the matter with respect to which the claim was asserted, the opportunity to correct and prevent any statement or omission and any other equitable considerations appropriate under the circumstances; provided, however, that (a) no contribution shall be made under circumstances where the maker would not have been liable for indemnification under the fault standards set forth in Section 9(a), (b) no Person guilty of fraudulent misrepresentation (within the meaning of Section 11(f) of the 1933 Act) shall be entitled to contribution from any other Person who was not guilty of such fraudulent misrepresentation and (c) the aggregate contribution by any seller of Registrable Securities shall be limited to the amount by which the proceeds received by such seller from the sale of such Registrable Securities exceeds the amount paid by such Investor for such Registrable Securities. (C) OTHER RIGHTS. The indemnification and contribution provided in this Section shall be in addition to any other rights and remedies available at law or in equity. 10. MISCELLANEOUS. (A) GOVERNING LAW. THIS AGREEMENT SHALL BE GOVERNED BY AND INTERPRETED IN ACCORDANCE WITH THE LAWS OF THE STATE OF NEW YORK. -41- (B) HEADINGS. The headings, captions and footers of this Agreement are for convenience of reference and shall not form part of, or affect the interpretation of, this Agreement. (C) SEVERABILITY. If any provision of this Agreement shall be invalid or unenforceable in any jurisdiction, such invalidity or unenforceability shall not affect the validity or enforceability of the remainder of this Agreement or the validity or enforceability of this Agreement in any other jurisdiction. (D) NOTICES. Any notices required or permitted to be given under the terms of this Agreement shall be in writing and shall be sent by mail, personal delivery, telephone line facsimile transmission or courier and shall be effective five days after being placed in the mail, if mailed, or upon receipt, if delivered personally, by telephone line facsimile transmission or by courier, in each case addressed to a party at such party's address (or telephone line facsimile transmission number) shown in the introductory paragraph or on the signature page of this Agreement or such other address (or telephone line facsimile transmission number) as a party shall have provided by notice to the other party in accordance with this provision. In the case of any notice to the Company, such notice shall be addressed to the Company at its address shown in the introductory paragraph of this Agreement, Attention: Vice President, Chief Financial Officer (telephone line facsimile number (610) 344-7563), and a copy shall also be given to: Morgan, Lewis & Bockius, LLP, 2000 One Logan Square, Philadelphia, Pennsylvania 19103, Attention: David R. King, Esq. (telephone line facsimile transmission number (215) 963-5299), and in the case of any notice to the Buyer, a copy shall be given to: Law Offices of Brian W Pusch, Penthouse Suite, 29 West 57th Street, New York, New York 10019 (telephone line facsimile transmission number (212) 980-7055), in each case with a copy to: Diaz & Altschul Capital, LLC, 745 Fifth Avenue, Suite 3001, New York, New York 10022 (telephone line facsimile transmission number (212) 751-5757). (E) COUNTERPARTS. This Agreement may be executed in counterparts and by the parties hereto on separate counterparts, each of which shall be deemed to be an original and all of which together shall constitute one and the same instrument. A telephone line facsimile transmission of this Agreement bearing a signature on behalf of a party hereto shall be legal and binding on such party. Although this Agreement is dated as of the date first set forth above, the actual date of execution and delivery of this Agreement by each party is the date set forth below such party's signature on the signature page hereof. Any reference in this Agreement or in any of the documents executed and delivered by the parties hereto in connection herewith to (1) the date of execution and delivery of this Agreement by the Buyer shall be deemed a reference to the date set forth below the Buyer's signature on the signature page hereof, (2) the date of execution and delivery of this Agreement by the Company shall be deemed a reference to the date set forth below the Company's signature on the signature page hereof and (3) the date of execution and delivery of this Agreement, or the date of execution and delivery of this Agreement by the Buyer and the Company, shall be deemed a reference to the later of the dates set forth below the signatures of the parties on the signature page hereof. -42- (F) ENTIRE AGREEMENT; BENEFIT. This Agreement, including the Annexes, constitutes the entire agreement between the parties hereto with respect to the subject matter hereof. There are no restrictions, promises, warranties, or undertakings, other than those set forth or referred to herein. This Agreement, including the Annexes, supersedes all prior agreements and understandings, whether written or oral, between the parties hereto with respect to the subject matter hereof. This Agreement and the terms and provisions hereof are for the sole benefit of only the Company, the Buyer and their respective successors and permitted assigns. (G) WAIVER. Failure of any party to exercise any right or remedy under this Agreement or otherwise, or delay by a party in exercising such right or remedy, or any course of dealing between the parties, shall not operate as a waiver thereof or an amendment hereof, nor shall any single or partial exercise of any such right or power, or any abandonment or discontinuance of steps to enforce such a right or power, preclude any other or further exercise thereof or exercise of any other right or power. (H) AMENDMENT. (1) No amendment, modification, waiver, discharge or termination of any provision of this Agreement on or prior to the Closing Date nor consent to any departure by the Buyer or the Company therefrom on or prior to the Closing Date shall in any event be effective unless the same shall be in writing and signed by the party to be charged with enforcement, and in any such case shall be effective only in the specific instance and for the purpose for which given. (2) No amendment, modification, waiver, discharge or termination of any provision of this Agreement after the Closing Date nor consent to any departure by the Company therefrom after the Closing Date shall in any event be effective unless the same shall be in writing and signed (x) by the Company if the Company is to be charged with enforcement or (y) by the Majority Holders, if the Buyer is to be charged with enforcement, and in any such case shall be effective only in the specific instance and for the purpose for which given. (3) No course of dealing between the parties hereto shall operate as an amendment of this Agreement. (I) FURTHER ASSURANCES. Each party to this Agreement will perform any and all acts and execute any and all documents as may be necessary and proper under the circumstances in order to accomplish the intents and purposes of this Agreement and to carry out its provisions. (J) ASSIGNMENT OF CERTAIN RIGHTS AND OBLIGATIONS. The rights of an Investor under Sections 5, 8, 9, and 10 of this Agreement shall be automatically assigned by such Investor to any transferee of all or any portion of such Investor's Registrable Securities (or all or any portion of the Note or the Warrants) only if: (1) such Investor agrees in writing with such transferee to -43- assign such rights, and a copy of such agreement is furnished to the Company within a reasonable time after such assignment, (2) the Company is, within a reasonable time after such transfer, furnished with notice of (A) the name and address of such transferee and (B) the securities with respect to which such rights and obligations are being transferred, (3) immediately following such transfer or assignment the further disposition of Registrable Securities by the transferee or assignee is restricted under the 1933 Act and applicable state securities laws, and (4) at or before the time the Company received the notice contemplated by clause (2) of this sentence the transferee agrees in writing with the Company to be bound by all of the provisions contained in Sections 5(a), 5(b), 8, 9, and 10 hereof. Upon any such transfer, the Company shall be obligated to such transferee to perform all of its covenants under Sections 5, 8, 9, and 10 of this Agreement as if such transferee were the Buyer. In connection with any such transfer the Company shall, at its sole cost and expense, promptly after such transfer take such actions as shall be reasonably acceptable to the transferring Investor and such transferee to assure that each Registration Statement and related Prospectus for which the transferring Investor is a selling stockholder are available for use by such transferee for sales of the Registrable Securities in respect of which such rights and obligations have been so transferred. Transfer of the Note shall be limited as provided therein and transfer of the Warrants shall be limited as provided therein. (K) EXPENSES. If the closing under this Agreement shall have occurred, all reasonable expenses incurred in connection with registrations, filings or qualifications pursuant to Sections 5(d), 5(e), 5(g) and 8 of this Agreement shall be paid by the Company, including, without limitation, all registration, listing and qualifications fees, printers and accounting fees and the fees and disbursements of counsel for the Company and the Investors but excluding (a) fees and expenses of investment bankers retained by any Investor and (b) brokerage commissions incurred by any Investor. The Company shall pay on demand all expenses incurred by the Buyer after the Closing Date, including reasonable attorneys' fees and expenses, as a consequence of, or in connection with (1) the negotiation, preparation or execution of any amendment, modification or waiver of any of the Transaction Documents, (2) any default or breach of any of the Company's obligations set forth in any of the Transaction Documents, and (3) the enforcement or restructuring of any right of, including the collection of any payments due, the Buyer under any of the Transaction Documents, including any action or proceeding relating to such enforcement or any order, injunction or other process seeking to restrain the Company from paying any amount due the Buyer. Except as otherwise provided in this Section 10(k), each of the Company and the Buyer shall bear its own expenses in connection with this Agreement and the transactions contemplated hereby. Nothing herein shall limit the rights of the Placement Agent under its Engagement Agreement with the Company. (L) TERMINATION. (1) The Buyer shall have the right to terminate this Agreement by giving notice to the Company at any time at or prior to the Closing Date if: (A) the Company shall have failed, refused, or been unable at or prior to the date of such termination of this Agreement to perform any of its obligations hereunder required to be performed prior to the time of such termination; -44- (B) any condition to the Buyer's obligations hereunder is not fulfilled at or prior to the time such condition is required to be satisfied; or (C) the closing shall not have occurred on a Closing Date on or before March 15, 1999, other than solely by reason of a breach of this Agreement by the Buyer. Any such termination shall be effective upon the giving of notice thereof by the Buyer. Upon such termination, the Buyer shall have no further obligation to the Company hereunder and the Company shall remain liable for any breach of this Agreement or the other documents contemplated hereby which occurred on or prior to the date of such termination. (2) The Company shall have the right to terminate this Agreement by giving notice to the Buyer at any time at or prior to the Closing Date if the closing shall not have occurred on a Closing Date on or before March 15, 1999, other than solely by reason of a breach of this Agreement by the Company, so long as the Company is not in breach of this Agreement at the time it gives such notice. Any such termination shall be effective upon the giving of notice thereof by the Company. Upon such termination, neither the Company nor the Buyer shall have any further obligation to one another hereunder. (M) SURVIVAL. The respective representations, warranties, covenants and agreements of the Company and the Buyer contained in this Agreement and the documents delivered in connection with this Agreement shall survive the execution and delivery of this Agreement and the closing hereunder and delivery of and payment for the Note and issuance of the Warrants, and shall remain operative and in full force and effect regardless of any investigation made by or on behalf of the Buyer or any Person controlling or acting on behalf of the Buyer or by the Company or any Person controlling or acting on behalf of the Company for a period ending on the later of (x) the date which is six years after the Closing Date and (y) the date which is two years after the Company shall have paid in full all amounts due from the Company under the Transaction Documents and performed in full all of its obligations under the Transaction Documents. (N) PUBLIC STATEMENTS, PRESS RELEASES, ETC. The Company and the Buyer shall have the right to approve before issuance any press releases or any other public statements with respect to the transactions contemplated hereby; provided, however, that the Company shall be entitled, without the prior approval of the Buyer, to make any press release or other public disclosure (other than in the Company's periodic and other reports filed with the SEC under the 1934 Act) with respect to such transactions as is required by applicable law or applicable requirements of any stock market on which securities of the Company are listed for trading (although the Buyer shall be consulted by the Company in connection with any such press release or other public disclosure prior to its release and shall be provided with a copy thereof). (O) CONSTRUCTION. The language used in this Agreement will be deemed to be -45- the language chosen by the parties to express their mutual intent, and no rules of strict construction will be applied against any party. [REMAINDER OF THIS PAGE INTENTIONALLY LEFT BLANK] -46- IN WITNESS WHEREOF, the parties hereto have caused this Agreement to be duly executed by their respective officers or other representatives thereunto duly authorized on the respective dates set forth below their signatures hereto. Principal Amount: $ Purchase Price: $ CEPHALON, INC. By: ___________________________________ Name: Title: Date: [NAME OF BUYER] By: ___________________________________ Name: Title: Date: Address: Facsimile No.: -47- SCHEDULE 4(A) ------------- CERTAIN EQUITY INVESTMENTS -------------------------- The Company has a $500,000 investment in the Series B Preferred Stock of Eukarion, Inc., a Delaware corporation. 4(a)-49 SCHEDULE 4(C) ------------- CERTAIN ANTIDILUTION ADJUSTMENTS -------------------------------- None 4(c)-50 SCHEDULE 4(R) ------------- MORTGAGES, LIENS, SECURITY INTERESTS, ENCUMBRANCES, ETC. ----------------------------- 1. The $10,000,000 Sunnyday Loan from the Commonwealth of Pennsylvania and the $2,000,000 Pennsylvania Industrial Development Authority loan created a lien on all buildings and equipment of Cephalon, Inc. located in Pennsylvania. In addition, Variable Annuity Life Insurance Company holds a first mortgage on all of the buildings located in Pennsylvania. 2. GE Capital holds liens for various leased equipment of Cephalon, Inc. 3. Additionally, Siemens Rolm holds liens for various leased equipment of Cephalon, Inc. 4. Additionally, a Letter of Credit was issued by First Union in the face amount of $2,000,000 to secure the obligations under the $2,000,000 Pennsylvania Industrial Development Authority loan. The reimbursement of the obligations under the Letter is secured by treasury securities of First Union. 4(r)-51 EX-4.3(B) 3 FORM OF REVENUE SHARING SENIOR SECURED NOTE EXHIBIT 4.3(B) ANNEX I TO NOTE PURCHASE AGREEMENT THIS NOTE HAS NOT BEEN REGISTERED UNDER THE SECURITIES ACT OF 1933, AS AMENDED (THE "1933 ACT"). THE ISSUANCE TO THE HOLDER OF THE SHARES OF COMMON STOCK ISSUABLE IN PARTIAL PAYMENT OF PRINCIPAL OR THE REDEMPTION PRICE OF THIS NOTE AND IN PAYMENT OF INTEREST ON THIS NOTE ARE NOT COVERED BY A REGISTRATION STATEMENT UNDER THE 1933 ACT. PURSUANT TO THE NOTE PURCHASE AGREEMENT, THIS NOTE HAS BEEN ACQUIRED, AND SUCH SHARES MUST BE ACQUIRED, FOR INVESTMENT ONLY AND MAY NOT BE SOLD, TRANSFERRED OR ASSIGNED IN THE ABSENCE OF REGISTRATION OF THE RESALE THEREOF UNDER THE 1933 ACT OR AN OPINION OF COUNSEL REASONABLY SATISFACTORY IN FORM, SCOPE AND SUBSTANCE TO THE COMPANY THAT SUCH REGISTRATION IS NOT REQUIRED. CEPHALON, INC. 11% REVENUE SHARING SENIOR SECURED NOTE DUE 2002 No. ____ $________ New York, New York March 1, 1999 FOR VALUE RECEIVED, CEPHALON, INC., a Delaware corporation (hereinafter called the "Company"), hereby promises to pay to [NAME], [ADDRESS], or registered assigns (the "Holder"), or order, the sum of ______________ Dollars ($________________), on the Maturity Date, and to pay interest on the unpaid principal balance hereof at the Applicable Rate from the date hereof, until the same becomes due and payable, whether at maturity or upon acceleration or by repurchase in accordance with the terms hereof or otherwise. Any amount, including, without limitation, principal of or interest on this Note or the Optional Redemption Price, the Repurchase Price or the Registration Repurchase Price, that is payable under this Note that is not paid when due shall bear interest at the Default Rate from the due date thereof until the same is paid ("Default Interest"). Regular interest shall be payable in arrears on each Interest Payment Date, commencing on June 1, 1999, on the principal amount outstanding on such date. Regular interest on this Note shall be computed on the basis of a 360-day year of 12 30-day months and actual days elapsed. No regular interest shall be payable on an Interest Payment Date on any portion of the principal amount of this Note which shall have been redeemed prior to such Interest Payment Date so long as the Company shall have complied in full with its obligations with respect to such redemption. All payments of principal of and premium, if any, interest, and other amounts on this Note shall be made in lawful money of the United States of America, or, at the option of the -1- Company and subject to the provisions of this Note, interest payable on the Interest Payment Dates may be paid in whole or in part in fully paid and nonassessable shares of Common Stock or, in accordance with Section 1.4, the Company is entitled under certain circumstances to pay a portion of the principal of this Note in shares of Common Stock. All cash payments shall be made by wire transfer of immediately available funds to such account as the Holder may from time to time designate by written notice in accordance with the provisions of this Note. Whenever any amount expressed to be due by the terms of this Note is due on any day which is not a Business Day, the same shall instead be due on the next succeeding day which is a Business Day and, in the case of any Interest Payment Date which is not the date on which this Note is paid in full, the extension of the due date thereof shall not be taken into account for purposes of determining the amount of interest due on such date. Certain capitalized terms used in this Note are defined in Article VIII. The obligations of the Company under this Note shall rank in right of payment on a parity with all other unsubordinated obligations of the Company for indebtedness for borrowed money or the purchase price of property. This Note is issued pursuant to the Note Purchase Agreement and the Holder of this Note and this Note are subject to the terms and entitled to the benefits of the Note Purchase Agreement. This Note is entitled to the benefits of the Security Agreement and the Patent and Trademark Security Agreement. The following terms shall apply to this Note: ARTICLE I CERTAIN PAYMENTS IN COMMON STOCK; OPTIONAL REDEMPTION 1.1 ISSUANCE OF COMMON STOCK IN LIEU OF CASH INTEREST. (a) If the ------------------------------------------------- Company exercises its option to make a payment of interest on this Note wholly or partly in Common Stock (herein sometimes called the "Share Interest Payment Option"), the issuance of Interest Payment Shares upon such exercise of the Share Interest Payment Option shall have been authorized by the Board of Directors of the Company. (b) The Company shall not be permitted to exercise the Share Interest Payment Option with respect to any payment of interest on this Note if: (i) the number of shares of Common Stock authorized, unissued and unreserved for all purposes, or held in the Company's treasury, is insufficient to pay the portion of such interest to be paid in Common Stock; (ii) the issuance or delivery of Interest Payment Shares or the public resale of such Interest Payment Shares by the Holder would require registration or filing with or -2- approval of any governmental authority under any law or regulation, and such registration, filing or approval has not been effected or obtained or is not in effect or on such Interest Payment Date or the date the Company delivers the Interest Payment Shares to the Holder the Interest Share Registration Statement is unavailable for use by the Holder for the resale of the Interest Payment Shares; (iii) the outstanding shares of Common Stock are neither (A) listed or admitted for trading on a national securities exchange nor (B) quoted on Nasdaq; or the Interest Payment Shares shall not at the time of issuance have been authorized for listing, upon official notice of issuance, on the principal securities exchange on which the Common Stock is then listed and traded; (iv) the Interest Share Price for the Interest Payment Shares is less than the par value of the Common Stock; or (v) an Event of Default has occurred and is continuing on the date the Company makes such election or on the applicable Interest Payment Date. (c) The Company may exercise its right to elect the Share Interest Payment Option with respect to any Interest Payment Date only by giving notice of such election to the Holder not less than 24 or more than 28 Trading Days prior to such Interest Payment Date, which notice shall state the percentage of the interest payable on such Interest Payment Date which is to be paid in Interest Payment Shares. The Company shall have the right to elect the Share Interest Payment Option with respect to this Note only if the Company also elects the similar option which it has with respect to the Other Notes for the interest due thereon on the date which is such Interest Payment Date and in each such case pro rata among this Note and the Other Notes, based on the amounts of interest due on such date hereon and thereon. If the Company elects the Share Interest Payment Option with respect to a particular Interest Payment Date, the Company shall issue to the Holder in respect of such Interest Payment Date the aggregate number of whole shares of Common Stock determined by dividing the per share Interest Share Price of the Common Stock on the applicable Interest Payment Date into an amount equal to 102% of the total amount of lawful money of the United States of America which the Holder would receive if the aggregate amount of interest on this Note which is being paid in Common Stock were being paid in such lawful money. If the Company elects the Share Interest Payment Option with respect to an Interest Payment Date, the Interest Payment Shares for such Interest Payment Date shall become issuable on such Interest Payment Date and the Company shall deliver, or cause to be delivered, the appropriate number of shares of Common Stock to the Holder within three Trading Days after the applicable Interest Payment Date. If in any case the Company shall fail to deliver or cause to be delivered such number of shares of Common Stock to the Holder within such period of three Trading Days, then in addition to any other liabilities the Company may have hereunder and under applicable law (1) the Company shall pay or reimburse the Holder on demand for all out-of-pocket expenses, including, without limitation, reasonable fees and expenses of legal counsel, incurred by the Holder as a result of such failure, (2) if as a result of such failure the Holder shall suffer any direct damages or liabilities from such -3- failure (including, without limitation, margin interest and the cost of covering a purchase (whether by the Holder or the Holder's securities broker) or borrowing of shares of Common Stock by the Holder for purposes of settling any trade involving a sale of shares of Common Stock made by the Holder during the period beginning on the date the Company notified the Holder of the Company's election of the Share Interest Payment Option and ending on the date the Company delivers or causes to be delivered to the Holder the shares of Common Stock issuable in respect thereof), then the Company shall upon demand of the Holder pay to the Holder an amount equal to the actual direct, out-of-pocket damages and liabilities suffered by the Holder by reason thereof which the Holder documents to the reasonable satisfaction of the Company, and (3) the Holder may by written notice (which may be given by mail, courier, personal service or telephone line facsimile transmission) or oral notice (promptly confirmed in writing), given at any time prior to delivery to the Holder of the shares of Common Stock issuable in connection with such exercise of the Share Interest Payment Option, require payment in cash of the interest in respect of which the Company exercised the Share Interest Payment Option, in which case the amount of such interest shall be immediately due and payable, with Default Interest thereon from the applicable Interest Payment Date until paid in full and the Company shall not be obligated or entitled to issue such Interest Payment Shares in respect of such Interest Payment Date. Notwithstanding the foregoing the Company shall not be liable to the Holder under clause (2) of the immediately preceding sentence to the extent the failure of the Company to deliver or to cause to be delivered such shares of Common Stock results from fire, flood, storm, earthquake, shipwreck, strike, war, acts of terrorism, crash involving facilities of a common carrier, acts of God, or any similar event outside the control of the Company (it being understood that the action or failure to act of the Transfer Agent shall not be deemed an event outside the control of the Company except to the extent resulting from fire, flood, storm, earthquake, shipwreck, strike, war, acts of terrorism, crash involving facilities of a common carrier, acts of God, the bankruptcy, liquidation or reorganization of the Transfer Agent under any bankruptcy, insolvency or other similar law or any similar event outside the control of the Transfer Agent). The Holder shall notify the Company in writing (or by telephone conversation, confirmed in writing) as promptly as practicable following the third Trading Day after such Interest Payment Date if the Holder becomes aware that shares of Common Stock so issuable have not been received as provided herein. If the Company shall have exercised the Share Interest Payment Option with respect to a particular Interest Payment Date and either (1) the Company shall notify the Holder on or after such Interest Payment Date that the Interest Payment Shares might not be delivered within three Trading Days after such Interest Payment Date or (2) the Holder learns after the date which is three Trading Days after such Interest Payment Date that the Holder has not received such Interest Payment Shares, then, without releasing the Company of its obligations with respect thereto, from and after the next succeeding Trading Day the Holder shall make reasonable efforts not to sell shares of Common Stock in anticipation of receipt of such Interest Payment Shares in a manner which is likely to increase materially the liability of the Company under clause (2) of the second preceding sentence. No fractional shares of Common Stock shall be issued in payment of interest on this Note. In lieu thereof, the Company may, at its option, issue a number of shares of Common Stock which reflects a rounding up to the next whole number or may pay lawful money of the United States of America in lieu of issuance of such fractional share. -4- (d) If the Company elects the Share Interest Payment Option with respect to a payment of interest on this Note with respect to a particular Interest Payment Date, the Company shall deliver to the Holder, on or prior to the date on which Interest Payment Shares for such payment of interest on this Note are to be received by the Holder, a Company Certificate setting forth (i) the total amount of the cash interest payment to which the Holder is entitled, (ii) the portion of such interest payment being made in Interest Payment Shares and the amount which is 102% thereof, (iii) the number of Interest Payment Shares allocable to such payment, as calculated pursuant to this Section 1.1, (iv) any rounding adjustment to such number or any payment necessary to be made pursuant to Section 1.1(c), (v) a brief statement of the facts requiring such adjustment, and (vi) a brief statement that none of the conditions set forth in Section 1.1(b) has occurred and is existing and that all of the requirements of this Section 1.1 have been met. The Interest Payment Shares shall be duly issued in the name of the Holder or its nominee. Such Company Certificate shall be conclusive evidence of the correctness of the calculation of the number of Interest Payment Shares allocable to the payments to which such Company Certificate relates and of any adjustments to such number made pursuant to this Section 1.1 in the absence of manifest error. On or before the pertinent payment date, the Company shall issue, or cause the transfer agent for the Common Stock to prepare and issue, the Interest Payment Shares in the name of the Holder or its nominee before being so delivered by the Company on the payment date. (e) The Interest Payment Shares, when issued pursuant to and in compliance with this Section 1.1, shall be, and for all purposes shall be deemed to be, validly issued, fully paid and nonassessable shares of Common Stock; the issuance and delivery thereof is in all respects hereby authorized; and the issuance thereof, together with lawful money of the United States of America, if any, paid in lieu of fractional shares of Common Stock, will be, and for all purposes shall be deemed to be, in full discharge and satisfaction of the Company's obligation to pay the interest on this Note to which such Interest Payment Shares relate. 1.2 OPTIONAL REDEMPTION. (a) At any time during the Optional ------------------- Redemption Period, the Company shall have the right to redeem at any one time all or from time to time any part of the outstanding principal amount of this Note at the Optional Redemption Price pursuant to this Section 1.2 on any Optional Redemption Date, so long as (x) on the date an Optional Redemption Notice is given and at all times to and including the applicable Optional Redemption Date, no Event of Default and no event which, with notice or passage of time, or both, would become an Event of Default has occurred and is continuing (unless the requirements of this clause (x) will be satisfied immediately after the applicable Optional Redemption Date and the Company shall furnish to the Holder Company Certificates to such effect on the date the applicable Optional Redemption Notice is given to the Holder and on the applicable Optional Redemption Date), (y) on the date an Optional Redemption Notice is given and at all times to and including the applicable Optional Redemption Date no Repurchase Event or Registration Repurchase Event has occurred with respect to which the Holder has the right to exercise repurchase rights pursuant to Sections 5.1 and 5.2 or Section 5.3 or with respect to which the Holder has exercised such repurchase rights and the Repurchase Price or the Registration Repurchase Price, as the case may be, has not been paid to the Holder and no event which, with notice or passage of time, or both, would become a -5- Repurchase Event has occurred and is continuing, and (z) on the date an Optional Redemption Notice is given, the Company has funds available to pay the Optional Redemption Price. In order to exercise its right of redemption under this Section 1.2, the Company shall give an Optional Redemption Notice to the Holder not less than 20 days or more than 30 days prior to the Optional Redemption Date stating that: (1) the Company is exercising its right to redeem a specified portion of this Note in accordance with this Section 1.2, (2) the principal amount of this Note to be redeemed, (3) the Optional Redemption Price and (4) the Optional Redemption Date. On the applicable Optional Redemption Date (or such later date as the Holder surrenders this Note to the Company) the Company shall pay to or upon the order of the Holder, by wire transfer of immediately available funds to such account as shall be specified for such purpose by the Holder at least one Business Day prior to the Optional Redemption Date, an amount equal to the Optional Redemption Price of the portion (which may be all) of this Note to be redeemed. (b) The Company shall not be entitled to give an Optional Redemption Notice or to redeem any portion of this Note with respect to which the Company has given the Holder notice pursuant to Section 1.4 that the Company is exercising the Share Principal Payment Option and to which exercise the Holder has consented. (c) Any redemption of this Note pursuant to this Section 1.2 shall be made at the same time as a redemption by the Company of a pro rata portion (based on the outstanding principal amounts) of the Other Notes and in each such case the aggregate principal amount of this Note and the Other Notes to be so redeemed shall be at least $5,000,000.00 or such lesser aggregate principal amount of this Note and the Other Notes as shall remain outstanding at the time an Optional Redemption Notice is given. The Company shall not redeem any of the Other Notes pursuant to the provisions thereof similar to this Section 1.2 or repurchase or otherwise acquire any of the Other Notes (other than a mandatory redemption pursuant to provisions of the Other Notes comparable to Article V) unless the Company offers simultaneously to redeem, repurchase or otherwise acquire a pro rata portion (based on outstanding principal amount) of this Note for cash at the same unit price as the Other Note or Other Notes. 1.3 NO PREPAYMENT. Except as specifically provided in Sections 1.2 ------------- and 6.2, this Note may not be prepaid, redeemed or repurchased at the option of the Company prior to the Maturity Date. The Company shall not repurchase or otherwise acquire any of the Other Notes unless the Company offers simultaneously to redeem, repurchase or otherwise acquire a pro rata portion of this Note for cash at the same price per unit of outstanding principal amount as the Other Note or Other Notes. Nothing in this Section 1.3 shall limit the Company's rights under Article VII. 1.4 ISSUANCE OF COMMON STOCK IN LIEU OF CASH PAYMENT OF PRINCIPAL OR ---------------------------------------------------------------- REDEMPTION PREMIUM. (a) The Company shall have the right to elect to pay (1) a - ------------------ portion of the principal amount of this Note on the Maturity Date or (2) a portion of the Optional Redemption Price payable upon a redemption of this Note in accordance with Section 1.2, in either such case in shares of Common Stock, if the Holder consents to such election (herein sometimes called the "Share Principal Payment Option"). If the Company elects the Share Principal Payment Option, the -6- issuance of Principal Payment Shares upon the exercise of the Share Principal Payment Option shall have been authorized by the Board of Directors of the Company. Such election, once made, shall be irrevocable. (b) The Company shall not be entitled to exercise the Share Principal Payment Option with respect to payment of a portion of this principal Note if: (i) the number of shares of Common Stock authorized, unissued, and unreserved for all purposes, or held in the Company's treasury, is insufficient to pay the portion of such principal to be paid in Common Stock; (ii) the issuance or delivery of Principal Payment Shares or the public resale of such Principal Payment Shares by the Holder would require registration or filing with or approval of any governmental authority under any law or regulation, and such registration, filing or approval has not been effected or obtained or is not in effect or on the Maturity Date the Payment Share Registration Statement is unavailable for use by the Holder for the resale of the Principal Payment Shares; (iii) the outstanding shares of Common Stock are neither (A) listed or admitted to trading on a national securities exchange nor (B) quoted on Nasdaq; or the Principal Payment Shares shall not at the time of issuance have been authorized for listing, upon official notice of issuance, on the principal securities exchange on which the Common Stock is then listed and traded; (iv) the Payment Share Price for the Principal Payment Shares is less than the par value of the Common Stock; or (v) an Event of Default has occurred and is continuing on the date the Company makes such election or on the Maturity Date. (c) The Company may exercise its right to elect the Share Principal Payment Option only by giving notice of such election to the Holder at least 100 Trading Days prior to the Maturity Date or the applicable Optional Redemption Date, as the case may be. The Company shall have the right to elect the Share Principal Payment Option with respect to a portion of the principal amount of this Note that is due on the Maturity Date that is equal to not more than 50 percent of the original principal amount of this Note (or, if less than 50 percent of the original principal amount of this Note is outstanding, up to the outstanding principal amount of this Note). The Company shall have the right to elect the Share Principal Payment Option with respect to a portion of the Optional Redemption Price equal to not more than 20 percent of the principal amount of this Note to be redeemed on any Optional Redemption Date. In each such case, the Company shall have the right to elect the Share Principal Payment Option with respect to this Note only if: -7- (i) the Company also elects the similar option which it has with respect to the Other Notes for the principal thereof due on the date which is the Maturity Date or a portion of the redemption price thereof which is payable on the applicable Optional Redemption Date, as the case may be, and in each such case pro rata among this Note and the Other Notes, based on the outstanding principal amounts hereof and thereof; and (ii) the Holder in its sole discretion consents to such election with respect to this Note by notice to the Company within ten Trading Days after the Company makes such election. If the Company elects the Share Principal Payment Option and the Holder so consents, the Company shall issue and deliver, or cause to be delivered to the Holder on or before the Maturity Date or the applicable Optional Redemption Date, as the case may be, the aggregate number of whole shares of Common Stock determined by dividing the per share Payment Share Price on the Maturity Date or the applicable Optional Redemption Date, as the case may be, into an amount equal to 105% of the total amount of lawful money of the United States of America which the Holder would receive if the aggregate amount of principal of this Note or the portion of the Optional Redemption Price of this Note, as the case may be, which is being paid in Common Stock were being paid in such lawful money. If the Company shall fail to deliver or cause to be delivered such number of shares of Common Stock to the Holder on or prior to the Maturity Date, or the applicable Optional Redemption Date, as the case may be, then in addition to any other liabilities the Company may have hereunder and under applicable law (1) the Company shall pay or reimburse the Holder on demand for all out-of- pocket expenses, including, without limitation, reasonable fees and expenses of legal counsel, incurred by the Holder as a result of such failure, (2) if as a result of such failure the Holder shall suffer any direct damages or liabilities from such failure (including, without limitation, margin interest and the cost of covering a purchase (whether by the Holder or the Holder's securities broker) or borrowing of shares of Common Stock by the Holder for purposes of settling any trade involving a sale of shares of Common Stock made by the Holder during the period beginning on the date the Company notified the Holder of the Company's election of the Share Principal Payment Option and ending on the Maturity Date or the applicable Optional Redemption Date, as the case may be), then the Company shall upon demand of the Holder pay to the Holder an amount equal to the actual direct, out-of-pocket damages and liabilities suffered by the Holder by reason thereof which the Holder documents to the reasonable satisfaction of the Company, and (3) the Holder may by written notice (which may be given by mail, courier, personal service or telephone line facsimile transmission) or oral notice (promptly confirmed in writing), given at any time prior to delivery to the Holder of the shares of Common Stock issuable in connection with such exercise of the Share Principal Payment Option, require payment in cash of the portion of the principal amount of this Note in respect of which the Company exercised the Share Principal Payment Option, in which case the amount of such principal shall be immediately due and payable, with Default Interest thereon from the Maturity Date or the applicable Optional Redemption Date, as the case may be, until paid in full and the Company shall not be obligated or entitled to issue such Principal Payment Shares in respect of such payment of principal or the Optional Redemption Date, as the case may be. Notwithstanding the foregoing the Company shall not be liable to the -8- Holder under clause (2) of the immediately preceding sentence to the extent the failure of the Company to deliver or to cause to be delivered such shares of Common Stock results from fire, flood, storm, earthquake, shipwreck, strike, war, acts of terrorism, crash involving facilities of a common carrier, acts of God, or any similar event outside the control of the Company (it being understood that the action or failure to act of the Transfer Agent shall not be deemed an event outside the control of the Company except to the extent resulting from fire, flood, storm, earthquake, shipwreck, strike, war, acts of terrorism, crash involving facilities of a common carrier, acts of God, the bankruptcy, liquidation or reorganization of the Transfer Agent under any bankruptcy, insolvency or other similar law or any similar event outside the control of the Transfer Agent). The Holder shall notify the Company in writing (or by telephone conversation, confirmed in writing) as promptly as practicable following the Maturity Date or the applicable Optional Redemption Date, as the case may be, if the Holder becomes aware that shares of Common Stock so issuable have not been received as provided herein. If the Company shall have exercised the Share Principal Payment Option with respect to a particular payment and either (1) the Company shall notify the Holder that such Principal Payment Shares might not be delivered when due or (2) the Holder learns after the date on which such Principal Payment Shares are due to be delivered to such Holder that the Holder has not received such Principal Payment Shares, then, without releasing the Company of its obligations with respect thereto (x) from and after the next succeeding Trading Day the Holder shall make reasonable efforts not to sell shares of Common Stock in anticipation of receipt of such Principal Payment Shares is a manner which is likely to increase materially the liability of the Company under clause (2) of the second preceding sentence and (y) if the Company so requests, the Holder will advise the Company of the Holder's open trading position in the Common Stock with respect to which the Holder expects receipt of such Principal Payment Shares and will take such action as may be directed by the Company to close such open trading position (subject to prevailing market conditions) so long as the Company pays in advance, or makes provision for such payment which is satisfactory to the Holder in its sole discretion, of all amounts required by the Holder to assure that the Holder will not suffer any economic or trading loss by reason of taking such action. No fractional shares of Common Stock shall be issued in payment of principal or any portion of the Optional Redemption Price of this Note. In lieu thereof, the Company may, at its option, issue a number of shares of Common Stock which reflects a rounding up to the next whole number or may pay lawful money of the United States of America in lieu of issuance of such fractional share. (d) (1) If the Company shall be entitled to issue Principal Payment Shares on the Maturity Date, the Company shall deliver to the Holder, on or prior to the Maturity Date: (A) a Company Certificate setting forth (i) the total amount of principal to which the Holder is entitled, (ii) the portion of the principal of this Note being paid in Principal Payment Shares and the amount which is 105% thereof, (iii) the number of Principal Payment Shares allocable to the payment of such amount, as calculated pursuant to this Section 1.4, (iv) any rounding adjustment to such number or any payment necessary to be made pursuant to Section 1.1(c), (v) a brief statement of the facts requiring such adjustment, and (vi) a brief statement that none of the conditions set forth in Section 1.4(b) has occurred and is existing and that all of the requirements of this Section 1.4 have been met; and -9- (B) an opinion of counsel selected by the Company and reasonably acceptable to the Majority Holders to the effect set forth in EXHIBIT B. (2) If the Company shall be entitled to issue Principal Payment Shares in partial payment of the Optional Redemption Price, the Company shall deliver to the Holder, on or prior to the applicable Optional Redemption Date: (A) a Company Certificate setting forth (i) the total amount of principal being redeemed on such Optional Redemption Date, (ii) the portion of the premium on such principal amount of this Note being paid in Principal Payment Shares and the amount which is 105% thereof, (iii) the number of Principal Payment Shares allocable to the payment of such amount, as calculated pursuant to this Section 1.4, (iv) any rounding adjustment to such number or any payment necessary to be made pursuant to Section 1.1(c), (v) a brief statement of the facts requiring such adjustment, and (vi) a brief statement that none of the conditions set forth in Section 1.4(b) has occurred and is existing and that all of the requirements of this Section 1.4 have been met; and (B) an opinion of counsel selected by the Company and reasonably acceptable to the Majority Holders to the effect set forth in EXHIBIT B. (3) The Principal Payment Shares shall be duly issued in the name of the Holder or its nominee. Such Company Certificate shall be conclusive evidence of the correctness of the calculation of the number of Principal Payment Shares and of any adjustments to such number made pursuant to this Section 1.4 in the absence of manifest error. On or before the Maturity Date or the applicable Optional Redemption Date, as the case may be, the Company shall issue, or cause the Transfer Agent for the Common Stock to prepare and issue, the Principal Payment Shares in the name of the Holder or its nominee before being so delivered by the Company on the Maturity Date or the applicable Optional Redemption Date, as the case may be. (f) The Principal Payment Shares, when issued pursuant to and in compliance with this Section 1.4, shall be, and for all purposes shall be deemed to be, validly issued, fully paid and nonassessable shares of Common Stock; the issuance and delivery thereof is in all respects hereby authorized; and the issuance thereof, together with lawful money of the United States of America, if any, paid in lieu of fractional shares of Common Stock, will be, and for all purposes shall be deemed to be, in full discharge and satisfaction of the Company's obligation to pay the portion of the principal amount of this Note to which such Principal Payment Shares relate or the portion of the Optional Redemption Price of this Note to which such Principal Payment Shares relate, as the case may be. (g) Notwithstanding any other provision hereof, if the Aggregate Share Payment Amount exceeds the Share Payment Threshold, then the Holder shall have the right, exercisable -10- by notice given to the Company on or before the Business Day immediately preceding the Maturity Date, to receive payment in cash rather than Principal Payment Shares on the Maturity Date of all or any portion of the Holder's pro rata (based on the portion of the principal amount of this Note and the Other Notes which the Company has elected to pay in shares of Common Stock and as to which the holders have consented) portion of such excess. ARTICLE II ADDITIONAL INTEREST 2.1 RIGHT TO ADDITIONAL INTEREST. In addition to all other amounts ---------------------------- provided in this Note and the Other Notes to be paid by the Company, the Holder and the registered holders of the Other Notes shall be entitled to payments based on a portion of the Net Revenues of the Products and the Competitive Products in the Territory during the Payment Period. The amount of such payments based on a portion of such Net Revenues of the Products and the Competitive Products during any Determination Period shall be the product obtained by multiplying (x) an amount equal to the Net Revenues from the Products and the Competitive Products in the Territory during such Determination Period times (y) the Payment Percentage in effect during such Determination Period, with each change therein during such Determination Period being given effect (such product, the "Noteholder Payment Amount"). Based on the U.S. federal income tax laws in effect on the Issuance Date, the Company intends to treat the Noteholder Payment Amounts as additional interest on this Note for U.S. federal income tax purposes. The Company shall remain obligated to make payments to the Holder pursuant to this Article II notwithstanding the payment or redemption of all or any portion of this Note. 2.2 CALCULATION OF NET REVENUES. The Company shall maintain in --------------------------- reasonable and adequate detail records of all components of and adjustments made in determining Net Revenues of the Products and the Competitive Products in the Territory during each Determination Period. Within 45 days after the end of each Determination Period, the Company shall (a) furnish to the Holder a Company Certificate setting forth (x) in reasonable detail for each Product or Competitive Product for which there were sales in the Territory during such Determination Period the amounts of (1) gross sales (excluding sales to Affiliates), (2) prompt payment and other discounts, (3) transportation and related insurance charges, (4) returns, bad debt and other allowances, (5) taxes deducted from gross sales in determining Net Revenues, (6) distributors', consignees' and wholesalers' fees and commissions, and (7) Net Revenues, in each such case of the preceding clauses (1) through (7) for such Determination Period, (y) the percentage and the amount, in currency of the United States of America, of such Net Revenues to be paid to the Holder and the holders of the Other Notes pursuant to Article II hereof and thereof, identifying each such Person, and (z) a statement that the information set forth in such Company Certificate is true and correct and (b) pay to the Holder an amount equal to the portion of the Noteholder Payment Amount for such Determination Period to which the Holder is entitled. -11- 2.3 ALLOCATION OF NOTEHOLDER PAYMENT AMOUNT. The Noteholder Payment --------------------------------------- Amount for any Determination Period shall be allocated among the Persons (including the Holder) who were registered holders of this Note and the Other Notes at any time during such Determination Period pro rata based on the principal amounts held by each and the portion of such Determination Period during which such registered holders held this Note and the Other Notes. 2.4 RECORDS, INSPECTION, ETC. The Holder shall have the right, ------------------------ exercisable from time to time, to examine, or to have its representatives examine, the relevant books of account and records of the Company, its Subsidiaries and their respective Affiliates upon reasonable prior notice and during normal business hours, to confirm the accuracy of the statements and information provided to the Holder pursuant to this Article II and the amounts of the payments required to be made by the Company to the Holder pursuant to this Article II. The Holder shall have the right from time to time to retain a firm of independent public accountants to examine the books of account and records of the Company and its Subsidiaries for any one or more Determination Periods for purposes of confirming the accuracy of such statements, information and amounts. The cost of such accountants shall be paid by the Holder unless (i) the amount of the Noteholder Payment Amount as determined by such accountants for any Determination Period was more than $25,000 greater than the amount thereof set forth in the Company Certificate furnished to the Holder for such Determination Period pursuant to Section 2.2 or (ii) the Company shall have failed to furnish a Company Certificate for such Determination Period to the Holder pursuant to Section 2.2 on or before the due date for such Company Certificate. The Company shall not be obligated to maintain the books and records referred to in this section for more than three years after the end of the Payment Period. 2.5 CERTAIN TRANSFERS OF PRODUCT OR PRODUCT RIGHTS. The Company ---------------------------------------------- shall not sell, assign, transfer or convey (including, without limitation, by means of a license) any Product or Competitive Product as an entirety or substantially as an entirety (except to the extent unrelated to sales and marketing of the Products and Competitive Products in the Territory), or any of its rights relating to any Product or Competitive Product in the Territory unless (1) such transfer is expressly made subject to the lien, security interest and other rights of the Holder and the holders of the Other Notes under the Transaction Documents, (2) such transferee shall execute and deliver such documents and instruments as shall be reasonably satisfactory to the Majority Holders to give effect to the preceding clause (1), and (3) such transferee shall by written instrument reasonably satisfactory to the Majority Holders expressly assume, jointly and severally with the Company, all obligations for the due and punctual payment and performance of all of the Company's obligations under this Article II and under the Security Agreement and Patent and Trademark Security Agreement; provided, however, that the provisions of this clause (3) only shall be inapplicable to any license or sublicense by the Company of its rights with respect to a Product or Competitive Product with respect to the Territory to a Person in connection with a co-marketing arrangement between the Company and such Person, so long as all revenues from sales of such Product or Competitive Product by such Person are included in the computation of Net Revenues for purposes of determining the Noteholder Payment Amount, whether or not such revenues are received by the -12- Company or reflected in the Company's books, records or financial statements. 2.6 NO REDEMPTION. The obligations of the Company under this Article ------------- II shall not be extinguished or eliminated by any redemption of this Note pursuant to Section 1.2, any acceleration or payment of this Note upon the occurrence of an Event of Default, any exercise by the Holder of repurchase rights under Article V or any prepayment of this Note in accordance with Section 6.2. ARTICLE III CERTAIN COVENANTS So long as the Company shall have any obligation under this Note, unless otherwise consented to in advance by the Majority Holders: 3.1 LIMITATIONS ON CERTAIN INDEBTEDNESS. The Company will not ----------------------------------- itself, and will not permit any Subsidiary to, create, assume, incur or in any manner become liable in respect of, including, without limitation, by reason of any business combination transaction (all of which are referred to herein as "incurring"), any Indebtedness other than Permitted Indebtedness. 3.2 MAINTENANCE OF CASH, CASH EQUIVALENT AND ELIGIBLE INVESTMENT ------------------------------------------------------------ BALANCES. The Company shall maintain Cash, Cash Equivalent and Eligible - -------- Investment Balances during the following periods at least equal to the amounts set forth below: Period Amount ------ ------ Issuance Date through December 31,1999 $40 million January 1, 2000 and thereafter 30 million The Company's Cash, Cash Equivalent and Eligible Investment Balances shall be determined as of the end of each calendar quarter. Within fifteen days after the end of each calendar quarter, the Company shall furnish to the Holder a Company Certificate setting forth the amount of the Company's Cash, Cash Equivalent and Eligible Investment Balances as of the end of such calendar quarter. If at the end of any calendar quarter the Company shall have less than the required amount of Cash, Cash Equivalents and Eligible Investment Balances, then the Company shall not be deemed to be in violation of this Section 3.2 unless such insufficiency exists on the date which is 30 days after the end of such calendar quarter, so long as during such 30-day period the Company is making bona fide efforts to cure such insufficiency. -13- 3.3 PAYMENT OF OBLIGATIONS. The Company will pay and discharge, and ---------------------- will cause each Significant Subsidiary to pay and discharge, all their respective material obligations and liabilities, including, without limitation, tax liabilities, except where the same may be contested in good faith by appropriate proceedings. 3.4 MAINTENANCE OF PROPERTY; INSURANCE. (a) The Company will keep, ---------------------------------- and will cause each Significant Subsidiary to keep, all property useful and necessary in its business in good working order and condition, ordinary wear and tear excepted. (b) The Company will maintain, and will cause each Significant Subsidiary to maintain, with financially sound and responsible insurance companies, insurance, including, without limitation, products liability insurance relating to the Product, in at least such amounts and against such risks as is reasonably adequate for the conduct of their respective businesses and the value of their respective properties. 3.5 CONDUCT OF BUSINESS AND MAINTENANCE OF EXISTENCE. The Company ------------------------------------------------ will continue, and will cause each Significant Subsidiary to continue, to engage in business of the same general type as now conducted by the Company, and will preserve, renew and keep in full force and effect, and will cause each Significant Subsidiary to preserve, renew and keep in full force and effect their respective corporate existence and their respective rights, privileges and franchises necessary or desirable in the normal conduct of business and except for any Subsidiary which is not involved in the manufacture, sale or marketing in the Territory of Products or Competitive Products and which the Board of Directors determines it is no longer in the Company's interest to own or operate and, if being sold, is being sold for a fair consideration. 3.6 COMPLIANCE WITH LAWS. The Company will comply, and will cause -------------------- each Significant Subsidiary to comply, in all material respects with all applicable laws, ordinances, rules, regulations, decisions, orders and requirements of governmental authorities and courts (including, without limitation, environmental laws) except (i) where compliance therewith is contested in good faith by appropriate proceedings or (ii) where non-compliance therewith could not reasonably be expected to have a material adverse effect on the business, condition (financial or otherwise), operations, performance, properties or prospects of the Company and the Subsidiaries, taken as a whole. 3.7 INVESTMENT COMPANY ACT. The Company will not be or become an ---------------------- open-end investment trust, unit investment trust or face-amount certificate company that is or is required to be registered under Section 8 of the Investment Company Act of 1940, as amended. 3.8 LIMITATIONS ON ASSET SALES, LIQUIDATIONS, ETC.; CERTAIN MATTERS. --------------------------------------------------------------- The Company shall not -14- (a) sell, convey or otherwise dispose of all or substantially all of the assets of the Company as an entirety or substantially as an entirety in a single transaction or in a series of related transactions; or (b) liquidate, dissolve or otherwise wind up the affairs of the Company. 3.9 LIMITATIONS ON LIENS. The Company will not itself, and will not -------------------- permit any Subsidiary to, create, assume or suffer to exist any mortgage, lien, pledge, security interest or other charge or encumbrance (including, without limitation, the lien or retained security title of a conditional vendor), all of which are referred to below as "liens", upon all or any part of its property of any character, whether owned at the date hereof or thereafter acquired, except: (a) liens upon any property of any Subsidiary or Subsidiaries as security for indebtedness owing to the Company; (b) purchase money liens upon any property acquired by the Company or any Subsidiary, or liens existing on such property at the time of acquisition; provided that (i) no such lien shall extend to or cover any other property of the Company or any Subsidiary, (ii) the principal amount of indebtedness secured by each such lien on any such property shall not exceed the cost (including such principal amount of the indebtedness secured thereby) to the Company or the Subsidiary of the property subject thereto, and (iii) the aggregate principal amount of all indebtedness of the Company and all Subsidiaries secured by all liens described in this subsection (b) and any extensions, renewals or replacements thereof, at any one time outstanding, shall not exceed $10 million for the Company and the Subsidiaries; and the extending, renewing or replacing of any lien permitted by this subsection (b) or of the indebtedness secured thereby; provided, however, that in any such case the lien by which any lien is extended, renewed or replaced shall not extend to or cover any other property of the Company or any Subsidiary and the principal amount of such indebtedness extended, renewed or replaced shall not be increased; (c) liens securing this Note and the Other Notes ratably; (d) liens for taxes or assessments or governmental charges or levies on its property if such taxes or assessments or charges or levies shall not at the time be due and payable or if the amount, applicability, or validity of any such tax, assessment, charge or levy shall currently be contested in good faith by appropriate proceedings or necessary preliminary steps are being taken to contest, compromise or settle the amount thereof or to determine the applicability or validity thereof and if the Company or such Subsidiary, as the case may be, shall have set aside on its books reserves (segregated to the extent required by sound accounting practice) deemed by it adequate with respect thereto; deposits or pledges to secure payment of worker's compensation, unemployment insurance, old age pensions or other social security; deposits or pledges to secure performance of bids, tenders, contracts (other than contracts for the payment of money borrowed or credit extended), leases, public or statutory obligations, surety or appeal bonds, or other deposits -15- or pledges for purposes of like general nature in the ordinary course of business; mechanics', carriers', workers', repairmen's or other like liens arising in the ordinary course of business securing obligations which are not overdue for a period of 60 days, or which are in good faith being contested or litigated, or deposits to obtain the release of such liens; liens created by or resulting from any litigation or legal proceedings or proceedings being contested in good faith by appropriate proceedings, provided any execution levied thereon shall be stayed; leases made, or existing on property acquired, in the ordinary course of business; landlords' liens under leases to which the Company or any Subsidiary is a party; and zoning restrictions, easements, licenses or restrictions on the use of real property or minor irregularities in title thereto; provided that all such liens described in this subsection (d) do not, in the aggregate, materially impair the use of such property in the operations of the business of the Company or any Subsidiary or the value of such property for the purpose of such business; and (e) liens existing on the Issuance Date and listed in Schedule 4(r) to the Note Purchase Agreement. 3.10 PRODUCTS AND COMPETITIVE PRODUCTS MARKETING. Until the end of ------------------------------------------- the Payment Period, the Company shall use all commercially reasonable efforts to market the Products and the Competitive Products in the Territory directly or through reliable third parties. 3.11 MANUFACTURE AND SALE OF THE PRODUCTS AND THE COMPETITIVE -------------------------------------------------------- PRODUCTS. Until the end of the Payment Period, the Company shall use all commercially reasonable efforts (a) to manufacture the Products and the Competitive Products in accordance with GMP in sufficient quantities to meet the demand therefor, either directly or through third party manufacturing and supply arrangements, and (b) to sell the Products and the Competitive Products in the Territory. 3.12 CERTAIN OBLIGATIONS. (a) The Company shall not amend, modify or ------------------- waive any provision of any of the Lafon Agreements as they relate to the Territory in a manner which would adversely affect the Collateral Agent's lien on and Security Interest in the Collateral. (b) The Company shall perform and comply in all material respects with the Lafon Agreements; and shall perform and comply in all material respects with any other agreement relating to any of the Products or the Competitive Products, the failure to comply with which could have a material adverse effect on the Net Revenues from the Products and the Competitive Products or adversely affect the Collateral Agent's lien on and security interest in the Collateral. 3.13 NOTICE OF DEFAULTS. The Company shall notify the Holder ------------------ promptly, but in any event not later than five days after the Company becomes aware of the fact, of any failure by the Company to comply with this Article III. 3.14 CERTAIN EVENTS OF DEFAULT. If an Event of Default specified in ------------------------- clause (c), (e), or (f) of Section 4.1 shall occur and be continuing, then, at the request of the Majority Holders, the -16- Company shall use all commercially reasonable efforts (a) to sell, license or otherwise dispose of the Products and the Competitive Products and the Company's interests therein as they relate to the Territory, subject to the terms and requirements of the Security Agreement and the Patent and Trademark Security Agreement, for a cash consideration at least equal to the fair market value thereof or (b) to complete one or more financing transactions to provide cash to the Company to enable it to repay or redeem this Note and the Other Notes in accordance with their terms on the earliest date on which the Company is permitted to do so and, if such Event of Default involves a violation by the Company of Section 3.2, to cure such violation. ARTICLE IV EVENTS OF DEFAULT 4.1 If any of the following events of default (each, an "Event of Default") shall occur: (A) FAILURE TO PAY PRINCIPAL, INTEREST, ETC. The Company fails (1) to --------------------------------------- pay the principal, the Optional Redemption Price, the Repurchase Price or the Registration Repurchase Price hereof when due, whether at maturity, upon acceleration or otherwise, as applicable, (2) to pay or perform the obligations of the Company under Article II (other than Section 2.4) or (3) to pay any installment of interest hereon when due and, in the case of this clause (3) of this Section 4.1(a) only, such failure continues for a period of five Business Days after the due date thereof; or (B) BREACH OF CERTAIN COVENANTS. The Company fails to comply with --------------------------- Section 3.1, 3.10, 3.11, 3.12, 3.13, or 3.14; or (C) BREACH OF OTHER COVENANTS. The Company fails to comply with ------------------------- Section 3.2 or fails to comply in any material respect with any other provision of Article III of this Note (other than Section 3.1, 3.10, 3.11, 3.12, 3.13, or 3.14) or breaches any other material covenant or other material term or condition of this Note or any of the other Transaction Documents (other than as specifically provided in clauses (a), (b), (i), and (j) of this Section 4.1), and such breach continues for a period of five days after written notice thereof to the Company from the Holder; or (D) BREACH OF REPRESENTATIONS AND WARRANTIES. Any representation or ---------------------------------------- warranty of the Company made herein or in any agreement, statement or certificate given in writing pursuant hereto or in connection herewith (including, without limitation, the Transaction Documents) shall be false or misleading in any material respect when made; or -17- (E) CERTAIN VOLUNTARY PROCEEDINGS. The Company or any Subsidiary ----------------------------- shall commence a voluntary case or other proceeding seeking liquidation, reorganization or other relief with respect to itself or its debts under any bankruptcy, insolvency or other similar law now or hereafter in effect or seeking the appointment of a trustee, receiver, liquidator, custodian or other similar official of it or any substantial part of its property, or shall consent to any such relief or to the appointment of or taking possession by any such official in an involuntary case or other proceeding commenced against it, or shall make a general assignment for the benefit of creditors, or shall fail generally to pay its debts as they become due or shall admit in writing its inability generally to pay its debts as they become due; or (F) CERTAIN INVOLUNTARY PROCEEDINGS. An involuntary case or other ------------------------------- proceeding shall be commenced against the Company or any Subsidiary seeking liquidation, reorganization or other relief with respect to it or its debts under any bankruptcy, insolvency or other similar law now or hereafter in effect or seeking the appointment of a trustee, receiver, liquidator, custodian or other similar official of it or any substantial part of its property, and such involuntary case or other proceeding shall remain undismissed and unstayed for a period of 60 consecutive days; or (G) JUDGMENTS. Any court of competent jurisdiction shall enter one or --------- more final judgments against the Company or any Subsidiary or any of their respective properties or other assets in an aggregate amount in excess of the Judgment Default Threshold, which is not vacated, bonded, stayed, discharged, satisfied or waived for a period of 30 consecutive days; or (H) DEFAULT UNDER OTHER AGREEMENTS. (a) The Company or any Subsidiary ------------------------------ shall (i) default in any payment with respect to any Indebtedness for borrowed money (other than this Note) which Indebtedness has an outstanding principal amount in excess of the Cross-Default Threshold, beyond the period of grace, if any, provided in the instrument or agreement under which such Indebtedness was created or (ii) default in the observance or performance of any agreement, covenant or condition relating to any such Indebtedness or contained in any instrument or agreement evidencing, securing or relating thereto, or any other event shall occur or condition exist, the effect of which default or other event or condition is to cause, or to permit the holder or holders of such Indebtedness (or a trustee or agent on behalf of such holder or holders) to cause, any such Indebtedness to become due prior to its stated maturity and such default or event shall continue beyond the period of grace, if any, provided in the instrument or agreement under which such Indebtedness was created (after giving effect to any consent or waiver obtained and then in effect thereunder); or (b) any Indebtedness of the Company or any Subsidiary which has an outstanding principal amount in excess of the Cross-Default Threshold shall, in accordance with its terms, be declared to be due and payable, or required to be prepaid other than by a regularly scheduled or required payment prior to the stated maturity thereof; or -18- (I) SECURITY AGREEMENT AND PATENT AND TRADEMARK SECURITY AGREEMENT, --------------------------------------------------------------- ETC. The occurrence of any "Event of Default" as defined in the Security --- Agreement or the Patent and Trademark Security Agreement; (J) CESSATION OF MANUFACTURE, SALES OR MARKETING. None of the Company -------------------------------------------- or any of its Affiliates shall (directly or through reliable third parties) be manufacturing, selling or marketing the Products in the Territory; then, (1) upon the occurrence and during the continuation of any Event of Default specified in clause (a), (b), (d), (i), or (j) of this Section 4.1, at the option of the Holder, and upon the occurrence of any Event of Default specified in clause (e) or (f) of this Section 4.1: (X) the Company shall, pay to the Holder an amount equal to the outstanding principal amount of this Note plus accrued and unpaid interest on such principal amount to the date of payment plus accrued and unpaid Default Interest, if any, thereon at the rate provided in this Note to the date of payment, (V) all other amounts payable hereunder or under any of the other Transaction Documents shall immediately become due and payable, all without demand, presentment or notice, all of which hereby are expressly waived, together with all costs, including, without limitation, reasonable legal fees and expenses, of collection, (Y) the Collateral Agent shall be entitled to exercise all rights and remedies under the Security Agreement and the Patent and Trademark Security Agreement, and (Z) the Holder shall be entitled to exercise all other rights and remedies available at law or in equity; and (2) upon the occurrence and during the continuation of any Event of Default specified in clause (c), (g) or (h) of this Section 4.1: (A) if any Event of Default continues during the period of 365 consecutive days following the occurrence of such Event of Default, then thereafter so long as any Event of Default is continuing (i) at the option of the Holder the Company shall pay to the Holder an amount equal to the outstanding principal amount of this Note plus accrued and unpaid interest on such principal amount to the date of payment plus accrued and unpaid Default Interest, if any, thereon at the rate provided in this Note to the date of payment, (ii) all other amounts payable hereunder shall immediately become due and payable, all without demand, presentment or notice, all of which hereby are expressly waived, together with all costs, including, without limitation, reasonable legal fees and expenses, of collection and (and) the Collateral Agent shall be entitled to exercise all rights and remedies under the Security Agreement, the Patent and Trademark Security Agreement, and (B) the Holder shall be entitled to exercise all rights and remedies available at law or in equity other than those set forth in the immediately preceding clause (A). ARTICLE V -19- REPURCHASE UPON A REPURCHASE EVENT OR REGISTRATION REPURCHASE EVENT 5.1 REPURCHASE RIGHT UPON REPURCHASE EVENT. If a Repurchase Event -------------------------------------- occurs, in addition to any other right of the Holder, the Holder shall have the right, at the Holder's option, to require the Company to repurchase all of this Note, or any portion hereof on the repurchase date that is five Business Days after the date of the Holder Notice delivered with respect to such Repurchase Event. The Holder shall have the right to require the Company to repurchase all or any such portion of this Note if a Repurchase Event occurs at any time while any portion of the principal amount of this Note is outstanding at a price equal to the Repurchase Price. 5.2 NOTICES; METHOD OF EXERCISING REPURCHASE RIGHTS, ETC. (a) On or ---------------------------------------------------- before the fifth Business Day after the occurrence of a Repurchase Event, the Company shall give to the Holder a Company Notice of the occurrence of the Repurchase Event and of the repurchase right set forth herein arising as a result thereof. Such Company Notice shall set forth: (i) the date by which the repurchase right must be exercised, and (ii) a description of the procedure (set forth in this Section 5.2) which the Holder must follow to exercise the repurchase right. No failure of the Company to give a Company Notice or defect therein shall limit the Holder's right to exercise the repurchase right or affect the validity of the proceedings for the repurchase of this Note or portion hereof. (b) To exercise the repurchase right, the Holder shall deliver to the Company on or before the 30th day after a Company Notice (or if no such Company Notice has been given, within 40 days after the Holder first learns of the Repurchase Event) (i) a Holder Notice setting forth the name of the Holder and the principal amount of this Note to be repurchased, and (ii) this Note, duly endorsed for transfer to the Company of the portion of the outstanding principal amount of this Note to be repurchased. A Holder Notice may be revoked by the Holder at any time prior to the time the Company pays the applicable Repurchase Price to the Holder. (c) If the Holder shall have given a Holder Notice, then on the date which is five Business Days after the date such Holder Notice is given (or such later date as the Holder surrenders this Note) the Company shall make payment in immediately available funds of the applicable Repurchase Price to such account as specified by the Holder in writing to the Company at least one Business Day prior to the applicable repurchase date. 5.3 REPURCHASE RIGHT UPON REGISTRATION REPURCHASE EVENT. If a --------------------------------------------------- Registration Repurchase Event occurs, in addition to any other right of the Holder, the Holder shall have the right, at the Holder's option, to require the Company to repurchase all of this Note, or from time to -20- time any portion hereof, by making payment of the Registration Repurchase Price to the Holder in immediately available funds to such account as specified by the Holder by notice to the Company at least one Business Day prior to the applicable repurchase date, on the repurchase date that is five Business Days after the date a Holder Registration Repurchase Notice is given by the Holder (or such later date as the Holder surrenders this Note to the Company). The Holder shall exercise its right to require repurchase pursuant to this Section 5.3 by giving a Holder Registration Repurchase Notice as follows: (i) if the Registration Repurchase Event occurs by reason of the Company's failure to timely file the Registration Statement with the SEC, at any time prior to the earlier of (x) the date which is 31 days after such event and (y) the date the Company files the Registration Statement with the SEC or (ii) if the Registration Repurchase Event occurs by reason of the non-occurrence of the SEC Effective Date within 90 days after the Issuance Date, at any time prior to the SEC Effective Date. If the Holder shall have given a Holder Registration Repurchase Notice, the Company shall repurchase this Note or the portion of this Note as stated in such Holder Registration Repurchase Notice at a purchase price equal to the Registration Repurchase Price. A Holder Registration Repurchase Notice may be revoked by the Holder at any time prior to the time the Company pays the applicable Registration Repurchase Price. 5.4 OTHER. A Holder Notice or a Holder Registration Repurchase ----- Notice given by the Holder shall be deemed for all purposes to be in proper form unless the Company notifies the Holder within three Business Days after such Holder Notice or Holder Registration Repurchase Notice has been given (which notice shall specify all defects in such Holder Notice or Holder Registration Repurchase Notice), and any Holder Notice or Holder Registration Repurchase Notice containing any such defect shall nonetheless be effective on the date given if the Holder promptly undertakes to correct all such defects. No such claim of defect shall limit or delay performance of the Company's obligation to repurchase any portion of this Note, the repurchase of which is not in dispute. ARTICLE VI EXTENSION OF MATURITY DATE 6.1 RIGHT TO EXTEND MATURITY DATE. The Company shall have the right, ----------------------------- exercisable by notice given to the Holder on a date not earlier than 90 or later than 30 days prior to the Original Maturity Date, which notice shall refer to this Section 6.1, to extend the Maturity Date to the Extended Maturity Date so long as the following conditions precedent are satisfied on the date the Company gives such notice to the Holder: (a) no Event of Default and no event which, with notice or passage of time, or both, would become an Event of Default, shall have occurred and be continuing; (b) no Repurchase Event or Registration Repurchase Event shall have occurred -21- with respect to which the Holder has the right to exercise repurchase rights under Sections 5.1 and 5.2 or Section 5.3 or with respect to which the Holder has exercised such repurchase rights and the Repurchase Price or the Registration Repurchase Price, as the case may be, has not been paid to the Holder and no event which, with notice or passage of time, or both, would become a Repurchase Event shall have occurred and be continuing; (c) Net Revenues from the Products and the Competitive Products in the Territory during the then most recent full calendar quarter preceding the date on which the Company gives such notice to the Holder shall have been at least 75% of the Target Revenues for the Products and the Competitive Products in the Territory for such calendar quarter; (d) the Company's Cash, Cash Equivalent and Eligible Investment Balances shall be greater than the sum of (1) an amount equal to 125% of the aggregate outstanding principal amount of this Note and the Other Notes at the close of business on the Business Day prior to the date on which the Company gives such notice to the Holder plus (2) an amount equal to 400% of the cash used in operations by the Company and the Subsidiaries during the then most recently completed fiscal quarter, as shown in the Company's consolidated statement of cash flows, prepared in accordance with Generally Accepted Accounting Principles on a basis consistent with the Company's then most recently prepared audited annual financial statements; (e) the Company shall be operating under a current business plan approved by the Company's Board of Directors which shows that from the date such notice is given to the Holder to the Extended Maturity Date the Company's Cash, Cash Equivalent and Eligible Investment Balances will not be less than 125% of the aggregate outstanding principal amount of this Note and the Other Notes on the date such notice is given to the Holder; (f) the Company shall have given notice to the holders of all of the Other Notes to extend the maturity date thereof to the Extended Maturity Date; and (g) the Company shall have furnished to the Holder a Company Certificate setting forth in reasonable detail confirmation of the satisfaction of the conditions in the preceding clauses (a) through (f). 6.2 ALTERNATIVE RIGHT TO EXTEND MATURITY DATE. If the Company is ----------------------------------------- unable to satisfy any one or more of the requirements of clause (c), (d) or (e) of Section 6.1, the Company shall have the right, exercisable by notice given to the Holder not earlier than 90 or later than 30 days prior to the Original Maturity Date, which notice shall refer to this Section 6.2, to extend the Maturity Date to the Extended Maturity Date so long as (x) the conditions precedent specified in clauses (a) (other than an Event of Default solely by reason of the Company's violation of Section 3.2), (b) and (f) of Section 6.1 are satisfied on the date the Company gives such notice to the Holder -22- and (y) Net Revenues of the Product and the portion of the Net Revenues of the Competitive Products included in the determination of the Noteholder Payment Amount in the Territory during the then most recent full fiscal quarter preceding the date on which the Company gives such notice to the Holder shall have been at least $3,750,000. If the Company gives such notice, then from and after the Original Maturity Date (1) the Applicable Rate shall be increased from 11% per annum to 14% per annum, (2) the Default Rate shall be increased from 21% per annum to 26% per annum and (3) the Payment Percentage shall be increased to 25 percent and, so long as no Event of Default has occurred and is continuing, the portion of the Noteholder Payment Amount paid to the Holder for any period during which such higher Payment Percentage shall be in effect which is in excess of the portion of the Noteholder Payment Amount which would have been paid to the Holder if the Payment Percentage during such period were 9.0 percent shall be paid to and applied by the Holder to the outstanding principal amount of this Note. ARTICLE VII SATISFACTION AND DISCHARGE OF CERTAIN PROVISIONS 7.1. DISCHARGE OF CERTAIN PROVISIONS. If ------------------------------- (i) the Company shall have deposited with the Collateral Agent, in trust, funds or Government Obligations, the principal of and interest on which when due will, together with any funds set aside at the same time and without the necessity for investment or reinvestment of such funds or for further investment or reinvestment of the principal amount of or interest on such Government Obligations, provide funds sufficient to pay at maturity or upon redemption all of this Note and the Other Notes, including principal and interest due or to become due to the Maturity Date or earlier redemption; (ii) in the case of this Note and the Other Notes which the Company may elect to redeem pursuant to Section 1.2 and the comparable provisions of the Other Notes, in whole or in part, prior to their maturity, all action other than the giving of notice of redemption necessary to redeem such of this Note and the Other Notes as of the specified redemption date or dates for this Note and such Other Notes shall have been taken and arrangements reasonably satisfactory to the Majority Holders shall have been made for the giving of notice of such redemption; (iii) notice of such deposit shall have been given to the Holder and the Holders of the Other Notes as to which such deposit is applicable, within ten days after the date of such deposit; (iv) no Event of Default or event which with notice or passage of time, or both, would become an Event of Default under Section 4.1(e) or 4.1(f) has occurred and is -23- continuing; and (v) no Event of Default or event which with notice or passage of time, or both would become an Event of Default (other than as specifically provided in the immediately preceding clause (iv)) has occurred and is continuing (unless the requirements of this clause (v) will be satisfied immediately after the 92-day period hereinbelow specified and the Company shall furnish to the Holder Company Certificates to such effect on the date of such deposit and on such 92nd day); and the Company shall also pay or cause to be paid all other sums payable hereunder by the Company, then on the date which is 92 days after the date of such deposit by the Company with the Collateral Agent, so long as during such 92-day period no Event of Default or event which with notice or passage of time, or both, would become an Event of Default under Section 4.1(e) or 4.1(f) has occurred (x) this Note shall cease to be of further effect (except as provided herein), (y) the Company shall be entitled to release of Collateral (other than the funds and Government Obligations so deposited and any interest or income thereon or any proceeds thereof) as provided in the Pledge Agreement and (z) the Holder, on demand of the Company accompanied by a Company Certificate and an opinion of counsel and at the cost and expense of the Company, shall execute proper instruments acknowledging the satisfaction and discharge of this Note to the extent set forth herein. So long as this Note shall remain outstanding after such discharge, this Note shall continue in effect following the discharge provided for above solely with respect to rights of registration of transfer, exchange or replacement of outstanding Notes, rights to receive payment of the principal hereof and interest hereon in accordance with the terms of this Note from such deposited funds or the proceeds of or interest on such deposited Government Obligations, the rights under Article II and the rights under Sections 3.10 and 3.11; provided, however, that, following such discharge, no claim for payment of principal of or interest on this Note shall be made against the Company. Upon such discharge, any Event of Default which occurred prior to such discharge solely by reason of one or more provisions of this Note with which the Company thereafter is no longer obligated to comply, then such Event of Default shall no longer exist. 7.2. DEPOSITED MONEYS AND GOVERNMENT OBLIGATIONS TO BE HELD IN --------------------------------------------------------- ACCORDANCE WITH SECURITY AGREEMENT. All funds and Government Obligations - ---------------------------------- deposited with the Collateral Agent pursuant to Section 7.1 shall be held in trust and subject to and in accordance with the terms of the Security Agreement and such funds and interest on such Government Obligations shall be applied by it to the payment of the Notes in accordance with the Security Agreement. 7.3. REINSTATEMENT. If (i) the Collateral Agent is unable to apply ------------- any funds in accordance with Section 7.2 and the Security Agreement by reason of any order or judgment of any court or governmental authority enjoining, restraining or otherwise prohibiting such application and (ii) the Majority Holders so specify by this notice to the Company, the Company's obligations under this Note shall be revived and reinstated as though no deposit had occurred pursuant to Section 7.1 -24- until such time as the Collateral Agent is permitted to apply all such funds in accordance with Section 7.2 and the Security Agreement. ARTICLE VIII DEFINITIONS 8.1 CERTAIN DEFINED TERMS. (a) All the agreements or instruments --------------------- herein defined shall mean such agreements or instruments as the same may from time to time be supplemented or amended or the terms thereof waived or modified to the extent permitted by, and in accordance with, the terms thereof and of this Note. (b) The following terms shall have the following meanings (such meanings to be equally applicable to both the singular and plural forms of the terms defined): "Aggregate Share Payment Amount" means the sum of (1) the principal amount of this Note as to which the Company has elected the Share Principal Payment Option and to which the Holder has consented plus (2) the aggregate principal amount of the Other Notes as to which the Company has elected to make payment in shares of Common Stock pursuant to provisions comparable to Section 1.4 and to which the respective holders of the Other Notes have consented in accordance with the terms of the Other Notes. "Applicable Rate" means 11 percent per annum except that, if the Company exercises its right to extend the Original Maturity Date to the Extended Maturity Date pursuant to Section 6.2, then from and after the Original Maturity Date such rate shall be increased to 14 percent per annum (or in either such case such lesser rate as shall be the highest rate permitted by applicable law). "Assignment Agreement" shall have the meaning provided in the Note Purchase Agreement. "Business Day" means any day other than a Saturday, Sunday or a day on which commercial banks in The City of New York are authorized or required by law or executive order to remain closed. "Cash, Cash Equivalent and Eligible Investment Balances" of any Person on any date shall be determined from such Person's books maintained in accordance with Generally Accepted Accounting Principles, and means, without duplication, the sum of (1) the cash accrued by such Person and its subsidiaries on a consolidated basis on such date and available for use by such Person and its subsidiaries on such date, (2) all assets which would, on a consolidated balance sheet of such Person and its subsidiaries prepared as of such date in accordance with -25- Generally Accepted Accounting Principles, be classified as cash equivalents and (3) all Eligible Marketable Securities which are assets which would, on a consolidated balance sheet of such Person and its subsidiaries prepared as of such date in accordance with Generally Accepted Accounting Principles, be classified as marketable securities. "Collateral Agent" means Delta Opportunity Fund, Ltd., as collateral agent under the Security Agreement and the Patent and Trademark Security Agreement, or its successors. "Common Stock" means the Common Stock, par value $.01 per share, or any shares of capital stock of the Company into which such shares shall be changed or reclassified after the Issuance Date. "Company" shall have the meaning provided in the first paragraph of this Note. "Company Certificate" means a certificate of the Company signed by an Officer. "Company Notice" means a Company Notice in the form attached hereto as EXHIBIT C. "Competitive Product" means a product, method or system, other than the Product, that (x) has received regulatory approval for use, or has received regulatory approval for any substantially similar use, in a human therapeutic indication as any Product, or (y) is so used for human therapeutic indication of excessive sleep disorder or excessive daytime sleep disorder but shall not include any product, method or system that an Affiliate of the Company was testing in preclinical or clinical trials or for which regulatory approval was received, prior to becoming an Affiliate of the Company. "Cross-Default Threshold" means as of any date an amount equal to the greater of (1) an amount equal to the product obtained by multiplying (a) the amount, if any, by which the Company's Cash, Cash Equivalent and Eligible Investment Balances on such date exceed the aggregate outstanding principal amount of this Note and the Other Notes on such date times (b) 50 percent; and (2) $1,000,000 for any single Indebtedness of the type referred to in Section 4.7 and $2,000,000 in the aggregate for the Company and the Subsidiaries for all Indebtedness referred to in Section 4.1(h). "Default Interest" shall have the meaning provided in the first paragraph of this Note. "Default Rate" means 21 percent per annum except that, if the Company exercises its right to extend the Original Maturity Date to the Extended Maturity Date pursuant to Section 6.2, -26- then from and after the Original Maturity Date such rate shall be increased to 26 percent per annum (or in either case such lesser rate equal to the highest rate permitted by applicable law). "Determination Period" means each calendar quarter, except that the first Determination Period shall begin on the Issuance Date and end on March 31, 1999 and the final Determination Period shall end on the last day of the Payment Period. "Eligible Bank" means a corporation organized or existing under the laws of the United States or any other state, having combined capital and surplus of at least $100 million and subject to supervision by federal or state authority and which has a branch located in New York, New York. "Eligible Marketable Securities" of the Company as of any date means marketable securities which would be reflected on a consolidated balance sheet of the Company and its subsidiaries prepared as of such date in accordance with Generally Accepted Accounting Principles and which are debt obligations within the Company's investment policies set forth on Exhibit M to the Company's Senior Convertible Notes due April 7, 1998. "Event of Default" shall have the meaning provided in Section 4.1. "Extended Maturity Date" means March 1, 2003. "Fundamental Change" means (a) Any consolidation or merger of the Company or any Subsidiary with or into another entity (other than a merger or consolidation of a Subsidiary into the Company or a wholly-owned Subsidiary) where the stockholders of the Company immediately prior to such transaction do not collectively own at least 51% of the outstanding voting securities of the surviving corporation of such consolidation or merger immediately following such transaction; or the sale of all or substantially all of the assets of the Company and the Subsidiaries in a safe transaction or a series of related transactions; or (b) The occurrence of any transaction or event in connection with which all or substantially all the Common Stock shall be exchanged for, converted into, acquired for or constitute the right to receive consideration (whether by means of an exchange offer, liquidation, tender offer, consolidation, merger, combination, reclassification, recapitalization or otherwise) which is not all or substantially all common stock which is (or will, upon consummation of or immediately following such transaction or event, will be) listed on a national securities exchange or approved for quotation on Nasdaq or any similar United States system of automated dissemination of transaction reporting of securities prices; or (c) The acquisition by a Person or entity or group of Persons or entities acting -27- in concert as a partnership, limited partnership, syndicate or group, as a result of a tender or exchange offer, open market purchases, privately negotiated purchases or otherwise, of beneficial ownership of securities of the Company representing 50% or more of the combined voting power of the outstanding voting securities of the Company ordinarily (and apart from rights accruing in special circumstances) having the right to vote in the election of directors. "Generally Accepted Accounting Principles" for any Person means the generally accepted accounting principles and practices applied by such Person from time to time in the preparation of its audited financial statements. "GMP" means the Good Manufacturing Practices established from time to time by the United States Food and Drug Administration. "Government Obligations" means direct obligations of, or obligations the timely payment of the principal of and the interest on which are unconditionally guaranteed by, the United States of America and which are not, by their terms, callable. "Holder" shall have the meaning provided in the first paragraph of this Note. "Holder Notice" means a Holder Notice in the form attached hereto as EXHIBIT D. "Holder Registration Repurchase Notice" means a Holder Registration Repurchase Notice in the form attached hereto as EXHIBIT E. "Indebtedness" as used in reference to any Person means all indebtedness of such Person for borrowed money, the deferred purchase price of property, goods and services and obligations under leases which are required to be capitalized in accordance with Generally Accepted Accounting Principles and shall include all such indebtedness guaranteed in any manner by such Person or in effect guaranteed by such Person through a contingent agreement to purchase and all indebtedness for the payment or purchase of which such Person has contingently agreed to advance or supply funds and all indebtedness secured by mortgage or other lien upon property owned by such Person, although such Person has not assumed or become liable for the payment of such indebtedness, and, for all purposes hereof, such indebtedness shall be treated as though it has been assumed by such Person. "Interest Payment Dates" means each March 1, June 1, September 1 and December 1 and the Maturity Date. "Interest Payment Shares" means the shares of Common Stock and the related Preferred Share Purchase Rights issuable in payment of interest on this Note in accordance with Section 1.1. -28- "Interest Share Price" for any Interest Payment Date means the arithmetic average of the Market Price of the Common Stock for all of the Trading Days during [ ] * "Interest Share Registration Statement" means the registration statement filed by the Company with the SEC under the 1933 Act pursuant to Section 8(a)(1) of the Note Purchase Agreement. "Issuance Date" means March 1, 1999. "Judgment Default Threshold" means as of any date of determination an amount equal to the greater of (1) an amount equal to the product obtained by multiplying (a) the amount, if any, by which the Company's Cash, Cash Equivalent and Eligible Investment Balances on such date exceed the aggregate outstanding principal amount of this Note and the Other Notes on such date times (b) 50 percent; and (2) $1,000,000. "Lafon" means Laboratoire L. Lafon, a French corporation. "Lafon Agreements" means (1) the License Agreement, dated January 20, 1993, by and between Lafon and the Company, as amended, (2) the Trademark Agreement, dated January 20, 1993, by and between Genelco S.A. and the Company, as amended, and (3) the Supply Agreement, dated January 20, 1993, between the Company and Lafon, as amended. "Majority Holders" means at any time such of the holders of this Note and the Other Notes which hold Notes and Other Notes which, based on the outstanding principal amounts thereof, represent a majority of the aggregate outstanding principal amount of this Note and the Other Notes. "Market Price" of any security on any date shall mean the closing bid price of such security on such date on Nasdaq or such other securities exchange or other market on which such security is listed for trading on such date which constitutes the principal securities market for such security, as reported by Bloomberg, L.P. "Maturity Date" means at any time the Original Maturity Date or the Extended Maturity Date, as in effect at such time. * THE CONFIDENTIAL MATERIAL CONTAINED HEREIN HAS BEEN OMITTTED AND FILED SEPARATELY WITH THE COMMISSION -29- "Nasdaq" means the Nasdaq National Market. "Nasdaq SmallCap" means the Nasdaq SmallCap Market. "Net Revenues" means, with respect to sales for any period and with respect to any item, the amount thereof accrued by the Company for financial reporting purposes, determined under the Generally Accepted Accounting Principles used in the preparation of the Company's then most recently published audited financial statements, from sales of Products or Competitive Products (as and to the extent applicable) by the Company, any Affiliate of the Company or any licensee or sublicensee of the Company or any Affiliate of the Company, but excluding sales to any Affiliate, licensee or sublicensee of the Company or any Affiliate of the Company; provided, however, that if for any period the aggregate Net Revenues for the Products and the Competitive Products (before application of this proviso) would exceed the Target Revenues for such period, then in determining Net Revenues for such period there shall be excluded the portion thereof, if any, arising from Competitive Products equal to the lesser of (x) the amount thereof for such period arising from Competitive Products and (y) the portion of the aggregate Net Revenues for the Products and the Competitive Products for such period (before application of this proviso) which shall be in excess of the Target Revenues for such period. In determining such amount, the amounts received from such sales shall be reduced by related prompt payment and other trade discounts, transportation and related insurance charges, returns, bad debt and other allowances, taxes (except income and franchise taxes) and distributors', consignees' and wholesalers' fees and commissions. The terms "licensee" and "sublicensee" shall mean any Person licensed or sublicensed by the Company or any Affiliate of the Company, including, without limitation, pursuant to any marketing, co-marketing or co-detailing agreement (or similar arrangement that is the functional equivalent of a license), but excluding customary distribution, wholesaling and consignment arrangements. For the purposes of this definition, distribution, wholesaling or consignment arrangements shall be limited to arrangements where the distributor, wholesaler or consignee is not obligated, in addition to selling a Product or Competitive Product, to undertake any significant promotional or similar marketing efforts directed at a Product or Competitive Product. In computing the portion of Net Revenues from Products which contain modafinil or any compound based on or derived therefrom as an active ingredient in combination with any other substance as an active ingredient which substance is also sold by the Company or any of its Affiliates not in combination with modafinil or any such compound based or derived therefrom, the portion of Net Revenues from such combination product included in Net Revenues for any period shall be a portion of the total Net Revenues for such combination product for such period which portion shall be determined as the product obtained by multiplying (x) an amount equal to the Net Revenues for such period from sales of such combination product times (y) a fraction (i) the numerator of which shall be the unit price at which the Company or an Affiliate sells products containing modafinil or such compound based on or derived therefrom and (ii) the denominator of which shall be the sum of (A) the amount referred to in the immediately preceding clause (i) plus (B) the unit price at which the Company or an Affiliate sells the products containing such other substance; provided, however, that in no event shall such combination product be sold at a unit price less than the amount referred to in the immediately preceding clause (i). In calculating Net Revenues, any particular unit of a -30- Product or Competitive Product shall be taken into account only once. "1934 Act" means the Securities Exchange Act of 1934, as amended. "1933 Act" means the Securities Act of 1933, as amended. "Note" means this instrument as originally executed, or if later amended or supplemented in accordance with its terms, then as so amended or supplemented. "Noteholder Payment Amount" shall have the meaning provided in Section 2.1. "Note Purchase Agreement" means the Note Purchase Agreement, dated as of February 24, 1999, by and between the Company and the original Holder of this Note. "Officer" means the Chairman of the Board, the Chief Executive Officer, the President or the Chief Financial Officer of the Company. "Optional Redemption Date" means each Business Day on which this Note is to be redeemed in whole or in part pursuant to Section 1.2. "Optional Redemption Notice" means an Optional Redemption Notice in the form attached hereto as EXHIBIT A. "Optional Redemption Period" means the period which commences on March 1, 2001 and ends on the Original Maturity Date. "Optional Redemption Price" means an amount in cash equal to the sum of (1) 120% of the outstanding principal amount of this Note specified in an Optional Redemption Notice as being redeemed by the Company plus (2) accrued and unpaid interest on such principal amount to the applicable Optional Redemption Date plus (3) accrued and unpaid Default Interest, if any, on the amount referred to in the immediately preceding clause (2) at the rate provided in this Note to the Optional Redemption Date. "Original Maturity Date" means March 1, 2002. "Other Note Purchase Agreements" means the several Note Purchase Agreements, dated as of February 24, 1999, by and between the Company and the respective original holders of the Other Notes. "Other Notes" means the several 11% Senior Secured Notes due 2002 issued by the Company pursuant to the Other Note Purchase Agreements. -31- "Patent and Trademark Security Agreement" means the Patent and Trademark Security Agreement, dated as of March 1, 1999, by and between the Company and the Collateral Agent. "Payment Percentage" means six percent; provided, however, that if an Event of Default shall have occurred, then the Payment Percentage shall be increased to 25 percent during the period from the date of such Event of Default until the earlier of (x) the date no Event of Default is continuing and (y) the date the Company pays the redemption price in full for a redemption of this Note and the Other Notes pursuant to Section 1.2 and the comparable provisions of the Other Notes; provided further, however, that if the Company extends the Original Maturity Date to the Extended Maturity Date pursuant to Section 6.2, then the Payment Percentage shall be increased as provided in Section 6.2; and provided further, however, that, unless a Fundamental Change shall have occurred, if the Company redeems all or any portion of this Note pursuant to Section 1.2 and the Other Notes pursuant to the comparable provisions thereof, then the Payment Percentage (as in effect immediately prior to such redemption) which shall be applicable during the last 12 months of the Payment Period shall be reduced for each such redemption by an amount determined as RPP = PP x PR x D -- --- PO 365 where RPP = amount of reduction in the Payment Percentage (as in effect immediately prior to such redemption) by reason of such redemption PP = Payment Percentage which would be in effect without regard to any reduction thereof at any time pursuant to this formula. PR = the aggregate principal amount of this Note and the Other Notes redeemed in such redemption PO = the original aggregate principal amount of this Note and the Other Notes D = the number of calendar days during the period commencing on and including the date the Company pays the full redemption price of this Note and the Other Notes which is in connection with such redemption and ending on and excluding the date which is the third anniversary of the Issuance Date "Payment Period" means the period which commences on the Issuance Date and ends on the fifth anniversary of the Issuance Date; provided, however, that if in accordance with Article VI the Company elects to extend the Maturity Date to the Extended Maturity Date, effective -32- on the date the Company gives notice of such extension to the Holder and the holders of the Other Notes, the Payment Period shall be extended by one year from the date the Payment Period would have ended as in effect immediately prior to such extension of the Maturity Date. "Payment Share Price" means the arithmetic average of the Market Price of the Common Stock for all of the Trading Days during [ ]. * "Payment Share Registration Statement" means the Registration Statement required to be filed by the Company with the SEC pursuant to Section 8(a)(2) of the Note Purchase Agreement if the Company elects to make the Share Principal Payment Option and the Holder consents to such election. "Permitted Indebtedness" means (1) Indebtedness outstanding on the Issuance Date; and (2) Indebtedness incurred after the Issuance Date which is unsecured and on a parity with or subordinated to this Note and the Other Notes. "Person" means any natural person, corporation, partnership, limited liability company, trust, incorporated organization, unincorporated association or similar entity or any government, governmental agency or political subdivision. "Preferred Share Purchase Rights" means the Preferred Share Purchase Rights issued or issuable pursuant to the Rights Agreement (or any similar rights issued by the Company with respect to the Common Stock after the date of this Agreement). "Principal Payment Shares" means the shares of Common Stock and the related Preferred Share Purchase Rights issuable in payment of a portion of the principal amount of the Note in accordance with Section 1.4. "Products" means all pharmaceutical compositions containing modafinil or any compound based on or derived therefrom as an active ingredient, whether alone or in combination with any other substance, which are developed, marketed or sold by the Company or any Subsidiary or Affiliate of the Company, including, without limitation, that pharmaceutical composition marketed by the Company on the Issuance Date under the name Provigil(R). "Registration Repurchase Event" means the occurrence of either of the following events: * THE CONFIDENTIAL MATERIAL CONTAINED HEREIN HAS BEEN OMITTTED AND FILED SEPARATELY WITH THE COMMISSION -33- (a) the Company fails to file the Registration Statement within the 45-day period provided in Section 8(a)(1) of the Note Purchase Agreement; or (b) the SEC Effective Date shall not have occurred on or before the date which is 90 days after the Issuance Date. "Registration Repurchase Price" means an amount in cash equal to the sum of (1) 100% of the principal amount of this Note to be repurchased, plus (2) accrued and unpaid interest on such principal amount to the date of such repurchase, plus (3) accrued and unpaid Default Interest, if any, thereon at the rate provided in this Note to the date of repurchase in accordance with Article V. "Registration Statement" means the Registration Statement required to be filed by the Company with the SEC pursuant to Section 8(a)(1) of the Note Purchase Agreement. "Repurchase Event" means the occurrence of any one or more of the following events: (a) Any Fundamental Change; or (b) The occurrence of any Event of Default specified in Article IV of this Note; provided, however, that in the case of only an Event of Default specified in clause (c), (g) or (h) of Section 4.1, such Event of Default shall become a Repurchase Event only on and after the date which is 365 days after the occurrence of such Event of Default if any Event of Default is continuing at such time. "Repurchase Price" means with respect to any repurchase pursuant to Sections 5.1 and 5.2 an amount in cash equal to the sum of (1) 101% of the outstanding principal amount of this Note plus (2) accrued and unpaid interest on such principal amount to the date of such repurchase plus (3) accrued and unpaid Default Interest, if any, thereon at the rate provided in this Note to the date of such repurchase. "Rights Agreement" means the Amended and Restated Rights Agreement, dated as of January 1, 1999, by and between the Company and Stocktrans, Inc., as Rights Agent. "SEC" means the Securities and Exchange Commission. "SEC Effective Date" means the date the Registration Statement is first declared effective by the SEC. "Security Agreement" means the Security Agreement, dated as of March 1, 1999, by and between the Company and the Collateral Agent. -34- "Share Interest Payment Option" shall have the meaning provided in Section 1.1(a). "Share Payment Threshold" means the product obtained by multiplying (x) the volume-weighted average Trading Price (as reported by Bloomberg, L.P. in its AQR function, or if such source or function ceases to be available, a comparable source and function selected by the Majority Holders and acceptable to the Company in its reasonable judgment) for all of the Trading Days during the 90 consecutive Trading Days ending on (and including) the Trading Day that is three Trading Days prior to the Maturity Date, times (y) the aggregate number of shares of Common Stock traded during such 90 consecutive Trading Days, as reported by Bloomberg, L.P. (or if such source ceases to be available, a comparable source selected by the Majority Holders and acceptable to the Company in its reasonable judgment), times (z) 0.05. "Share Principal Payment Option" shall have the meaning provided in Section 1.4(a). "Significant Subsidiary" shall have the meaning provided in Regulation S-X of the SEC, except that a Subsidiary shall not be a Significant Subsidiary only if such Subsidiary, when consolidated for financial reporting purposes with all other Subsidiaries which are not Significant Subsidiaries, would not constitute a Significant Subsidiary. "Subsidiary" means any corporation or other entity of which a majority of the capital stock or other ownership interests having ordinary voting power to elect a majority of the board of directors or other Persons performing similar functions are at the time directly or indirectly owned by the Company. "Target Revenues" means for any period the amount set forth for such period in EXHIBIT F attached hereto. "Territory" means the United States, its territories and possessions. "Trading Day" means a day on which either the national securities exchange or Nasdaq which then constitutes the principal securities market for the Common Stock is open for general trading of securities. "Trading Price" for any trade of the Common Stock on any date means the lowest sale price (regular way) for one share of Common Stock on such date in such trade, on the first applicable among the following: (a) the national securities exchange on which the Common Stock is listed which constitutes the principal securities market for the Common Stock, (b) Nasdaq, (c) the Nasdaq SmallCap Market or (d) such other market as at the time constitutes the principal trading market for the Common Stock, in any such case as reported by Bloomberg, L.P. (subject to equitable adjustment from time to time on terms reasonably acceptable to the Majority Holders for (i) stock splits, (ii) stock dividends, (iii) combinations, (iv) capital reorganizations, (v) issuance to all -35- holders of Common Stock of rights or warrants to purchase Common Stock at a price per share less than the Trading Price which would otherwise be applicable, (vi) the distribution by the Company to all holders of Common Stock of evidences of indebtedness of the Company or cash (other than regular quarterly cash dividends), (vii) Tender Offers by the Company or any subsidiary of the Company or other repurchases of Common Stock in one or more transactions which, individually or in the aggregate, result in the purchase of more than 10% of the Common Stock outstanding and (viii) similar events, in each such case relating to the Common Stock and which occur on or after the Issuance Date). "Transaction Documents" means this Note, the Note Purchase Agreement, the Security Agreement, the Patent and Trademark Security Agreement, and the Warrants. "Transfer Agent" means Stocktrans, Inc., or its successor as transfer agent and registrar for the Common Stock. "Warrants" means Common Stock Purchase Warrants of the Company issued to the original Holder of this Note pursuant to the Note Purchase Agreement. ARTICLE IX MISCELLANEOUS 9.1 FAILURE OR INDULGENCY NOT WAIVER. No failure or delay on the -------------------------------- part of the Holder in the exercise of any power, right or privilege hereunder shall operate as a waiver thereof, nor shall any single or partial exercise of any such power, right or privilege preclude other or further exercise thereof or of any other right, power or privileges. All rights and remedies existing hereunder are cumulative to, and not exclusive of, any rights or remedies otherwise available. 9.2 NOTICES. Except as otherwise specifically provided herein, any ------- notice herein required or permitted to be given shall be in writing and may be personally served, sent by telephone line facsimile transmission or delivered by courier or sent by United States mail and shall be deemed to have been given upon receipt if personally served, sent by telephone line facsimile transmission or sent by courier or three days after being deposited in the facilities of the United States Postal Service, certified, with postage pre-paid and properly addressed, if sent by mail. For the purposes hereof, the address and facsimile line transmission number of the Holder shall be as furnished by the Holder for such purpose and shown on the records of the Company; and the address of the Company shall be 145 Brandywine Parkway, West Chester, Pennsylvania 19380, Attention: Chief Financial Officer (telephone line facsimile transmission number (610) 344-7563). The Holder or the Company may change its address for notice by service of written notice to the other as herein provided. -36- 9.3 AMENDMENT, WAIVER, ETC. Neither this Note or any Other Note nor ---------------------- any terms hereof or thereof may be changed, waived, discharged or terminated unless such change, waiver, discharge or termination is in writing signed by the Company and the Majority Holders, provided that no such change, waiver, discharge or termination shall, without the consent of the Holder and the holders of the Other Notes affected thereby (i) extend the scheduled final maturity of this Note or any Other Note, or reduce the rate or extend the time of payment of interest (other than as a result of waiving the applicability of any post-default increase in interest rates) hereon or thereon or reduce the principal amount hereof or thereof or the Optional Redemption Price, the Repurchase Price or the Registration Repurchase Price, (ii) release the collateral or reduce the amount of collateral required to be deposited or maintained by the Company pursuant to the Security Agreement or the Patent and Trademark Security Agreement, except as expressly provided in the respective agreement, (iii) amend, modify or waive any provision of Article II, (iv) amend, modify or waive any provision of this Section 9.3, (v) reduce any percentage specified in, or otherwise modify, the definition of Majority Holders or (vi) except as provided in this Note, change the method of calculating the Payment Share Price, the Interest Share Price or the Optional Redemption Price in a manner adverse to the Holder. 9.4 ASSIGNABILITY. This Note shall be binding upon the Company and ------------- its successors, and shall inure to the benefit of and be binding upon the Holder and its successors and permitted assigns. The Company may not assign its rights or obligations under this Note. 9.5 CERTAIN EXPENSES. The Company shall pay on demand all expenses ---------------- incurred by the Holder, including reasonable attorneys' fees and expenses, as a consequence of, or in connection with (x) any amendment or waiver of this Note or any other Transaction Document, (y) any default or breach of any of the Company's obligations set forth in the Transaction Documents and (z) the enforcement or restructuring of any right of, including the collection of any payments due, the Holder under the Transaction Documents, including any action or proceeding relating to such enforcement or any order, injunction or other process seeking to restrain the Company from paying any amount due the Holder. 9.6 GOVERNING LAW. This Note shall be governed by the internal laws ------------- of the State of New York, without regard to the principles of conflict of laws. 9.7 TRANSFER OF NOTE AND NOTEHOLDER PAYMENT AMOUNT. This Note has ---------------------------------------------- not been and is not being registered under the provisions of the 1933 Act or any state securities laws and this Note may not be transferred unless the Holder shall have delivered to the Company an opinion of counsel, reasonably satisfactory in form, scope and substance to the Company, to the effect that this Note may be sold or transferred without registration under the 1933 Act. Prior to any such transfer, such transferee shall have represented in writing to the Company that such transferee has requested and received from the Company all information relating to the business, properties, operations, condition (financial or other), results of operations or prospects of the Company and the Subsidiaries deemed relevant by such transferee; that such transferee has been afforded the opportunity to ask questions of the Company concerning the foregoing and has had the opportunity -37- to obtain and review the reports and other information concerning the Company which at the time of such transfer have been filed by the Company with the SEC pursuant to the 1934 Act. If such transfer is intended to assign the rights and obligations under 5(a), 5(b), 8, 9 and 10 of the Note Purchase Agreement, such transfer shall otherwise be made in compliance with Article V of the Note Purchase Agreement. The Holder may not transfer a portion of this Note to any Person if such transfer would result in an increase in the aggregate number of registered holders of this Note and the Other Notes of more than one such holder without the prior written consent of the Company, which consent will not be unreasonably withheld. Any instrument issued upon any such transfer of a portion of this Note which results in such increase of one holder shall bear a legend that the holder thereof shall not be entitled to transfer such instrument in a manner which would further increase the aggregate number of registered holders of this Note and the Other Notes without the prior written consent of the Company, which consent shall not be unreasonably withheld. The Holder shall have the right to transfer all or any part of its rights under Article II of this Note separate from its rights under the other provisions of this Note only with the prior written consent of the Company, which consent will not be unreasonably withheld. 9.8 ENFORCEABLE OBLIGATION. The Company represents and warrants that ----------------------- at the time of the original issuance of this Note it received the full purchase price payable pursuant to the Note Purchase Agreement in an amount at least equal to the original principal amount of this Note, and that this Note is an enforceable obligation of the Company which is not subject to any offset, reduction, counterclaim or disallowance of any sort. 9.9 NOTE REGISTER; REPLACEMENT OF NOTES. The Company shall maintain ----------------------------------- a register showing the names, addresses and telephone line facsimile numbers of the Holder and the registered holders of the Other Notes. The Company shall also maintain a facility for the registration of transfers of this Note and the Other Notes and at which this Note and the Other Notes may be surrendered for split up into instruments of smaller denominations or for combination into instruments of larger denominations. Upon receipt by the Company of evidence reasonably satisfactory to it of the ownership of and the loss, theft, destruction or mutilation of this Note and (a) in the case of loss, theft or destruction, of indemnity from the Holder reasonably satisfactory in form to the Company (and without the requirement to post any bond or other security) or (b) in the case of mutilation, upon surrender and cancellation of this Note, the Company will execute and deliver to the Holder a new Note of like tenor without charge to the Holder. 9.10 PAYMENT OF NOTE ON REDEMPTION OR REPURCHASE; DEPOSIT OF ------------------------------------------------------- REDEMPTION PRICE OR REPURCHASE PRICE, ETC. (a) If this Note or any portion of - ----------------------------------------- this Note is to be redeemed as provided in Section 1.2 or repurchased as provided in Sections 5.1 and 5.2 or Section 5.3 and any notice required in connection therewith shall have been given as provided therein and the Company shall have otherwise complied with the requirements of this Note with respect thereto, then this Note or the portion of this Note to be so redeemed or repurchased and with respect to which any such notice has been given shall become due and payable on the date stated in such notice at the applicable Optional Redemption Price, Repurchase Price or Registration Repurchase Price. On and after the Optional Redemption Date or repurchase date so stated in such notice, provided that the -38- Company shall have deposited with an Eligible Bank on or prior to such Optional Redemption Date or repurchase date, an amount sufficient to pay the applicable Optional Redemption Price, Repurchase Price or Registration Repurchase Price, interest on this Note or the portion of this Note to be so redeemed or repurchased shall cease to accrue, and this Note or such portion hereof shall be deemed not to be outstanding and shall not be entitled to any benefit with respect to principal of or interest on the portion to be so redeemed or repurchased except to receive payment of the applicable Optional Redemption Price, Repurchase Price or Registration Repurchase Price. On presentation and surrender of this Note or such portion hereof, this Note or the specified portion hereof shall be paid and redeemed or repurchased at the applicable Optional Redemption Price, Repurchase Price or Registration Repurchase Price. If a portion of this Note is to be redeemed or repurchased, upon surrender of this Note to the Company in accordance with the terms hereof, the Company shall execute and deliver to the Holder without service charge, a new Note or Notes, having the same date hereof and containing identical terms and conditions, in such denomination or denominations as requested by the Holder in aggregate principal amount equal to, and in exchange for, the unredeemed or unrepurchased portion of the principal amount of this Note so surrendered. (b) Upon the payment in full of all amounts payable by the Company under this Note and the Other Notes (other than amounts payable pursuant to Article II hereof and thereof which are not yet due) or the deposit thereof as provided in Section 9.10(a) and the like provisions of the Other Notes, thereafter the obligations of the Company under this Note shall be as set forth in Article II, Sections 3.10, 3.11, this Article IX, and, in the case of such deposit, to pay the Optional Redemption Price, Repurchase Price or Registration Repurchase Price, as the case may be, from the funds so deposited. Upon such payment or deposit, any Event of Default which occurred prior to such payment or deposit by reason of one or more provisions of this Note with which the Company thereafter is no longer obligated to comply, then such Event of Default shall no longer exist. [REMAINDER OF THIS PAGE INTENTIONALLY LEFT BLANK] -39- IN WITNESS WHEREOF, the Company has caused this Note to be signed in its name by its duly authorized officer as of the day and in the year first above written. CEPHALON, INC. By: Name: Title: -40- EXHIBIT A --------- OPTIONAL REDEMPTION NOTICE (SECTION 1.2 OF 11% REVENUE SHARING SENIOR SECURED NOTE DUE 2002) TO: ___________________________ (Name of Holder) (1) Pursuant to the terms of the 11% Revenue Sharing Senior Secured Note due 2002 (the "Note"), Cephalon, Inc., a Delaware corporation (the "Company"), hereby notifies the above-named Holder that the Company is exercising its right to redeem the Note in accordance with Section 1.2 of the Note as set forth below: (i) The principal amount of the Note to be redeemed is $_____________. (ii) The Optional Redemption Price is $_______________. (iii) The Optional Redemption Date is ______________. (2) Capitalized terms used herein and not otherwise defined herein have the respective meanings provided in the Note. Date _________________________ CEPHALON, INC. By: Title: A-41 EXHIBIT B --------- FORM OF OPINION OF COUNSEL TO BE DELIVERED IN CONNECTION WITH ISSUANCE OF PRINCIPAL PAYMENT SHARES [Letterhead of Counsel] _______________, 200_____ To The Holders Listed on Schedule A hereto Re: Cephalon, Inc. -------------- Ladies and Gentlemen: We have acted as counsel to Cephalon, Inc., a Delaware corporation (the "Company"), in connection with the issuance by the Company of ____________________________ Principal Payment Shares in accordance with the terms of the Company's 11% Revenue Sharing Senior Secured Notes due 2002 in the original aggregate principal amount of $30,000,000 (the "Notes"), which Notes were issued pursuant to the several Note Purchase Agreements, dated as of February __, 1999 (the "Note Purchase Agreements"), by and between the Company and the Buyers parties thereto (the "Buyers"). All capitalized terms used herein without definition are used herein with the respective meanings ascribed to them in the Notes or, if not defined in the Notes, in the Note Purchase Agreements. This opinion is being delivered to you pursuant to Section 1.4(d)[(1)(B) OR (2)(B)] of the Notes. In connection with this opinion letter, we have relied upon the representations and warranties of the Company set forth in the Note Purchase Agreements and the Notes (the "Principal Documents"). As to various questions of fact material to our opinion, we have also relied upon certificates of officers and representatives of the Company and upon certificates of public officials. We have made no independent review or investigation of any nature as to such representations and warranties, the matters set forth in the certificates or the assumptions set forth below upon which we are relying, and no inference of any knowledge on the part of this Firm as to these legal or factual matters should be drawn from our representation of the Company in connection with the Principal Documents or otherwise. We have also assumed the genuineness of all signatures, the authenticity of all documents submitted to us as originals and the conformity with originals of all documents submitted to us as copies. We have also assumed that the Principal Documents have each been duly authorized, B-42 executed and delivered by all parties thereto other than the Company and that all such other parties have full power, authority and legal right to execute, deliver and perform their obligations under the Principal Documents, and that such Principal Documents are valid, binding and enforceable in accordance with their respective terms against such other parties. Based on the foregoing, and subject to the qualifications and limitations set forth below, we are of the opinion that the Principal Payment Shares are duly authorized and will be, upon issuance and delivery in accordance with the terms of the Notes, validly issued, fully paid and nonassessable. Upon issuance, each Principal Payment Share will have attached thereto a Preferred Share Purchase Right pursuant to the terms of the Company's Rights Plan if and as then in effect. We express no opinion as to the validity of the Rights Plan or the Preferred Share Purchase Rights. None of the Principal Payment Shares are subject to preemptive rights pursuant to the Certificate of Incorporation or the Delaware General Corporation Law (the "DGCL") or, to our knowledge, other similar rights of the stockholders of the Company. The foregoing opinions and comments are subject to the following additional qualifications: (a) Wherever we have stated herein that we have assumed a matter, it is intended to indicate that we have assumed such matter without making any independent legal or factual review or investigation of any nature to determine the accuracy of such assumption, and without expressing any opinion or conclusion of any kind concerning the matter, and no inference as to our knowledge of any legal or factual matters bearing on the accuracy of any such assumption should be drawn from the fact of our current or prior representation of the Company. (b) We express no opinion with respect to the laws of any jurisdiction other than the federal laws of the United States of America, the laws of the Commonwealth of Pennsylvania and the State of New York and the DGCL. We express no opinion with respect to any federal or state laws relating to tax and antitrust matters. We express no opinion as to compliance with applicable anti- fraud statutes, rules or regulations of any applicable jurisdiction governing the issuance of securities. (c) The opinions expressed above are subject to applicable bankruptcy, insolvency, fraudulent conveyance, reorganization, moratorium and similar laws (including without limitation preference rules) affecting the rights of creditors generally and to general principles of equity (regardless of whether considered in a proceeding in equity or at law). (d) [IF OPINION GIVEN PURSUANT TO SECTION 1.4(D)(2)(B) OF NOTE: For purposes of this opinion, we have assumed that the formulas contained in the Notes to calculate the Optional Redemption Price represent stipulated damages that are not plainly disproportionate to the possible loss to the holders of the Notes and, therefore, are not "penalties" as a matter of law. We express no opinion as to whether the issuance of the Principal Payment Shares may be determined to be interest payable with respect to the Notes, or as to the effect of any laws of any B-43 jurisdiction restricting the interest that may be charged upon debt obligations, and our opinion set forth above assumes that such laws do not adversely affect any determination that the Principal Payment Shares are fully paid and non- assessable.] (e) The foregoing opinion and comments are as of the date hereof, and we assume no obligation to update or supplement them to reflect any facts or circumstances which may hereafter come to our attention or any changes in laws which may hereafter occur. This opinion letter is solely for the benefit of the Holders for use in connection with the transactions contemplated by the Notes and may not be relied upon by any other person or for any other purpose without our express written consent. Very truly yours, B-44 Schedule A Holders of Notes ---------------- B-45 EXHIBIT C --------- COMPANY NOTICE (SECTION 5.2(A) OF 11% REVENUE SHARING SENIOR SECURED NOTE DUE 2002) TO: ___________________________ (Name of Holder) (1) A Repurchase Event described in the 11% Revenue Sharing Senior Secured Note due 2002 (the "Note") of Cephalon, Inc., a Delaware corporation (the "Company"), occurred on ____________________, ______. As a result of such Repurchase Event, the Holder is entitled to exercise its repurchase rights pursuant to Section 5.2 of the Note. (2) The Holder's repurchase right must be exercised on or before ______________, _______. (3) At or before the date set forth in the preceding paragraph (2), the Holder must: (a) deliver to the Company a Holder Notice, in the form attached as EXHIBIT D to the Note; and (b) the Note, duly endorsed for transfer to the Company of the portion of the principal amount to be repurchased. (4) Capitalized terms used herein and not otherwise defined herein have the respective meanings provided in the Note. Date _________________________ CEPHALON, INC. By: Title: C-46 EXHIBIT D --------- HOLDER NOTICE (SECTION 5.2(B) OF 11% REVENUE SHARING SENIOR SECURED NOTE DUE 2002) TO: CEPHALON, INC. (1) Pursuant to the terms of the 11% Revenue Sharing Senior Secured Note due 2002 (the "Note"), the undersigned Holder hereby elects to exercise its right to require repurchase by the Company pursuant to Sections 5.2(a) and 5.2(b) of $_________________________ of the Note, equal to the sum of $____________________ principal amount of the Note, $____________________ of accrued and unpaid interest on such principal amount and $____________________ of Default Interest on such interest at the Repurchase Price provided in the Note. (2) Capitalized terms used herein and not otherwise defined herein have the respective meanings provided in the Note. Date: NAME OF HOLDER: By Signature of Registered Holder (Must be signed exactly as name appears in the Note.) D-47 EXHIBIT E --------- HOLDER REGISTRATION REPURCHASE NOTICE (SECTION 5.3 OF 11% REVENUE SHARING SENIOR SECURED NOTE DUE 2002) TO: CEPHALON, INC. (1) Pursuant to the terms of the 11% Revenue Sharing Senior Secured Note due 2002 (the "Note"), the undersigned Holder hereby elects to exercise its right to require repurchase by the Company pursuant to Section 5.3 of $____________________ of the Note, equal to the sum of $____________________ principal amount of the Note, $____________________ of accrued and unpaid interest on such principal amount and $____________________ of Default Interest on such interest at the Registration Repurchase Price provided in the Note. (2) Capitalized terms used herein and not otherwise defined herein have the respective meanings provided in the Note. Date: NAME OF HOLDER: By _________________________________ Signature of Registered Holder (Must be signed exactly as name appears in the Note.) E-48 EXHIBIT F --------- TARGET REVENUES Period 3 Months 12 Months Ended Ended Ended ----- ----------- ----------- [ ] * * THE CONFIDENTIAL MATERIAL CONTAINED HEREIN HAS BEEN OMITTTED AND FILED SEPARATELY WITH THE COMMISSION F-49 EX-4.3(C) 4 FORM OF CLASS A WARRANT EXHIBIT 4.3(C) ANNEX II TO NOTE PURCHASE AGREEMENT NEITHER THIS WARRANT NOR ISSUANCE OF THE SECURITIES ISSUABLE UPON THE EXERCISE HEREOF TO THE HOLDER HAVE BEEN REGISTERED UNDER THE SECURITIES ACT OF 1933 OR QUALIFIED OR REGISTERED UNDER STATE SECURITIES OR BLUE SKY LAWS. NEITHER THIS WARRANT NOR SUCH SECURITIES MAY BE SOLD, OFFERED FOR SALE, PLEDGED, HYPOTHECATED OR OTHERWISE TRANSFERRED OR DISPOSED OF EXCEPT IN COMPLIANCE WITH THE SECURITIES ACT OF 1933, APPLICABLE STATE SECURITIES OR BLUE SKY LAWS AND THE APPLICABLE RULES AND REGULATIONS THEREUNDER. THIS WARRANT MAY NOT BE TRANSFERRED, DIVIDED, COMBINED OR EXCHANGED, EXCEPT AS DESCRIBED IN SECTION 5 HEREIN. CEPHALON, INC. WARRANT FOR THE PURCHASE OF SHARES OF COMMON STOCK -------------------------------------------------- Name of Registered Holder: _________________________ No. ____ ___________ Shares of Common Stock For good and valuable consideration the receipt of which is hereby acknowledged, Cephalon, Inc., a Delaware corporation (the "Company"), hereby grants the rights herein specified and certifies that ____________________ (the "Initial Holder") (or any registered assignee of the Initial Holder) (each of the Initial Holder and any such registered assignee being hereinafter referred to as the "Holder"), is entitled, subject to the conditions and upon the terms of this Warrant, to purchase from the Company, at any time or from time to time during the Exercise Period (as defined in Section 1 hereof), the number of shares of Common Stock (as defined in Section 1 hereof) set forth above at the Exercise Price (as defined in Section 1 hereof). The number of shares of Common Stock to be received upon the exercise of this Warrant and the Exercise Price are subject to adjustment from time to time as hereinafter set forth. Section 1. Certain Definitions. Terms defined in the preceding paragraph ------------------- and elsewhere in this Warrant have the respective meanings provided for therein. The following additional terms, as used herein, have the following respective meanings: -1- "Act" means the Securities Act of 1933, as amended. "Applicable Portion" means the lesser of (x) the unexercised portion of this Warrant that is outstanding on the applicable date of redemption pursuant to Section 9 and (y) the portion of this Warrant which entitles the Holder to purchase a number of shares of Common Stock (or other securities deliverable hereunder) equal to twenty-five percent (25%) of the aggregate number of Warrant Shares subject to this Warrant, determined without regard to any prior exercise hereof; provided, however, that if in connection with a redemption of this -------- ------- Warrant the Average Market Price shall be greater than two hundred fifty percent (250%) of the Exercise Price as in effect during the period of twenty (20) consecutive Trading Days during which the Average Market Price is determined, then the Applicable Portion determined pursuant to this clause (y) shall be the portion of this Warrant which entitles the Holder to purchase a number of shares of Common Stock (or other securities deliverable hereunder) equal to fifty percent (50%) of the aggregate number of Warrant Shares subject to this Warrant, determined without regard to any prior exercise hereof less the portion, if any, of this Warrant which has previously been called for redemption in accordance with Section 9. "Average Market Price" means the arithmetic average of the Closing Price during any period of twenty (20) consecutive Trading Days during the ninety-day period which commences on the date which is 1,000 days after the Issuance Date and ends on and includes the date which is 1,089 days after the Issuance Date. "Class A Warrants" means this Warrant and the Other Warrants of like tenor issued by the Company in connection with the issuance of the Notes. "Class B Warrants" means the Class B Common Stock Purchase Warrants issued by the Company in connection with the issuance of the Notes. "Closing Price" means on any date the last reported sale price (regular way), or if there are no sales of Common Stock on such date, the closing bid price, per share of the Common Stock on the principal national securities exchange on which the Common Stock is listed or admitted to trading or, if not listed or traded on any such exchange, on the Nasdaq National Market, or if not listed or traded on any such exchange or system, the average of the bid and asked price per share on the Nasdaq Stock Market in each such case, as reported by such exchange or market or, if such quotations are not available, the fair market value as reasonably determined by the Board of Directors of the Company or any committee of such Board. "Common Stock" means the Company's Common Stock, $.01 par value, and the related Preferred Share Purchase Rights as authorized on the date hereof, and any other securities into which or for which the Common Stock or such Preferred Share Purchase Rights may be converted or exchanged pursuant to a plan of recapitalization, reorganization, merger, sale of assets or otherwise or any similar rights distributed by the Company to the holders of the Common Stock. "Early Redemption Option" means the right of the Company to redeem the Notes Pursuant to Section 1.2 thereof. -2- "Exchange Act" means the Securities Exchange Act of 1934, as amended. "Exercise Period" means the period beginning on the date hereof, and ending on March 1, 2004. "Exercise Price" means $10.08 subject to change or adjustment pursuant to Section 8 hereof. "Issuance Date" means March 1, 1999. "Nasdaq" means the Nasdaq Stock Market. "Nasdaq National Market" means the Nasdaq National Market of Nasdaq. "Notes" means the 11% Revenue Sharing Senior Secured Notes of the Company. "Other Securities" means any stock (other than Common Stock) and other securities of the Company or any other person (corporate or otherwise) which the Holder of this Warrant at any time shall be entitled to receive, or shall have received, on the exercise of this Warrant, in lieu of or in addition to the Warrant Shares, or which at any time shall be issuable or shall have been issued in exchange for or in replacement of the Warrant Shares or Other Securities pursuant to Section 8. "Other Warrants" means the other Class A Warrants for the Purchase of Shares of Common Stock issued by the Company in connection with the issuance of the Notes. "Permitted Transfer" means (a) any transfer, assignment or succession by operation of law or pursuant to any court order issued by a court of competent jurisdiction, (b) any transfer to an immediate family member, (c) any transfer through probate or through intestate succession, (d) in the case of a transfer by a corporation, partnership, or trust, any transfer to any person that, directly or indirectly, through one or more intermediaries, controls, is controlled by, or is under common control with, the transferor, (e) any distribution by a retirement plan to any participant in the plan (f) any transfer or assignment by the Initial Holder to its employee, or (g) any transfer or assignment to a person who is an "accredited investor," as defined in Regulation D under the Securities Act. "Redemption Date" has the meaning provided in Section 9(b). "Redemption Price" has the meaning provided in Section 9(a). "Redemption Target Price" means an amount equal to two hundred percent (200%) of the Exercise Price as in effect during the period of twenty (20) consecutive Trading Days during which the Average Market Price is determined. -3- "Reorganization Event" means the occurrence of any one or more of the following events: (i) any consolidation, merger or similar transaction of the Company or any Subsidiary with or into another entity (other than a merger or consolidation or similar transaction of a Subsidiary into the Company or a wholly-owned Subsidiary) where the stockholders of the Company immediately prior to such transaction do not collectively own at least 51% of the outstanding voting securities of the surviving corporation of such consolidation or merger immediately following such transaction; or the sale of all or substantially all of the assets of the Company and the Subsidiaries in a sale transaction or a series of related transactions; or (ii) the occurrence of any transaction or event in connection with which all or substantially all the Common Stock shall be exchanged for, converted into, acquired for or constitute the right to receive consideration (whether by means of an exchange offer, liquidation, tender offer, consolidation, merger, share exchange, combination, reclassification, recapitalization, or otherwise) which is not all or substantially all common stock which is (or will, upon consummation of or immediately following such transaction or event, be) listed on a national securities exchange or approved for quotation on Nasdaq or any similar United States system of automated dissemination of transaction reporting of securities prices; or (iii) the acquisition by a person or entity or group of persons or entities acting in concert as a partnership, limited partnership, syndicate or group, as a result of a tender or exchange offer, open market purchases, privately negotiated purchases or otherwise, of beneficial ownership of securities of the Company representing 50% or more of the combined voting power of the outstanding voting securities of the Company ordinarily (and apart from rights accruing in special circumstances) having the right to vote in the election of directors. "SEC" means the Securities and Exchange Commission. "Securities Act" means the Securities Exchange Act of 1934, as amended. "Subsidiary" means any corporation or other entity of which a majority of the capital stock or other ownership interests having ordinary voting power to elect a majority of the board of directors or other persons performing similar functions are at the time directly or indirectly owned by the Company. "Trading Day" means a day on which either the national securities exchange or the Nasdaq National Market which then constitutes the principal securities market for the Common Stock (or other securities deliverable hereunder) is open for general trading of securities. "Warrant" means this Warrant and any Warrant or Warrants which may be issued pursuant to Section 4 or 5 hereof in substitution or exchange for or upon transfer of this Warrant, any Warrant which may be issued pursuant to Section 2 hereof upon partial exercise of this Warrant and any Warrant which may be issued pursuant to Section 6 hereof upon the loss, theft, destruction or mutilation of this Warrant. -4- "Warrant Register" means the register maintained at the principal office of the Company, or at the office of its agent, in which the name of the Holder of this Warrant shall be registered. "Warrant Shares" means the shares of Common Stock, as adjusted from time to time in accordance with Section 8 hereof, deliverable upon exercise of this Warrant. Section 2. Exercise of Warrant. This Warrant may be exercised, in whole ------------------- or in part, at any time or from time to time during the Exercise Period, by presentation and surrender hereof to the Company at its principal office at the address set forth on the signature page hereof (or at such other address of the Company or any agent appointed by the Company to act hereunder as the Company or such agent may hereafter designate in writing to the Holder), with the purchase form attached hereto as ANNEX I (the "Purchase Form") duly executed and accompanied by cash or a certified or official bank check drawn to the order of "CEPHALON, INC." (or its successor in interest, if any) in the amount of the Exercise Price, multiplied by the number of Warrant Shares specified in such Purchase Form. If this Warrant should be exercised in part only, the Company or its agent shall, upon surrender of this Warrant, execute and deliver a Warrant evidencing the right of the Holder thereof to purchase the balance of the Warrant Shares purchasable hereunder. Upon receipt by the Company during the Exercise Period of this Warrant and such Purchase Form in proper form for exercise, together with proper payment of the Exercise Price at its principal office, or by its agent at its office, the Holder shall be deemed to be the holder of record of the number of Warrant Shares specified in such Purchase Form; provided, however, that if the date of such receipt by the Company or its -------- ------- agent is a date on which the stock transfer books of the Company are closed, such person shall be deemed to have become the record holder of such Warrant Shares on the next business day on which the stock transfer books of the Company are open. The Company shall pay any and all documentary, stamp or similar issue or transfer taxes payable in respect of the issue or delivery of such Warrant Shares. Any Warrant issued upon partial exercise of this Warrant pursuant to this Section 2 shall be dated the date of this Warrant. Section 3. Reservation of Shares. The Company agrees that at all times it --------------------- will keep reserved solely for issuance and delivery pursuant to this Warrant the number of shares of its Common Stock (or other securities) that are or would be issuable from time to time upon exercise of this Warrant. All such shares shall be duly authorized and, when issued upon such exercise, shall be validly issued, fully paid and nonassessable, free and clear of all liens, security interests, charges and other encumbrances or restrictions on sale and free of all preemptive rights. Before taking any action that would cause an adjustment pursuant to Section 8 hereof reducing the Exercise Price below the then par value (if any) of the Warrant Shares issuable upon exercise of this Warrant, the Company will take any corporate action that may, in the opinion of its counsel, be necessary in order that the Company may validly and legally issue fully paid and nonassessable Warrant Shares at the Exercise Price as so adjusted. Section 4. Transfer in Compliance with Applicable Securities Laws. ------------------------------------------------------ (a) Neither this Warrant nor any of the Warrant Shares, nor any interest in either, may be sold, assigned, pledged, hypothecated, encumbered or in any other manner -5- transferred or disposed of, in whole or in part, except in accordance with Section 5 hereof and in compliance with applicable United States federal and state securities laws and the terms and conditions hereof. Except as provided in subsection (b) of this Section 4, each Warrant shall bear the following legend: NEITHER THIS WARRANT NOR THE SECURITIES ISSUABLE UPON THE EXERCISE HEREOF HAVE BEEN REGISTERED UNDER THE SECURITIES ACT OF 1933 OR QUALIFIED OR REGISTERED UNDER STATE SECURITIES OR BLUE SKY LAWS. NEITHER THIS WARRANT NOR SUCH SECURITIES MAY BE SOLD, OFFERED FOR SALE, PLEDGED, HYPOTHECATED OR OTHERWISE TRANSFERRED OR DISPOSED OF EXCEPT IN COMPLIANCE WITH THE SECURITIES ACT OF 1933, APPLICABLE STATE SECURITIES OR BLUE SKY LAWS AND THE APPLICABLE RULES AND REGULATIONS THEREUNDER. (b) If (i) the Warrant Shares have been registered under the Act and registered or qualified under applicable state securities or Blue Sky laws or (ii) the Holder has received an opinion of counsel reasonably satisfactory to the Company that the Warrant Shares may be freely transferred without registration under the Act or registration or qualification under applicable state securities or Blue Sky laws, the Holder may require the Company to issue, in substitution for a Warrant with the foregoing legend, a Warrant with the following legend: THIS WARRANT HAS NOT BEEN REGISTERED UNDER THE SECURITIES ACT OF 1933 OR QUALIFIED OR REGISTERED UNDER STATE SECURITIES OR BLUE SKY LAWS. THIS WARRANT MAY NOT BE SOLD, OFFERED FOR SALE, PLEDGED, HYPOTHECATED OR OTHERWISE TRANSFERRED OR DISPOSED OF EXCEPT IN COMPLIANCE WITH THE SECURITIES ACT OF 1933, APPLICABLE STATE SECURITIES OR BLUE SKY LAWS AND THE APPLICABLE RULES AND REGULATIONS THEREUNDER. (c) The Holder may require the Company to issue a Warrant without either of the foregoing legends in substitution for a Warrant bearing one of such legends if either (i) this Warrant and the Warrant Shares issuable upon the exercise hereof have been registered under the Act and registered or qualified under applicable state securities laws or (ii) the Holder has received an opinion of counsel reasonably satisfactory to the Company that this Warrant and the Warrant Shares may be freely transferred without registration under the Act or registration or qualification under applicable state securities laws. The provisions of this Section 4 shall be binding on all subsequent holders of this Warrant. Section 5. Exchange, Transfer or Assignment of Warrant. ------------------------------------------- (a) This Warrant may be, at the option of the Holder, upon presentation and surrender hereof to the Company at its principal office or to the Company's agent at its office, (i) exchanged for other Warrants of different denominations, registered in the name of the Holder, entitling the Holder to purchase in the aggregate the same number of Warrant Shares at the Exercise Price or, (ii) if delivered together with a written notice signed by the Holder specifying the -6- denominations in which new Warrants are to be issued, divided or combined with other Warrants registered in the name of the Holder that carry the same rights. (b) If the Holder has received an opinion of counsel satisfactory to the Company that this Warrant may be sold or transferred without registration under the Act, as contemplated by Section 4 hereof, (x) this Warrant may be transferred and assigned, subject to subparagraph (y) of this Section 5(b), at the option of the Holder, upon surrender of this Warrant to the Company at its principal office or to the Company's agent at its office, with the warrant assignment form attached hereto as ANNEX II (the "Warrant Assignment Form") duly executed and accompanied by funds sufficient to pay any transfer tax, except that (y) no transfer or assignment of this Warrant may be made unless (i) such transfer or assignment is a Permitted Transfer or (ii) the Company consents in writing to such transfer or assignment, which consent may be withheld in its absolute discretion. The Company shall execute and deliver a new Warrant or Warrants in the name of the assignee or assignees named in such Warrant Assignment Form. (c) Any transfer or exchange of this Warrant shall be without charge to the Holder and any Warrant or Warrants issued pursuant to this Section 5 shall be dated the date hereof. (d) The Holder shall not be entitled to transfer a portion of this Warrant with respect to the purchase of a number of Warrant Shares that is less than 10,000 without the prior written consent of the Company. (e) In order to give effect to Section 9, if this Warrant shall be exercised in part, then (1) any Warrant issued to the Holder to evidence the unexercised portion of this Warrant shall bear a notation of the original number of Warrant Shares subject to this Warrant and (2) in connection with any split- up of this Warrant into two or more instruments, each such instrument shall bear a notation of a portion of the original number of Warrant Shares subject to this Warrant, determined by pro rata allocation thereto of the aggregate original such amount based on the portion of the unexercised amount of this Warrant (determined immediately prior to such split-up) evidenced by such instrument. Section 6. Lost, Mutilated or Missing Warrant. Upon receipt by the ---------------------------------- Company or its agent of evidence satisfactory to it of the loss, theft or destruction of this Warrant, and of satisfactory indemnification, and upon surrender and cancellation of this Warrant if mutilated, the Company or its agent shall execute and deliver a Warrant of like tenor and date in exchange for this Warrant. Section 7. Rights of the Holder. The Holder shall not, by virtue hereof, -------------------- be entitled to any rights of a shareholder in the Company, either at law or in equity, and the rights of the Holder are limited to those expressed in this Warrant. Section 8. Anti-dilution. (a) If the Company shall fix or have fixed a ------------- record date at any time after the date hereof and before the expiration of the Exercise Period for: -7- (i) The declaration of a dividend or distribution on the Common Stock (or other securities deliverable hereunder) payable in shares of capital stock (whether shares of Common Stock or of capital stock of any other class), (A) the subdivision of shares of the Common Stock into a greater number of shares, (B) the combination of the Common Stock into a smaller number of shares or (C) the issuance of any shares of its capital stock by reclassification of the Common Stock in connection with a consolidation or merger with a subsidiary of the Company in which the Company is the continuing corporation, then, in any such event, upon exercise of this Warrant the Holder shall be entitled to receive the aggregate number and kind of shares which, if the Warrant had been exercised immediately prior to such record date, the Holder would have been entitled to receive by virtue of such dividend, distribution, subdivision, combination or reclassification, and the Exercise Price shall be appropriately adjusted. Such adjustment shall be made successively whenever any event listed above shall occur. (ii) Issuance at Less than Current Market Price. The issuance ------------------------------------------ of rights, options or warrants to all holders of Common Stock (or other securities deliverable hereunder) entitling them to subscribe for or purchase Common Stock (or other securities deliverable hereunder) at a price per share or having a conversion or exercise price per share (including the amount paid, if any, for such rights, options or warrants) less than the Closing Price on such record date (excluding rights or warrants that are not immediately exercisable and for which provision is made for the Holder to receive comparable rights or warrants upon exercise), then the number of Warrant Shares to be received hereunder after such record date shall be determined by multiplying the number of shares receivable hereunder immediately prior to such record date by a fraction, the denominator of which shall be the number of shares of Common Stock (or other securities deliverable hereunder) outstanding on such record date plus the number of shares of Common Stock (or other securities deliverable hereunder) that the aggregate offering price of the total number of shares so offered for subscription or purchase would purchase at such Closing Price, and the numerator of which shall be the number of shares of Common Stock (or other securities deliverable hereunder) outstanding on such record date plus the number of additional shares of Common Stock (or other securities deliverable hereunder) offered for subscription or purchase, and the Exercise Price shall be appropriately adjusted so that the aggregate purchase price of the Warrant Shares to be received hereunder after such record date is equal to the aggregate purchase price of the Warrant Shares receivable hereunder immediately prior to such record date. Shares of Common Stock owned by or held for the account of the Company or any subsidiary of the Company on such record date shall not be deemed outstanding for the purpose of any such computation. Such adjustment shall become effective immediately after such record date. Such adjustment shall be made successively whenever any such event shall occur. If such rights, options or warrants are not so issued, the number of Warrant Shares receivable hereunder shall again be adjusted to be the number that would have been in effect had such record date not been fixed. On the expiration of such rights, options or warrants the number of Warrant Shares receivable hereunder shall be readjusted to be the number that would have obtained had the adjustment made upon the issuance of such rights, options or warrants been made upon the basis of the issuance of only the number of shares of Common Stock (or other securities deliverable hereunder) actually issued upon the exercise of such rights, options -8- or warrants, provided, however, that if the Holder of this Warrant shall -------- ------- have exercised this Warrant prior to any such readjustment, the number of Warrant Shares that have been delivered or the number of Warrant Shares to be delivered shall not be subject to any readjustment. In any case in which this subsection (ii) shall require that an adjustment in the number of shares receivable hereunder or the Exercise Price be made effective as of a record date for a specified event, the Company may elect to defer until the occurrence of such event issuing to the Holder of any Warrant exercised after such record date the number of Warrant Shares, if any, issuable upon such exercise over and above the number of Warrant Shares, if any, issuable upon such exercise on the basis of the Exercise Price in effect prior to such adjustment; provided, however, that the Company shall deliver to such -------- ------- Holder a due bill or other appropriate instrument evidencing such Holder's right to receive such additional Warrant Shares upon the occurrence of the event requiring such adjustments. (iii) Distribution of Subscription Rights, Warrants, Evidences -------------------------------------------------------- of Indebtedness or Assets. The making of a distribution to all holders of ------------------------- Common Stock (or other securities deliverable hereunder) (including any such distribution to be made in connection with a consolidation or merger in which the Company is to be the continuing corporation) of (A) any shares of capital stock of the Company (other than Common Stock), (B) subscription rights or warrants (excluding those for which adjustment is provided in subsection 8(a)(ii) above and excluding those that are not immediately exercisable and for which provision is made for the Holder to receive comparable subscription rights or warrants upon exercise) or (C) evidences of its indebtedness or assets (excluding (x) dividends paid in or distributions of the Company's capital stock for which the number of Warrant Shares receivable hereunder shall have been adjusted pursuant to paragraph 8(a)(i) and (y) cash dividends or distributions payable out of earnings or surplus not in excess of 10% of the average Closing Price for the thirty trading days prior to the fifth day before the date of declaration multiplied by the number of outstanding shares of Common Stock) (any of the foregoing being hereinafter in this paragraph (iii) called the "Securities"), then in each such case (unless the Company elects to reserve shares or other units of such Securities for distribution to each Holder upon exercise of this Warrant so that, in addition to the shares of Common Stock (or other securities deliverable hereunder) to which each Holder is entitled, each Holder will receive upon such exercise the amount and kind of such Securities which such Holder would have received if the Holder had, immediately prior to the record date for the distribution of the Securities, exercised the Warrant) the number of Warrant Shares receivable hereunder after such record date shall be determined by multiplying the number of Warrant Shares receivable hereunder immediately prior to such record date by a fraction, the denominator of which shall be the Closing Price on the Trading Day immediately prior to the first Trading Day on which the Common Stock (or other securities deliverable hereunder) trades without the right to receive such Securities, less the fair market value (as determined in the reasonable judgment of the Board of Directors of the Company and described in a statement mailed to the Holder) of the portion of the assets or evidences of indebtedness so to be distributed to a holder of one share of the Common Stock or of such subscription rights or warrants applicable to one share of the Common Stock, and the numerator of which shall be the Closing Price of the Common Stock on such Trading Day; and the Exercise Price shall be appropriately adjusted so that -9- the aggregate purchase price of the Warrant Shares to be received hereunder after such record date is equal to the aggregate purchase price of the Warrant Shares receivable hereunder immediately prior to such record date. Such adjustment shall become effective immediately after such record date and shall be made successively whenever such a record date is fixed. If such distribution is not so made, the number of Warrant Shares receivable hereunder shall be readjusted to be the number that was in effect immediately prior to such record date. In the event that the Holder exercises this Warrant after an adjustment is made under this paragraph (iii) and prior to a readjustment under this paragraph (iii), the number of Warrant Shares that have been delivered or the number of Warrant Shares to be delivered shall not be subject to any readjustment. In any case in which this paragraph (iii) shall require that an adjustment in the number of Warrant Shares receivable hereunder or the Exercise Price be made effective as of a record date for a specified event, the Company may elect to defer until the occurrence of such event issuing to the Holder of any Warrant exercised after such record date the number of Warrant Shares, if any, issuable upon such exercise over and above the number of Warrant Shares, if any, issuable upon such exercise on the basis of the Exercise Price in effect prior to such adjustment; provided, however, that the Company shall -------- ------- deliver to such Holder a due bill or other appropriate instrument evidencing such Holder's right to receive such additional Warrant Shares upon the occurrence of the event requiring such adjustments. (b) Reorganization Event. In case of any Reorganization Event the -------------------- Company shall, as a condition precedent to the consummation of the transaction constituting, or announced as, such Reorganization Event, cause effective provisions to be made so that the Holder shall have the right immediately thereafter, by exercising this Warrant, to receive the aggregate amount and kind of shares of stock and other securities and property that were receivable upon such Reorganization Event by a holder of the number of shares of Common Stock that would have been received immediately prior to such Reorganization Event upon exercise of this Warrant. Any such provision shall include provision for adjustments in respect of such shares of stock and other securities and property that shall be as nearly equivalent as may be practicable to the adjustments provided for in Section 8(a). The foregoing provisions of this Section 8(b) shall similarly apply to successive Reorganization Events. (c) Fractional Shares. No fractional shares of Common Stock (or ----------------- other securities deliverable hereunder) or scrip shall be issued to any Holder in connection with the exercise of this Warrant. Instead of any fractional share of Common Stock (or other securities deliverable hereunder) that would otherwise be issuable to such Holder, the Company shall pay to such Holder a cash adjustment in respect of such fractional interest in an amount equal to such fractional interest multiplied by the Closing Price per share of Common Stock (or other securities deliverable hereunder) on the date of such exercise. (d) Carryover. Notwithstanding any other provision of this --------- Section 8, no adjustment shall be made to the number of shares of Common Stock (or other securities deliverable hereunder) to be delivered to each Holder (or to the Exercise Price) if such adjustment would represent less than one percent of the number of shares to be so delivered, but any such adjustment shall be carried forward and shall be made at the time and together with the next subsequent adjustment which, together with any adjustments so carried forward, shall amount to -10- one percent or more of the number of shares to be so delivered. (e) Notices of Certain Events. If at any time after the date ------------------------- hereof and before the expiration of the Exercise Period: (i) the Company authorizes the issuance to all holders of its Common Stock of (A) rights or warrants to subscribe for or purchase shares of its Common Stock or (B) any other subscription rights or warrants; (ii) the Company authorizes the distribution to all holders of its Common Stock of evidences of its indebtedness or assets (other than cash dividends or distributions excluded from the operation of paragraph 8(a)(iii)); (iii) there shall be any capital reorganization of the Company or reclassification of the Common Stock (other than a change in par value of the Common Stock or an increase in the authorized capital stock of the Company not involving the issuance of any shares thereof) or any consolidation or merger to which the Company is a party (other than a consolidation or merger with a subsidiary in which the Company is the continuing corporation and that does not result in any reclassification or change in the Common Stock outstanding) or a conveyance or transfer of all or substantially all of the properties and assets of the Company: (iv) there shall be any voluntary or involuntary dissolution, liquidation or winding-up of the Company; or (v) there shall be any other event that would result in an adjustment pursuant to this Section 8 in the Exercise Price or the number of Warrant Shares that may be purchased upon the exercise hereof; the Company will cause to be mailed to the Holder, at least twenty (20) days (or ten (10) days in any case specified in the clauses (i) or (ii) above) before the applicable record or effective date hereinafter specified, or as soon as practicable after the occurrence of an event specified in clause (v) if such event was beyond the control of the Company and the Company did not have knowledge of such event at least ten (10) days before such date, a notice stating (A) the date as of which the holders of Common Stock of record entitled to receive any such rights, warrants or distributions is to be determined, or (B) the date on which any such reorganization, reclassification, consolidation, merger, conveyance, transfer, dissolution, liquidation or winding-up is expected to become effective, and the date as of which it is expected that holders of Common Stock of record will be entitled to exchange their shares of Common Stock for securities or other property, if any, deliverable upon such reorganization, reclassification, consolidation, merger, conveyance, transfer, dissolution, liquidation or winding-up. (f) Failure to Give Notice. The failure to give the notice ---------------------- required by Section 8(e) hereof or any defect therein shall not affect the legality or validity of any distribution right, warrant, consolidation, merger, conveyance, transfer, dissolution, liquidation or winding-up or the vote upon any such action. -11- Section 9. Redemption of Warrant. (a) Provided that the Company has not --------------------- previously elected to exercise its Early Redemption Option to retire all or any part of the Notes, at any time on or after the date which is 1,000 days after the Issuance Date, the Company shall have the right, but not the obligation, on not less than forty-five (45) and not more than sixty (60) days prior notice, to redeem the Applicable Portion of this Warrant, at a redemption price of $0.01 per share of Common Stock (or unit of other securities deliverable hereunder) issuable upon exercise of the portion of this Warrant so redeemed (the "Redemption Price"), if the Average Market Price of one share of Common Stock (or unit of other securities deliverable hereunder) receivable upon exercise of this Warrant shall exceed the Redemption Target Price. Any notice of redemption shall be given within twenty (20) days after the last Trading Day in the period of twenty (20) consecutive Trading Days which gave rise to the right of the Company to redeem this Warrant. If this Warrant is called for redemption, the Company shall simultaneously call for redemption a portion of the Other Warrants in accordance with their terms that are similar to this Section 9. (b) If the requirements set forth in Section 9(a) are met, and the Company wishes to exercise its right so to redeem the Applicable Portion of this Warrant, the Company shall give a notice of redemption to the Holder not later than the 45th day prior to the date fixed for redemption (the "Redemption Date"). (c) The notice of redemption shall specify (i) the portion of this Warrant to be redeemed, (ii) the aggregate Redemption Price for the Applicable Portion of this Warrant to be redeemed, (iii) the date fixed for redemption, (iv) the place where this Warrant shall be delivered and the Redemption Price paid, and (v) that the right to exercise the Applicable Portion of this Warrant that is being redeemed shall terminate at 5:00 p.m., New York City time, on the Trading Day immediately preceding the Redemption Date unless otherwise agreed by the Company. (d) If the Company shall have exercised its right to redeem the Applicable Portion of this Warrant, any right to exercise such Applicable Portion of this Warrant shall terminate at 5:00 p.m., New York City time, on the Trading Day immediately preceding the Redemption Date unless otherwise agreed by the Company. On and after the Redemption Date, unless otherwise agreed by the Company, the Holder shall have no further rights with respect to the Applicable Portion being so redeemed except to receive, upon surrender of this Warrant, the Redemption Price. (e) From and after the Redemption Date, the Company shall, at the place specified in the notice of redemption, upon presentation and surrender to the Company by or on behalf of the Holder, deliver or cause to be delivered to or upon the written order of the Holder a sum in cash equal to the aggregate Redemption Price of the Applicable Portion of this Warrant being so redeemed. From and after the Redemption Date and upon the deposit or setting aside by the Company of a sum sufficient to redeem such Applicable Portion of this Warrant, such Applicable Portion of this Warrant shall expire and become void and all rights hereunder, except the right to receive payment of the Redemption Price, shall cease. (f) If the Company shall have exercised its right to redeem a portion of -12- this Note and, during any period of twenty (20) consecutive Trading Days during which the Average Market Price may be determined pursuant to this Warrant, the Average Market Price of one share of Common Stock (or unit of other securities deliverable hereunder) receivable upon exercise of this Warrant shall exceed an amount equal to two hundred fifty percent (250%) of the Exercise Price, then the Company shall have the right to exercise its right of redemption on a second occasion. Such redemption shall otherwise be made in accordance with this Section 9. Section 10. Officers' Certificate. Whenever the number of Warrant Shares --------------------- that may be purchased on exercise of this Warrant or the Exercise Price is adjusted as required by the provisions of Section 8 hereof, the Company will forthwith file in the custody of its Secretary or an Assistant Secretary at its principal office and at the office of its agent an officers' certificate showing the adjusted number of Warrant Shares that may be purchased at the Exercise Price on exercise of this Warrant and the adjusted Exercise Price determined as herein provided, setting forth in reasonable detail the facts requiring such adjustment and the manner of computing such adjustment. Each such officers' certificate shall be signed by the President, Chief Financial Officer or Treasurer of the Company and by the Secretary or an Assistant Secretary of the Company. Each such officers' certificate shall be made available at all reasonable times for inspection by the Holder. The Company shall, forthwith after each such adjustment, cause such certificate to be mailed to the Holder. Section 11. Availability of Information. In addition to the requirements --------------------------- of Section 5(h), the Company shall comply with all applicable public information reporting requirements of the SEC and applicable state securities laws to which it may from time to time be subject. The Company will also cooperate with each Holder of any Warrants and each holder of any Warrant Shares in supplying such information concerning the Company as may be necessary for such Holder or holder to complete and file any information reporting forms currently or hereafter required by the SEC as a condition to the availability of an exemption from the Act for the sales of any Warrants or Warrant Shares. Section 12. Warrant Register. The Company will register this Warrant in ---------------- the Warrant Register in the name of the record holder to whom it has been distributed or assigned in accordance with the terms hereof. The Company may deem and treat the registered Holder of this Warrant as the absolute owner hereof (notwithstanding any notation of ownership or other writing hereon made by anyone) for the purpose of any exercise hereof or any distribution to the Holder and for all other purposes, and the Company shall not be affected by any notice to the contrary. Section 13. Successors. All of the provisions of this Warrant by or for ---------- the benefit of the Company or the Holder shall bind and inure to the benefit of their respective successors and assigns. Section 14. Headings. The headings of sections of this Warrant have been -------- inserted for convenience of reference only, are not to be considered a part hereof and shall in no way modify or restrict any of the terms or provisions hereof. Section 15. Amendments. This Warrant may be amended by the affirmative ---------- vote of -13- Holders holding Warrants to purchase not less than two-thirds of the Warrant Shares purchasable pursuant to all of the then outstanding Warrants; provided, -------- that, except as expressly provided herein, this Warrant may not be amended, without the consent of the Holder, to change (i) any price at which this Warrant may be exercised, (ii) the period during which this Warrant may be exercised, (iii) the number or type of securities to be issued upon the exercise hereof or (iv) the provisions of this Section 15. Section 16. Notices. Unless otherwise provided in this Warrant, any ------- notice or other communication required or permitted to be made or given to any party hereto pursuant to this Warrant shall be in writing and shall be deemed made or given if delivered by hand, on the date of such delivery to such party, or, if mailed, on the fifth day after the date of mailing, if sent to such party by certified or registered mail, postage prepaid, addressed to it (in the case of a Holder) at its address in the Warrant Register or (in the case of the Company) at its address set forth below, or to such other address as is designated by written notice, similarly given to each party hereto. Section 17. Governing Law. This Warrant shall be deemed to be a contract ------------- made under the laws of the State of New York and for all purposes shall be construed in accordance with the laws of said State as applied to the contracts made and to be performed in New York between New York residents. [REMAINDER OF THIS PAGE INTENTIONALLY LEFT BLANK] -14- IN WITNESS WHEREOF, the Company has duly caused this Warrant to be signed and attested by its duly authorized officer and to be dated as of __________, 1999. CEPHALON, INC. By: Name: Title: Address: 145 Brandywine Parkway West Chester, Pennsylvania 19380 Attention: Senior Vice President and Chief Financial Officer -15- ANNEX I TO WARRANT PURCHASE FORM ------------- TO CEPHALON, INC.: The undersigned, ________________________, hereby irrevocably elects to exercise the within Warrant to purchase ___________________________ shares of Common Stock of Cephalon, Inc., a Delaware corporation, and hereby makes payment of $_____________________ in payment of the exercise price thereof. Dated: ____________________________ _____________________________ [SIGNED] _____________________________ [STREET ADDRESS] _____________________________ [CITY AND STATE] I-16 ANNEX II TO WARRANT WARRANT ASSIGNMENT FORM ----------------------- TO CEPHALON, INC.: FOR VALUE RECEIVED, the undersigned, __________________________________________________, ("Assignor"), hereby sells, assigns and transfers unto Name: ________________________________________ ("Assignee") (Please type or print in block letters.) Address: _____________________________________ Social Security or Taxpayer I.D. No.: _______________________ Assignor's right to purchase up to _________________ shares of Common Stock of Cephalon, Inc., a Delaware corporation, represented by this Warrant and does hereby irrevocably constitute and appoint the Company and any of its officers, secretary or assistant secretaries, as its officers, secretary or assistant secretaries, as attorneys-in-fact to transfer the same on the books of the Company, with full power of substitution in the premises. Date: __________________________ Print Name: II-17 EX-4.3(D) 5 FORM OF CLASS B WARRANT EXHIBIT 4.3(D) ANNEX III TO NOTE PURCHASE AGREEMENT NEITHER THIS WARRANT NOR ISSUANCE OF THE SECURITIES ISSUABLE UPON THE EXERCISE HEREOF TO THE HOLDER HAVE BEEN REGISTERED UNDER THE SECURITIES ACT OF 1933 OR QUALIFIED OR REGISTERED UNDER STATE SECURITIES OR BLUE SKY LAWS. NEITHER THIS WARRANT NOR SUCH SECURITIES MAY BE SOLD, OFFERED FOR SALE, PLEDGED, HYPOTHECATED OR OTHERWISE TRANSFERRED OR DISPOSED OF EXCEPT IN COMPLIANCE WITH THE SECURITIES ACT OF 1933, APPLICABLE STATE SECURITIES OR BLUE SKY LAWS AND THE APPLICABLE RULES AND REGULATIONS THEREUNDER. THIS WARRANT MAY NOT BE TRANSFERRED, DIVIDED, COMBINED OR EXCHANGED, EXCEPT AS DESCRIBED IN SECTION 5 HEREIN. CEPHALON, INC. WARRANT FOR THE PURCHASE OF SHARES OF COMMON STOCK -------------------------------------------------- Name of Registered Holder: _________________________ No. ____ ___________ Shares of Common Stock For good and valuable consideration the receipt of which is hereby acknowledged, Cephalon, Inc., a Delaware corporation (the "Company"), hereby grants the rights herein specified and certifies that ____________________ (the "Initial Holder") (or any registered assignee of the Initial Holder) (each of the Initial Holder and any such registered assignee being hereinafter referred to as the "Holder"), is entitled, subject to the conditions and upon the terms of this Warrant, to purchase from the Company, at any time or from time to time during the Exercise Period (as defined in Section 1 hereof), the number of shares of Common Stock (as defined in Section 1 hereof) set forth above at the Exercise Price (as defined in Section 1 hereof). The number of shares of Common Stock to be received upon the exercise of this Warrant and the Exercise Price are subject to adjustment from time to time as hereinafter set forth. Section 1. Certain Definitions. Terms defined in the preceding paragraph ------------------- and elsewhere in this Warrant have the respective meanings provided for therein. The following additional terms, as used herein, have the following respective meanings: -1- "Acceleration Date" means the earlier of the date on which a Reorganization Event occurs or the date on which the Company shall agree to effect a Reorganization Event, provided, that if approval of the stockholders of the -------- Company is required in connection with such Reorganization Event, the Acceleration Date means the date of such approval. "Act" means the Securities Act of 1933, as amended. "Applicable Portion" means the portion of this Warrant which entitles the Holder to purchase a number of shares of Common Stock (or other securities deliverable hereunder) equal to the product of (i) the aggregate number of Warrant Shares subject to this Warrant immediately prior to such redemption times (ii) the quotient of (a) the amount of Net Revenues for the period from the Issuance Date to the third anniversary of the Issuance Date minus an amount equal to fifty percent (50%) of the Target Revenues for such period, divided by (b) an amount equal to fifty percent (50%) of the Target Revenues for the period from the Issuance Date to the third anniversary of the Issuance Date; provided, -------- however, that in no event shall such quotient be greater than one or less than - ------- zero. "Average Market Price" means the arithmetic average of the Closing Price during any period of twenty (20) consecutive Trading Days during the ninety-day period which commences on the date which is 1,000 days after the Issuance Date and ends on and includes the date which is 1,089 days after the Issuance Date. "Class A Warrants" means the Class A Common Stock Purchase Warrants issued by the Company in connection with the issuance of the Notes. "Class B Warrants" means this Warrant and the Other Warrants of like tenor issued by the Company in connection with the issuance of the Notes. "Closing Price" means on any date the last reported sale price (regular way), or if there are no sales of Common Stock on such date, the closing bid price, per share of the Common Stock on the principal national securities exchange on which the Common Stock is listed or admitted to trading or, if not listed or traded on any such exchange, on the Nasdaq National Market, or if not listed or traded on any such exchange or system, the average of the bid and asked price per share on the Nasdaq Stock Market in each such case, as reported by such exchange or market or, if such quotations are not available, the fair market value as reasonably determined by the Board of Directors of the Company or any committee of such Board. "Common Stock" means the Company's Common Stock, $.01 par value, and the related Preferred Share Purchase Rights as authorized on the date hereof, and any other securities into which or for which the Common Stock or such Preferred Share Purchase Rights may be converted or exchanged pursuant to a plan of recapitalization, reorganization, merger, sale of assets or otherwise or any similar rights distributed by the Company to the holders of the Common Stock. "Early Redemption Option" means the right of the Company to redeem the Notes Pursuant to Section 1.2 thereof. -2- "Exchange Act" means the Securities Exchange Act of 1934, as amended. "Exercise Period" means the period beginning on March 1, 2002 (or such earlier date determined in accordance with Section 8(b)(ii)) and ending on March 1, 2004. "Exercise Price" means $10.08 subject to change or adjustment pursuant to Section 8 hereof. "Issuance Date" means March 1, 1999. "Nasdaq" means the Nasdaq Stock Market. "Nasdaq National Market" means the Nasdaq National Market of Nasdaq. "Net Revenues" has the meaning provided in the Notes. "Notes" means the 11% Revenue Sharing Senior Secured Notes of the Company. "Other Securities" means any stock (other than Common Stock) and other securities of the Company or any other person (corporate or otherwise) which the Holder of this Warrant at any time shall be entitled to receive, or shall have received, on the exercise of this Warrant, in lieu of or in addition to the Warrant Shares, or which at any time shall be issuable or shall have been issued in exchange for or in replacement of the Warrant Shares or Other Securities pursuant to Section 8. "Other Warrants" means the other Class B Warrants for the Purchase of Shares of Common Stock issued by the Company in connection with the issuance of the Notes. "Permitted Transfer" means (a) any transfer, assignment or succession by operation of law or pursuant to any court order issued by a court of competent jurisdiction, (b) any transfer to an immediate family member, (c) any transfer through probate or through intestate succession, (d) in the case of a transfer by a corporation, partnership, or trust, any transfer to any person that, directly or indirectly, through one or more intermediaries, controls, is controlled by, or is under common control with, the transferor, (e) any distribution by a retirement plan to any participant in the plan (f) any transfer or assignment by the Initial Holder to its employee, or (g) any transfer or assignment to a person who is an "accredited investor," as defined in Regulation D under the Securities Act. "Redemption Date" has the meaning provided in Section 9(b). "Redemption Price" has the meaning provided in Section 9(a). "Redemption Target Price" means an amount equal to two hundred percent (200%) of the -3- Exercise Price as in effect during the period of twenty (20) consecutive Trading Days during which the Average Market Price is determined. "Reorganization Event" means the occurrence of any one or more of the following events: (i) any consolidation, merger or similar transaction of the Company or any Subsidiary with or into another entity (other than a merger or consolidation or similar transaction of a Subsidiary into the Company or a wholly-owned Subsidiary) where the stockholders of the Company immediately prior to such transaction do not collectively own at least 51% of the outstanding voting securities of the surviving corporation of such consolidation or merger immediately following such transaction; or the sale of all or substantially all of the assets of the Company and the Subsidiaries in a sale transaction or a series of related transactions; or (ii) the occurrence of any transaction or event in connection with which all or substantially all the Common Stock shall be exchanged for, converted into, acquired for or constitute the right to receive consideration (whether by means of an exchange offer, liquidation, tender offer, consolidation, merger, share exchange, combination, reclassification, recapitalization, or otherwise) which is not all or substantially all common stock which is (or will, upon consummation of or immediately following such transaction or event, be) listed on a national securities exchange or approved for quotation on Nasdaq or any similar United States system of automated dissemination of transaction reporting of securities prices; or (iii) the acquisition by a person or entity or group of persons or entities acting in concert as a partnership, limited partnership, syndicate or group, as a result of a tender or exchange offer, open market purchases, privately negotiated purchases or otherwise, of beneficial ownership of securities of the Company representing 50% or more of the combined voting power of the outstanding voting securities of the Company ordinarily (and apart from rights accruing in special circumstances) having the right to vote in the election of directors. "SEC" means the Securities and Exchange Commission. "Securities Act" means the Securities Exchange Act of 1934, as amended. "Subsidiary" means any corporation or other entity of which a majority of the capital stock or other ownership interests having ordinary voting power to elect a majority of the board of directors or other persons performing similar functions are at the time directly or indirectly owned by the Company. "Target Revenues" has the meaning provided in the Notes. "Trading Day" means a day on which either the national securities exchange or the Nasdaq National Market which then constitutes the principal securities market for the Common Stock (or other securities deliverable hereunder) is open for general trading of securities. "Warrant" means this Warrant and any Warrant or Warrants which may be issued pursuant -4- to Section 4 or 5 hereof in substitution or exchange for or upon transfer of this Warrant, any Warrant which may be issued pursuant to Section 2 hereof upon partial exercise of this Warrant and any Warrant which may be issued pursuant to Section 6 hereof upon the loss, theft, destruction or mutilation of this Warrant. "Warrant Register" means the register maintained at the principal office of the Company, or at the office of its agent, in which the name of the Holder of this Warrant shall be registered. "Warrant Shares" means the shares of Common Stock, as adjusted from time to time in accordance with Section 8 hereof, deliverable upon exercise of this Warrant. Section 2. Exercise of Warrant. This Warrant may be exercised, in whole ------------------- or in part, at any time or from time to time during the Exercise Period, by presentation and surrender hereof to the Company at its principal office at the address set forth on the signature page hereof (or at such other address of the Company or any agent appointed by the Company to act hereunder as the Company or such agent may hereafter designate in writing to the Holder), with the purchase form attached hereto as ANNEX I (the "Purchase Form") duly executed and accompanied by cash or a certified or official bank check drawn to the order of "CEPHALON, INC." (or its successor in interest, if any) in the amount of the Exercise Price, multiplied by the number of Warrant Shares specified in such Purchase Form. If this Warrant should be exercised in part only, the Company or its agent shall, upon surrender of this Warrant, execute and deliver a Warrant evidencing the right of the Holder thereof to purchase the balance of the Warrant Shares purchasable hereunder. Upon receipt by the Company during the Exercise Period of this Warrant and such Purchase Form in proper form for exercise, together with proper payment of the Exercise Price at its principal office, or by its agent at its office, the Holder shall be deemed to be the holder of record of the number of Warrant Shares specified in such Purchase Form; provided, however, that if the date of such receipt by the Company or its -------- ------- agent is a date on which the stock transfer books of the Company are closed, such person shall be deemed to have become the record holder of such Warrant Shares on the next business day on which the stock transfer books of the Company are open. The Company shall pay any and all documentary, stamp or similar issue or transfer taxes payable in respect of the issue or delivery of such Warrant Shares. Any Warrant issued upon partial exercise of this Warrant pursuant to this Section 2 shall be dated the date of this Warrant. Section 3. Reservation of Shares. The Company agrees that at all times it --------------------- will keep reserved solely for issuance and delivery pursuant to this Warrant the number of shares of its Common Stock (or other securities) that are or would be issuable from time to time upon exercise of this Warrant. All such shares shall be duly authorized and, when issued upon such exercise, shall be validly issued, fully paid and nonassessable, free and clear of all liens, security interests, charges and other encumbrances or restrictions on sale and free of all preemptive rights. Before taking any action that would cause an adjustment pursuant to Section 8 hereof reducing the Exercise Price below the then par value (if any) of the Warrant Shares issuable upon exercise of this Warrant, the Company will take any corporate action that may, in the opinion of its counsel, be necessary in order that the Company may validly and legally issue fully paid and nonassessable Warrant Shares at the Exercise Price as so adjusted. -5- Section 4. Transfer in Compliance with Applicable Securities Laws. ------------------------------------------------------ (a) Neither this Warrant nor any of the Warrant Shares, nor any interest in either, may be sold, assigned, pledged, hypothecated, encumbered or in any other manner transferred or disposed of, in whole or in part, except in accordance with Section 5 hereof and in compliance with applicable United States federal and state securities laws and the terms and conditions hereof. Except as provided in subsection (b) of this Section 4, each Warrant shall bear the following legend: NEITHER THIS WARRANT NOR THE SECURITIES ISSUABLE UPON THE EXERCISE HEREOF HAVE BEEN REGISTERED UNDER THE SECURITIES ACT OF 1933 OR QUALIFIED OR REGISTERED UNDER STATE SECURITIES OR BLUE SKY LAWS. NEITHER THIS WARRANT NOR SUCH SECURITIES MAY BE SOLD, OFFERED FOR SALE, PLEDGED, HYPOTHECATED OR OTHERWISE TRANSFERRED OR DISPOSED OF EXCEPT IN COMPLIANCE WITH THE SECURITIES ACT OF 1933, APPLICABLE STATE SECURITIES OR BLUE SKY LAWS AND THE APPLICABLE RULES AND REGULATIONS THEREUNDER. (b) If (i) the Warrant Shares have been registered under the Act and registered or qualified under applicable state securities or Blue Sky laws or (ii) the Holder has received an opinion of counsel reasonably satisfactory to the Company that the Warrant Shares may be freely transferred without registration under the Act or registration or qualification under applicable state securities or Blue Sky laws, the Holder may require the Company to issue, in substitution for a Warrant with the foregoing legend, a Warrant with the following legend: THIS WARRANT HAS NOT BEEN REGISTERED UNDER THE SECURITIES ACT OF 1933 OR QUALIFIED OR REGISTERED UNDER STATE SECURITIES OR BLUE SKY LAWS. THIS WARRANT MAY NOT BE SOLD, OFFERED FOR SALE, PLEDGED, HYPOTHECATED OR OTHERWISE TRANSFERRED OR DISPOSED OF EXCEPT IN COMPLIANCE WITH THE SECURITIES ACT OF 1933, APPLICABLE STATE SECURITIES OR BLUE SKY LAWS AND THE APPLICABLE RULES AND REGULATIONS THEREUNDER. (c) The Holder may require the Company to issue a Warrant without either of the foregoing legends in substitution for a Warrant bearing one of such legends if either (i) this Warrant and the Warrant Shares issuable upon the exercise hereof have been registered under the Act and registered or qualified under applicable state securities laws or (ii) the Holder has received an opinion of counsel reasonably satisfactory to the Company that this Warrant and the Warrant Shares may be freely transferred without registration under the Act or registration or qualification under applicable state securities laws. The provisions of this Section 4 shall be binding on all subsequent holders of this Warrant. Section 5. Exchange, Transfer or Assignment of Warrant. ------------------------------------------- -6- (a) This Warrant may be, at the option of the Holder, upon presentation and surrender hereof to the Company at its principal office or to the Company's agent at its office, (i) exchanged for other Warrants of different denominations, registered in the name of the Holder, entitling the Holder to purchase in the aggregate the same number of Warrant Shares at the Exercise Price or, (ii) if delivered together with a written notice signed by the Holder specifying the denominations in which new Warrants are to be issued, divided or combined with other Warrants registered in the name of the Holder that carry the same rights. (b) If the Holder has received an opinion of counsel satisfactory to the Company that this Warrant may be sold or transferred without registration under the Act, as contemplated by Section 4 hereof, (x) this Warrant may be transferred and assigned, subject to subparagraph (y) of this Section 5(b), at the option of the Holder, upon surrender of this Warrant to the Company at its principal office or to the Company's agent at its office, with the warrant assignment form attached hereto as ANNEX II (the "Warrant Assignment Form") duly executed and accompanied by funds sufficient to pay any transfer tax, except that (y) no transfer or assignment of this Warrant may be made unless (i) such transfer or assignment is a Permitted Transfer or (ii) the Company consents in writing to such transfer or assignment, which consent may be withheld in its absolute discretion. The Company shall execute and deliver a new Warrant or Warrants in the name of the assignee or assignees named in such Warrant Assignment Form. (c) Any transfer or exchange of this Warrant shall be without charge to the Holder and any Warrant or Warrants issued pursuant to this Section 5 shall be dated the date hereof. (d) The Holder shall not be entitled to transfer a portion of this Warrant with respect to the purchase of a number of Warrant Shares that is less than 10,000 without the prior written consent of the Company. (e) In order to give effect to Section 9, if this Warrant shall be exercised in part, then (1) any Warrant issued to the Holder to evidence the unexercised portion of this Warrant shall bear a notation of the original number of Warrant Shares subject to this Warrant and (2) in connection with any split- up of this Warrant into two or more instruments, each such instrument shall bear a notation of a portion of the original number of Warrant Shares subject to this Warrant, determined by pro rata allocation thereto of the aggregate original such amount based on the portion of the unexercised amount of this Warrant (determined immediately prior to such split-up) evidenced by such instrument. Section 6. Lost, Mutilated or Missing Warrant. Upon receipt by the ---------------------------------- Company or its agent of evidence satisfactory to it of the loss, theft or destruction of this Warrant, and of satisfactory indemnification, and upon surrender and cancellation of this Warrant if mutilated, the Company or its agent shall execute and deliver a Warrant of like tenor and date in exchange for this Warrant. Section 7. Rights of the Holder. The Holder shall not, by virtue hereof, -------------------- be entitled to any rights of a shareholder in the Company, either at law or in equity, and the rights of the Holder -7- are limited to those expressed in this Warrant. Section 8. Anti-dilution. (a) If the Company shall fix or have fixed a ------------- record date at any time after the date hereof and before the expiration of the Exercise Period for: (i) The declaration of a dividend or distribution on the Common Stock (or other securities deliverable hereunder) payable in shares of capital stock (whether shares of Common Stock or of capital stock of any other class), (A) the subdivision of shares of the Common Stock into a greater number of shares, (B) the combination of the Common Stock into a smaller number of shares or (C) the issuance of any shares of its capital stock by reclassification of the Common Stock in connection with a consolidation or merger with a subsidiary of the Company in which the Company is the continuing corporation, then, in any such event, upon exercise of this Warrant the Holder shall be entitled to receive the aggregate number and kind of shares which, if the Warrant had been exercised immediately prior to such record date, the Holder would have been entitled to receive by virtue of such dividend, distribution, subdivision, combination or reclassification, and the Exercise Price shall be appropriately adjusted. Such adjustment shall be made successively whenever any event listed above shall occur. (ii) Issuance at Less than Current Market Price. The issuance ------------------------------------------ of rights, options or warrants to all holders of Common Stock (or other securities deliverable hereunder) entitling them to subscribe for or purchase Common Stock (or other securities deliverable hereunder) at a price per share or having a conversion or exercise price per share (including the amount paid, if any, for such rights, options or warrants) less than the Closing Price on such record date (excluding rights or warrants that are not immediately exercisable and for which provision is made for the Holder to receive comparable rights or warrants upon exercise), then the number of Warrant Shares to be received hereunder after such record date shall be determined by multiplying the number of shares receivable hereunder immediately prior to such record date by a fraction, the denominator of which shall be the number of shares of Common Stock (or other securities deliverable hereunder) outstanding on such record date plus the number of shares of Common Stock (or other securities deliverable hereunder) that the aggregate offering price of the total number of shares so offered for subscription or purchase would purchase at such Closing Price, and the numerator of which shall be the number of shares of Common Stock (or other securities deliverable hereunder) outstanding on such record date plus the number of additional shares of Common Stock (or other securities deliverable hereunder) offered for subscription or purchase, and the Exercise Price shall be appropriately adjusted so that the aggregate purchase price of the Warrant Shares to be received hereunder after such record date is equal to the aggregate purchase price of the Warrant Shares receivable hereunder immediately prior to such record date. Shares of Common Stock owned by or held for the account of the Company or any subsidiary of the Company on such record date shall not be deemed outstanding for the purpose of any such computation. Such adjustment shall become effective immediately after such record date. Such adjustment shall be made successively whenever any such event shall occur. If such rights, options or warrants are not so issued, the number of Warrant Shares receivable hereunder shall again be adjusted to be the number that would have been in effect had such record date not been fixed. On -8- the expiration of such rights, options or warrants the number of Warrant Shares receivable hereunder shall be readjusted to be the number that would have obtained had the adjustment made upon the issuance of such rights, options or warrants been made upon the basis of the issuance of only the number of shares of Common Stock (or other securities deliverable hereunder) actually issued upon the exercise of such rights, options or warrants, provided, however, that if the Holder of this Warrant shall have -------- ------- exercised this Warrant prior to any such readjustment, the number of Warrant Shares that have been delivered or the number of Warrant Shares to be delivered shall not be subject to any readjustment. In any case in which this subsection (ii) shall require that an adjustment in the number of shares receivable hereunder or the Exercise Price be made effective as of a record date for a specified event, the Company may elect to defer until the occurrence of such event issuing to the Holder of any Warrant exercised after such record date the number of Warrant Shares, if any, issuable upon such exercise over and above the number of Warrant Shares, if any, issuable upon such exercise on the basis of the Exercise Price in effect prior to such adjustment; provided, however, that the Company shall deliver to such -------- ------- Holder a due bill or other appropriate instrument evidencing such Holder's right to receive such additional Warrant Shares upon the occurrence of the event requiring such adjustments. (iii) Distribution of Subscription Rights, Warrants, ---------------------------------------------- Evidences of Indebtedness or Assets. The making of a distribution to all ----------------------------------- holders of Common Stock (or other securities deliverable hereunder) (including any such distribution to be made in connection with a consolidation or merger in which the Company is to be the continuing corporation) of (A) any shares of capital stock of the Company (other than Common Stock), (B) subscription rights or warrants (excluding those for which adjustment is provided in subsection 8(a)(ii) above and excluding those that are not immediately exercisable and for which provision is made for the Holder to receive comparable subscription rights or warrants upon exercise) or (C) evidences of its indebtedness or assets (excluding (x) dividends paid in or distributions of the Company's capital stock for which the number of Warrant Shares receivable hereunder shall have been adjusted pursuant to paragraph 8(a)(i) and (y) cash dividends or distributions payable out of earnings or surplus not in excess of 10% of the average Closing Price for the thirty trading days prior to the fifth day before the date of declaration multiplied by the number of outstanding shares of Common Stock) (any of the foregoing being hereinafter in this paragraph (iii) called the "Securities"), then in each such case (unless the Company elects to reserve shares or other units of such Securities for distribution to each Holder upon exercise of this Warrant so that, in addition to the shares of Common Stock (or other securities deliverable hereunder) to which each Holder is entitled, each Holder will receive upon such exercise the amount and kind of such Securities which such Holder would have received if the Holder had, immediately prior to the record date for the distribution of the Securities, exercised the Warrant) the number of Warrant Shares receivable hereunder after such record date shall be determined by multiplying the number of Warrant Shares receivable hereunder immediately prior to such record date by a fraction, the denominator of which shall be the Closing Price on the Trading Day immediately prior to the first Trading Day on which the Common Stock (or other securities deliverable hereunder) trades without the right to receive such Securities, less the fair market value (as determined in the reasonable judgment of the Board of -9- Directors of the Company and described in a statement mailed to the Holder) of the portion of the assets or evidences of indebtedness so to be distributed to a holder of one share of the Common Stock or of such subscription rights or warrants applicable to one share of the Common Stock, and the numerator of which shall be the Closing Price of the Common Stock on such Trading Day; and the Exercise Price shall be appropriately adjusted so that the aggregate purchase price of the Warrant Shares to be received hereunder after such record date is equal to the aggregate purchase price of the Warrant Shares receivable hereunder immediately prior to such record date. Such adjustment shall become effective immediately after such record date and shall be made successively whenever such a record date is fixed. If such distribution is not so made, the number of Warrant Shares receivable hereunder shall be readjusted to be the number that was in effect immediately prior to such record date. In the event that the Holder exercises this Warrant after an adjustment is made under this paragraph (iii) and prior to a readjustment under this paragraph (iii), the number of Warrant Shares that have been delivered or the number of Warrant Shares to be delivered shall not be subject to any readjustment. In any case in which this paragraph (iii) shall require that an adjustment in the number of Warrant Shares receivable hereunder or the Exercise Price be made effective as of a record date for a specified event, the Company may elect to defer until the occurrence of such event issuing to the Holder of any Warrant exercised after such record date the number of Warrant Shares, if any, issuable upon such exercise over and above the number of Warrant Shares, if any, issuable upon such exercise on the basis of the Exercise Price in effect prior to such adjustment; provided, however, that the -------- ------- Company shall deliver to such Holder a due bill or other appropriate instrument evidencing such Holder's right to receive such additional Warrant Shares upon the occurrence of the event requiring such adjustments. (b) Reorganization Event. -------------------- (i) In case of any Reorganization Event the Company shall, as a condition precedent to the consummation of the transaction constituting, or announced as, such Reorganization Event, cause effective provisions to be made so that the Holder shall have the right immediately thereafter, by exercising this Warrant, to receive the aggregate amount and kind of shares of stock and other securities and property that were receivable upon such Reorganization Event by a holder of the number of shares of Common Stock that would have been received immediately prior to such Reorganization Event upon exercise of this Warrant. Any such provision shall include provision for adjustments in respect of such shares of stock and other securities and property that shall be as nearly equivalent as may be practicable to the adjustments provided for in Section 8(a). The foregoing provisions of this Section 8(b) shall similarly apply to successive Reorganization Events. (ii) If a Reorganization Event occurs or the Company agrees to effect a Reorganization Event, then the Exercise Period shall commence on the applicable Acceleration Date. The Company shall, at least twenty (20) days before the Acceleration Date relating to any Reorganization Event (or if such Reorganization Event was beyond the control of the Company, and the Company did not have knowledge twenty (20) days before such Acceleration Date, as soon as practicable thereafter), cause to be mailed to the Holder a notice describing in reasonable detail such Reorganization Event and informing the Holder of the date that -10- the Exercise Period will (or did) commence and that the Holder may exercise this Warrant at any time during the Exercise Period. (c) Fractional Shares. No fractional shares of Common Stock (or ----------------- other securities deliverable hereunder) or scrip shall be issued to any Holder in connection with the exercise of this Warrant. Instead of any fractional share of Common Stock (or other securities deliverable hereunder) that would otherwise be issuable to such Holder, the Company shall pay to such Holder a cash adjustment in respect of such fractional interest in an amount equal to such fractional interest multiplied by the Closing Price per share of Common Stock (or other securities deliverable hereunder) on the date of such exercise. (d) Carryover. Notwithstanding any other provision of this --------- Section 8, no adjustment shall be made to the number of shares of Common Stock (or other securities deliverable hereunder) to be delivered to each Holder (or to the Exercise Price) if such adjustment would represent less than one percent of the number of shares to be so delivered, but any such adjustment shall be carried forward and shall be made at the time and together with the next subsequent adjustment which, together with any adjustments so carried forward, shall amount to one percent or more of the number of shares to be so delivered. (e) Notices of Certain Events. If at any time after the date ------------------------- hereof and before the expiration of the Exercise Period: (i) the Company authorizes the issuance to all holders of its Common Stock of (A) rights or warrants to subscribe for or purchase shares of its Common Stock or (B) any other subscription rights or warrants; (ii) the Company authorizes the distribution to all holders of its Common Stock of evidences of its indebtedness or assets (other than cash dividends or distributions excluded from the operation of paragraph 8(a)(iii)); (iii) there shall be any capital reorganization of the Company or reclassification of the Common Stock (other than a change in par value of the Common Stock or an increase in the authorized capital stock of the Company not involving the issuance of any shares thereof) or any consolidation or merger to which the Company is a party (other than a consolidation or merger with a subsidiary in which the Company is the continuing corporation and that does not result in any reclassification or change in the Common Stock outstanding) or a conveyance or transfer of all or substantially all of the properties and assets of the Company: (iv) there shall be any voluntary or involuntary dissolution, liquidation or winding-up of the Company; or (v) there shall be any other event that would result in an adjustment pursuant to this Section 8 in the Exercise Price or the number of Warrant Shares that may be purchased upon the exercise hereof; -11- the Company will cause to be mailed to the Holder, at least twenty (20) days (or ten (10) days in any case specified in the clauses (i) or (ii) above) before the applicable record or effective date hereinafter specified, or as soon as practicable after the occurrence of an event specified in clause (v) if such event was beyond the control of the Company and the Company did not have knowledge of such event at least ten (10) days before such date, a notice stating (A) the date as of which the holders of Common Stock of record entitled to receive any such rights, warrants or distributions is to be determined, or (B) the date on which any such reorganization, reclassification, consolidation, merger, conveyance, transfer, dissolution, liquidation or winding-up is expected to become effective, and the date as of which it is expected that holders of Common Stock of record will be entitled to exchange their shares of Common Stock for securities or other property, if any, deliverable upon such reorganization, reclassification, consolidation, merger, conveyance, transfer, dissolution, liquidation or winding-up. (f) Failure to Give Notice. The failure to give the notice ---------------------- required by Section 8(e) hereof or any defect therein shall not affect the legality or validity of any distribution right, warrant, consolidation, merger, conveyance, transfer, dissolution, liquidation or winding-up or the vote upon any such action. Section 9. Redemption of Warrant. (a) On the date which is 45 days after --------------------- the third anniversary of the Issuance Date, the Company shall have the right, but not the obligation, on not less than forty-five (45) and not more than sixty (60) days prior notice, to redeem the Applicable Portion, if any, of this Warrant, at a redemption price of $0.01 per share of Common Stock (or unit of other securities deliverable hereunder) issuable upon exercise of the portion of this Warrant so redeemed (the "Redemption Price"). If this Warrant is called for redemption, the Company shall simultaneously call for redemption a portion of the Other Warrants in accordance with their terms that are similar to this Section 9. (b) If the Company wishes to exercise its right so to redeem the Applicable Portion of this Warrant, the Company shall give a notice of redemption to the Holder not later than the 45th day prior to the date fixed for redemption (the "Redemption Date"). (c) The notice of redemption shall specify (i) the portion of this Warrant to be redeemed, (ii) the aggregate Redemption Price for the Applicable Portion of this Warrant to be redeemed, (iii) the date fixed for redemption, (iv) the place where this Warrant shall be delivered and the Redemption Price paid, and (v) that the right to exercise the Applicable Portion of this Warrant that is being redeemed shall terminate at 5:00 p.m., New York City time, on the Trading Day immediately preceding the Redemption Date unless otherwise agreed by the Company. (d) If the Company shall have exercised its right to redeem the Applicable Portion of this Warrant, any right to exercise such Applicable Portion of this Warrant shall terminate at 5:00 p.m., New York City time, on the Trading Day immediately preceding the Redemption Date unless otherwise agreed by the Company. On and after the Redemption Date, unless otherwise agreed by the Company, the Holder shall have no further rights with respect to the Applicable Portion being redeemed except to receive, upon surrender of this Warrant, the Redemption Price. -12- (e) From and after the Redemption Date, the Company shall, at the place specified in the notice of redemption, upon presentation and surrender to the Company by or on behalf of the Holder, deliver or cause to be delivered to or upon the written order of the Holder a sum in cash equal to the aggregate Redemption Price of the Applicable Portion of this Warrant being so redeemed. From and after the Redemption Date and upon the deposit or setting aside by the Company of a sum sufficient to redeem the Applicable Portion of this Warrant, the Applicable Portion of this Warrant shall expire and become void and all rights hereunder, except the right to receive payment of the Redemption Price, shall cease. Section 10. Officers' Certificate. Whenever the number of Warrant --------------------- Shares that may be purchased on exercise of this Warrant or the Exercise Price is adjusted as required by the provisions of Section 8 hereof, the Company will forthwith file in the custody of its Secretary or an Assistant Secretary at its principal office and at the office of its agent an officers' certificate showing the adjusted number of Warrant Shares that may be purchased at the Exercise Price on exercise of this Warrant and the adjusted Exercise Price determined as herein provided, setting forth in reasonable detail the facts requiring such adjustment and the manner of computing such adjustment. Each such officers' certificate shall be signed by the President, Chief Financial Officer or Treasurer of the Company and by the Secretary or an Assistant Secretary of the Company. Each such officers' certificate shall be made available at all reasonable times for inspection by the Holder. The Company shall, forthwith after each such adjustment, cause such certificate to be mailed to the Holder. Section 11. Availability of Information. In addition to the --------------------------- requirements of Section 5(h), the Company shall comply with all applicable public information reporting requirements of the SEC and applicable state securities laws to which it may from time to time be subject. The Company will also cooperate with each Holder of any Warrants and each holder of any Warrant Shares in supplying such information concerning the Company as may be necessary for such Holder or holder to complete and file any information reporting forms currently or hereafter required by the SEC as a condition to the availability of an exemption from the Act for the sales of any Warrants or Warrant Shares. Section 12. Warrant Register. The Company will register this Warrant in ---------------- the Warrant Register in the name of the record holder to whom it has been distributed or assigned in accordance with the terms hereof. The Company may deem and treat the registered Holder of this Warrant as the absolute owner hereof (notwithstanding any notation of ownership or other writing hereon made by anyone) for the purpose of any exercise hereof or any distribution to the Holder and for all other purposes, and the Company shall not be affected by any notice to the contrary. Section 13. Successors. All of the provisions of this Warrant by or for ---------- the benefit of the Company or the Holder shall bind and inure to the benefit of their respective successors and assigns. Section 14. Headings. The headings of sections of this Warrant have -------- been inserted for convenience of reference only, are not to be considered a part hereof and shall in no way modify or restrict any of the terms or provisions hereof. -13- Section 15. Amendments. This Warrant may be amended by the affirmative ---------- vote of Holders holding Warrants to purchase not less than two-thirds of the Warrant Shares purchasable pursuant to all of the then outstanding Warrants; provided, that, except as expressly provided herein, this Warrant may not be - -------- amended, without the consent of the Holder, to change (i) any price at which this Warrant may be exercised, (ii) the period during which this Warrant may be exercised, (iii) the number or type of securities to be issued upon the exercise hereof or (iv) the provisions of this Section 15. Section 16. Notices. Unless otherwise provided in this Warrant, any ------- notice or other communication required or permitted to be made or given to any party hereto pursuant to this Warrant shall be in writing and shall be deemed made or given if delivered by hand, on the date of such delivery to such party, or, if mailed, on the fifth day after the date of mailing, if sent to such party by certified or registered mail, postage prepaid, addressed to it (in the case of a Holder) at its address in the Warrant Register or (in the case of the Company) at its address set forth below, or to such other address as is designated by written notice, similarly given to each party hereto. Section 17. Governing Law. This Warrant shall be deemed to be a ------------- contract made under the laws of the State of New York and for all purposes shall be construed in accordance with the laws of said State as applied to the contracts made and to be performed in New York between New York residents. [REMAINDER OF THIS PAGE INTENTIONALLY LEFT BLANK] -14- IN WITNESS WHEREOF, the Company has duly caused this Warrant to be signed and attested by its duly authorized officer and to be dated as of __________, 1999. CEPHALON, INC. By: Name: Title: Address: 145 Brandywine Parkway West Chester, Pennsylvania 19380 Attention: Senior Vice President and Chief Financial Officer -15- ANNEX I TO WARRANT PURCHASE FORM ------------- TO CEPHALON, INC.: The undersigned, ________________________, hereby irrevocably elects to exercise the within Warrant to purchase ___________________________ shares of Common Stock of Cephalon, Inc., a Delaware corporation, and hereby makes payment of $_____________________ in payment of the exercise price thereof. Dated: _________________ _____________________________ [SIGNED] _____________________________ [STREET ADDRESS] _____________________________ [CITY AND STATE] I-16 ANNEX II TO WARRANT WARRANT ASSIGNMENT FORM ----------------------- TO CEPHALON, INC.: FOR VALUE RECEIVED, the undersigned, ________________________________, ("Assignor"), hereby sells, assigns and transfers unto Name: __________________________________________ ("Assignee") (Please type or print in block letters.) Address: ______________________________________ Social Security or Taxpayer I.D. No.: ___________________________ Assignor's right to purchase up to _________________ shares of Common Stock of Cephalon, Inc., a Delaware corporation, represented by this Warrant and does hereby irrevocably constitute and appoint the Company and any of its officers, secretary or assistant secretaries, as its officers, secretary or assistant secretaries, as attorneys-in-fact to transfer the same on the books of the Company, with full power of substitution in the premises. Date: __________________ Print Name: II-17 EX-4.3(E) 6 SECURITY AGREEMENT DATED 03/01/99 EXHIBIT 4.3(E) ANNEX IV TO NOTE PURCHASE AGREEMENT SECURITY AGREEMENT This SECURITY AGREEMENT, dated as of the 1st day of March, 1999, made by Cephalon, Inc., a Delaware corporation ("Grantor"), to Delta Opportunity Fund, Ltd., as collateral agent (in such capacity, the "Collateral Agent") on behalf of the Holders. W I T N E S S E T H: ------------------- WHEREAS, Grantor and the Buyers are parties to certain Note Purchase Agreements, dated as of February 24, 1999 (as from time to time amended or supplemented, the "Note Purchase Agreements"), pursuant to which, among other things, the Buyers have agreed to purchase $30,000,000 aggregate principal amount of 11% Revenue Sharing Senior Secured Notes due 2002 (the "Notes"); WHEREAS, Grantor has agreed to grant to Collateral Agent a security interest in certain of its property and assets relating to the Pharmaceutical Compositions to secure the performance of the obligations of Grantor under the Notes and the Note Purchase Agreements; WHEREAS, it is a condition precedent to the several obligations of the Buyers to purchase their respective Notes that the Grantor shall have executed and delivered this Security Agreement to the Collateral Agent for the ratable benefit of the Holders; and WHEREAS, the Grantor is contemporaneously entering into a Patent and Trademark Security Agreement with the Collateral Agent for the ratable benefit of the Holders; NOW, THEREFORE, in consideration of the premises and to induce the Buyers to purchase their respective Notes, the Grantor hereby agrees with the Collateral Agent, for the ratable benefit of the Holders, as follows: 1. Defined Terms. Unless otherwise defined herein, capitalized terms ------------- used herein which are defined in the Notes are so used as so defined, and the meanings assigned to terms defined herein or in the Notes shall be equally applicable to both the singular and plural forms of such terms. In addition, the terms set forth below have the following meanings: "Accounts" means all rights to payment for goods sold or leased or for services -1- rendered, whether or not such rights have been earned by performance. "Buyer" means any of the several buyers party to a Note Purchase Agreement. "Chattel Paper" shall have the meaning assigned to such term under the Code. "Code" means the Uniform Commercial Code as from time to time in effect in the Commonwealth of Pennsylvania. "Compound" shall mean modafinil and/or any other similar compound, isomer or salt thereof. "Contracts" shall have the meaning assigned to such term under the Code. "Documents" shall have the meaning assigned to such term under the Code. "Event of Default" means: (1) the failure by the Grantor to perform in any material respect any obligation of the Grantor under this Security Agreement as and when required by this Security Agreement; or (2) any representation or warranty made by the Grantor pursuant to this Security Agreement shall have been untrue in any material respect when made; (3) the failure by the Grantor to perform in any material respect any obligation of the Grantor under the Patent and Trademark Security Agreement as and when required by the required by the Patent and Trademark Security Agreement; (4) any representation or warranty made by the Grantor pursuant to the Patent and Trademark Security Agreement shall have been untrue in any material respect when made; or (5) any Event of Default, as that term is defined in any of the Notes. "General Intangibles" shall have the meaning assigned to such term under the Code. "Holder" means any Buyer or any holder from time to time of any Note. "Inventory" shall have the meaning assigned to such term under the Code, and in any event, including all inventory, merchandise, goods and other personal property that -2- are held by or on behalf of a Person for sale or lease or to be furnished under a contract of service or which give rise to any Account, including returned goods. "Investment Property" shall have the meaning assigned to such term under the Code. "Lafon" shall mean Laboratoire L. Lafon. "Lafon Agreements" shall mean collectively, the License Agreement, the Supply Agreement and the Trademark Agreement. "License Agreement" shall mean the License Agreement entered into by Grantor and Lafon on January 20, 1993, as amended. "Lien" shall mean any lien, mortgage, security interest, chattel mortgage, pledge or other encumbrance (statutory or otherwise) of any kind securing satisfaction or performance of an obligation, including any agreement to give any of the foregoing, any conditional sales or other title retention agreement, any lease in the nature thereof, and the filing of or the agreement to give any financing statement under the Code of any jurisdiction or similar evidence of any encumbrance, whether within or outside the United States. "New Drug Application Rights" shall mean all rights of Grantor presently existing or hereafter arising with respect to all new drug applications (as they may be amended) filed with the U.S. Food and Drug Administration relating to the marketing, distribution, promotion and sale of the Pharmaceutical Compositions in the Territory. "Obligations" shall mean: (1) the full and prompt payment when due of all obligations and liabilities to the Holders, whether now existing or hereafter arising, under the Notes, this Agreement or the other Transaction Documents and the due performance and compliance with the terms of the Notes and the other Transaction Documents; (2) any and all sums advanced by the Collateral Agent or any Holder in order to preserve the Collateral or to preserve the Collateral Agent's security interest in the Collateral; and (3) in the event of any proceeding for the collection or enforcement of any obligations or liabilities of the Grantor referred to in the immediately preceding clauses (1) through (2) in accordance with the terms of the Notes and this Agreement, the reasonable expenses of re-taking, holding, preparing for sale, selling or otherwise -3- disposing of or realizing on the Collateral, or of any other exercise by the Collateral Agent of its rights hereunder, together with reasonable attorneys' fees and court costs. "Orphan Drug Act Rights" shall mean all rights of Grantor presently existing or hereafter arising under the Orphan Drug Act relating to the marketing exclusivity of the Pharmaceutical Compositions in the Territory. "Patent and Trademark Security Agreement" shall mean that certain Patent and Trademark Security Agreement dated March 1, 1999 between the Grantor and the Collateral Agent. "Pharmaceutical Compositions" shall mean all pharmaceutical compositions containing the Compound. "Proceeds" shall have the meaning assigned to such term under the Code. "Proprietary Information" means information generally unavailable to the public that has been created, discovered, developed or otherwise become known to Grantor or in which property rights have been assigned or otherwise conveyed to Grantor, which information has economic value or potential economic value to the marketing, sale and distribution of the Pharmaceutical Compositions in the United States, its territories and possessions. Proprietary Information shall include, but not be limited to, trade secrets, processes, formulas, writings data, know-how, negative know- how, improvements, discoveries, developments, designs, inventions, techniques, technical data, customer and supplier lists, financial information, business plans or projections and modifications or enhancements to any of the above. Proprietary Information shall include all information existing on the date hereof and all information developed or acquired hereafter. "Security Agreement" means this Security Agreement, as amended, supplemented or otherwise modified from time to time. "Supply Agreement" shall mean the Supply Agreement entered into between Grantor and Lafon on January 20, 1993, as amended. "Territory" shall mean the United States of America, its territories and possessions. "Trademark Agreement" shall mean the Trademark Agreement entered into between Grantor and Genelco S.A. on January 20, 1993, as amended. 2. Grant of Security Interest. As collateral security for the prompt -------------------------- and complete payment and performance when due of the Obligations, the Grantor hereby grants to the -4- Collateral Agent, for the ratable benefit of the Holders, a continuing first priority security interest in all of the following property now owned or at any time hereafter acquired by the Grantor or in which the Grantor now has or at any time in the future may acquire right, title or interest (collectively, the "Collateral"): (i) the License Agreement, and the right to use and rely upon the inventions and other intellectual property conveyed thereunder, to the extent and only to the extent that the License Agreement authorizes the use and sale of the Compound to make, have made, use and sell the Pharmaceutical Compositions in the Territory; (ii) the Supply Agreement to the extent and only to the extent necessary to provide suitable quantities of the Compound to make, have made, use or sell the Pharmaceutical Compositions in the Territory; (iii) the rights of Grantor under the Trademark Agreement, in and to the use of the trademark "Provigil" as a trademark for the Pharmaceutical Compositions in the Territory; together with any good will of the business associated with the use of such trademark in the Territory; (iv) all Proprietary Information possessed by Cephalon, whether existing on the date hereof or developed or acquired hereafter, to the extent and only to the extent necessary to practice the technology subject to the security interest granted hereby; (v) the Orphan Drug Act Rights; (vi) the New Drug Application Rights; (vii) Contracts, Documents and General Intangibles developed or acquired by Cephalon, whether now existing or hereafter arising, to the extent and only to the extent necessary to use or sell Compound for the purpose of manufacturing, marketing, selling or distributing the Pharmaceutical Compositions in the Territory; (viii) all insurance policies to the extent and only to the extent they relate to items (i) through (viii) above; (ix) all books, ledgers, books of account, records, writings, databases, information and other property relating to, used or useful in connection with, evidencing, embodying, incorporating, or referring to any of the foregoing; and -5- (x) to the extent not otherwise included, all Proceeds, products, rents, issues, profits and returns of and from any and all of the foregoing, which Proceeds may be in the form of Accounts, Chattel Paper, Inventory or otherwise. 3. Rights of Collateral Agent; Limitations on Collateral Agent's ------------------------------------------------------------- Obligations. - ----------- (a) Grantor Remains Liable under Accounts and Contracts. --------------------------------------------------- Anything herein to the contrary notwithstanding, the Grantor shall remain liable under each of the Accounts and Contracts that constitute part of the Collateral to observe and perform all the conditions and obligations to be observed and performed by it thereunder, all in accordance with the terms of any agreement giving rise to each such Account and in accordance with and pursuant to the terms and provisions of each such Contract. The Collateral Agent shall not have any obligation or liability under any Account that constitutes part of the Collateral (or any agreement giving rise thereto) or under any Contract that constitutes part of the Collateral by reason of or arising out of this Security Agreement or the receipt by the Collateral Agent of any payment relating to such Account or Contract pursuant hereto, nor shall the Collateral Agent be obligated in any manner to perform any of the obligations of the Grantor under or pursuant to any such Account (or any agreement giving rise thereto) or under or pursuant to any such Contract, to make any payment, to make any inquiry as to the nature or the sufficiency of any payment received by it or as to the sufficiency of any performance by any party under any such Account (or any agreement giving rise thereto) or under any such Contract, to present or file any claim, to take any action to enforce any performance or to collect the payment of any amounts which may have been assigned to it or to which it may be entitled at any time or times. (b) Notice to Account Debtors and Contracting Parties. Upon the ------------------------------------------------- request of the Collateral Agent at any time that an Event of Default has occurred and is continuing, but in the case of Events of Default that are solely ones covered by the final clause (2) of Section 4.01 of any Note, only after the expiration of the 365-day period specified in such clause (2), the Grantor shall notify account debtors on the Accounts that constitutes part of the Collateral and parties to the Contracts that constitutes part of the Collateral that such Accounts and such Contracts have been assigned to the Collateral Agent for the ratable benefit of the Holders and that payments in respect thereof shall be made directly to the Collateral Agent or as the Collateral Agent shall direct. (c) Verification and Analysis of Accounts. If an Event of ------------------------------------- Default has occurred and is continuing, but in the case of Events of Default that are solely ones covered by the final clause (2) of Section 4.01 of any Note, only after the expiration of the 365-day period specified in such clause (2), the Collateral Agent shall have the right in its own name or in the name of others to communicate with account debtors on the Accounts that constitute part of the Collateral and parties to the Contracts that constitute part of the Collateral to verify with them to its satisfaction the existence, amount and terms of any such Accounts or Contracts and to make test verifications of such Accounts in any manner and through any medium that it reasonably -6- considers advisable, and the Grantor shall furnish all such assistance and information as the Collateral Agent may require in connection therewith. At any time and from time to time, upon the Collateral Agent's reasonable request and at the expense of the Grantor, the Grantor shall cause independent public accountants or others satisfactory to the Collateral Agent to furnish to the Collateral Agent reports showing reconciliations, aging and test verifications of, and trial balances for, such Accounts. 4. Representations and Warranties. The Grantor hereby represents and ------------------------------ warrants that: (a) Title; No Other Liens. Except for the Lien granted to the --------------------- Collateral Agent for the ratable benefit of the Holders pursuant to this Security Agreement and the Lien granted to the Collateral Agent for the ratable benefit of the Holders pursuant to the terms of the Patent and Trademark Security Agreement, the Grantor owns each item of the Collateral free and clear of any and all Liens or claims of others except as permitted by Section 3.9 of the Notes. No security agreement, financing statement or other public notice with respect to all or any part of the Collateral is on file or of record in any public office, except such as may have been filed in favor of the Collateral Agent, for the ratable benefit of the Holders, pursuant to this Security Agreement. (b) Perfected First Priority Liens. The Liens granted pursuant ------------------------------ to this Security Agreement will constitute upon the completion of all the filings or notices listed in Schedule I hereto, perfected Liens on all Collateral, which are prior to all other Liens on such Collateral and which are enforceable as such against all creditors of the Grantor. (c) Accounts. No amount payable to the Grantor under or in -------- connection with any Account that constitutes part of the Collateral is evidenced by any Instrument (other than checks in the ordinary course of business) or Chattel Paper which has not been delivered to the Collateral Agent. The place where the Grantor keeps its records concerning the Accounts that constitute part of the Collateral is set forth on Schedule II hereto. (d) Consents. No consent (other than consents that have been -------- obtained) of any party (other than the Grantor) to any Contract that constitutes part of the Collateral is required, or purports to be required, in connection with the execution, delivery and performance of this Security Agreement. (e) Inventory. The Inventory that constitute part of the --------- Collateral are, as of the Closing Date, kept at the locations listed on Schedule III hereto and have not been kept at any other location within the five-month period ending on the Closing Date. (f) Chief Executive Office. The Grantor's chief executive office ---------------------- and chief place of business is located at 145 Brandywine Parkway, West Chester, Pennsylvania 19380. -7- (g) Power and Authority. The Grantor has full power, authority ------------------- and legal right to enter into this Security Agreement and to grant the Collateral Agent the Lien on the Collateral pursuant to this Security Agreement. (h) Binding Obligation. This Agreement has been duly executed ------------------ and delivered by the Grantor and constitutes a legal, valid and binding obligation of the Grantor enforceable in accordance with its terms. (i) Non-Contravention. The execution, delivery and performance ----------------- of this Security Agreement will not violate any provision of any applicable law or regulation or of any order, judgment, writ, award or decree of any court, arbitrator or governmental authority, domestic or foreign, or of any securities issued by the Grantor, or of any mortgage, indenture, lease, contract or other agreement, instrument or undertaking to which the Grantor is a party or which purports to be binding upon the Grantor or upon any of its assets and will not result in the creation or imposition of any Lien on any of the assets of the Grantor except as contemplated by this Security Agreement. (j) Consents. No consent, filing, approval, registration, -------- recording, registration or other action is required (x) for the grant by the Grantor of the Lien on the Collateral pursuant to this Security Agreement or for the execution, delivery or performance of this Security Agreement by the Grantor, or (y) to perfect the Lien purported to be created by this Agreement, in each case except as contemplated by Section 4(b) above, except with respect to Sections 2(v) and (vi) above. 5. Covenants. The Grantor covenants and agrees with the Collateral --------- Agent that from and after the date of this Security Agreement until the payment or performance in full by the Grantor of all of its obligations under this Security Agreement, the Guaranty and the Patent and Trademark Security Agreement: (a) Further Documentation; Pledge of Instruments and Chattel -------------------------------------------------------- Paper. At any time and from time to time, upon the written request of the - ----- Collateral Agent, and at the sole expense of the Grantor, the Grantor will promptly and duly execute and deliver such further instruments and documents and take such further action as the Collateral Agent may reasonably request for the purpose of obtaining or preserving the full benefits of this Security Agreement and of the rights and powers herein granted, including, without limitation, (i) the filing of any financing or continuation statements under the Code in effect in any such jurisdiction with respect to the Liens created hereby and (ii) providing to the Grantor such documents or instruments as shall be necessary or desirable for the transfer of New Drug Application Rights to the Collateral Agent or its designee, subject, in the case of documents or instruments provided under this clause (ii), to the limitations upon the use or exercise thereof contained in Section 5(j) below. The Grantor also hereby authorizes the Collateral Agent to file any such financing or continuation -8- statement without the signature of the Grantor to the extent permitted by applicable law. A carbon, photographic or other reproduction of this Security Agreement shall be sufficient as a financing statement for filing in any jurisdiction. If any amount payable under or in connection with any of the Collateral shall be or become evidenced by any Instrument or Chattel Paper, such Instrument or Chattel Paper shall be immediately delivered to the Collateral Agent, duly endorsed in a manner satisfactory to the Collateral Agent, to be held as Collateral pursuant to this Security Agreement. (b) Indemnification. The Grantor agrees to pay, and to save the --------------- Collateral Agent and each Holder harmless from, any and all liabilities, costs and expenses (including, without limitation, legal fees and expenses) (i) with respect to, or resulting from, any delay in paying, any and all excise, sales or other taxes which may be payable or determined to be payable with respect to any of the Collateral, (ii) with respect to, or resulting from, any delay by Grantor in complying with any law or regulation applicable to any of the Collateral or (iii) in connection with this Security Agreement or any action taken by the Collateral Agent or any Holder in exercising its rights hereunder. In any suit, proceeding or action brought by the Collateral Agent or any Holder under any Account or Contract that constitutes part of the Collateral for any sum owing thereunder, or to enforce any provisions of any such Account or Contract, the Grantor will save, indemnify and keep the Collateral Agent and each Holder harmless from and against all expense, loss or damage suffered by reason of any defense, setoff, counterclaim, recoupment or reduction or liability whatsoever of the account debtor or obligor thereunder, arising out of a breach by the Grantor of any obligation thereunder or arising out of any other agreement, indebtedness or liability at any time owing to or in favor of such account debtor or obligor or its successors from the Grantor. (c) Maintenance of Records. The Grantor will keep and maintain ---------------------- at its own cost and expense satisfactory and complete records of the Collateral, including, without limitation, a record of all payments received and all credits granted with respect to the Accounts that constitute part of the Collateral. For the further security of the Holders, the Grantor hereby grants to the Collateral Agent, for the ratable benefit of the Holders, a security interest in all of the Grantor's books and records pertaining to the Collateral, and the Grantor shall turn over any such books and records for inspection at the office of the Grantor to the Collateral Agent or to its representatives during normal business hours at the request of the Collateral Agent. (d) Limitation on Liens on Collateral. The Grantor (x) will not --------------------------------- create, incur or permit to exist, will defend the Collateral against, and will take such other action as is necessary to remove, any Lien or claim on or to the Collateral, other than the Liens created hereby and as permitted by Section 3.9 of the Note, and (y) will defend the right, title and interest of the Collateral Agent in and to any of the Collateral against the claims and demands of all persons whomsoever. (e) Limitations on Dispositions of Collateral. The Grantor will ----------------------------------------- not sell, -9- transfer, lease or otherwise dispose of any of the Collateral, or attempt, offer or contract to do so except for sales of Inventory and the collection and use of cash proceeds in the ordinary course of its business. (f) Limitations on Performance of Contracts and Agreements ------------------------------------------------------ Giving Rise to Accounts. The Grantor will not (i) fail to exercise promptly and - ----------------------- diligently each and every material right or fail to perform each material obligation which it may have under each Contract that constitutes part of the Collateral and each agreement giving rise to an Account that constitutes part of the Collateral (other than any right of termination) except where the Grantor determines in its reasonable business judgment that the failure to exercise such right or perform such obligation is in the best interest of the Grantor and consistent with the protection and preservation of the rights and interests of the Collateral Agent in the Collateral or (ii) fail to deliver to the Collateral Agent, upon request, a copy of each material demand, notice or document received by it relating in any way to any Contract that constitutes part of the Collateral or any agreement giving rise to an Account that constitutes part of the Collateral. The Grantor will not amend or modify the terms of, or waive any rights under, any Contracts, including the Lafon Agreements, in a manner having a material adverse effect on the value of such Contracts to the manufacturing, marketing, sale or distribution of the Pharmaceutical Compositions in the Territory. (g) Further Identification of Collateral. The Grantor will ------------------------------------ furnish to the Collateral Agent from time to time, upon the request of the Collateral Agent, statements and schedules further identifying and describing the Collateral and such other reports in connection with the Collateral as the Collateral Agent may reasonably request, all in reasonable detail. (h) Notices. The Grantor will advise the Collateral Agent ------- promptly, in reasonable detail, at its address in accordance with Section 16, (i) of any Lien (other than Liens permitted hereunder) on, or claim asserted against, any of the Collateral and (ii) of the occurrence of any other event which could reasonably be expected to have a material adverse effect on the value of any material portion of the Collateral or on the Liens created hereunder. (i) Changes in Locations, Name, Etc. The Grantor will not (i) ------------------------------- change the location of its chief executive office/chief place of business from that specified in Section 4(f) or remove its books and records from the location specified in Section 4(c) or (ii) change its name, identity or corporate structure to such an extent that any financing statement filed by the Collateral Agent in connection with this Security Agreement would become misleading, unless it shall have given the Collateral Agent at least 30 days prior written notice thereof and, prior to such action or event, shall have taken appropriate action to preserve and protect the Collateral Agent's security interest under this Security Agreement. (j) Transfer of New Drug Application Rights. The Grantor has --------------------------------------- provided to the Collateral Agent a letter, addressed to the U.S. Food and Drug Administration (the "FDA"), in the form of Exhibit A hereto, executed by the Grantor but undated, providing the -10- FDA notice of the transfer of the new drug application of the Grantor with respect to modafinil (the "NDA Transfer Letter"). During any period in which an Event of Default is continuing, but in the case of Events of Default that are solely ones covered by the final clause (2) of Section 4.01 of any Note, only after the expiration of the 365-day period specified in such clause (2), the Collateral Agent may complete the NDA Transfer Letter by indicating the name of the transferee and dating the NDA Transfer Letter and may forward the NDA Transfer Letter to the FDA. (k) Subsidiaries. This Agreement is entered into on behalf of ------------ and for the benefit of the Grantor and its subsidiaries and other entities controlled by the Grantor which have rights in the Collateral. The security interest granted by the Grantor hereunder is intended to include all rights of the Grantor in and to the Collateral, including any rights of its subsidiaries and such other entities in and to such Collateral, and the Grantor will not permit such subsidiaries and entities to exercise any of their rights with respect to the Collateral. 6. Collateral Agent's Appointment as Attorney-in-Fact. -------------------------------------------------- (a) Powers. The Grantor hereby irrevocably constitutes and ------ appoints the Collateral Agent and any officer or agent thereof, with full power of substitution, as its true and lawful attorney-in-fact with full irrevocable power and authority in the place and stead of the Grantor and in the name of the Grantor or in its own name, from time to time in the Collateral Agent's discretion, during any period in which an Event of Default is continuing, but in the case of Events of Default that are solely ones covered by the final clause (2) of Section 4.01 of any Note, only after the expiration of the 365-day period specified in such clause (2), for the purpose of carrying out the terms of this Security Agreement, to take any and all appropriate action and to execute any and all documents and instruments which may be necessary or desirable to accomplish the purposes of this Security Agreement, and, without limiting the generality of the foregoing, the Grantor hereby gives the Collateral Agent the power and right, on behalf of the Grantor, without notice to or assent by the Grantor, except any notice required by law, to do the following: (i) to take possession of and endorse and collect any checks, drafts, notes, acceptances or other instruments for the payment of moneys due under or with respect to any Collateral and to file any claim or to take any other action or proceeding in any court of law or equity or otherwise deemed appropriate by the Collateral Agent for the purpose of collecting any and all such moneys due under or with respect to any such Collateral whenever payable, in each case in the name of the Grantor or its own name, or otherwise; (ii) to pay or discharge taxes and liens levied or placed on or threatened against the Collateral and to pay all or any part of the premiums therefor and the costs thereof; and -11- (iii) (A) to direct any party liable for any payment under any of the Collateral to make payment of any and all moneys due or to become due thereunder directly to the Collateral Agent or as the Collateral Agent shall direct; (B) to ask or demand for, collect, receive payment of and receipt for, any and all moneys, claims and other amounts due or to become due at any time in respect of or arising out of any Collateral; (C) to sign and endorse any invoices, freight or express bills, bills of lading, storage or warehouse receipts, drafts against debtors, assignments, verifications, notices and other documents in connection with any of the Collateral; (D) to commence and prosecute any suits, actions or proceedings at law or in equity in any court of competent jurisdiction to collect the Collateral or any thereof and to enforce any other right in respect of any Collateral; (E) to defend any suit, action or proceeding brought against the Grantor with respect to any Collateral; (F) to settle, compromise or adjust any suit, action or proceeding described in clause (E) above and, in connection therewith, to give such discharges or releases as the Collateral Agent may deem appropriate; and (G) generally, to sell, transfer, pledge and make any agreement with respect to or otherwise deal with any of the Collateral as fully and completely as though the Collateral Agent were the absolute owner thereof for all purposes, and to do, at the Collateral Agent's option and the Grantor's expense, at any time, or from time to time, all acts and things which the Collateral Agent deems necessary to protect, preserve or realize upon the Collateral and the Collateral Agent's Liens thereon and to effect the intent of this Security Agreement, all as fully and effectively as the Grantor might do. The Grantor hereby ratifies all that said attorneys shall lawfully do or cause to be done by virtue hereof. This power of attorney is a power coupled with an interest and shall be irrevocable until the Grantor shall have paid and performed in full all of its obligations under this Security Agreement, the Notes and the Patent and Trademark Security Agreement. (b) Other Powers. The Grantor also authorizes the Collateral ------------ Agent, from time to time during any period in which an Event of Default is continuing, but in the case of Events of Default that are solely ones covered by the final clause (2) of Section 4.01 of any Note, only after the expiration of the 365-day period specified in such clause (2), to execute, in connection with the sale provided for herein, any endorsements, assignments or other instruments of conveyance or transfer with respect to the Collateral. (c) No Duty on Collateral Agent's Part. The powers conferred on ---------------------------------- the Collateral Agent hereunder are solely to protect the Collateral Agent's interests in the Collateral and shall not impose any duty upon the Collateral Agent to exercise any such powers. The Collateral Agent shall be accountable only for amounts that it actually receives as a result of the exercise of such powers, and neither it nor any of its officers, directors, employees or agents shall be responsible to the Grantor for any act or failure to act hereunder, except for their own gross negligence or willful misconduct. -12- 7. Performance by Collateral Agent of Grantor's Obligations. If the -------------------------------------------------------- Grantor fails to perform or comply with any of its agreements contained herein and the Collateral Agent, as provided for by the terms of this Security Agreement and following reasonable notice to the Grantor, shall itself perform or comply, or otherwise cause performance or compliance, with such agreement, the expenses of the Collateral Agent incurred in connection with such performance or compliance shall be payable by the Grantor to the Collateral Agent on demand and shall constitute Obligations secured hereby. 8. Remedies. If an Event of Default has occurred and is continuing, -------- but in the case of Events of Default that are solely ones covered by the final clause (2) of Section 4.01 of any Note, only after the expiration of the 365-day period specified in such clause (2), the Collateral Agent may exercise, in addition to all other rights and remedies granted to it in this Security Agreement and in any other instrument or agreement securing, evidencing or relating to the Obligations, all rights and remedies of a secured party under the Code. Without limiting the generality of the foregoing, if an Event of Default has occurred and is continuing, but in the case of Events of Default that are solely ones covered by the final clause (2) of Section 4.01 of any Note, only after the expiration of the 365-day period specified in such clause (2), the Collateral Agent, without demand of performance or other demand, presentment, protest, advertisement or notice of any kind (except any notice required by law referred to below or expressly provided for) to or upon the Grantor or any other Person (all and each of which demands, defenses, advertisements and notices are, to the extent permitted by applicable law, hereby waived), may in such circumstances forthwith collect, receive, appropriate and realize upon the Collateral, or any part thereof, and/or may forthwith sell, license, assign, give option or options to purchase, or otherwise dispose of and deliver the Collateral or any part thereof (or contract to do any of the foregoing), at public or private sale or sales, at any exchange, broker's board or office of the Collateral Agent or elsewhere upon such terms and conditions as it may deem advisable and at such prices as it may deem best, for cash or on credit or for future delivery without assumption of any credit risk. The Collateral Agent shall have the right upon any such public sale or sales, and, to the extent permitted by law, upon any such private sale or sales, to purchase the whole or any part of the Collateral so sold, free of any right or equity of redemption in the Grantor, which right or equity is hereby waived, to the extent permitted by applicable law, or released. The Grantor further agrees that, if an Event of Default has occurred and is continuing, but in the case of Events of Default that are solely ones covered by the final clause (2) of Section 4.01 of any Note, only after the expiration of the 365-day period specified in such clause (2), at the Collateral Agent's request Collateral, to assemble the Collateral and make it available to the Collateral Agent at places which the Collateral Agent shall reasonably select, whether at the Grantor's premises or elsewhere. The Collateral Agent shall apply the net proceeds of any such collection, recovery, receipt, appropriation, realization or sale, after deducting all reasonable costs and expenses of every kind incurred therein or incidental to the care or safekeeping of any of the Collateral or in any way relating to the Collateral or the rights of the Collateral Agent hereunder, including, without limitation, reasonable attorneys' fees and disbursements, to the payment in -13- whole or in part of the Obligations, in such order as the Collateral Agent may elect, and only after such application and after the payment by the Collateral Agent of any other amount required by any provision of law, need the Collateral Agent account for the surplus, if any, to the Grantor. To the extent permitted by applicable law, the Grantor waives all claims, damages and demands it may acquire against the Collateral Agent arising out of the exercise by it of any rights hereunder, provided, that nothing contained in this Section shall relieve -------- the Collateral Agent from liability arising solely from its gross negligence or willful misconduct. If any notice of a proposed sale or other disposition of Collateral shall be required by law, such notice shall be deemed reasonable and proper if given at least ten (10) days before such sale or other disposition. The Grantor shall remain liable for any deficiency if the proceeds of any sale or other disposition of the Collateral are insufficient to pay the Obligations and the fees and disbursements of any attorneys employed by the Collateral Agent to collect such deficiency. 9. Limitation on Duties Regarding Preservation of Collateral. The --------------------------------------------------------- Collateral Agent's sole duty with respect to the custody, safekeeping and physical preservation of the Collateral in its possession, under Section 9-207 of the Code or otherwise, shall be to deal with it in the same manner as the Collateral Agent deals with similar property for its own account. Neither the Collateral Agent nor any of its directors, officers, employees or agents shall be liable for failure to demand, collect or realize upon all or any part of the Collateral or for any delay in doing so or shall be under any obligation to sell or otherwise dispose of any Collateral upon the request of the Grantor or otherwise. 10. Powers Coupled with an Interest. All authorizations and agencies ------------------------------- herein contained with respect to the Collateral are irrevocable and powers coupled with an interest until Grantor has paid and performed in full all of its obligations under this Security Agreement, the Guaranty and the Patent and Trademark Security Agreement. 11. Severability. Any provision of this Security Agreement which is ------------ prohibited or unenforceable in any jurisdiction shall, as to such jurisdiction, be ineffective to the extent of such prohibition or unenforceability without invalidating the remaining provisions hereof, and any such prohibition or unenforceability in any jurisdiction shall not invalidate or render unenforceable such provision in any other jurisdiction. 12. Paragraph Headings. The paragraph headings used in this Security ------------------ Agreement are for convenience of reference only and are not to affect the construction hereof or be taken into consideration in the interpretation hereof. 13. No Waiver; Cumulative Remedies. The Collateral Agent shall not by ------------------------------ any act, delay, indulgence, omission or otherwise be deemed to have waived any right or remedy hereunder or to have acquiesced in any Event of Default or in any breach of any of the terms and conditions hereof. No failure to exercise, nor any delay in exercising, on the part of the Collateral Agent, any right, power or privilege hereunder shall operate as a waiver thereof. No -14- single or partial exercise of any right, power or privilege hereunder shall preclude any other or further exercise thereof or the exercise of any other right, power or privilege. A waiver by the Collateral Agent of any right or remedy hereunder on any one occasion shall not be construed as a bar to any right or remedy which the Collateral Agent would otherwise have on any future occasion. The rights and remedies herein and in the Guaranty and the Notes provided are cumulative, may be exercised singly or concurrently and are not exclusive of any rights or remedies provided by law or in equity or by statute. 14. Waivers and Amendments; Successors and Assigns. None of ---------------------------------------------- the terms or provisions of this Security Agreement may be waived, amended, supplemented or otherwise modified except by a written instrument executed by the party to be charged with enforcement; provided, however, that any provision -------- ------- of this Security Agreement may be waived, amended, supplemented or otherwise modified by the Collateral Agent only with the prior written approval of the Majority Holders. This Security Agreement shall be binding upon the successors and permitted assigns of the Grantor and shall inure to the benefit of the Collateral Agent and its successors and assigns. The Grantor may not assign its rights or obligations under this Agreement without the prior written consent of the Collateral Agent. 15. Termination of Security Interest; Release of Collateral. ------------------------------------------------------- (a) Upon the payment and performance in full by the Grantor of its obligations under the Notes, this Agreement and the Patent and Trademark Security Agreement, the security interest granted in the Collateral pursuant to this Agreement (the "Security Interest") shall terminate and all rights to the Collateral shall revert to the Grantor. At any time and from time to time prior to such termination of the Security Interest, the Collateral Agent shall release any of the Collateral only with the prior written consent of the Majority Holders. (b) Upon any such termination of the Security Interest, the Collateral Agent will, at the expense of the Grantor, execute and deliver to the Grantor such documents and take such other actions as the Grantor shall reasonably request to evidence the termination of the Security Interest and deliver to the Grantor all Collateral so released then in its possession. 16. Notices. Any notices required or permitted to be given ------- under the terms of this Agreement shall be in writing and shall be sent by mail, personal delivery, telephone line facsimile transmission or courier and shall be effective five days after being placed in the mail, if mailed, or upon receipt, if delivered personally, by telephone line facsimile transmission or by courier, in each case addressed to a party at such party's address (or telephone line facsimile transmission number) shown below or such other address (or telephone line facsimile transmission number) as a party shall have provided by notice to the other party in accordance with this provision. In the case of any notice to the Grantor, such notice shall be addressed to the Grantor at 145 Brandywine Parkway, West Chester, Pennsylvania 19380, Attention: Chief Financial Officer (telephone line facsimile transmission number (610) 344-7563), and a copy shall also be -15- given to: Morgan, Lewis & Bockius, LLP, 2000 One Logan Square, Philadelphia, Pennsylvania 19103, Attention: David R. King, Esq. (telephone line facsimile transmission number (215) 963-5299), and in the case of any notice to the Collateral Agent, such notice shall be addressed to the Collateral Agent c/o International Fund Administration, Inc., 48 Par la Ville Road, Suite 464, Hamilton HM11, Bermuda, Attention: Mr. Keith Bish (telephone line facsimile number (441) 295-9637), and a copy shall also be given to: Diaz & Altshcul Advisors, LLC, 745 Fifth Avenue, Suite 1710, New York, New York 10151 (telephone line facsimile number (212) 751-5757), and Law Offices of Brian W Pusch, Penthouse Suite, 29 West 57th Street, New York, New York 10019 (telephone line facsimile transmission number (212) 980-7055). 17. Concerning Collateral Agent. The Grantor acknowledges that --------------------------- the rights and responsibilities of the Collateral Agent under this Security Agreement with respect to any action taken by the Collateral Agent or the exercise or nonexercise by the Collateral Agent of any option, right, request, judgment or other right or remedy provided for herein or resulting or arising out of this Security Agreement shall, as between the Collateral Agent and the Holders, be governed by Schedule IV hereto and by such other agreements with respect thereto as may exist from time to time among them, but, as between the Collateral Agent and the Grantor, except as expressly provided in Sections 14 and 15, the Collateral Agent shall be conclusively presumed to be acting as agent for the Holders with full and valid authority so to act or refrain from acting, and the Grantor shall not be under any obligation to make any inquiry respecting such authority. The Collateral Agent hereby waives for the benefit of the Holders any claim, right or lien of the Collateral Agent against the Collateral arising under applicable law or arising from any business or transaction between the Collateral Agent and the Grantor other than pursuant to this Security Agreement or any of the other Transaction Documents. 18. Integration. This Security Agreement represents the ----------- agreement of the Grantor and the Collateral Agent with respect to the subject matter hereof, and there are no promises, undertakings, representations or warranties by the Collateral Agent relative to subject matter hereof not expressly set forth or referred to herein. 19. Governing Law. This Security Agreement and the rights and ------------- obligations of the Grantor under this Security Agreement shall be governed by, and construed and interpreted in accordance with, the law of the State of New York, except to the extent that under the New York Uniform Commercial Code the laws of another jurisdiction govern matters of perfection and the effect of perfection or non-perfection of any security interest granted hereunder. -16- IN WITNESS WHEREOF, the Grantor has caused this Security Agreement to be duly executed and delivered as of the date first above written. CEPHALON, INC. By: Name: Title: ACKNOWLEDGED AND AGREED: DELTA OPPORTUNITY FUND, LTD. By: Name: Title: -17- SCHEDULE I Filings Required to Perfect Security Interest --------------------------------------------- I-18 SCHEDULE II Location of Records Concerning Accounts --------------------------------------- II-19 SCHEDULE III Inventory --------- III-20 SCHEDULE IV The Collateral Agent -------------------- 1. Appointment. The Holders (all capitalized terms used in this Schedule IV and not otherwise defined shall have the respective meanings provided in the Security Agreement to which this Schedule IV is attached (the "Security Agreement")), by their acceptance of the benefits of the Security Agreement, hereby irrevocably designate Delta Opportunity Fund, Ltd., as Collateral Agent to act as specified herein and in the Security Agreement. Each Buyer hereby irrevocably authorizes, and each other Holder of any Note by the acceptance of such Note shall be deemed irrevocably to authorize, the Collateral Agent to take such action on its behalf under the provisions of the Security Agreement and any other instruments and agreements referred to herein or therein and to exercise such powers and to perform such duties hereunder and thereunder as are specifically delegated to or required of the Collateral Agent by the terms hereof and thereof and such other powers as are reasonably incidental thereto. The Collateral Agent may perform any of its duties hereunder by or through its agents or employees. 2. Nature of Duties. The Collateral Agent shall have no duties or responsibilities except those expressly set forth in the Security Agreement. Neither the Collateral Agent nor any of its officers, directors, employees or agents shall be liable for any action taken or omitted by it as such under the Security Agreement or hereunder or in connection herewith or therewith, unless caused by its or their gross negligence or willful misconduct. The duties of the Collateral Agent shall be mechanical and administrative in nature; the Collateral Agent shall not have by reason of the Security Agreement or any other Transaction Document a fiduciary relationship in respect of any Holder; and nothing in the Security Agreement, expressed or implied, is intended to or shall be so construed as to impose upon the Collateral Agent any obligations in respect of the Security Agreement except as expressly set forth herein. The Collateral Agent shall not be liable for any act it may do or omit to do while acting in good faith and in the exercise of its own best judgment. Any act done or omitted by the Collateral Agent on the advice of its own attorneys shall be deemed conclusively to have been done or omitted in good faith. The Collateral Agent shall have the right at any time to consult with counsel on any question arising under this Security Agreement. The Collateral Agent shall incur no liability for any delay reasonably required to obtain the advice of counsel. 3. Lack of Reliance on the Collateral Agent. Independently and without reliance upon the Collateral Agent, each Holder, to the extent it deems appropriate, has made and shall continue to make (i) its own independent investigation of the financial condition and affairs of the Grantor and its subsidiaries in connection with the making and the continuance of the Obligations and the taking or not taking of any action in connection therewith, and (ii) its own appraisal of the creditworthiness of the Grantor and its subsidiaries, and the Collateral Agent shall have no duty or responsibility, either initially or on a continuing basis, to provide any Holder with any credit or other information with respect thereto, whether coming into its possession before IV-21 any Obligation arises or the purchase of any Note, or at any time or times thereafter. The Collateral Agent shall not be responsible to any Holder for any recitals, statements, information, representations or warranties herein or in any document, certificate or other writing delivered in connection herewith or for the execution, effectiveness, genuineness, validity, enforceability, perfection, collectibility, priority or sufficiency of the Security Agreement or the financial condition of the Grantor or be required to make any inquiry concerning either the performance or observance of any of the terms, provisions or conditions of the Security Agreement, or the financial condition of the Grantor, or the existence or possible existence of any Event of Default. 4. Certain Rights of the Collateral Agent. No Holder shall have the right to cause the Collateral Agent to take any action with respect to the Collateral, with only the Majority Holders having the right to direct the Collateral Agent to take any such action. If the Collateral Agent shall request instructions from the Majority Holders with respect to any act or action (including failure to act) in connection with the Security Agreement, the Collateral Agent shall be entitled to refrain from such act or taking such action unless and until it shall have received instructions from the Majority Holders, and to the extent requested, appropriate indemnification in respect of actions to be taken by the Collateral Agent; and the Collateral Agent shall not incur liability to any person by reason of so refraining. Without limiting the foregoing, no Holder shall have any right of action whatsoever against the Collateral Agent as a result of the Collateral Agent acting or refraining from acting hereunder in accordance with the instructions of the Majority Holders or as otherwise specifically provided in the Security Agreement. 5. Reliance. The Collateral Agent shall be entitled to rely, and shall be fully protected in relying, upon any note, writing, resolution, notice, statement, certificate, telex, teletype or telecopier message, cablegram, radiogram, order or other document or telephone message signed, sent or made by the proper person or entity, and, with respect to all legal matters pertaining to the Security Agreement and its duties thereunder, upon advice of counsel selected by it. 6. Indemnification. To the extent the Collateral Agent is not reimbursed and indemnified by the Grantor and/or its subsidiaries, the Holders will reimburse and indemnify the Collateral Agent, in proportion to their respective principal amounts of Obligations, for and against any and all liabilities, obligations, losses, damages, penalties, actions, judgments, suits, costs, expenses or disbursements of any kind or nature whatsoever which may be imposed on, incurred by or asserted against the Collateral Agent in performing its duties hereunder or under the Security Agreement, or in any way relating to or arising out of the Security Agreement except for those determined by a final judgment (not subject to further appeal) of a court of competent jurisdiction to have resulted solely from the Collateral Agent's own negligence or willful misconduct. 7. The Collateral Agent in its Individual Capacity. The Collateral Agent and its affiliates may lend money to, purchase, sell and trade in securities of and generally engage in IV-22 any kind of business with the Grantor or any affiliate or subsidiary of the Grantor as if it were not performing the duties specified herein, and may accept fees and other consideration from the Grantor for services to the Grantor in connection with the Transaction Documents and otherwise without having to account for the same to the Holders; provided, however, that the Collateral Agent on behalf of itself and such affiliates, hereby waives any claim, right or lien against the Collateral in any way arising from or relating to any such loan, securities transaction or business with the Grantor. 8. Holders. The Collateral Agent may deem and treat the holder of record of any Note as the owner thereof for all purposes hereof unless and until a written notice of the assignment or transfer thereof, as the case may be, shall have been filed with the Collateral Agent. Any request, authority or consent of any person or entity who, at the time of making such request or giving such authority or consent, is the holder of record of any Note shall be conclusive and binding on any subsequent holder, transferee or assignee, as the case may be, of such Note or of any Note(s) issued in exchange therefor. 9. Resignation by the Collateral Agent. (a) The Collateral Agent may resign from the performance of all its functions and duties under the Security Agreement at any time by giving 60 Business Days' prior written notice (as provided in the Security Agreement) to the Grantor and the Holders. Such resignation shall take effect upon the appointment of a successor Collateral Agent pursuant to clauses (b) and (c) below. (b) Upon any such notice of resignation, the Majority Holders shall appoint a successor Collateral Agent hereunder. (c) If a successor Collateral Agent shall not have been so appointed within said 60 Business Day period, the Collateral Agent shall then appoint a successor Collateral Agent who shall serve as Collateral Agent hereunder or thereunder until such time, if any, as the Majority Holders appoint a successor Collateral Agent as provided above. If a successor Collateral Agent has not been appointed within such 60-day period, the Collateral Agent may petition any court of competent jurisdiction or may interplead the Grantor and Holders in a proceeding for the appointment of a successor Collateral Agent, and all fees, including but not limited to extraordinary fees associated with the filing of interpleader, and expenses associated therewith shall be payable by the Grantor. (d) The fees of any successor Collateral Agent for its services as such shall be payable by the Grantor. IV-23 EXHIBIT A (Cephalon Letterhead) ------------------- (date) ---- Food and Drug Administration 1390 Piccard Drive Rockville, MD 20850 Re: Transfer of Ownership New Drug Application NDA NDA 20-717 ----------------------------------- To Whom It May Concern: We are hereby informing you, in accordance with Section 505 of the Federal Food, Drug and Cosmetic Act (the "Act"), that as of , _________, ___________(the "Transferee"), is the new official owner and responsible party for the following New Drug Application (NDA) which, prior to ______________was officially owned and held by Cephalon, Inc.: NDA NDA 20-717 (________________) and all supplements and pending supplements thereto (see attached list). --- In accordance with 21 C.F.R. 314.81, the Transferee has received from Cephalon, Inc. a complete copy of the above-referenced NDA and all of its supplements, pending supplements, amendments, and reports thereto. Should any questions arise in connection with the above, please do not hesitate to contact me. Sincerely, CEPHALON, INC. IV-A-24 By: ________________ Title: ________________ IV-A-25 ATTACHMENT TO CEPHALON, INC. OWNERSHIP TRANSFER OF NDA As of March 1, 1999, there are currently no supplements or pending supplements to NDA 20-717. IV-A-26 EX-4.3(F) 7 PATENT AND TRADEMARK AGREEMENT DATED 03/01/99 EXHIBIT 4.3(f) ANNEX V TO NOTE PURCHASE AGREEMENT PATENT AND TRADEMARK SECURITY AGREEMENT This PATENT AND TRADEMARK SECURITY AGREEMENT dated as of the 1st day of March 1999, made by Cephalon Inc., a Delaware corporation, ("Grantor") to Delta Opportunity Fund, Ltd., as collateral agent (in such capacity, the "Collateral Agent") on behalf of the Holders. WITNESSETH WHEREAS, Grantor and the Buyers are parties to certain Note Purchase Agreements, dated as of February 24, 1999 (as from time to time amended or supplemented, the "Note Purchase Agreements"), pursuant to which, among other things, the Buyers have agreed to purchase $30,000,000 aggregate principal amount of 11% Revenue Sharing Senior Secured Notes due 2002 (the "Notes"); WHEREAS, it is a condition precedent to the several obligations of the Buyers to purchase their respective Notes that the Grantor shall have executed and delivered this Patent and Trademark Security Agreement to the Collateral Agent for the ratable benefit of the Holders; WHEREAS, Grantor has certain right, title and interest in certain U.S. patents and patent applications and U.S. trademarks; WHEREAS, Grantor wishes to grant to Collateral Agent a security interest in all of its property and assets to secure the performance of its obligations under the Notes; WHEREAS, the Grantor is contemporaneously entering into a Security Agreement with the Collateral Agent for the ratable benefit of the Holders; NOW, THEREFORE, in consideration of the premises and to induce the Buyers to purchase their respective Notes, the Grantor hereby agrees with the Collateral Agent, for the ratable benefit of the Holders, as follows: TERMS 1. Defined Terms. Unless otherwise defined herein, capitalized terms ------------- used herein -1- which are defined in the Notes are so used as so defined, and the meanings assigned to terms defined herein or in the Notes shall be equally applicable to both the singular and plural forms of such terms and shall have the following meanings: "Buyer" means any one of the several buyers party to a Note Purchase ----- Agreement. "Code" means the Uniform Commercial Code as from time to time in effect ---- in the Commonwealth of Pennsylvania. "Collateral" shall have the meaning assigned to it in Section 2 of this ---------- Patent and Trademark Security Agreement. "Event of Default" means: ---------------- (1) the failure by the Grantor to perform in any material respect any obligation of the Grantor under this Patent and Trademark Security Agreement as and when required by this Patent and Trademark Security Agreement; or (2) any representation and warranty made by the Grantor pursuant to this Patent and Trademark Security Agreement shall have been untrue in any material respect when made; (3) the failure by the Grantor to perform in any material respect any obligation of the Grantor under the Security Agreement as and when required by the Security Agreement; (4) any representation and warranty made by the Grantor pursuant to the Security Agreement shall have been untrue in any material respect when made; or (5) any Event of Default, as that term is defined in any of the Notes. "General Intangibles" shall have the meaning ascribed to it in the ------------------- Uniform Commercial Code in effect in the Commonwealth of Pennsylvania on the date hereof. "Holder" means any Buyer or any holder from time to time of any Note. ------ "Lien" shall mean any lien, mortgage, security interest, chattel ---- mortgage, pledge or other encumbrance (statutory or otherwise) of any kind securing satisfaction or performance of an obligation, including any agreement to give any of the foregoing, any conditional sales or other title retention agreement, any lease in the nature thereof, and the filing of or the agreement to give any financing statement under the Code of any jurisdiction or similar evidence of any encumbrance, whether within or outside the United States. "Obligations" shall mean: ----------- -2- (1) the full and prompt payment when due of all obligations and liabilities to the Holders, whether now existing or hereafter arising, under the Notes, this Agreement or the other Transaction Documents and the due performance and compliance with the terms of the Notes and the other Transaction Documents; (2) any and all sums advanced by the Collateral Agent or any Holder in order to preserve the Collateral or to preserve the Collateral Agent's security interest in the Collateral; and (3) in the event of any proceeding for the collection or enforcement of any obligations or liabilities of the Grantor referred to in the immediately preceding clauses (1) through (2) in accordance with the terms of the Notes and this Agreement, the reasonable expenses of re-taking, holding, preparing for sale, selling or otherwise disposing of or realizing on the Collateral, or of any other exercise by the Collateral Agent of its rights hereunder, together with reasonable attorneys' fees and court costs. "Patent and Trademark Security Agreement" means this Patent and --------------------------------------- Trademark Security Agreement, as amended, supplemented or otherwise modified from time to time. "Patent Licenses" means the license agreements, as amended, identified --------------- in Exhibit A hereto as it may be amended, supplemented or otherwise modified from time to time. "Patent(s)" means all U.S. patents and patent applications, including --------- any and all extensions, reissues, substitutes, continuations, continuations-in-part, patents of addition, and renewals thereof, and patents issuing therefrom, as necessary to use and sell modafinil to make, have made, use or sell pharmaceutical compositions containing modafinil (the "Pharmaceutical Compositions") in the United States, its territories and possessions, and conveyed by a Patent License as such Patent License may be amended, supplemented or otherwise modified from time to time. The term shall also include U.S. Patent 5,618,845 entitled "Acetamide Derivative Having Defined Particle Size," specifically identified in Exhibit B hereto, including any and all extensions, reissues, substitutes, continuations, continuations in part, patents of addition, and renewals thereof. "Proceeds" shall have the meaning ascribed to it in the Uniform -------- Commercial Code in effect in the Commonwealth of Pennsylvania on the date hereof. "Security Agreement" means that certain Security Agreement, dated as of ------------------ March 1, 1999, between the Grantor and the Collateral Agent. "Trademark License" means the license agreement, as amended, identified ----------------- in Exhibit C hereto as it may be amended, supplemented or otherwise modified from time to time. -3- "Trademarks" means (a) all U.S. trademarks, trade names, corporate ---------- names, company names, business names, fictitious business names, trade styles, service marks, logos and other source or business identifiers of the Grantor adopted for use in conjunction with the sale of Phamaceutical Compositions, now existing in the United States or hereinafter adopted or acquired, whether currently in use or not, and the goodwill associated therewith, all registrations and recordings thereof, and all applications in connection therewith, including, without limitation, that identified in Exhibit C hereto as being conveyed under the Trademark License as it may be amended, supplemented or otherwise modified from time to time, and (b) all renewals thereof. 2. Grant of Security Interest. As collateral security for the prompt -------------------------- and complete payment and performance when due of the Obligations, the Grantor hereby grants to the Collateral Agent, for the ratable benefit of the Holders, a continuing first priority security interest in all of the following property now owned or at any time hereafter acquired by the Grantor or in which the Grantor now has or at any time in the future may acquire right, title or interest (collectively, the "Collateral"): All General Intangibles and Proceeds arising from all Patents, all Patents Licenses, all Trademarks and all Trademark Licenses; all Patents; all Patent Licenses; all Trademarks; all Trademark Licenses; to the extent not otherwise included, all proceeds and products of any and all of the foregoing. 3. Representations and Warranties. The Grantor hereby represents and ------------------------------ warrants that: (a) Title; No Other Liens. Except for the Lien granted to the --------------------- Collateral Agent for the ratable benefit of the Holders pursuant to this Patent and Trademark Security Agreement and the Lien granted to the Collateral Agent for the ratable benefit of the Holders pursuant to the terms of the Security Agreement, the Grantor owns each item of the Collateral free and clear of any and all Liens or claims of others except as permitted by Section 3.9 of the Notes. No security agreement, financing statement or other public notice with respect to all or any part of the Collateral is on file or of record in any public office, except such as may have been filed in favor of the Collateral Agent, for the ratable benefit of the Holders, pursuant to this Patent and Trademark Security Agreement or the Security Agreement. (b) Perfected First Priority Liens. The Liens granted pursuant to this ------------------------------ Patent and Trademark Security Agreement will constitute upon the completion of all the filings or notices listed in Exhibit D hereto, which Exhibit includes --------- all UCC-1 financing statements to be filed pursuant to the terms of the Security Agreement and all requisite filings to be made with the U.S. Patent and Trademark Office in the form substantially similar to that of Exhibit F and --------- Exhibit G, perfected Liens on all Collateral, which are prior to all other Liens - --------- on such Collateral and which are enforceable as such against all creditors of the Grantor. -4- (c) Consents. No consent (other than consents that have been obtained) -------- of any party (other than the Grantor) to any Contract that constitutes part of the Collateral is required, or purports to be required, in connection with the execution, delivery and performance of this Patent and Trademark Security Agreement. (d) Chief Executive Office. The Grantor's chief executive office and ---------------------- chief place of business is located at 145 Brandywine Parkway, West Chester, Pennsylvania 19380. (e) Authority. The Grantor has full power, authority and legal right to --------- enter into this Patent and Trademark Security Agreement and to grant the Collateral Agent the Lien on the Collateral pursuant to this Patent and Trademark Security Agreement. (f) Due Execution and Delivery. This Patent and Trademark Security -------------------------- Agreement has been duly executed and delivered by the Grantor and constitutes a legal, valid and binding obligation of the Grantor enforceable in accordance with its terms. (g) No Violation. The execution, delivery and performance of this ------------ Patent and Trademark Security Agreement will not violate any provision of any applicable law or regulation or of any order, judgment, writ, award or decree of any court, arbitrator or governmental authority, domestic or foreign, or of any securities issued by the Grantor, or of any mortgage, indenture, lease, contract or other agreement, instrument or undertaking to which the Grantor is a party or which purports to be binding upon the Grantor or upon any of its assets and will not result in the creation or imposition of any Lien on any of the assets of the Grantor except as contemplated by this Patent and Trademark Security Agreement. (h) No Consent or Approval. No consent, filing, approval, ---------------------- registration, recording, registration or other action is required (x) for the grant by the Grantor of the Lien on the Collateral pursuant to this Patent and Trademark Security Agreement or for the execution, delivery or performance of this Patent and Trademark Security Agreement by the Grantor, or (y) to perfect the Lien purported to be created by this Agreement, in each case except as contemplated by Section 3(b) above. 4. Covenants. The Grantor covenants and agrees with the Collateral --------- Agent that from and after the date of this Patent and Trademark Security Agreement until the payment or performance in full by the Grantor of all of its obligations under the Transaction Documents: (a) Further Documentation. At any time and from time to time, upon the --------------------- written request of the Collateral Agent, and at the sole expense of the Grantor, the Grantor will promptly and duly execute and deliver such further instruments and documents and take such further action as the Collateral Agent may request for the purpose of obtaining or preserving the full benefits of this Patent and Trademark Security Agreement and of the rights and powers herein granted, including, without limitation, the filing of any financing or continuation statements under the Code in effect in any such jurisdiction with respect to the Liens created hereby. The Grantor also -5- hereby authorizes the Collateral Agent to file any such financing or continuation statement without the signature of the Grantor to the extent permitted by applicable law. A carbon, photographic or other reproduction of this Patent and Trademark Security Agreement shall be sufficient as a financing statement for filing in any jurisdiction. (b) Indemnification. The Grantor agrees to pay, and to save the --------------- Collateral Agent and each Holder harmless from, any and all liabilities, costs and expenses (including, without limitation, legal fees and expenses) (i) with respect to, or resulting from, any delay in paying, any and all excise, sales or other taxes which may be payable or determined to be payable with respect to any of the Collateral, (ii) with respect to, or resulting from, any delay by Grantor in complying with any law or regulation applicable to any of the Collateral or (iii) in connection with this Patent and Trademark Security Agreement or any action taken by the Collateral Agent or any Holder in exercising its rights hereunder. (c) Maintenance of Records. The Grantor will keep and maintain at its ---------------------- own cost and expense satisfactory and complete records of the Collateral. For the further security of the Holders, the Grantor hereby grants to the Collateral Agent, for the ratable benefit of the Holders, a security interest in all of the Grantor's books and records pertaining to the Collateral, and the Grantor shall turn over any such books and records for inspection at the office of the Grantor to the Collateral Agent or to its representatives during normal business hours at the request of the Collateral Agent. (d) Limitation on Liens on Collateral. The Grantor (x) will not create, --------------------------------- incur or permit to exist, will defend the Collateral against, and will take such other action as is necessary to remove, any Lien or claim on or to the Collateral, other than the Liens created hereby or as permitted by Section 3.9 of the Notes, and (y) will defend the right, title and interest of the Collateral Agent in and to any of the Collateral against the claims and demands of all persons whomsoever. (e) Limitations on Dispositions of Collateral. The Grantor will not ----------------------------------------- sell, transfer, assign, or sublicense any of the Collateral, or attempt, offer or contract to do so including, but not limited to, marketing and promotion thereof, or otherwise agreed to by the parties in writing. (f) Limitations on Modifications, Waivers, Extensions of Trademark -------------------------------------------------------------- Licenses. Except in the ordinary course of business, the Grantor will not (i) - -------- amend, modify, terminate or waive any provision of the Trademark License with respect to the Trademark in any manner which could reasonably be expected to materially adversely affect the value of such Trademark License as Collateral, (ii) fail to exercise promptly and diligently each and every material right which it may have under each Trademark License with respect to any Trademarks. Additionally, the Grantor will deliver to the Collateral Agent a copy of each material demand, notice or document received by it relating in any way to such Trademark License. -6- (g) Further Identification of Collateral. The Grantor will furnish to ------------------------------------ the Collateral Agent from time to time, upon the request of the Collateral Agent, statements and schedules further identifying and describing the Collateral and such other reports in connection with the Collateral as the Collateral Agent may reasonably request, all in reasonable detail. (h) Notices. The Grantor will advise the Collateral Agent promptly, in ------- reasonable detail, at its address set forth in accordance with Section 15, (i) of any Lien on, or claim asserted against, any of the Collateral, other than as created hereby or as permitted hereby, and (ii) of the occurrence of any other event which could reasonably be expected to have a material adverse effect on the Liens created hereunder. (i) Patents. ------- (i) The Grantor will notify the Collateral Agent immediately if it knows, of has reason to know, that any application relating to any Patent may become abandoned or of any adverse determination or development (including, without limitation, the institution of, or any such determination or development in, any proceeding in the United States Patent and Trademark Office or any court or tribunal in any country) regarding the Grantor's ownership of any Patent. (ii) The Grantor will, with respect to any Patent that the Grantor obtains after the Issuance Date or any Patent License that the Grantor acquires after the Issuance Date, promptly (i) take all actions necessary so that the Collateral Agent shall obtain a perfected security interest in such Patent or Patent License and (ii) provide to the Collateral Agent a revised Exhibit A and Exhibit B, listing all --------- --------- Patents and all Patent Licenses in which Grantor has an interest. (iii) Upon request of the Collateral Agent, the Grantor shall execute and deliver any and all agreements, instruments, documents, and papers as the Collateral Agent may request to evidence the Collateral Agent's security interest in such Patents or Patent Licenses, and the Grantor hereby constitutes the Collateral Agent its attorney-in-fact to execute and file all such writings for the foregoing purposes, all acts of such attorney being hereby ratified and confirmed; such power being coupled with an interest is irrevocable until the Grantor shall have paid and performed in full all of its obligations under this Patent and Trademark Security Agreement and the Security Agreement. (iv) Subject to the terms of the Patent License, if applicable, the Grantor will take all reasonable and necessary steps, including, without limitation, in any proceeding before the United States Patent and Trademark Office, to maintain and pursue each Patent including, without limitation, payment of maintenance fees. -7- (v) Subject to the terms of the Patent License, if applicable, in the event that any Patent included in the Collateral is infringed by a third party, the Grantor shall promptly notify the Collateral Agent after it learns thereof and shall, if appropriate, sue for infringement, seeking injunctive relief where appropriate and to recover any and all damages for such infringement, or take such other actions as the Grantor shall reasonably deem appropriate under the circumstances to protect such Patent. (j) Trademarks. ---------- (i) The Grantor (either itself or through licensees) will, with respect to each Trademark identified in Exhibit C hereto as it may --------- be amended, supplemented or otherwise modified from time to time, (i) continue to use or have used such Trademark to the extent necessary to maintain such Trademark in full force free from any claim of abandonment for non-use, (ii) maintain as in the past the quality of products and services offered under such Trademark, (iii) employ such Trademark with the appropriate notice of registration, (iv) not adopt or use any mark which is confusingly similar or a colorable imitation of such Trademark unless the Collateral Agent, for the ratable benefit of the Holders, shall obtain a first priority perfected security interest in the Company's interest in such mark pursuant to this Patent and Trademark Security Agreement, and (v) not (and not permit any licensee or sublicensee thereof to) do any act or knowingly omit to do any act whereby any such Trademark may become invalidated. (ii) The Grantor will promptly notify the Collateral Agent if any application or registration relating to any Trademark may become abandoned, canceled or dedicated, or of any adverse determination or development (including, without limitation, the institution of, or any such determination or development in, any proceeding in the United States Patent and Trademark Office or any court or tribunal in any country) regarding the Grantor's ownership interest in such Trademark or its right to register the same or to keep and maintain the same. (iii) The Grantor will, with respect to any Trademark that the Grantor registers after the Closing Date or any Trademark License that the Grantor acquires after the Closing Date, promptly (i) take all actions necessary so that the Collateral Agent, for the ratable benefit of the Holders, shall obtain a perfected security interest in such Trademark or Trademark License and (ii) provide to the Collateral Agent a revised listing of all registered Trademarks and all Trademark Licenses in which the Grantor has an interest. (iv) Upon request of the Collateral Agent, the Grantor shall execute and deliver any and all agreements, instruments, documents, and papers as the Collateral Agent may request to evidence the Collateral Agent's security interest in any Trademark and the goodwill and general intangibles of the Grantor relating thereto or represented thereby, and the Grantor hereby constitutes the Collateral Agent its attorney-in-fact to execute and -8- file all such writings for the foregoing purposes, all acts of such attorney being hereby ratified and confirmed; such power being coupled with an interest is irrevocable until the Grantor shall have paid and performed in full all of its obligations under the Transaction Documents. (v) Subject to the terms of the Trademark License, the Grantor will take all reasonable and necessary steps, including, without limitation, in any proceeding before the United States Patent and Trademark Office to maintain and pursue each application (and to obtain the relevant registration) and to maintain the registration of the Trademarks, including, without limitation, filing of applications for renewal, affidavits of use and affidavits of incontestability. (vi) Subject to the terms of the Trademark License, in the event that any Trademark included in the Collateral is infringed, misappropriated or diluted by a third party, the Grantor shall notify the Collateral Agent and shall, if appropriate, sue for infringement, misappropriation or dilution, seeking injunctive relief where appropriate and to recover any and all damages for such infringement, misappropriation or dilution, or take such other action as the Grantor reasonably deems appropriate under the circumstances to protect such Trademark. (k) License Agreements. The Grantor shall comply with its obligations ------------------ under each of its Patent Licenses and Trademark Licenses. (l) Changes in Locations, Name, Etc. The Grantor will not (i) change ------------------------------- the location of its chief executive office/chief place of business from that specified in Section 3(d) or (ii) change its name, identity or corporate structure to such an extent that any statement filed by the Collateral Agent with the Patent and Trademark Office in connection with this Patent and Trademark Security Agreement would become misleading, unless it shall have given the Collateral Agent at least 30 days prior written notice thereof and, prior to such action or event, shall have taken appropriate action to preserve and protect the Collateral Agent's security interest under this Patent and Trademark Security Agreement. 5. Collateral Agent's Appointment as Attorney-in-Fact. -------------------------------------------------- (a) Powers. The Grantor hereby irrevocably constitutes and appoints the ------ Collateral Agent and any officer or agent thereof, with full power of substitution, as its true and lawful attorney-in-fact with full irrevocable power and authority in the place and stead of the Grantor and in the name of the Grantor or in its own name, from time to time in the Collateral Agent's discretion, during any period in which an Event of Default is continuing, for the purpose of carrying out the terms of this Patent and Trademark Security Agreement, to take any and all appropriate action and to execute any and all documents and instruments which may be necessary or desirable to accomplish the purposes of this Patent and Trademark Security Agreement, and, -9- without limiting the generality of the foregoing, the Grantor hereby gives the Collateral Agent the power and right, on behalf of the Grantor, without notice to or assent by the Grantor, except any notice required by law, to do the following: (i) to take possession of and endorse and collect any checks, drafts, notes, acceptances or other instruments for the payment of moneys due under or with respect to any Collateral and to file any claim or to take any other action or proceeding in any court of law or equity or otherwise deemed appropriate by the Collateral Agent for the purpose of collecting any and all such moneys due under or with respect to any such Collateral whenever payable, in each case in the name of the Grantor or its own name, or otherwise; (ii) to pay or discharge taxes and Liens levied or placed on or threatened against the Collateral and to pay all or any part of the premiums therefor and the costs thereof; and (iii) (A) to direct any party liable for any payment under any of the Collateral to make payment of any and all moneys due or to become due thereunder directly to the Collateral Agent or as the Collateral Agent shall direct; (B) to ask or demand for, collect, receive payment of and receipt for, any and all moneys, claims and other amounts due or to become due at any time in respect of or arising out of any Collateral; (C) to sign and endorse any invoices, freight or express bills, bills of lading, storage or warehouse receipts, drafts against debtors, assignments, verifications, notices and other documents in connection with any of the Collateral; (D) to commence and prosecute any suits, actions or proceedings at law or in equity in any court of competent jurisdiction to collect the Collateral or any thereof and to enforce any other right in respect of any Collateral; (E) to defend any suit, action or proceeding brought against the Grantor with respect to any Collateral; (F) to settle, compromise or adjust any suit, action or proceeding described in clause (E) above and, in connection therewith, to give such discharges or releases as the Collateral Agent may deem appropriate; (G) to assign (along with the goodwill of the business pertaining thereto) any Patent or Trademark in the U.S. for such term or terms, on such conditions, and in such manner, as the Collateral Agent shall in its sole discretion determine; and (H) generally, to sell, transfer, pledge and make any agreement with respect to or otherwise deal with any of the Collateral as fully and completely as though the Collateral Agent were the absolute owner thereof for all purposes, and to do, at the Collateral Agent's option and the Grantor's expense, at any time, or from time to time, all acts and things which the Collateral Agent deems necessary to protect, preserve or realize upon the Collateral and the Collateral Agent's Liens thereon and to effect the intent of this Patent and Trademark Security Agreement, all as fully and effectively as the Grantor might do. The Grantor hereby ratifies all that said attorneys shall lawfully do or cause to be done by virtue hereof. This power of attorney is a power coupled with an interest and shall be irrevo cable until -10- the Grantor shall have paid and performed in full all of its obligations under this Patent and Trademark Security Agreement, the Note and the Security Agreement. (b) Other Powers. The Grantor also authorizes the Collateral Agent, at ------------ any time and from time to time, to execute, in connection with the sale provided for herein, any endorsements, assignments or other instruments of conveyance or transfer with respect to the Collateral. (c) No Duty on Collateral Agent's Part. The powers conferred on the ---------------------------------- Collateral Agent hereunder are solely to protect the Collateral Agent's interests in the Collateral and shall not impose any duty upon the Collateral Agent to exercise any such powers. The Collateral Agent shall be accountable only for amounts that it actually receives as a result of the exercise of such powers, and neither it nor any of its officers, directors, employees or agents shall be responsible to the Grantor for any act or failure to act hereunder, except for their own gross negligence or willful misconduct. 6. Performance by Collateral Agent of Grantor's Obligations. If the -------------------------------------------------------- Grantor fails to perform or comply with any of its agreements contained herein and the Collateral Agent, as provided for by the terms of this Patent and Trademark Security Agreement and following reasonable notice to the Grantor, shall itself perform or comply, or otherwise cause performance or compliance, with such agreement, the expenses of the Collateral Agent incurred in connection with such performance or compliance shall be payable by the Grantor to the Collateral Agent on demand and shall constitute Obligations secured hereby. 7. Remedies. If Event of Default has occurred and is continuing, the -------- Collateral Agent may exercise, in addition to all other rights and remedies granted to them in this Patent and Trademark Security Agreement and in any other instrument or agreement securing, evidencing or relating to the Obligations, all rights and remedies of a secured party under the Code. Without limiting the generality of the foregoing, if an Event of Default has occurred and is continuing, the Collateral Agent, without demand of performance or other demand, presentment, protest, advertisement or notice of any kind (except any notice required by law referred to below or expressly provided for) to or upon the Grantor or any other Person (all and each of which demands, defenses, advertisements and notices are, to the extent permitted by applicable law, hereby waived), may in such circumstances forthwith collect, receive, appropriate and realize upon the Collateral, or any part thereof, and/or may forthwith sell, license, assign, give option or options to purchase, or otherwise dispose of and deliver the Collateral or any part thereof (or contract to do any of the foregoing), at public or private sale or sales, at any exchange, broker's board or office of the Collateral Agent or elsewhere upon such terms and conditions as it may deem advisable and at such prices as it may deem best, for cash or on credit or for future delivery without assumption of any credit risk. The Collateral Agent shall have the right upon any such public sale or sales, and, to the extent permitted by law, upon any such private sale or sales, to purchase the whole or any part of the Collateral so sold, free of any right or equity of redemption in the Grantor, which right or equity is hereby waived, to the extent permitted by applicable law, -11- or released. The Grantor further agrees, if an Event of Default has occurred and is continuing, and at the Collateral Agent's request, to assemble the Collateral and make it available to the Collateral Agent at places which the Collateral Agent shall reasonably select, whether at the Grantor's premises or elsewhere. The Collateral Agent shall apply the net proceeds of any such collection, recovery, receipt, appropriation, realization or sale, after deducting all reasonable costs and expenses of every kind incurred therein or incidental to the care or safekeeping of any of the Collateral or in any way relating to the Collateral or the rights of the Collateral Agent hereunder, including, without limitation, reasonable attorneys' fees and disbursements, to the payment in whole or in part of the Obligations, in such order as the Collateral Agent may elect, and only after such application and after the payment by the Collateral Agent of any other amount required by any provision of law, need the Collateral Agent account for the surplus, if any, to the Grantor. To the extent permitted by applicable law, the Grantor waives all claims, damages and demands it may acquire against the Collateral Agent arising out of the exercise by it of any rights hereunder, provided, that nothing contained in this Section shall relieve the Collateral Agent from liability arising solely from its gross negligence or willful misconduct. If any notice of a proposed sale or other disposition of Collateral shall be required by law, such notice shall be deemed reasonable and proper if given at least ten (10) days before such sale or other disposition. The Grantor shall remain liable for any deficiency if the proceeds of any sale or other disposition of the Collateral are insufficient to pay the Obligations and the fees and disbursements of any attorneys employed by the Collateral Agent to collect such deficiency. 8. Limitation on Duties Regarding Preservation of Collateral. The --------------------------------------------------------- Collateral Agent's sole duty with respect to the custody, safekeeping and physical preservation of the Collateral in its possession, under Section 9-207 of the Code or otherwise, shall be to deal with it in the same manner as the Collateral Agent deals with similar property for its own account. Neither the Collateral Agent nor any of its directors, officers, employees or agents shall be liable for failure to demand, collect or realize upon all or any part of the Collateral or for any delay in doing so or shall be under any obligation to sell or otherwise dispose of any Collateral upon the request of the Grantor or otherwise. 9. Powers Coupled with an Interest. All authorizations and agencies ------------------------------- herein contained with respect to the Collateral are irrevocable and powers coupled with an interest until Grantor has paid and performed in full all of its obligations under the Transaction Documents. 10. Severability. Any provision of this Patent and Trademark Security ------------ Agreement which is prohibited or unenforceable in any jurisdiction shall, as to such jurisdiction, be ineffective to the extent of such prohibition or unenforceability without invalidating the remaining provisions hereof, and any such prohibition or unenforceability in any jurisdiction shall not invalidate or render unenforceable such provision in any other jurisdiction. -12- 11. Paragraph Headings. The paragraph headings used in this Patent and ------------------ Trademark Security Agreement are for convenience of reference only and are not to affect the construction hereof or be taken into consideration in the interpretation hereof. 12. No Waiver; Cumulative Remedies. The Collateral Agent shall not by ------------------------------ any act, delay, indulgence, omission or otherwise be deemed to have waived any right or remedy hereunder or to have acquiesced in any Event of Default or in any breach of any of the terms and conditions hereof. No failure to exercise, nor any delay in exercising, on the part of the Collateral Agent, any right, power or privilege hereunder shall operate as a waiver thereof. No single or partial exercise of any right, power or privilege hereunder shall preclude any other or further exercise thereof or the exercise of any other right, power or privilege. A waiver by the Collateral Agent of any right or remedy hereunder on any one occasion shall not be construed as a bar to any right or remedy which the Collateral Agent would otherwise have on any future occasion. The rights and remedies herein and in the Notes provided are cumulative, may be exercised singly or concurrently and are not exclusive of any rights or remedies provided by law or in equity or by statute. 13. Waivers and Amendments; Successors and Assigns. None of the terms ---------------------------------------------- or provisions of this Patent and Trademark Security Agreement may be waived, amended, supplemented or otherwise modified except by a written instrument executed by the party to be charged with enforcement; provided, however, that any provision of this Patent and Trademark Security Agreement may be waived, amended, supplemented or otherwise modified by the Collateral Agent only with the prior written approval of the Majority Holders. This Patent and Trademark Security Agreement shall be binding upon the successors and assigns of the Grantor and shall inure to the benefit of the Collateral Agent and its successors and assigns. The Grantor may not assign its rights or obligations under this Agreement without the prior written consent of the Collateral Agent. 14. Termination of Security Interest; Release of Collateral. (a) Upon ------------------------------------------------------- the payment and performance in full by the Grantor of its obligations under the Transaction Documents, the security interest granted in the Collateral pursuant to this Agreement (the "Security Interest") shall terminate and all rights to the Collateral shall revert to the Grantor. At any time and from time to time prior to such termination of the Security Interest, the Collateral Agent shall release any of the Collateral with the prior written consent of the Majority Holders. (b) Upon any such termination of the Security Interest, the Collateral Agent will, at the expense of the Grantor, execute and deliver to the Grantor such documents and take such other actions as the Grantor shall reasonably request to evidence the termination of the Security Interest and deliver to the Grantor all Collateral so released then in its possession. 15. Notices. Any notices required or permitted to be given under the ------- terms of this Agreement shall be in writing and shall be sent by mail, personal delivery, telephone line -13- facsimile transmission or courier and shall be effective five days after being placed in the mail, if mailed, or upon receipt, if delivered personally, by telephone line facsimile transmission or by courier, in each case addressed to a party at such party's address (or telephone line facsimile transmission number) shown below or such other address (or telephone line facsimile transmission number) as a party shall have provided by notice to the other party in accordance with this provision. In the case of any notice to the Grantor, such notice shall be addressed to the Grantor at, 145 Brandywine Parkway, West Chester, Pennsylvania 19380, President (telephone line facsimile transmission number (510) 344-7563), and a copy shall also be given to: Morgan, Lewis & Bockius LLP, 1701 Market Street, Philadelphia, Pennsylvania 19103, Attention: David R. King, Esq. (telephone line facsimile transmission number (215) 963- 5299), and in the case of any notice to the Collateral Agent, such notice shall be addressed to the Collateral Agent at, Delta Opportunity Fund c/o International Fund Administration, Inc., 48 Par la Ville Road, Suite 464, Hamilton HM11 Bermuda, Attention: Mr. Keith Bish (telephone line facsimile transmission number (441) 295-9637), and copies shall also be given to: Diaz & Altshul Advisors, LLC, 745 Fifth Avenue, Suite 1710, New York, New York 10151 (telephone line facsimile transmission number (212)751-5757) and Law Offices of Brian W. Pusch, Penthouse Suite, 29 West 57th Street, New York, New York 10019 (telephone line facsimile transmission number (212) 980-7055). 16. Concerning Collateral Agent. The Grantor acknowledges that the --------------------------- rights and responsibilities of the Collateral Agent under this Patent and Trademark Security Agreement with respect to any action taken by the Collateral Agent or the exercise or nonexercise by the Collateral Agent of any option, right, request, judgment or other right or remedy provided for herein or resulting or arising out of this Patent and Trademark Security Agreement shall, as between the Collateral Agent and the Holders, be governed by Exhibit E hereto --------- and by such other agreements with respect thereto as may exist from time to time among them, but, as between the Collateral Agent and the Grantor, except as expressly provided in Sections 12 and 13, the Collateral Agent shall be conclusively presumed to be acting as agent for the Investors with full and valid authority so to act or refrain from acting, and the Grantor shall not be under any obligation to make any inquiry respecting such authority. The Collateral Agent hereby waives for the benefit of the Holders any claim, right or Lien of the Collateral Agent against the Collateral arising under applicable law or arising from any business or transaction between the Collateral Agent and the Grantor other than pursuant to this Patent and Trademark Security Agreement or any of the other Transaction Documents. 17. Integration. This Patent and Trademark Security Agreement ----------- represents the agreement of the Grantor and the Collateral Agent with respect to the subject matter hereof, and there are no promises, undertakings, representations or warranties by the Collateral Agent relative to subject matter hereof not expressly set forth or referred to herein. 18. Governing Law. This Patent and Trademark Security Agreement and the ------------- rights and obligations of the Grantor under this Patent and Trademark Security Agreement shall be -14- governed by, and construed and interpreted in accordance with, the law of the State of New York, except to the extent that under the New York Uniform Commercial Code the laws of another jurisdiction govern matters of perfection and the effect of perfection or non-perfection of any security interest granted hereunder. -15- IN WITNESS WHEREOF, the Grantor has caused this Patent and Trademark Security Agreement to be duly executed and delivered as of the date first above written. CEPHALON, INC. By:______________________ Name: Title: ACKNOWLEDGED AND AGREED: DELTA OPPORTUNITY FUND, LTD. By: ______________________ -16- STATE OF _____________ ) ) ss. COUNTY OF ____________ ) On this ___ day of February 1999, before me personally appeared J. Kevin Buchi proved to me on the basis of satisfactory evidence to be the person who executed the above Patent and Trademark Security Agreement as Senior Vice President, Finance and Chief Financial Officer on behalf of Cephalon, Inc., and acknowledged to me that the corporation executed it. WITNESS my hand and official seal. _______________________ NOTARY PUBLIC STATE OF _____________ ) ) ss. COUNTY OF ___________ ) On this _____ day of February 1999, before me personally appeared ________________ proved to me on the basis of satisfactory evidence to be the person who executed the above Patent and Trademark Security Agreement as _____________________ on behalf of Delta Opportunity Fund, Ltd., and acknowledged to me that the corporation executed it. WITNESS my hand and official seal. ______________________ NOTARY PUBLIC -17- EXHIBIT A : PATENT LICENSE AGREEMENT - --------- ------------------------ 1. The License Agreement entered into by and between Laboratoire L. Lafon and Cephalon, Inc. dated as of 20 January 1993, as amended. Rights were transferred to certain patents and patent applications, including but not limited to, the following: ISSUED U.S. PATENTS -------------------
- ------------------------------------------------------------------------------------------------------------------- PATENT NO. TITLE ASSIGNEE ISSUE DATE ---------- ----- -------- ---------- - ------------------------------------------------------------------------------------------------------------------- US 4,177,290 "Acetamide Derivatives" Laboratoire 12/4/79 L.Lafon - ------------------------------------------------------------------------------------------------------------------- US 4,927,855 "Levorotatory Isomer of Benzyhydrylsulfinyl Laboratoire 5/22/90 Derivatives" L.Lafon - ------------------------------------------------------------------------------------------------------------------- US 5,180,745 "Method for Providing a Neuroprotective Effect" Laboratoire 1/19/93 L.Lafon - ------------------------------------------------------------------------------------------------------------------- US unknown "Extrusion and Freeze-Drying Method for Preparing Laboratoire Allowed Particles Containing an Active Ingredient" L.Lafon - ------------------------------------------------------------------------------------------------------------------- US 5,391,576 "Method for Treating and Protecting the Cerebral Laboratoire 2/21/95 Tissue Against Repercussions of Cerebral Ischaemia L.Lafon and Cerebral Infarctions" - ------------------------------------------------------------------------------------------------------------------- US 5,401,776 "Use of Modafinil for the Treatment of Urinary and Laboratoire 3/28/95 Fecal Incontinence" L.Lafon - ------------------------------------------------------------------------------------------------------------------- US 5,612,379 "Modafinil for the Treatment of Sleep Apneas and Laboratoire 4/18/97 Ventilatory Disorders of Central Origin" L.Lafon - -------------------------------------------------------------------------------------------------------------------
A-18 - ----------------------------------------------------------------------------------------------------------------- US 5,719,168 "Acetamide Derivatives and Their Use as Feeding Laboratoire L. 2/17/98 Behavior Modifiers" Lafon - -----------------------------------------------------------------------------------------------------------------
A-19 EXHIBIT B: CEPHALON PATENT -------------------------- - ----------------------------------------------------------------------------------------------------------------- US 5,618,845 "Acetamide Derivative Having Defined Particle Size" Cephalon, Inc. 4/8/97 - -----------------------------------------------------------------------------------------------------------------
B-20 EXHIBIT C: TRADEMARK AGREEMENT ------------------------------ 1. The License Agreement entered into by and between Genelco S.A. and Cephalon, Inc. dated as of 20 January 1993, as amended. Rights were transferred to a certain trademarks, including:
TRADEMARK U.S. REGISTRATION NUMBER REGISTRANT - --------- ------------------------ ---------- PROVIGIL 2,000,231 Genelco, S.A.
C-21 EXHIBIT D: FILINGS REQUIRED TO PERFECT SECURITY INTEREST -------------------------------------------------------- 1. Filing with the Patent and Trademark Office 2. Filing of UCC-1 Financing Statement with the Commonwealth of Pennsylvania 3. Filing of UCC-1 Financing Statement with the Prothonotary of Chester County, Pennsylvania 4. Filing of UCC-1 Financing Statement with the Commonwealth of Pennsylvania 5. Filing of UCC-1 Financing Statement with New Castle County, Delaware D-22 EXHIBIT E: THE COLLATERAL AGENT ------------------------------- 1. Appointment. The Holders (all capitalized terms used in this Exhibit C and not otherwise defined shall have the respective meanings provided in the Patent and Trademark Security Agreement to which this Exhibit C is attached (the "Patent and Trademark Security Agreement")), by their acceptance of the benefits of the Patent and Trademark Security Agreement, hereby irrevocably designate Delta Opportunity Fund, Ltd., as Collateral Agent to act as specified herein and in the Patent and Trademark Security Agreement. Each Buyer hereby irrevocably authorizes, and each other Holder of any Note by the acceptance of such Note shall be deemed irrevocably to authorize, the Collateral Agent to take such action on its behalf under the provisions of the Patent and Trademark Security Agreement and any other instruments and agreements referred to herein or therein and to exercise such powers and to perform such duties hereunder and thereunder as are specifically delegated to or required of the Collateral Agent by the terms hereof and thereof and such other powers as are reasonably incidental thereto. The Collateral Agent may perform any of its duties hereunder by or through its agents or employees. 2. Nature of Duties. The Collateral Agent shall have no duties or responsibilities except those expressly set forth in the Patent and Trademark Security Agreement. Neither the Collateral Agent nor any of its officers, directors, employees or agents shall be liable for any action taken or omitted by it as such under the Patent and Trademark Security Agreement or hereunder or in connection herewith or therewith, unless caused by its or their gross negligence or willful misconduct. The duties of the Collateral Agent shall be mechanical and administrative in nature; the Collateral Agent shall not have by reason of the Patent and Trademark Security Agreement or any other Transaction Document a fiduciary relationship in respect of any Holder; and nothing in the Patent and Trademark Security Agreement, expressed or implied, is intended to or shall be so construed as to impose upon the Collateral Agent any obligations in respect of the Patent and Trademark Security Agreement except as expressly set forth herein. The Collateral Agent shall not be liable for any act it may do or omit to do while acting in good faith and in the exercise of its own best judgment. Any act done or omitted by the Collateral Agent on the advice of its own attorneys shall be deemed conclusively to have been done or omitted in good faith. The Collateral Agent shall have the right at any time to consult with counsel on any question arising under this Patent and Trademark Security Agreement. The Collateral Agent shall incur no liability for any delay reasonably required to obtain the advice of counsel. 3. Lack of Reliance on the Collateral Agent. Independently and without reliance upon the Collateral Agent, each Holder, to the extent it deems appropriate, has made and E-23 shall continue to make (i) its own independent investigation of the financial condition and affairs of the Grantor and its subsidiaries in connection with the making and the continuance of the Obligations and the taking or not taking of any action in connection therewith, and (ii) its own appraisal of the creditworthiness of the Grantor and its subsidiaries, and the Collateral Agent shall have no duty or responsibility, either initially or on a continuing basis, to provide any Holder with any credit or other information with respect thereto, whether coming into its possession before any Obligation arises or the purchase of any Note, or at any time or times thereafter. The Collateral Agent shall not be responsible to any Holder for any recitals, statements, information, representations or warranties herein or in any document, certificate or other writing delivered in connection herewith or for the execution, effectiveness, genuineness, validity, enforceability, perfection, collectibility, priority or sufficiency of the Patent and Trademark Security Agreement or the financial condition of the Grantor or be required to make any inquiry concerning either the performance or observance of any of the terms, provisions or conditions of the Patent and Trademark Security Agreement, or the financial condition of the Grantor, or the existence or possible existence of any Event of Default. 4. Certain Rights of the Collateral Agent. No Holder shall have the right to cause the Collateral Agent to take any action with respect to the Collateral, with only the Majority Holders having the right to direct the Collateral Agent to take any such action. If the Collateral Agent shall request instructions from the Majority Holders with respect to any act or action (including failure to act) in connection with the Patent and Trademark Security Agreement, the Collateral Agent shall be entitled to refrain from such act or taking such action unless and until it shall have received instructions from the Majority Holders, and to the extent requested, appropriate indemnification in respect of actions to be taken by the Collateral Agent; and the Collateral Agent shall not incur liability to any person by reason of so refraining. Without limiting the foregoing, no Holder shall have any right of action whatsoever against the Collateral Agent as a result of the Collateral Agent acting or refraining from acting hereunder in accordance with the instructions of the Majority Holders or as otherwise specifically provided in the Patent and Trademark Security Agreement. 5. Reliance. The Collateral Agent shall be entitled to rely, and shall be fully protected in relying, upon any note, writing, resolution, notice, statement, certificate, telex, teletype or telecopier message, cablegram, radiogram, order or other document or telephone message signed, sent or made by the proper person or entity, and, with respect to all legal matters pertaining to the Patent and Trademark Security Agreement and its duties thereunder, upon advice of counsel selected by it. 6. Indemnification. To the extent the Collateral Agent is not reimbursed and indemnified by the Grantor and/or its subsidiaries, the Holders will reimburse and indemnify the Collateral Agent, in proportion to their respective principal amounts of Obligations, for and against any and all liabilities, obligations, losses, damages, penalties, actions, judgments, suits, costs, expenses or disbursements of any kind or nature whatsoever which may be imposed on, E-24 incurred by or asserted against the Collateral Agent in performing its duties hereunder or under the Patent and Trademark Security Agreement, or in any way relating to or arising out of the Patent and Trademark Security Agreement except for those determined by a final judgment (not subject to further appeal) of a court of competent jurisdiction to have resulted solely from the Collateral Agent's own negligence or willful misconduct. 7. The Collateral Agent in its Individual Capacity. The Collateral Agent and its affiliates may lend money to, purchase, sell and trade in securities of and generally engage in any kind of business with the Grantor or any affiliate or subsidiary of the Grantor as if it were not performing the duties specified herein, and may accept fees and other consideration from the Grantor for services to the Grantor in connection with the Transaction Documents and otherwise without having to account for the same to the Holders; provided, however, that the Collateral Agent on behalf of itself and such affiliates, hereby waives any claim, right or Lien against the Collateral in any way arising from or relating to any such loan, securities transaction or business with the Grantor. 8. Holders. The Collateral Agent may deem and treat the holder of record of any Note as the owner thereof for all purposes hereof unless and until a written notice of the assignment or transfer thereof, as the case may be, shall have been filed with the Collateral Agent. Any request, authority or consent of any person or entity who, at the time of making such request or giving such authority or consent, is the holder of record of any Note shall be conclusive and binding on any subsequent holder, transferee or assignee, as the case may be, of such Note or of any Note(s) issued in exchange therefor. 9. Resignation by the Collateral Agent. (a) The Collateral Agent may resign from the performance of all its functions and duties under the Patent and Trademark Security Agreement at any time by giving 60 Business Days' prior written notice (as provided in the Patent and Trademark Security Agreement) to the Grantor and the Holders. Such resignation shall take effect upon the appointment of a successor Collateral Agent pursuant to clauses (b) and (c) below. (b) Upon any such notice of resignation, the Majority Holders shall appoint a successor Collateral Agent hereunder. (c) If a successor Collateral Agent shall not have been so appointed within said 60 Business Day period, the Collateral Agent shall then appoint a successor Collateral Agent who shall serve as Collateral Agent hereunder or thereunder until such time, if any, as the Majority Holders appoint a successor Collateral Agent as provided above. If a successor Collateral Agent has not been appointed within such 60-day period, the Collateral Agent may petition any court of competent jurisdiction or may interplead the Grantor and Holders in a proceeding for the appointment of a successor Collateral Agent, and all fees, including but not limited to extraordinary fees associated with the filing of interpleader, and expenses associated therewith shall be payable by the Grantor. E-25 (d) The fees of any successor Collateral Agent for its services as such shall be payable by the Grantor. E-26 EXHIBIT F FORM OF PATENT SECURITY AGREEMENT This PATENT SECURITY AGREEMENT dated this _____ day of February 1999, made by Cephalon Inc., a Delaware corporation, ("Grantor") to Delta Opportunity Fund, Ltd., as collateral agent (in such capacity, the "Collateral Agent") on behalf of the Holders. BACKGROUND WHEREAS, Grantor has acquired certain right, title and interest in certain U.S. patents and patent applications (identified in Exhibit A hereto); WHEREAS, Grantor and the Buyers are parties to certain Note Purchase Agreements, dated as of February ___, 1999 (as from time to time amended or supplemented, the "Note Purchase Agreements"), pursuant to which, among other things, the Buyers have agreed to purchase $30,000,000 aggregate principal amount of 11% Revenue Sharing Senior Secured Notes due 2002 (the "Notes"); WHEREAS, it is a condition precedent to the several obligations of the Buyers to purchase their respective Notes that the Grantor shall have executed and delivered a Patent and Trademark Security Agreement to the Collateral Agent for the ratable benefit of the Holders; WHEREAS, Grantor wishes to grant to Collateral Agent a security interest in all of its property and assets to secure the performance of its obligations under the Notes; WHEREAS, the Grantor is contemporaneously entering into a Security Agreement and a Patent and Trademark Security Agreement with the Collateral Agent for the ratable benefit of the Holders; and WHEREAS, Grantor and Collateral Agent by this instrument seek to confirm and make a record of the grant of a security interest in the Patents. F-27 NOW, THEREFORE, for good and valuable consideration, the receipt and adequacy of which are hereby acknowledged, Grantor does hereby acknowledge that it has granted to Collateral Agent a security interest in all of Grantor's right, title and interest in, to, and under the Patents. Grantor also acknowledges and confirms that the rights and remedies of Collateral Agent with respect to the security interests in the Patents granted hereby are more fully set forth in the Patent and Trademark Security Agreement and the Security Agreement, the terms and provisions of which are incorporated herein by reference. CEPHALON DELTA OPPORTUNITY FUND, LTD. By:________________________ By:___________________________ Name: Name Title: Title: F-28 STATE OF ____________________) ) SS: COUNTY OF ___________________) Subscribed and sworn to this ____ day of _______________, 1999. ________________________________ Notary Public My Commission Expires: ___________ F-29 EXHIBIT A ISSUED U.S. PATENTS -------------------
- ------------------------------------------------------------------------------------------------------------ PATENT NO. TITLE ASSIGNEE ISSUE DATE ---------- ----- -------- ---------- - ------------------------------------------------------------------------------------------------------------ US 4,177,290 "Acetamide Derivatives" Lafon 12/4/79 Laboratories - ------------------------------------------------------------------------------------------------------------ US 4,927,855 "Levorotatory Isomer of Lafon 5/22/90 Benzyhydrylsulfinyl Derivatives" Laboratories - ------------------------------------------------------------------------------------------------------------ US 5,180,745 "Method for Providing a Neuroprotective Lafon 1/19/93 Effect" Laboratories - ------------------------------------------------------------------------------------------------------------ US unknown "Extrusion and Freeze-Drying Method for Lafon Allowed Preparing Particles Containing an Active Laboratories Ingredient" - ------------------------------------------------------------------------------------------------------------ US 5,391,576 "Method for Treating and Protecting the Lafon 2/21/95 Cerebral Tissue Against Repercussions of Laboratories Cerebral Ischaemia and Cerebral Infarctions" - ------------------------------------------------------------------------------------------------------------ US 5,401,776 "Use of Modafinil for the Treatment of Lafon 3/28/95 Urinary and Fecal Incontinence" Laboratories - ------------------------------------------------------------------------------------------------------------ US 5,612,379 "Modafinil for the Treatment of Sleep Lafon 4/18/97 Apneas and Ventilatory Disorders of Laboratories Central Origin" - ------------------------------------------------------------------------------------------------------------ US 5,719,168 "Acetamide Derivatives and Their Use as Lafon 2/17/98 Feeding Behaviour Modifiers" Laboratories - ------------------------------------------------------------------------------------------------------------
F-30 - ------------------------------------------------------------------------------------------------------------ US 5,618,845 "Acetamide Derivative Having Defined Cephalon, Inc. 4/8/97 Particle Size" - ------------------------------------------------------------------------------------------------------------
F-31 EXHIBIT G FORM OF TRADEMARK SECURITY AGREEMENT This TRADEMARK SECURITY AGREEMENT dated this ___ day of February 1999, made by Cephalon Inc., a Delaware corporation, ("Grantor") to Delta Opportunity Fund, Ltd., as collateral agent (in such capacity, the "Collateral Agent") on behalf of the Holders. BACKGROUND WHEREAS, Grantor has acquired an interest in a certain trademark (the "Trademark") (identified in Exhibit A hereto); WHEREAS, Grantor and the Buyers are parties to certain Note Purchase Agreements, dated as of February 25, 1999 (as from time to time amended or supplemented, the "Note Purchase Agreements"), pursuant to which, among other things, the Buyers have agreed to purchase $30,000,000 aggregate principal amount of 11% Revenue Sharing Senior Secured Notes due 2002 (the "Notes"); WHEREAS, it is a condition precedent to the several obligations of the Buyers to purchase their respective Notes that the Grantor shall have executed and delivered a Patent and Trademark Security Agreement to the Collateral Agent for the ratable benefit of the Holders; WHEREAS, Grantor wishes to grant to Collateral Agent a security interest in all of its property and assets to secure the performance of its obligations under the Transaction Documents; WHEREAS, the Grantor is contemporaneously entering into a Security Agreement and a Patent and Trademark Security Agreement with the Collateral Agent for the ratable benefit of the Holders; WHEREAS, Grantor and Collateral Agent by this instrument seek to confirm and make a record of the grant of a security interest its interest in the Trademark. G-32 NOW, THEREFORE, for good and valuable consideration, the receipt and adequacy of which are hereby acknowledged, Grantor does hereby acknowledge that it has granted to Collateral Agent a security interest in all of Grantor's interests the Trademark. Grantor also acknowledges and confirms that the rights and remedies of Collateral Agent with respect to the security interests in the Trademark granted hereby are more fully set forth in the Patent and Trademark Security Agreement, the terms and provisions of which are incorporated herein by reference. CEPHALON, INC. DELTA OPPORTUNITY FUND, LTD. By:____________________________ By:___________________________ Name: Name: Title: Title: G-33 STATE OF ____________________) ) SS: COUNTY OF ___________________) Subscribed and sworn to this ____ day of _______________, 1999. __________________________________ Notary Public My Commission Expires: __________ G-34 EXHIBIT A
TRADEMARK U.S. REGISTRATION NUMBER REGISTRANT - --------- ------------------------ ---------- PROVIGIL 2,000,231 Genelco, S.A.
G-35 EX-10.5(H) 8 AMENDMENT NO.5 TO LICENSE AGREEMENT Exhibit 10.5(h) [LOGO OF CEPHALON APPEARS HERE] January 21, 1998 Laboratoire L. Lafon 39, rue Francois ler 75008 Paris FRANCE Re Amendment No. 5 to License Agreement and Supply Agreement Gentlemen: This letter shall serve as an amendment to (i) that certain License Agreement dated as of January 20, 1993, as amended (the "License Agreement"), between Cephalon, Inc. (hereinafter "Cephalon") and Laboratoire L. Lafon (hereinafter "Lafon"); and (ii) that certain Supply Agreement (the "Supply Agreement") dated as of January 20, 1993, as amended, between Cephalon and Lafon. Unless otherwise defined herein, all capitalized terms shall have the meanings ascribed to them in the License Agreement and the Supply Agreement. 1. Under the terms of the License Agreement, Lafon granted Cephalon a license, with the right to sublicense to a Japanese company, to develop and commercialize in Japan products containing the drug substance "modafinil" (the "Compound"). Under the terms of the Supply Agreement, Lafon agreed to supply the Compound to Cephalon or to its sublicensee in Japan. Cephalon hereby provides notice that it has agreed to such a sublicense arrangement with Nippon Shoji Kaisha., Ltd. ("Nippon Shoji"), and in connection with such arrangement, Cephalon and Lafon hereby agree to the following: a. Under the terms of a sublicense, product development and compound supply agreement, Cephalon will grant Nippon Shoji the right to make tablets, use and sell the Product in Japan, and will agree to supply Nippon Shoji with Compound, as well as provide Nippon Shoji with access to certain pre-clinical and clinical data concerning the Product. In consideration of this grant of rights and supply of Compound, Nippon Shoji will pay Cephalon an amount equal to [*] percent ([*]) of Net Sales of Product in Japan (as well as an additional [*] percent ([*]) in connection with the use of a trademark which Cephalon will remit on its behalf directly to the trademark owner). As provided in amendment number four to the License Agreement and the Supply Agreement dated August 23, 1995, Lafon and Cephalon hereby agree to further amend the aforementioned License Agreement and Supply Agreement insofar as the * THE CONFIDENTIAL MATERIAL CONTAINED HEREIN HAS BEEN OMITTED AND HAS BEEN FILED SEPARATELY WITH THE COMMISSION. royalty rate applicable under Article V(2) of the License Agreement for the grant of rights in Japan, and the price to be paid to Lafon by Cephalon under Article 3(b) of the Supply Agreement for the supply of Compound for use in Japan, shall be an amount equal to [*] percent [*]of Net Sales of Product in Japan by Nippon Shoji. b. With reference to Article 8 of the Supply Agreement concerning the right of rejection of Compound, the parties agree that with respect to Compound shipped to Japan, Cephalon shall not be deemed to be in receipt of Compound until the date on which Nippon Shoji has released said Compound into its inventory, and Cephalon shall have thirty (30) days from such date to notify Lafon of its intent to reject. 2. With reference to Article 3 of the Supply Agreement, the parties confirm their understanding with respect to the calculation of compensation to Lafon for the supply of Compound, as follows: a. Lafon will supply Compound to Cephalon free of charge for the following purposes: (i) to conduct pre-clinical and clinical studies in countries in the Territory prior to the date of initial marketing approval in such country, and to conduct such studies subsequent to the date of such initial marketing approval in any given country in the Territory if required by the respective regulatory authorities or if intended for purposes of obtaining new or expanded indications for the Product in such country; (ii) to manufacture Product samples to be distributed by Cephalon prior to the third anniversary date of commercial launch of the Product in the United States (with such amount of Compound not to exceed 120 kilograms during any twelve-month period, unless otherwise mutually agreed); and (iii) to develop a Product formulation that does not contain Compressil(R). b. The initial provisional price for Compound ordered by Cephalon shall be set at an amount equal to US$[*] per kilogram (except for quantities of Compound to be used for those non-commercial purposes specified in subparagraph (a) above, as to which no provisional price or compensation shall be due Lafon). The parties acknowledge that this initial provisional price is based upon the current selling price charged by Lafon for sale of the Product in France; the parties further acknowledge that the selling price to be charged by Cephalon for sale of the Product in the United States may well be lower than such amount, and accordingly, the parties agree to reduce this initial provisional price to properly reflect the actual U.S. selling price promptly after such U.S. selling price is established by Cephalon. Following this adjustment in the provisional price, and as provided in the Supply Agreement, the parties will adjust the provisional price annually (or more often, if necessary) so that said provisional price will reflect accurately the selling price for Product in the Territory. c. Within two months after the end of each calendar year, Cephalon and Lafon will reconcile the provisional price paid by Cephalon for all Compound delivered during such preceding calendar year with the amount of compensation due Lafon under the Supply Agreement. Except for (i) those quantities specified in clause (a) above; * THE CONFIDENTIAL MATERIAL CONTAINED HEREIN HAS BEEN OMITTED AND HAS BEEN FILED SEPARATELY WITH THE COMMISSION. and (ii) a quantity in an amount equal to three percent (3%) of all Compound delivered in such preceding calendar year (in order to properly reflect the ordinary and customary yield loss in preparing the finished Product), Cephalon will pay Lafon for all kilograms of Compound delivered an amount per kilogram equal to the percentage of Net Sales specified in the Supply Agreement (e.g., 11% for Compound sold in the United States), multiplied by the average Net Sales Price per kilogram of Compound sold during the immediately preceding year in the corresponding country within the Territory. 3. Cephalon and Lafon further confirm their understanding as to the calculation of "Net Sales," as defined in Article I of the License Agreement, as follows: a. With respect to calculations to be made under the terms of the License Agreement and the Supply Agreement, Cephalon may deduct from its gross sales proceeds in the Territory the amount of any governmental rebates and allowances (including Medicaid rebates), and the amount of any wholesaler credits or chargebacks, as well as those deductions otherwise specified in such definition. b. With respect to calculations to be made under the terms of the License Agreement (but not the Supply Agreement), Cephalon may further deduct from its gross sales proceeds in the Territory the amount of any uncollected accounts or receivables. Please indicate your consent to the sublicense arrangement described above, and your agreement with the other terms, conditions and clarifications set forth above, by signing this letter in the space provided below, and return an executed copy to us at your earliest convenience. CEPHALON, INC. By /s/ Frank Baldino ---------------------------- Frank Baldino AGREED, ACKNOWLEDGED AND ACCEPTED: LABORATOIRE L. LAFON By: /s/ F.C. Lafon ----------------------------- F.C. Lafon EX-10.5(I) 9 AMENDMENT NO.6 TO LICENSE AGREEMENT Exhibit 10.5(i) [LOGO OF CEPHALON APPEARS HERE] February 2, 1998 Laboratoire L. Lafon 19 Avenue du Professeur-Cadiot 94701 Maisons Alfort France RE: Amendment No. 6 to License Agreement and Supply Agreement --------------------------------------------------------- Gentlemen: This letter agreement shall serve as an amendment to (a) the License Agreement dated January 20, 1993, as previously amended ("License Agreement") between Cephalon, Inc. ("Cephalon") and Laboratoire L. Lafon ("Lafon"), and (b) the Supply Agreement dated January 20, 1993, as previously amended (the "Supply Agreement") between Cephalon and Lafon. All capitalized terms not otherwise defined herein shall be used as defined in the License Agreement. 1. The term "Territory," for all purposes under the License Agreement and the Supply Agreement, is hereby expanded to include the Republics of Italy and San Marino (collectively, the "Italian Territory"). 2. Appendix A to the License Agreement is hereby amended to add all patents and patent applications related to the composition, manufacture or use of modafinil, as filed or registered in the Italian Territory as of the date hereof, including, without limitation, the following: European Patent 91 401 563.1 European Patent 92 403 381.4 3. In consideration of the expansion of the Territory, Cephalon shall pay to Lafon, in addition to the license fees and royalties to be paid by Cephalon for other licensed territories pursuant to Section 1 of Article V of the License Agreement and previous letter agreements, the following license fees totaling [*] US Dollars (USD[*]): a. [*] US Dollars (USD [*]), payable upon Lafon's signature of this letter agreement; * THE CONFIDENTIAL MATERIAL CONTAINED HEREIN HAS BEEN OMITTED AND HAS BEEN FILED SEPARATELY WITH THE COMMISSION. Laboratoire L. Lafon February 2, 1998 Page -2- b. [*] US Dollars (USD [*]), payable upon the initial regulatory approval of a Licensed Product by the Italian Ministry of Health. 4. Sections 3.b and 3.c of the License Agreement shall not apply to the Italian Territory. Instead, the following provisions shall apply to product registration activities in the Italian Territory: 3.b. It is agreed that all product registrations (and applications) within the Italian Territory are to be in CEPHALON's name (or the name of a CEPHALON Affiliate or sublicensee). LAFON shall take such actions as may be required to identify CEPHALON (or its Affiliate or sublicensee) as the applicant and the holder of the product license within the Italian Territory, and, upon request, shall sign any instruments required by applicable law to confirm Cephalon's authorization under this Agreement to apply for any other authorizations required to market the Licensed Product in the Italian Territory, and/or join in any such application by Cephalon, if required. CEPHALON and/or its sublicensee shall have the right to meet with the appropriate regulatory authorities (including pricing and reimbursement authorities), but shall keep LAFON informed of all such meetings and, upon request, shall provide LAFON with copies of all relevant correspondence with such authorities. 3.c. CEPHALON shall conduct, at its own expense, all necessary trials for purposes of obtaining regulatory approvals of the Licensed Product in the Italian Territory. 3.d. LAFON will furnish CEPHALON, upon request, copies of correspondence and communications whether occurring prior to the date hereof or hereafter between LAFON and the Italian regulatory authorities related to applications for marketing approval for the Licensed Product in the Italian Territory. 5. Section l.b. of Article V of the License Agreement is hereby amended and restated in its entirety as follows: "In addition, CEPHALON shall pay to LAFON a royalty on Net Sales of Licensed Products by CEPHALON and/or its sublicensees, calculated at the rate of [*] per cent ([*]) during the first [*] from the date of first commercial sale of the first Licensed Product in each country within the Territory, and [*] per cent ([*]) thereafter in such country." *THE CONFIDENTIAL MATERIAL CONTAINED HEREIN HAS BEEN OMITTED AND HAS BEEN FILED SEPARATELY WITH THE COMMISSION. Laboratoire L. Lafon February 2, 1998 Page -3- 6. Lafon and Cephalon shall cooperate to take all actions that are reasonably available under applicable laws to extend the term of each of the Patents in the Italian Territory including, without limitation, applying for a "Supplementary Protection Certificate" pursuant to Council Regulation (EEC) No. 1768/92 of 18 June, 1992 of The Council of the European Communities. The out-of- pocket costs and expenses associated with such actions shall be shared equally by the parties. 7. Each of Cephalon and Lafon hereby restates its respective representations and warranties made in the License Agreement and the Supply Agreement, as each such agreement has been amended pursuant to this letter agreement. Lafon confirms that it is free to enter into this letter agreement, without obligation to any third party. Cephalon shall not be responsible to any third party asserting a claim through Lafon with respect to the development, manufacture or sale of Licensed Product for the Italian Territory. 8. Except as specifically supplemented by this letter agreement, all provisions of each of the License Agreement and the Supply Agreement (in each case, as amended prior to the date hereof) are confirmed to be and shall remain in full force and effect. If the foregoing is acceptable, please indicate your agreement in the space provided below. CEPHALON, INC By: /s/ Bruce A. Peacock ---------------------------- Bruce A. Peacock, Executive Vice President and Chief Operating Officer Accepted and agreed to this 10th of February, 1998. LABORATOIRE L. LAFON By: /s/ F.C. Lafon ------------------------- F.C. Lafon Chief Executive Officer EX-10.5(J) 10 AMENDMENT NO.3 TO TRADEMARK AGREEMENT Exhibit 10.5(j) [LETTERHEAD OF CEPHALON, INC. APPEARS HERE] January 21, 1998 Genelco S.A. 8 Route de Beaumont 1701 Fribourg Switzerland Re: Amendment No. 3 to Trademark License Agreement Gentlemen: This letter shall serve as an amendment to that certain Trademark Agreement dated as of January 20, 1993, as amended (the "Trademark Agreement"), between Cephalon, Inc. (hereinafter "Cephalon") and Genelco S.A. (hereinafter "Genelco"). Unless otherwise defined herein, all capitalized terms shall have the meanings ascribed to them in the Trademark Agreement. Under the terms of the Trademark Agreement, Genelco granted Cephalon a license, with the right to sublicense to a Japanese company, to use a trademark in connection with the commercialization in Japan of products containing the drug substance "modafinil" (the "Compound"). As required under the terms of the Trademark Agreement, Nippon Shoji will select a trademark for the Product to be used in Japan, and will allow said trademark to be registered in the name of Genelco S.A. In accordance with the terms of the Trademark Agreement, and on behalf of Nippon Shoji, Cephalon shall pay Genelco S.A. an amount equal to [*] percent ([*]) of Net Sales of Product in Japan by Nippon Shoji, subject to the withholding of any tax as required under law. * THE CONFIDENTIAL MATERIAL CONTAINED HEREIN HAS BEEN OMITTED AND HAS BEEN FILED SEPARATELY WITH THE COMMISSION. Please indicate your consent to the arrangement described above, and your agreement with the other terms, conditions and clarifications set forth above, by signing this letter in the space provided below, and return an executed copy to us at your earliest convenience. CEPHALON, INC. By: /s/ Frank Baldino ------------------------------ Frank Baldino GENELCO S.A. By: /s/ [SIGNATURE ILLEGIBLE] ------------------------------ EX-10.5(K) 11 AMENDMENT NO.4 TO TRADEMARK AGREEMENT Exhibit 10.5(k) February 9, 1998 Genelco S.A. 8 Route de Beaumont 1701 Fribourg Switzerland Re: Amendment No. 4 to Trademark Agreement -------------------------------------- Gentlemen: This letter agreement shall serve as an amendment to the Trademark Agreement dated January 20, 1993, as amended prior to the date hereof (the "Trademark Agreement") between Cephalon, Inc. ("Cephalon") and Genelco S.A. ("Genelco"). All capitalized terms not otherwise defined herein shall be used as defined in the Trademark Agreement. 1. The term "Territory," for all purposes under the Trademark Agreement is hereby expanded to include the Republics of Italy and San Marino (collectively, "Italy"). 2. All trademark applications and registered trademarks related to Licensed Products and/or the Compound, including the mark "Provigil", that are or will be filed in the Territory are hereby licensed to Cephalon under the Trademark Agreement. 3. For and in consideration of the expansion of the Territory to include Italy under this Amendment No. 4 (and in addition to any compensation payable under the Trademark Agreement with respect to other countries in the Territory), Cephalon will pay to Genelco, pursuant to Article III(1) of the Trademark Agreement, a royalty with respect to Net Sales of a Licensed Product in Italy that will be calculated at the rate of [*] of such Net Sales. 4. Each of Cephalon and Genelco hereby restates its respective representations and warranties made in the Trademark Agreement, as amended pursuant to this letter agreement. 5. Except as modified by this letter agreement, all provisions of the Trademark Agreement are confirmed to be and shall remain in full force and effect. * THE CONFIDENTIAL MATERIAL CONTAINED HEREIN HAS BEEN OMITTED AND HAS BEEN FILED SEPARATELY WITH THE COMMISSION. Genelco S.A. Amendment No. 4 February 9, 1998 Page 2 If the foregoing is acceptable, please indicate your agreement in the space provided below. CEPHALON, INC. By: /s/ Frank Baldino ------------------------------------- Frank Baldino, Jr., Ph.D. President and Chief Executive Officer Accepted and agreed to this 23/rd/ day of February, 1998. GENELCO S.A. By: /s/ [SIGNATURE ILLEGIBLE] ------------------------------- EX-10.12 12 TOLL MFG. AND PACKAGING AGREEMENT Exhibit 10.12 TOLL MANUFACTURING AND PACKAGING AGREEMENT This Toll Manufacturing and Packaging Agreement is made as of this 24/th/ day of February, 1998, by and between Cephalon, Inc., 145 Brandywine Parkway, West Chester, PA 19380-4245 ("CEPHALON") and Circa Pharmaceuticals, Inc., 33 Ralph Avenue, P.O. Box 30, Copiague, NY 11726-0030 ("CIRCA"'). WHEREAS, CEPHALON holds certain rights to manufacture, market and sell in the United States, Mexico, Japan, the United Kingdom and Ireland, the pharmaceutical product modafinil; WHEREAS, CEPHALON possesses certain know how and other confidential and proprietary information relating to the process of manufacturing and packaging modafinil in finished dosage form; WHEREAS, CEPHALON previously has engaged CIRCA to perform certain manufacturing and consulting activities relating to the supply of modafinil, and now wishes to engage CIRCA on a long-term basis to formulate and package modafinil tablets in dosage form for subsequent sale by CEPHALON in the United States, Mexico, Japan, the United Kingdom and Ireland, and for certain clinical and other purposes; and WHEREAS, CIRCA has suitable facilities and equipment and sufficient qualified personnel at its plant in Copiague, New York to formulate and package commercial quantities of modafinil in dosage form, and is willing to provide such services on the terms and conditions set forth below. NOW, THEREFORE, the parties hereto agree as follows: I. DEFINITIONS As Used in this Agreement: 1.1 "Active Drug Substance" means the compound modafinil having those specifications as set forth on Schedule A hereto. 1.2 "Adverse Experience" or "AE" shall mean any unfavorable and unintended change in the structure (signs), function (symptoms), or chemistry (laboratory data) of the body temporally associated with any use of a Product or of a derivative thereof, whether or not the adverse experience is considered to be related to the use of the Product, including but not limited to any of the following: an unexpected side effect, injury, toxicity or sensitivity reaction, which may include an experience of unexpected incidence and severity; an adverse experience occurring in the course of the use of a drug product in professional practice; an adverse experience occurring in clinical studies; an adverse experience occurring from drug overdose; whether accidental or intentional; an adverse experience occurring from drug abuse; an adverse experience occurring from drug withdrawal; and any significant failure of expected pharmacological action. -1- 1.3 "Affiliate" means any corporation or other business entity which, directly or indirectly, is controlled by, controls, or is under common control with CEPHALON or CIRCA. For this purpose, "control" shall be deemed to mean ownership of fifty percent (50%) or more of the stock or other equity of such entity. 1.4 "Confidential Information" means any confidential or proprietary information relating to the manufacture and packaging of the Product. 1.5 "Product" means modafinil in final packaged dosage forms meeting the Product specifications established in Schedule B hereto. 1.6 "Starting Material" means certain interactive raw material (including without limitation, compressil) necessary to formulate and package the Product to be acquired directly CIRCA, as set forth in Schedule A hereto. 1.7 "Trademark" or "Trademarks" shall mean Provigil(R), as well as any other trademark owned or used by CEPHALON in connection with the Product and listed on Schedule A hereto. II. APPOINTMENT AND TERM 2.1 Appointment. CEPHALON hereby appoints CIRCA, and CIRCA hereby ------------ accepts appointment, as a toll manufacturer to formulate and package the Product. 2.2 Manufacturing and Packaging Services. During the term of this ------------------------------------- Agreement, CIRCA shall formulate Product, which shall include the validation of commercial batches of the Product in accordance with the procedures established in Schedule D hereto, and the preparation of the Product for commercial sale to customers by CEPHALON. In addition, Circa shall label and package Product in accordance with instructions provided by CEPHALON. CEPHALON will supply masters for labels, package inserts and packaging. The content of the labels, package inserts and packaging shall be the sole and exclusive responsibility of CEPHALON. CIRCA will procure, test, inspect and approve all labels, package inserts and packaging used for this Product. CIRCA will submit all new labels, package inserts and packaging used for Product to CEPHALON for approval prior to use. 2.3 Specific Duties. In addition to its general obligations relating to ---------------- formulating and packaging, CIRCA shall perform the following services: (i) receiving and storing all Active Drug Substance; (ii) placing orders for, acquiring and storing all Starting Material and packaging components; -2- (iii) quality control and testing of all Active Drug Substance, Starting Material in process materials, bulk tablets, finished dosage Product and packaging components, in order to assure compliance with all applicable standards and specifications; (iv) managing clearance of customs for all Starting Materials and packaging components, as necessary; (v) conducting stability testing of Product in accordance with the procedures established in Schedule D hereto; and (vi) performing such other services as agreed upon in writing by the parties. 2.4 Term. Unless terminated in accordance with the provisions of Article ---- XX, this Agreement will remain in effect for a period of three (3) years from the date hereof (the "Initial Term"), and shall automatically be renewed for consecutive terms of one year. III. PRODUCT QUANTITY, QUALITY AND MANUFACTURING PROCESSES 3.1 Quantity. CIRCA will manufacture, package and supply to CEPHALON all -------- quantities of Product ordered by CEPHALON or an Affiliate thereof for subsequent sale by CEPHALON or an Affiliate or agent thereof in the United States, Mexico, Japan, the United Kingdom or Ireland, and for certain clinical or other purposes as may be determined by CEPHALON. The parties acknowledge that, during the pendency of this Agreement, CIRCA shall serve as the manufacturer of a majority of Product produced for sale by CEPHALON in such geographic ares, provided however, that CEPHALON shall have no obligation to place any orders for any minimum quantities of Product, and provided further, that CEPHALON may in its sole discretion engage a second toll manufacturer and packager to produce Product for sale in such areas. 3.2 Quality. All Product manufactured by CIRCA for CEPHALON under this ------- Agreement will meet the Product specifications established in Schedule B hereto (the Specifications"), as well as the quality assurance standards established in Schedule C hereto (the "Technical Agreement"). Such Specifications, as well as the terms and conditions of the Technical Agreement, will be provided by CEPHALON, agreed upon by CIRCA, and are subject to modification from time to time by mutual agreement of the parties. 3.3 Manufacturing Processes. Circa has furnished CEPHALON with a copy of ----------------------- its production procedures and has identified to CEPHALON the equipment to be used to produce the Product, all as set forth in Schedule C hereto. CIRCA agrees that it will not modify these procedures, nor modify any method of formulation, packaging, labeling or testing the Product (including analytical procedures, components, process, Specifications, controls, storage, stability protocols), without notifying CEPHALON or obtaining CEPHALON's prior written consent as -3- required in Schedule C hereto. Costs incurred by CIRCA as a result of any such changes or modifications requested by the FDA or by CEPHALON and relating solely to the production of the Product will be borne by CEPHALON; costs for other changes will be borne by CIRCA. IV. TOLLING FEES For each unit of Product made and supplied to CEPHALON under this Agreement (provided it meets the quality requirements established herein) CEPHALON will pay CIRCA a tolling fee in accordance with the terms established in Schedule E hereto. V. CONFIDENTIAL INFORMATION AND KNOW-HOW 5.1 The parties acknowledge that CEPHALON has provided Confidential Information to CIRCA in connection with the formulation and packaging of the Product, and further acknowledge that all such Confidential Information (as well as any additional Confidential information provided to CIRCA by CEPHALON hereunder) shall be subject to the provisions of the Article V. Any and all information, knowledge, technology, and trade secrets relating to the Product or the production, packaging, labeling or testing thereof, including any of the foregoing that is obtained or developed by CIRCA in the performance of this Agreement (herein the "Know-How") shall be held in confidence by CIRCA, and CIRCA shall not use such Know-How for itself or for any third party nor disclose the same to any third party except as provided below. 5.2 CIRCA will disclose to CEPHALON all Confidential Information and Know- How developed by or for CIRCA during the term of this Agreement, promptly as it is developed. CIRCA agrees and acknowledges that any Confidential Information and Know-How, whether developed by CEPHALON, by CIRCA, or by CEPHALON and CIRCA in collaboration hereunder, shall be the property of CEPHALON, and the CIRCA shall have no rights or claims to any such Know-How except insofar as it shall have access to and use of such Know-How to fulfill its obligations hereunder. If any such Know-How is considered to be a patentable invention, CEPHALON shall be responsible for the preparation, filing, prosecution and maintenance of all patent applications and patents covering such invention as provided below. 5.3 All Know-How or other Confidential Information, disclosed or confirmed in writing and designated as confidential by CEPHALON, shall be held in confidence by CIRCA, shall not be used by CIRCA for any purpose except as provided hereunder and shall not be disclosed to third parties except for disclosure to its Affiliates or governmental authorities, or except as otherwise necessary to carry out CIRCA's obligations under this Agreement. If CIRCA finds it necessary to disclose such Confidential Information or Know-How to a third party, CIRCA will not do so without first obtaining the written consent of CEPHALON and entering into an agreement with the third party which binds the third party to the same obligations of restricted use and disclosure as are undertaken by CIRCA in this Agreement. -4- 5.4 CIRCA shall keep all such Know-How and Confidential Information in a special file which shall be solely under the direction and control of CIRCA's senior management. CIRCA shall not distribute any such Know-How or Confidential Information except to its employees who have a need to know in connection with the performance of their duties in satisfying the obligations of CIRCA hereunder. Any CIRCA employee who receives such Know-How or Confidential Information shall be advised as to the confidential nature thereof and the prohibitions contained herein. CIRCA will use its best efforts to keep a record of those individuals who have received copies of the Know-How and Confidential Information or any portions thereof, and all copies of any portions thereof will be identified by CIRCA as confidential. Upon termination of this Agreement, and upon the request of CEPHALON, CIRCA shall return or destroy all such Know-How and Confidential Information and any copies thereof in its possession. 5.5 Termination of this Agreement shall not operate to extinguish CIRCA's obligation to treat Know-How and Confidential Information as provided herein, and the same shall continue in effect in accordance with the Article for ten (10) years with respect to such Confidential Information, and until such Know-How is otherwise disclosed, as the case may be. 5.6 Nothing contained herein shall be deemed to grant to CIRCA, either expressed or implied, a license or other right or interest in the Know-How or in any patent, trademark or other similar property of CEPHALON other than as expressly provided hereunder. 5.7 CIRCA shall not use the name of CEPHALON, or disclose the existence of this Agreement for any marketing, advertising or promotional purpose, without CEPHALON's prior written consent. 5.8 If CEPHALON learns of any confidential or proprietary information of CIRCA that does not relate to the manufacture or packaging of the Product, then the provisions of this Article V shall apply to govern CEPHALON with respect to the treatment of such information. VI. COMPONENT SUPPLY 6.1 Active Drug Substance. CEPHALON will provide free of charge, and --------------------- deliver to CIRCA at its designated production facility not less than thirty (30) days in advance of the date of production of Product, appropriate quantities of Active Drug Substance which meets the specifications established in Schedule A. Following such delivery, CIRCA shall assume full responsibility for the safekeeping and safe handling, and shall bear all risk of loss, of all such Active Drug Substance that is in its possession. Legal title to all Active Drug Substance will remain with CEPHALON, provided however, that CIRCA shall reimburse CEPHALON for the replacement cost of any Active Drug Substance that is lost, contaminated, or destroyed while in the possession of CIRCA. CIRCA will use its best efforts to obtain maximum yield of Product from the Active Drug Substance provided by CEPHALON in connection with the formulation and packaging services provided hereunder. The parties anticipate that the combined yield loss suffered in the course of formulating and packaging the Product in any given lot shall not exceed -5- five percent (5%). Notwithstanding the above, if the yield loss over any given twelve month period during the term hereof exceeds five percent (5%), then CIRCA will reimburse CEPHALON for its costs for that amount of Active Drug Substance lost that exceeds the aforementioned five percent (5%) maximum threshold. Notwithstanding the above, the parties agree to calculate the actual yield loss after production by CIRCA of the first ten (10) batches of Product, and to negotiate in good faith to adjust the aforementioned yield loss threshold if the actual yield loss proves to be substantially more than or less than five percent (5%). 6.2 Starting Material. CIRCA will obtain at its expense Starting Material ----------------- which meets the specifications established in Scheduled A. CIRCA assumes full responsibility and liability for the storage and handling of all Starting Material. 6.3 Packaging Components. Product will be labeled and packaged in -------------------- accordance with instructions provided by CEPHALON. CIRCA will provide to CEPHALON master samples of all labels, package inserts and packaging prior to use and CEPHALON thereafter promptly will approve said master samples. Upon approval by CEPHALON, CIRCA will procure, test, inspect and approve all labels, package inserts and packaging used in connection with the Products. VII. FORECASTS AND ORDERS 7.1 Orders. CEPHALON will submit firm written purchase orders to CIRCA ------ not less than ninety (90) days in advance of the required date of shipment. CEPHALON must deliver all Active Drug Substance necessary to formulate Product for any given shipment to CIRCA not less than ninety (90) days in advance of said date of shipment. 7.2 Forecasts and Forecast Changes. CEPHALON will provide CIRCA with an ------------------------------ initial volume forecast setting forth CEPHALON's anticipated quantity requirements for the forthcoming twelve (12) months on or about the Effective Date, and with rolling, updated volume forecasts on a quarterly basis thereafter. Forecasts provided by CEPHALON to CIRCA hereunder are for planning purposes only. CEPHALON can increase or decrease its firm order quantities with CIRCA's prior agreement and CIRCA can adjust its shipping quantities with CEPHALON'S prior agreeement. Both parties shall accommodate reasonable change requests from the other. VIII. SHIPMENT AND PAYMENT 8.1 CIRCA's Responsibilities. CIRCA will properly prepare the Product so ------------------------ that it may be lawfully and safely shipped to warehouse locations in the United States, Mexico, Japan, the United Kingdom and Ireland as designated by CEPHALON. CIRCA will prepare and execute all necessary shipping documents. CEPHALON will choose the carrier by indicating same on its purchase order provided to CIRCA. -6- 8.2 Terms of Shipment. CIRCA will ship Product ex factory to CEPHALON's ----------------- warehouse or other designated sites. All transport costs and risk of loss during shipment will be borne by CEPHALON. 8.3 Terms of Payment. CEPHALON will pay CIRCA the toll fee within thirty ---------------- (30) days after the date on which CEPHALON receives said invoice from CIRCA, together with copies of all documentation required for Product release as provided in Schedule C hereto. XI. INSPECTION AND ANALYSIS 9.1 Inspection by CIRCA. CIRCA will analyze each Product lot for ------------------- compliance with the Specifications established in Schedule B. CIRCA will send to CEPHALON a certificate of analysis and a certificate of release (together with any other documentation required under procedures established in Schedule C hereto) prior to, or together with, each shipment of Product. In this regard, CIRCA agrees to retain all records and documents necessary to fulfill the requirements established by all applicable regulatory agencies. The parties acknowledge that, subject to the terms set forth in Schedule C hereof, under the laws and regulations of the United Kingdom and Ireland, CEPHALON or its authorized agent shall serve as the designated "Qualified Person" under the laws and regulation for the European Union for purposes of releasing the Product into the market. 9.2 Inspection by CEPHALON. CEPHALON or its authorized representative will ---------------------- inspect all shipments upon their receipt and will report any reasonably discernible defects in the Product to CIRCA within sixty (60) days of its receipt of the Product and related records. Any defects not reasonable discernible will be reported to CIRCA by CEPHALON within thirty (30) days of CEPHALON's discovery of same. 9.3 Non-Conforming Product. If CEPHALON notifies CIRCA in writing that any ---------------------- Product lot does not meet Product Specifications established in Schedule B or in the Technical Agreement set forth in Schedule C as determined by CEPHALON's testing and inspection of the Product, then solely at its option CEPHALON may either (i) demand that CIRCA remanufacture or repackage (as appropriate) said Product at no charge to CEPHALON and pay all round-trip shipping charges to and from the destination of the original shipment, or (ii) be relieved of any obligation to pay CIRCA the toll fees otherwise payable for the manufacture of said Product, and CIRCA shall reimburse CEPHALON for the costs incurred by CEPHALON in properly disposing of the Product. In any event, CIRCA shall not be liable for reimbursing CEPHALON its cost of Active Drug Substance used in formulating such non-conforming Product, provided however, that nothing herein shall be construed to limit CIRCA's obligations established in Section 6.1 hereof. 9.4 Independent Testing. If CEPHALON notifies CIRCA that any Product does ------------------- not meet applicable Specifications or quality assurance guidelines, and CIRCA does not agree with CEPHALON'S position, the parties will attempt to reach a mutually acceptable resolution of the dispute. If they are unable to do so after a reasonable period of time (such period not to exceed three months from the date of original notification), the matter will be submitted to an -7- independent testing laboratory acceptable to both parties. Both parties will accept the judgement of the independent laboratory. The cost of such testing will be borne by the party whose position is determined to have been in error. If the Product is determined by said independent laboratory to have been conforming, then the provisions of Section 9.3 hereof shall not apply, and CEPHALON shall not be relieved of its obligations to pay CIRCA for the production of such Product. X. REPRESENTATIONS AND WARRANTIES 10.1 General. CIRCA represents and warrants to CEPHALON that (i) it has ------- and will maintain throughout the pendency of this Agreement, the expertise, with respect to personnel and equipment, to fulfill the obligations established hereunder, and has obtained all requisite licenses, authorizations and approvals required by federal, state or local government authorities to manufacture the Product; (ii) the production facility, equipment and personnel to be employed to formulate and package the Product will be qualified to manufacture GMP grade product at the time each such batch of Product is produced, and that the production facility to be employed is in compliance with all applicable laws and regulations, provided however, that CEPHALON acknowledges that CIRCA shall not be required to establish or to maintain a dedicated production facility solely on the basis of this representation; (iii) there are no pending or uncorrected citations or adverse conditions noted in any inspection of the production facility to be employed which would cause the Product to be misbranded or adulterated within the meaning of the federal Food, Drug and Cosmetic Act, as amended; (iv) it has provided to CEPHALON all FDA inspection reports and FORM 483s received by CIRCA in the last two (2) years, and that the documents provided are true and complete copies thereof (except as noted); (v) the execution, delivery and performance of this Agreement by CIRCA does not conflict with, or constitute a breach of any order, judgement, agreement, or instrument to which CIRCA is a party; (vi) the execution, delivery and performance of this Agreement by CIRCA does not require the consent of any person or the authorization of (by notice or otherwise) any governmental or regulatory authority (other than those relating to the granting of approval to commercialize the Product); and (vii) CIRCA has not been debarred by the United States Food & Drug Administration ("FDA") under the General Drug Enforcement Act of 1992 (or by any analogous agency or under any analogous law or regulation), and neither it nor any of its officers or directors has ever been convicted of a felony under the laws of the United States or of the Territory for conduct relating to the development or approval of a drug product or relating to the marketing or sale of a drug product, and further that no individual or firm debarred by any governmental authority will participate in the performance, supervision, management or review of the production of Product supplied to CEPHALON under this Agreement. 10.2 Manufacturing Warranty. CIRCA warrants that all products supplied to ---------------------- CEPHALON will be manufactured in accordance with current good manufacturing practices as specified by the applicable laws and regulations of the United States, Mexico, Japan, the European Union, the United Kingdom and of Ireland (as may be applicable), at the time of manufacture. A statement to this effect shall be printed on CIRCA'S certificate of analysis for each batch of Product delivered. Moreover, CIRCA will provide to CEPHALON concurrent with each invoice the applicable batch records and test results establishing such compliance, as -8- provided in Schedule C hereto. 10.3 Product Warranty. CIRCA hereby warrants that all Product delivered to ---------------- CEPHALON (i) will not be adulterated, misbranded, or otherwise prohibited within the meaning of any European Union, national, state or local law or regulation, (ii) will be free from defects in materials (so long as such materials are within the control of CIRCA during the manufacturing process) and manufacture, (iii) will conform to the specification set forth in the applicable Product registration on file with the FDA, the Japanese Ministry of Health and Welfare, the European Medicines Evaluative Agency, any other authority, and (iv) will conform to Specifications as established in Schedule B hereto. 10.4 Environmental Warranty. CIRCA warrants that all waste generated in ---------------------- operations under this Agreement will be stored, transported and disposed of in a safe and environmentally sound manner consistent with all federal, state and local laws and regulations. CIRCA further warrants that it will conduct its business so as to comply with the terms and conditions of all air pollution control permits, sanitary sewer discharge permits, and authorizations required by applicable federal, state and local laws, rules and regulations relating to the protection of the environment. CIRCA will not undertake any production or development activities for itself or on behalf of a third party which, together with the emissions from activities under this Agreement, would cause air emissions from isopropyl alcohol or any other substance to exceed any applicable legal limits. 10.5 Technology Warranty. CEPHALON hereby represents and warrants to CIRCA ------------------- that the technology established in the Specifications, or as otherwise disclosed hereunder (collectively, the "Technology") is, to the best knowledge of CEPHALON, sufficient to enable CIRCA to manufacture and package the Product as contemplated hereunder. Except as otherwise disclosed to CIRCA, CEPHALON owns all right, title and interest to said Technology, free and clear of any adverse ownership claims Except as otherwise disclosed to CIRCA, CEPHALON has not received any notice that any portion of the Technology infringes upon the patent, trade secret or other intellectual property rights or interests of any third party and, to the best knowledge of CEPHALON, there has been no such infringement. XI. QUALITY CONTROL, RECORDS AND INSPECTIONS 11.1 Product and Component Samples. CIRCA will maintain a sample of each ----------------------------- chemical component (including Active Drug Substance) as required by applicable regulatory standards or as otherwise mutually agreed by CEPHALON and CIRCA. CIRCA will be responsible for maintaining retention samples of the Product as may be required by applicable regulatory standards. 11.2 Validation. CIRCA will validate all process, methods, equipment ---------- utilities, facilities and computers used in the formulation, packaging, storage, testing and release of Product in conformance with the provisions of Schedule D hereto, and all applicable laws and regulations. CEPHALON will have the right to review the results of said validation upon request. -9- 11.3 Quality Compliance. CIRCA will provide CEPHALON with timely ------------------ notification of all significant deviations, notes to file, and other deficiencies that may impact the quality of the Product, as well as all FDA reports regarding testing, manufacture, packaging, or labeling of the Product or the production facility. 11.4 Manufacturing Records. CIRCA will maintain complete and accurate --------------------- records relating to the Product and the manufacture, packaging, labeling and testing thereof for the period required by applicable Regulatory Standards, and CIRCA shall provide copies thereof to CEPHALON upon CEPHALON's request. The records shall be subject to audit and inspection under this Article XI. 11.5 Batch Records. CIRCA will supply for each batch of Product, including ------------- each pilot batch, complete batch production and control records. Records which include the information relating to the manufacturing, packaging and quality operation for each lot of Product will be prepared by CIRCA at the time such operations occur. The records will include, without limitation, mixing and filling records; container and component traceability records; equipment usage records; in-process and final laboratory testing results; in-process and final Product physical inspection results; yield reconciliation for bulk and finished Product; labeling and packaging records; and records relating to deviations from approved procedure, as well as CIRCA's investigation and corrective actions. Copies of batch records will be forwarded to CEPHALON prior to or along with shipment of each Product lot. 11.6 Records Retention. CIRCA will retain records and documents for ----------------- periods meeting all applicable regulations of the FDA and other applicable regulatory agencies. 11.7 Regulatory Inspections. CIRCA will promptly inform CEPHALON of any ---------------------- contact, inspection or audit by any governmental agency, related to or affecting the Product. CIRCA will promptly provide CEPHALON with copies of any government-issued inspection observation reports (including without limitation FDA Form 483s) and agency correspondence, that may affect the Product. CIRCA and CEPHALON will cooperate in resolving any concerns with any governmental agency. CIRCA will also inform CEPHALON of any action taken by any governmental agency against CIRCA or any of its officers and employees, within 24 hours after the action is taken. 11.8 CEPHALON Inspections. CEPAHLON or its authorized representative will -------------------- have the right during normal business hours, at reasonable intervals and on reasonable prior notice, to inspect CIRCA's facilities used in the manufacturing, packaging, storage, testing, shipping or receiving of Product and Product components. Such inspections may include GMP inspections and system audits. Representatives of CEPHALON (and its designated Affiliate) will have access during audits to all documents, records, reports, data, procedures, facilities, regulatory submissions, and all other information required to be maintained by applicable government regulations. CIRCA shall take appropriate actions to adopt reasonable suggestions of CEPHALON to correct any deficiencies identified by such inspection or audit. In addition, CEPHALON shall have the right to observe from time to time the manufacture, packaging and quality control testing of the Product by CIRCA, including without limitation, the right to -10- arrange, at its cost and expense, to have a CEPHALON employee or other representative located on the premises of CIRCA's production facility to participate in the monitoring of Product production, testing, packaging and labeling under this Agreement. No testing of the Product by CEPHALON and no inspection or audit by CEPHALON of the CIRCA production facility under this Agreement shall operate as a waiver of or otherwise diminish CIRCA's responsibility to ensure Product quality under this Agreement. XII. COMPLAINTS, ADVERSE EXPERIENCES AND RECALLS 12.1 Product Complaints and AE's. CEPHALON will correspond with ---------------------------- complainants as to any complaints associated with Product, whether received during or after the term hereof. CIRCA will assist CEPHALON in investigating Product complaints by analyzing Product, manufacturing processes and components to determine the nature and cause of an alleged Product manufacturing defect or alleged Product failure. CIRCA will also assist CEPHALON in the investigation of any Adverse Experience (AE) reported to either party when such AEs are believed to be attributable to the Product. If CEPHALON determines that any reasonable pyhsical, chemical, biological or other evaluation should be conducted in relation to an AE or Product compliant, CIRCA will conduct the evaluation and provide CEPHALON with a written report of such evaluation within thirty (30) days from receipt of CEPHALON's written request for same, together with samples of the Product from the relevant lot. CIRCA will notify CEPHALON within 24 hours of any Product that fails to meet the Specifications set forth in Schedule B hereto. 12.2 AE Reports. CEPHALON or its Affiliates will file any AE Reports ----------- required under United States or foreign laws and regulations for the Product. CIRCA will notify CEPHALON by facsimile transmission of all Product complaints and AEs received within two (2) days of its receipt thereof. All such notices shall be sent to the attention of the Director, Medical Affairs at CEPHALON, facsimile number (610) 738-6313. 12.3 Recall Action. If CEPHALON should elect or be required to initiate a -------------- Product recall, withdrawal or field correction because of (i) supply by CIRCA of Product that does not conform to the Specifications and warranties established by this Agreement or (ii) the negligent or intentional wrongful act or omission of CIRCA, CEPHALON will notify CIRCA and provide a copy of its recall letter prior to initiation of the recall. CIRCA will assist CEPHALON (and its designated Affiliate) in any investigation to determine the cause and extent of the problem. All regulatory authority contacts and coordination of any recall activities will be initiated by CEPHALON. 12.4 Recall Expenses. If any Product is recalled as a result of (i) ---------------- supply by CIRCA of Product that does not conform to the warranties in this Agreement or (ii) the negligent or intentional wrongful act or omission of CIRCA, then CIRCA will bear all costs and expenses of such recall. Recalls for any other reason will be at CEPHALON's expense. If each Party contributes to the cause for a recall, the cost will be shared in proportion to each Party's contribution. -11- 12.5 Recall Records. CIRCA will maintain complete and accurate records --------------- for such periods as may be required by applicable law or regulation, but not less than three (3) years following the applicable date of expiration of a given Product lot, or all Product supplied under this Agreement. XIII. EQUIPMENT Notwithstanding anything to the contrary herein, the parties acknowledge that CEPHALON will reimburse CIRCA for its out-of-pocket expenses incurred in connection with the purchase of certain tablet tooling equipment required for the manufacture, packaging and labeling of the Product (the "Equipment"), including without limitation punches and dies for tablet presses, and special change parts for bottle handling. The parties shall agree in writing on the specifications and costs of any such Equipment and related materials prior to such purchase. CIRCA agrees to use said Equipment solely in connection with the performance of its duties and obligations established hereunder. CIRCA shall maintain all such Equipment in good working order. CEPHALON will be responsible for the cost of purchasing replacement Equipment at the end of its useful life, provided however that CIRCA will be responsible for any such costs stemming from damage or premature or undue wear and tear to the Equipment based upon neglect for misuse by CIRCA. CEPHALON shall retain title to such Equipment, which will be returned by CIRCA at the request of CEPHALON following termination of this Agreement. XIV. INSURANCE During the term hereof, CIRCA shall maintain product liability/completed operations insurance for and providing coverage of not less than TEN MILLION AND 00/100 DOLLARS ($10,000,000.00) per occurrence and in the aggregate providing a defense for and insuring CIRCA against all costs, fees, judgments, and liabilities arising out of or alleged to rise out of its obligations and representations and warranties under this Agreement. In addition, CIRCA will maintain at all times sufficient property casualty insurance to cover the total quantity of Active Drug Substance and Product on hand at its full cost of replacement. CIRCA will provide to CEPHALON, upon request, evidence of such insurance overages. CIRCA further agrees to cause such policies to name CEPHALON as an additional insured at no cost to CEPHALON. XV. TRADEMARKS 15.1 CIRCA shall have the non-exclusive right to use the Trademarks in packaging the Product in connection with fulfilling its obligations hereunder. The rights granted CIRCA hereunder to use the Trademarks shall in no way affect CEPHALON's ownership of such Trademarks. No other right, title or interest in the Trademarks is established hereby, and nothing herein shall be construed to grant any right or license to CIRCA to use the CEPHALON trademark or the name CEPHALON, other than as specifically set forth herein. -12- 15.2 CIRCA shall not make any use or take any action with respect to the Trademarks to prejudice or infringe CEPHALON's rights thereto including the use of any confusingly similar trademark and shall forthwith, upon objection by CEPHALON, desist from any use thereof or action therewith which is in violation of this Agreement. 15.3 CIRCA will only market the Product using the relevant Trademarks as listed in Schedule A during the term of this Agreement. Upon termination of this Agreement, CIRCA will cease all use of the Trademarks and cancel any license to such Trademarks granted hereunder. 15.4 CIRCA will use the Trademarks in strict accordance with the instructions given by CEPHALON, and shall refrain from making any changes in connection therewith without first obtaining CEPHALON's written consent. CIRCA further agrees that at all times the Trademarks shall be used in accordance with good trademark practice, including notation of the fact that they are trademarks and use of the appropriate notice of registration. CEPHALON reserves the right to unilaterally determine the adequacy of the use and protection given the Trademarks by CIRCA as set forth herein. 15.5 CIRCA shall notify CEPHALON, in writing, of any conflicting use of and applications or registrations for, any of the Trademarks, or any acts of infringements, or acts of unfair competition involving the Trademark, promptly after such matters are brought to its attention or its has knowledge thereof. CIRCA further agrees to assist CEPHALON, at CEPHALON's expense, in registering or perfecting CEPHALON's rights to the Trademarks in the Territory. 15.6 In the event of any claim or litigation by a third party against CIRCA alleging that any of the Trademarks initiates or infringes a trademark of such third party or is invalid, CIRCA shall promptly give notice of such claims or litigation to CEPHALON and CEPHALON shall assume responsibility for and control of the handling, defense or settlement thereof. CIRCA shall cooperation fully with CEPHALON during the pendency of any such claim or litigation. CEPHALON shall keep CIRCA notified of the current status of any trademark claim, litigation or infringement of any of the Trademarks and shall permit CIRCA to assume the handling, defense or settlement thereof if CEPHALON declines to do so. CEPHALON may at any time modify adopt or withdraw from use of any Trademark without any liability to CIRCA. XVI. INVENTIONS Any inventions or discoveries made by CIRCA in the performance of this Agreement that relate to the Product (including any new use or change in the method of producing, testing or storing the Product) shall be owned by CEPHALON. Any other invention or discovery made by CIRCA in the performance of this Agreement shall be owned by CIRCA, but CEPHALON shall have a nonexclusive, perpetual, nontransferable, paid-up license to use any such invention to make or have made the Product. Each party shall execute such instruments as shall be required to evidence or effectuate the other party's ownership of any such inventions, and shall cooperate upon reasonable request (and at the expense of the requesting party) in the prosecution of patents -13- and other intellectual property rights related to any such invention. XVII. INDEMNIFICATION 17.1 By CIRCA. CIRCA will indemnify and hold CEPHALON harmless from --------- any and all liability, damage, loss, cost, or expense (including reasonable attorneys' fees) which arise from (i) CIRCA'S breach of any of the covenants, warranties, and representations contained herein, or (ii) CIRCA's negligence or other wrongful conduct as determined by a court of competent jurisdiction. 17.2 By CHEPHALON. CEPHALON will indemnify and hold CIRCA harmless ------------- from any and all liability, damage, loss, cost, or expense (including reasonable attorneys' fees) which arise from (i) CEPHALON'S breach of any of the covenants, warranties, and representations contained herein, or (ii) CEPHALON's negligence or other wrongful conduct as determined by a court of competent jurisdiction, or (iii) a claim that the manufacture of the Product by CIRCA in accordance with this Agreement infringes a patent registered in the United States, or any other jurisdiction. 17.3 By Each Party. In the event that negligence or willful -------------- misconduct of both CIRCA and CEPHALON contribute to any such loss, damage, claim, injury, cost or expense, CIRCA and CEPHALON will each indemnify and hold harmless the other with respect to that portion of the loss, damage, claim, injury, cost or expense attributable to its negligence or willful misconduct. 17.4 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 including the retention of legal counsel engaged to handle such matter. The indemnifying party hereunder will be liable for any costs associated with the settlement of any claim or action brought against it or other party unless it has received prior notice of the settlement negotiations and has agreed to the settlement. XVIII. FURTHER ENGAGEMENTS If CEPHALON develops a revised formulation of the Product, or otherwise desires to engage CIRCA to formulate or package pharmaceutical products other than the Product, then the parties will negotiate in good faith to reach agreement on mutually acceptable terms and conditions under which this Agreement shall be expanded to cover such additional engagement(s). -14- XIX. TERMINATION 19.1 Without Cause. CEPHALON may terminate this Agreement, effective on -------------- the third anniversary of the date hereof or on subsequent anniversary date(s), if applicable, by giving three (3) months written notice to CIRCA. 19.2 Breach. If either party hereto commits a material breach of any of ------- its obligations hereunder, the non-breaching party may, at its option, terminate this Agreement by giving the other party at least sixty (60) days prior written notice of its intent to terminate this Agreement, which notice shall specify the breach and the termination date, unless the breaching party cures said breach prior to the specified termination date (or prior to the expiration of a longer period as may be reasonably necessary to cure such breach, provided that the breaching party is making diligent efforts to cure such breach, and provided further that such longer period shall not in any event exceed one hundred twenty (120) days from the date of notice.) 19.3 Insolvency. Either party may terminate this Agreement immediately in ----------- its entirety if the other Party files a petition of bankruptcy, is adjudged bankrupt, takes advantage of any insolvency act, or executes a bill of sale, deed of trust, or assignment for the benefit of creditors. 19.4 Survival. The rights and obligations contained in sections covering --------- representations and warranties, indemnification and confidentiality will survive termination of this Agreement, as will any rights to payment or other rights or obligations that have accrued under this Agreement prior to termination. Termination will not affect the liability of either party by reason of any act, default, or occurrence prior to said termination. 19.5 Transfer. If either party terminates this Agreement, CIRCA will upon --------- request provide reasonable assistance in transferring production of Product to a facility owned by CEPHALON or a third party selected by CEPHALON. 19.6 Return of Product and Components. Upon termination under this -------------------------------- Article, CIRCA shall return promptly to CEPHALON all Product, Active Drug Substance, and packaging components in its possession on the effective date of termination. XX. ALTERNATE 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. 20.1 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 contract terms. 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. -15- 20.2 If any dispute or claim arising under this contract cannot be readily resolved by the parties pursuant to the process described in Section 21.1, the parties agree to refer the matter to a panel consisting of one (1) senior executive employed by each party who is not directly involved in the claim or dispute for review and resolution. A copy of the contract terms, agreed upon facts (and areas of disagreement), and concise summary of the basis for each side's contentions will be provided to both such senior executives who shall review the same, confer, and attempt to reach a mutual resolution of the issue. 20.3 If the matter has not been resolved utilizing the process set forth in this Article XXI, and the parties are unwilling to accept the non-binding decision of the panel, either or both parties may elect to pursue resolution through litigation, or other legal remedies available to the parties. XXI. MISCELLANEOUS 21.1 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 hereof. 21.2 Severability. In the event that any provision of this Agreement is ------------ found to be invalid or unenforceable, then the offending provision shall not render any other provision of this Agreement invalid or unenforceable, and all other provisions shall remain in full force and effect and shall be enforceable, unless the provisions which have been found to be invalid or unenforceable shall substantially affect the remaining rights or obligations granted or undertaken by either party. 21.3 Entire Agreement. This Agreement, including all those Schedules ---------------- appended hereto, 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, including without limitation that certain Manufacturing Agreement between the parties dated as of November 14, 1994 (except for those provisions thereof that were designated by the parties to survive termination of said Manufacturing Agreement). Further, this Agreement may not be changed, modified, amended or supplemented except by written instrument signed by both parties. 21.4 Assignability. This Agreement and the rights hereunder may not be ------------- assigned or transferred by either party without the prior written consent of the other party (other than for rights to payment), provided however, that either party may assign this Agreement to an Affiliate, and provided further that in the event of a merger, acquisition or sale of substantially all of the assets of CEPHALON, the rights and obligations of CEPHALON under this Agreement may be assigned to the survivor or purchaser in that transaction. In the event that this Agreement is assigned, it shall be binding upon and inure to the benefit of the parties and their respective successors and assigns. -16- 21.5 Further Assurances. Each party hereto agrees to execute, acknowledge ------------------ and deliver such further instruments, and to take such other actions, as may be necessary or appropriate in order to carry out the purposes and intent of this Agreement. 21.6 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 waiver of the provision of itself. 21.7 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. A party whose performance has been excused will perform such obligations as soon as is reasonably practicable after the termination or cessation of such event or circumstance. 21.8 Remedies. CIRCA agrees and acknowledges that its failure to produce -------- Product, its disclosure of Confidential Information, or the breach of any other provision set forth in this Agreement may cause irreparable harm to CEPHALON, and therefore that any such breach or threatened breach will entitle CEPHALON to injunctive relief, in addition to any other legal remedies available to CEPHALON in a court of competent jurisdiction. 21.9 Governing Law. This Agreement shall in all respects be construed and ------------- enforced in accordance with the laws of the State of Delaware. 21.10 Independent Contractors. The parties are independent contractors ----------------------- under this Agreement. Nothing contained in this Agreement is to be construed so as to constitute CEPHALON and CIRCA as partners, agents or employees of the other, including with respect to this Agreement. Neither party hereto shall have any express or implied right or authority to assume or create any obligations on behalf of, or in the name of, the other party or to bind the other party to any contract, agreement or undertaking with any third party unless expressly so authorized in writing by the other party. 21.11 Counterparts. This Agreement may be executed in multiple ------------ counterparts, each of which shall be considered and shall have the force and effect of an original. 21.12 Notices. Except as set forth in Section 12.2 above, or as otherwise ------- stated herein, all notices, consents or approvals required by this Agreement shall be in writing and sent by certified or registered air mail, postage prepaid or by facsimile or cable (confirmed by such certified or registered mail) to the parties at the following addresses or such other addresses as may be designated in writing by the respective parties. Notices shall be deemed effective on the date of mailing. -17- Director, Technical Operations Cephalon, Inc. 145 Brandywine Parkway West Chester, PA 19380-4245 Facsimile: (610) 344-7563 General Manager Circa Pharmaceuticals, Inc. 33 Ralph Avenue P.O. Box 30 Copiague, New York 11726-0030 Facsimile: (516) 842-8630 IN WITNESS WHEREOF, the undersigned parties have caused this Agreement to be executed as of the date first above written. CEPHALON, INC. By: /s/ Bruce A. Peacock ------------------------------------ Bruce A. Peacock CIRCA PHARMACEUTICALS, INC. By: /s/ Stan J. Martinez ------------------------------------ -18- SCHEDULE A ---------- ACTIVE DRUG SUBSTANCE AND STARTING MATERIAL SPECIFICATIONS; TRADEMARKS ---------------------------------------------------------------------- The parties have agreed upon all those applicable specifications for the Active Drug Substance and Starting Materials as set forth in the following documents. Any modifications to any such specifications shall be agreed upon by the parties. DCRA # DOCUMENT # TITLE - ------ ---------- ----- 893 PKG/CAPLINER Packaging Component - Cap Liner (PE) 892 PKG/DESS Packaging Component - Desiccant Canister 891 PKG/HDPE Packaging Component - HDPE Container 894 PKG/RAYON Packaging Component - Rayon Coil 865 RM/CRMLNA Raw Material - Croscarmellose Sodium, NF 864 RM/CRN STR Raw Material - Corn Starch [*] 867 RM/LACHY Raw Material - Lactose Monohydrate, NF 929 RM/MAGSIL Raw Material - Magnesium Silicate [*] 869 RM/MAGSTR Raw Material - Magnesium Stearate, NF 873 RM/MODAF Raw Material - Modafinil 870 RM/PVP Raw Material - Povidone, USP 907 RM/PWATER Raw Material - Purified Water, USP 872 RM/TALC Raw Material - Talc, USP 875 STD/MODAF Requalification of Standard - Modafinil 876 VQ/MODAF Vendor Qualification - Modafinil * THE CONFIDENTIAL MATERIAL CONTAINED HEREIN HAS BEEN OMITTED AND HAS BEEN FILED SEPARATELY WITH THE COMMISSION. -19- Int. Cl.: 42 Prior U.S. Cls.: 100 and 101 Reg. No. 1,983,615 United States Patent and Trademark Office Registered July 2, 1996 - ----------------------------------------------------------------------- SERVICE MARK PRINCIPAL REGISTER [LOGO] CEPHALON, INC. (DELAWARE CORPORATION) 145 BRANDYWINE PARKWAY WEST CHESTER, PA 19380 FOR: BIOFILARMACEUTICAL RESEARCH AND DEVELOPMENT SERVICES, NAMELY DEVELOPING FOR OTHERS DIAGNOSTIC AND THERAPEUTIC AGENTS FOR DISEASES OF ANIMALS AND HUMANS, IN CLASS 42 (U.S. CLS. 100 AND 101). FIRST USE 6-0-1988: IN COMMERCE 6-0-1988 THE STIPPLING IN THE DRAWING IS FOR SHADING PURPOSES ONLY. THE MARK IS A STYLIZED LETTER "C" DESIGN SER. NO. 74-622-072, FILED 1-17-1995 DAVID H. STINE, EXAMINING ATTORNEY Provigil(R) Cephalon(R) -20- SCHEDULE B ---------- PRODUCT SPECIFICATIONS ---------------------- The parties have agreed upon all those applicable specifications for the Product as set forth in the following documents. Any modifications to any such specifications shall be agreed upon by the parties. DCRA # DOCUMENT # TITLE - ------ ---------- ----- 877 BL/MODAF Master Blend - Modafinil Tablets 878 FP/100MODAF Finished Product - Modafinil 100 mg Tablets 890 FP/100MODAFEUR Finished Product Modafinil 100 mg Tablets (European) [*] 881 FP/200MODAF Finished Product - Modafinil 200 mg Tablets [*] 875 STD/MODAF Requalification of Standard - Modafinil * THE CONFIDENTIAL MATERIAL CONTAINED HEREIN HAS BEEN OMITTED AND HAS BEEN FILED SEPARATELY WITH THE COMMISSION. -21- SCHEDULE C ---------- TECHNICAL AGREEMENT ------------------- -22- [LOGO OF CIRCA PHARMACEUTICALS, INC.] CEPHALON - CIRCA TECHNICAL AGREEMENT FOR THE COMMERCIAL MANUFACTURING AND TESTING OF PROVIGIL(R) DRUG PRODUCT I. PURPOSE AND SCOPE This is the Quality Assurance policy between Cephalon and Circa. This agreement specifies the QA responsibilities and requirements of each party for the commercial manufacturing and testing of Provigil(R) Drug Product. This policy also specifies the Provigil related requirements for record keeping, quality reporting, and change control. II. DEPARTMENTS AFFECTED Quality Assurance - Cephalon Quality Assurance - Circa Commerical Operations - Cephalon Quality Control - Circa Regulatory Affairs - Cephalon Manufacturing Operations - Circa Regulatory Affairs - Circa III. RESPONSIBILITY It is the responsibility of the Quality Assurance management at Cephalon and Circa, in cooperation with Manufacturing Operations, Quality Control and Regulatory Affairs, to assure compliance with this agreement. IV. RESPONSIBILITIES AND REQUIREMENTS - CIRCA A. Circa Responsibilities . Manufacture and test Provigil Drug Product in accordance with cGMP and the approved Provigil marketing applications. . Perform a Quality review of every lot of Provigil drug product and subsequently release or reject the lot in accordance with cGMP. . All initial and stability testing of both active and inactive components and finished dosage forms are performed in-house by the staff of the Circa Quality Control Department in accordance with approved specifications and procedures (as listed in this agreement) and/or the approved Provigil marketing applications and protocols for Provigil drug product. [LOGO OF CIRCA APPEARS HERE] . Quality Control Raw Material Report for release of each lot of modafinil drug substance tested and released for use in the manufacturing of Provigil drug product. . Quality Control Release Report for each lot of Provigil Master Blend used in the manufacturing of Provigil drug product. . Quality Control Release Report for each lot of Provigil Compression Process used in the manufacture of Provigil drug product. . Certificate of Release (to Cephalon) for each labeled and packaged lot of Provigil final drug product. . All investigations, incident reports, anomaly reports, associated with the manufacturing and testing of every lot of Provigil. The following documents shall be provided to Cephalon on a schedule mutually agreed to by Circa and Cephalon or on an as need basis: . Stability Reports . Product Quality Review Reports (Summarized annually as the "Annual Product Review)" - Summary Report - Product complaints - Summary Report - Incident reports and anomaly explanation reports - Summary Report - Production deviations - Summary Report - Out-of-specification results - Summary Report - QA product disposition - Summary Report - In-process and finished product data trends - Summary Report - Retain sample evaluation V. RESPONSIBILITIES AND REQUIREMENTS - CEPHALON A. RESPONSIBILITIES . Cephalon's QA shall review the Provigil summary lot file documentation prior to market distribution. Documentation of the sponsor review and disposition will be provided to Circa prior to the shipment of the lot to the designated distributor. [LOGO OF CIRCA APPEARS HERE] . To assure that all raw materials and packaging components are tested and released, as per the most current Specifications and Procedures (as listed in this agreement), and/or the approved Provigil marketing applications and Standard Operating Procedures, prior to usage in the manufacturing of Provigil drug product. . The manufacturing and packaging is to be executed under the most current Master Batch and Packaging Records (as listed in this agreement), that are controlled through Circa's internal change control procedure. . Compile and report the following Provigil specific information necessary for the periodic product quality assessment: - Investigations; - Deviations; - List of Provigil Lots Released; - List of Provigil Lots Rejected; - Product Complaints; and - Product Stability - In-Process and Finished Product Data Trends - Retain Sample Evaluation B. Change Control - Circa Circa shall not implement, modify or delete any specification, process, or procedure directly related to the manufacture or testing of Provigil Drug Product, or change the equipment used, or change the vendors, without notifying Cephalon or without prior written approval from Cephalon. The following require joint Cephalon - Circa approval prior to implementation, ------------------------- modification or deletion: . Master Batch Formula: Master Blend . Master Batch Formula: 100 mg Compression Process . Master Batch Formula: 200 mg Compression Process . Modafinil Raw Material Specification and Procedure: RM/MODAF . In-Process Specification and Procedure: BL/MODAF . Finish Product Specification and Procedure, Provigil Tablets, 100 mg FP/100 MODAF . Finished Product Specification and Procedure, Provigil Tablets, 200 mg FP/200 MODAF . Stability Specification and Procedure, Provigil Tablets, 100 mg STAB/100 MODAF . Stability Specification and Procedure, Provigil Tablets, 200 mg STAB/200 MODAF . Raw Material Specification and Procedure for Magnesium Silicate [*] RM/MAGSIL . Master Packaging Record: Provigil Tablets, 100 mg Capsule Shaped * THE CONFIDENTIAL MATERIAL CONTAINED HEREIN HAS BEEN OMITTED AND HAS BEEN FILED SEPARATELY WITH THE COMMISSION. [LOGO OF CIRCA APPEARS HERE] . Master Packaging Record: Provigil Tablets, 200 mg . Other procedures, processes, and documentation exclusive to Provigil manufacturing and testing operations...for example: - Provigil Process Validation - Provigil Cleaning Validation The following require Cephalon notification prior to implementation, --------------------- modification or deletion: . "Spec & Pros" specific (but not exclusive) to the manufacturing and testing operations of Provigil Drug Product. . Raw Material Specifications and Procedure for the following: Purified Water, USP: RM/Water [*] Providone K90D, USP: RM/PVP Lactose Monohydrate, NF: RM/LACHY Corn Starch, NF: RM/CRNSTR Croscarmellose Sodium NF: RM/CRMLNA Talc USP: RM/TALC Magnesium Stearate, NF: RM/MAGSTR . Other procedures, processes, and documentation specific to Provigil or the Cephalon sponsored drug product applications...for example: - Addition or deletion of a Circa qualified outside testing laboratory - Circa's facilities and equipment specific in the manufacturing and testing of Provigil, including but not limited to: [*] C. SUMMARY DOCUMENTATION AND REPORTS - CIRCA Circa shall provide Cephalon with documentation specific to the manufacturing testing and quality review of Provigil drug product as indicated below. Upon request, Circa shall provide any and all Provigil specific manufacturing, testing, QA and distribution documentation (Lot File documentation). At a minimum, a copy of the following documents shall be provided to Cephalon prior to the initial shipment of each lot of Provigil final product: * THE CONFIDENTIAL MATERIAL CONTAINED HEREIN HAS BEEN OMITTED AND HAS BEEN FILED SEPARATELY WITH THE COMMISSION. [LOGO OF CIRCA APPEARS HERE] Cephalon's Professional Services will receive and report adverse drug experiences (ADEs). All spontaneous reports of adverse events received by Circa or Cephalon will be directed to Cephalon as follows: Cephalon, Inc. Professional Services Representative 145 Brandywine Parkway West Chester, PA 19380-4245 Telephone: 1-800-896-5855 Fax: 610-738-6313 . Cephalon's Professional Services will receive product quality complaints. All product complaints received by Circa or Cephalon will be directed to Cephalon's Professional Services as specified above. Cephalon will forward all product quality complaints to Circa and processed in accordance with Circa's drug quality complaint procedure. . Cephalon's Quality Assurance is ultimately responsible for all Provigil recall activities. . Cephalon's will periodically monitor and audit Circa's manufacturing and testing operations for compliance to the Provigil NDA and for compliance to cGMP. B. DOCUMENTATION AND REPORTS . A copy of the Cephalon QA Provigil final product disposition will be sent to Circa to effect the shipment of same lot to the designated distributor (CORD). . Cephalon will report all Provigil product quality complaints to Circa within 10 working days of receipt. /s/ Robert Urban 9/17/97 ---------------------------------------------- --------- Cephalon, Inc. Manufacturing Operations Date /s/ Doug Claney 9/17/97 ---------------------------------------------- --------- Cephalon, Inc. Quality Assurance Date /s/ [SIGNATURE ILLEGIBLE] 9/16/97 ---------------------------------------------- --------- Circa Pharmaceuticals, Inc. Regulatory Affairs Date /s/ [SIGNATURE ILLEGIBLE] 9/16/97 ---------------------------------------------- --------- Circa Pharmaceuticals, Inc Quality Assurance Date SCHEDULE D ---------- PRODUCT VALIDATION AND STABILITY TESTING PROCEDURES --------------------------------------------------- The parties have agreed upon all those applicable specifications for Product validation and stability testing as set forth in the following documents. Any modifications to any such specifications shall be agreed upon by the parties. DCRA # DOCUMENT # TITLE - ------ ---------- ----- 874 RD/RA/MODAF Residual Active Assay - Modafinil Cleaning Validation 880 STAB/100MODAF Stability - Modafinil 100 mg Tablets 889 STAB/100MODAFEU Stability - Modafinil 100 mg Tablets (European) 883 STAB/200MODAF Stability - Modafinil 200 mg Tablets 875 STD/MODAF Requalification of Standard - Modafinil PV-001-10047 Process Validation Protocol - Master Blend for Modafinil 100 mg & 200 mg Tablets PV-002-11047 Process Validation Protocol - Compression Process for Modafinil 100 mg Tablets PV-003-11047 Process Validation Protocol - Compression Process for Modafinil 200 mg Tablets PV-004-06057 Process Validation Protocol - Packaging Process for Modafinil 100 mg & 200 mg Tablets CV-003-21047 Cleaning Validation Protocol - Modafinil 200 mg Tablets -23- SCHEDULE E ---------- TOLLING FEES ------------ CEPHALON shall pay CIRCA the following amounts in consideration of the formulation and packaging services rendered hereunder: BATCH PRICING COST/BATCH ------------- ---------- . A single lot per P.O. and delivery Date: Provigil(R) 100 mg packed in 100 counts [*] Provigil(R) 100 mg packed in 12 counts Provigil(R) 200 mg packed in 100 counts Provigil(R) 200 mg packed in 6 counts . 3 or more of the same batch on a single P.O. with the same delivery date: Provigil(R) 100 mg packed in 100 counts [*] Provigil(R) 100 mg packed in 12 counts Provigil(R) 200 mg packed in 100 counts Provigil(R) 200 mg packed in 6 counts VOLUME DISCOUNTS: - ---------------- A volume discount will be applied when a determined quantity of batches has been purchased in a 12-month period starting with the anniversary date of the first commercial batch. The determined quantities for the volume discounts are as follows: . [*] Batches: A [*] credit will be applied toward the next P.O. for commercial batches. . [*] Batches: A [*] credit will be applied toward the next P.O. for commercial batches. Beginning on the first anniversary of the effective date of this Agreement and on each anniversary thereafter, the above tolling fees shall be increased or decreased (as the case may be) by the percentage change from the immediately proceeding anniversary date in the Producer Price Index (PPI) for finished pharmaceutical preparations, ethical, as published by the Bureau of Labor Statistics of the U.S. Department of Labor for the region in which the production facility is located. * THE CONFIDENTIAL MATERIAL CONTAINED HEREIN HAS BEEN OMITTED AND HAS BEEN FILED SEPARATELY WITH THE COMMISSION. -24- Page 1 of 2 BUREAU OF LABOR STATISTICS DATA [LOGO] DATA EXTRACTED ON: FEBRUARY 27, 1998 (11:28 AM) PRODUCER PRICE INDEX-COMMODITIES SERIES CATALOG: Series ID: wpu06.35 Not Seasonally Adjusted Group: Chemicals and allied products Item: Preparations, ethical (prescription) Base Date: 8200 DATA:
- --------------------------------------------------------------------------------------------------------------------------------- YEAR JAN FEB MAR APR MAY JUN JUL AUG SEP OCT NOV DEC ANN - --------------------------------------------------------------------------------------------------------------------------------- 1998 162.6 163.4 166.0 167.1 168.2 167.5 168.9 169.8 172.0 172.6 175.1 174.5 169.0 - --------------------------------------------------------------------------------------------------------------------------------- 1989 177.4 177.6 180.3 182.1 182.1 183.4 184.6 187.4 187.7 189.0 190.0 191.1 184.4 - --------------------------------------------------------------------------------------------------------------------------------- 1990 193.1 196.4 197.4 199.5 201.2 199.4 201.0 202.4 202.4 204.4 205.4 206.5 200.8 - --------------------------------------------------------------------------------------------------------------------------------- 1991 208.7 211.5 212.1 216.6 216.7 216.8 219.4 220.8 219.5 223.2 222.5 222.6 217.5 - --------------------------------------------------------------------------------------------------------------------------------- 1992 225.2 227.5 228.5 230.5 230.8 231.3 232.3 234.4 233.2 235.0 234.4 236.9 231.7 - --------------------------------------------------------------------------------------------------------------------------------- 1993 237.2 239.7 240.0 242.1 241.5 241.7 242.8 244.2 243.5 244.9 244.0 244.5 242.2 - --------------------------------------------------------------------------------------------------------------------------------- 1994 247.9 248.5 248.6 249.2 250.7 250.3 249.2 250.2 250.7 250.3 251.9 252.0 250.0 - --------------------------------------------------------------------------------------------------------------------------------- 1995 251.3 253.6 253.3 256.2 255.9 255.4 256.8 257.1 258.8 261.3 261.6 262.6 257.0 - --------------------------------------------------------------------------------------------------------------------------------- 1996 262.3 262.2 263.1 263.4 265.6 266.3 267.1 266.9 266.5 266.6 266.6 267.9 265.4 - --------------------------------------------------------------------------------------------------------------------------------- 1997 270.2 271.0 271.9 271.6 272.7 273.2 273.4 273.5 273.9 275.4(P) 276.4(P) 276.9(P) 273.3(P) - --------------------------------------------------------------------------------------------------------------------------------- 1998 279.4(P) - ---------------------------------------------------------------------------------------------------------------------------------
P: Preliminary. All indexes are subject to revision four months after original publication. [GRAPH APPEARS HERE] DATA HOME PAGE -------------- EX-21 13 SUBSIDIARIES OF CEPHALON, INC. EXHIBIT 21 SUBSIDIARIES OF CEPHALON, INC.
Place of PERCENTAGE NAME Incorporation Ownership - -------------------------------------------------------------------- ------------------- ----------------- Cephalon Development Corporation.................................... Delaware 100% Cephalon Investments, Inc........................................... Delaware 100% Cephalon Technology, Inc............................................ Delaware 100% Cephalon International Holdings, Inc................................ Delaware 100%
EX-23.1 14 CONSENT OF ARTHUR ANDERSEN Exhibit 23.1 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. 33-85776, No. 33- 69096, No. 33-74320, No. 333-02888 and No. 333-20321. ARTHUR ANDERSEN LLP Philadelphia, Pennsylvania March 2, 1999 EX-27 15 FINANCIAL DATA SCHEDULE
5 THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM CEPHALON, INC'S FORM 10-K FOR THE YEAR ENDED DECEMBER 31, 1998 AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS. 0000873364 CEPHALON, INC YEAR DEC-31-1998 JAN-01-1998 DEC-31-1998 3,975,000 63,371,000 0 0 0 72,594,000 33,944,000 13,439,000 94,673,000 18,480,000 15,096,000 0 0 288,000 57,314,000 94,673,000 0 15,655,000 0 0 43,649,000 0 1,874,000 (55,407,000) 0 0 0 0 0 (55,407,000) (1.95) (1.95)
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