10-Q 1 a10-5819_110q.htm 10-Q

Table of Contents

 

 

 

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 


 

FORM 10-Q

 

(Mark One)

 

x

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

 

For the quarterly period ended March 31, 2010

 

 

Or

 

 

o

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 000-19119

 

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.)

 

 

 

41 Moores Road

 

 

P.O. Box 4011

 

 

Frazer, Pennsylvania

 

19355

(Address of Principal Executive Offices)

 

(Zip Code)

 

(610) 344-0200
(Registrant’s Telephone Number, Including Area Code)

 

Not Applicable
(Former Name, Former Address and Former Fiscal Year, If Changed Since Last Report)

 


 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports) and (2) has been subject to such filing requirements for the past 90 days. Yes x   No o.

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes o   No o.

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definitions of “large accelerated filer,” “accelerated filer,” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

 

Large accelerated filer x

 

Accelerated filer o

 

 

 

Non-accelerated filer o

(Do not check if a smaller reporting company)

 

Smaller reporting company o

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o   No x.

 

Indicate the number of shares outstanding of each of the registrant’s classes of common stock, as of the latest practicable date.

 

Class

 

Outstanding as of April 30, 2010

Common Stock, par value $.01

 

75,191,556 Shares

 

 

 



Table of Contents

 

TABLE OF CONTENTS

 

Cautionary Note Regarding Forward-Looking Statements

ii

 

 

 

PART I — FINANCIAL INFORMATION

 

 

 

 

Item 1.

Consolidated Financial Statements

 

 

 

 

 

Consolidated Statements of Operations — Three months ended March 31, 2010 and 2009

1

 

 

 

 

Consolidated Balance Sheets — March 31, 2010 and December 31, 2009

2

 

 

 

 

Consolidated Statement of Changes in Equity — Three months ended March 31, 2010 and 2009

3

 

 

 

 

Consolidated Statements of Cash Flows — Three months ended March 31, 2010 and 2009

4

 

 

 

 

Notes to Consolidated Financial Statements

5

 

 

 

Item 2.

Management’s Discussion and Analysis of Financial Condition and Results of Operations

19

 

 

 

Item 3.

Quantitative and Qualitative Disclosures About Market Risk

32

 

 

 

Item 4.

Controls and Procedures

32

 

 

PART II — OTHER INFORMATION

32

 

 

 

Item 1.

Legal Proceedings

32

 

 

 

Item 1A.

Risk Factors

32

 

 

 

Item 2.

Unregistered Sales of Equity Securities and Use of Proceeds

45

 

 

 

Item 5.

Other Information

45

 

 

 

Item 6.

Exhibits

46

 

 

 

SIGNATURES

47

 

i



Table of Contents

 

CAUTIONARY NOTE REGARDING FORWARD-LOOKING STATEMENTS

 

In addition to historical facts or statements of current condition, this report and the documents into which this report is and will be incorporated contain forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. Forward-looking statements contained in this report or incorporated herein by reference constitute our expectations or forecasts of future events as of the date this report was filed with the Securities and Exchange Commission and are not statements of historical fact. You can identify these statements by the fact that they do not relate strictly to historical or current facts. Such statements may include words such as “anticipate,” “will,” “estimate,” “expect,” “project,” “intend,” “should,” “plan,” “believe,” “hope,” and other words and terms of similar meaning in connection with any discussion of, among other things, future operating or financial performance, strategic initiatives and business strategies, regulatory or competitive environments, our intellectual property and product development. In particular, these forward-looking statements include, among others, statements about:

 

·                  our dependence on sales of PROVIGIL® (modafinil) Tablets [C-IV] and NUVIGIL® (armodafinil) Tablets [C-IV] in the United States and the market prospects and future marketing efforts for PROVIGIL, NUVIGIL, FENTORA® (fentanyl buccal tablet) [C-II], AMRIX® (cyclobenzaprine hydrochloride extended-release capsules) and TREANDA® (bendamustine hydrochloride);

 

·                  any potential approval of our product candidates, including with respect to any expanded indications for TREANDA, NUVIGIL and/or FENTORA;

 

·                  our anticipated scientific progress in our research programs and our development of potential pharmaceutical products including our ongoing or planned clinical trials, the timing and costs of such trials and the likelihood or timing of revenues from these products, if any;

 

·                  our ability to adequately protect our technology and enforce our intellectual property rights and the future expiration of patent and/or regulatory exclusivity on certain of our products;

 

·                  our ability to comply fully with the terms of our settlement agreements (including our corporate integrity agreement) with the U.S. Attorney’s Office (“USAO”), the U.S. Department of Justice (“DOJ”), the Office of the Inspector General of the Department of Health and Human Services (“OIG”) and other federal government entities, the Offices of the Attorneys General of Connecticut and Massachusetts and the various states;

 

·                  our ongoing litigation matters, including litigation stemming from the settlement of the PROVIGIL patent litigation, the FENTORA patent infringement lawsuits we have filed against Watson Laboratories, Inc. (“Watson”) and Barr Laboratories, Inc. (“Barr”), the AMRIX patent infringement lawsuits we have filed against Barr, Mylan Pharmaceuticals, Inc. (“Mylan”), Impax Laboratories, Inc. (“Impax”) and Anchen Pharmaceuticals, Inc. (“Anchen”), and the NUVIGIL patent infringement lawsuits we have filed against Actavis Pharma Manufacturing Pvt Ltd. (“Actavis”), Lupin Limited (“Lupin”), Mylan, Sandoz, Inc. (“Sandoz”), Teva Pharmaceuticals USA, Inc. (“Teva”) and Watson;

 

·                  our future cash flow, our ability to service or repay our existing debt and our ability to raise additional funds, if needed, in light of our current and projected level of operations, acquisition activity and general economic conditions; and

 

·                  other statements regarding matters that are not historical facts or statements of current condition.

 

Any or all of our forward-looking statements in this report and in the documents we have referred you to may turn out to be wrong. They can be affected by inaccurate assumptions we might make or by known or unknown risks and uncertainties. Therefore, you should not place undue reliance on any such forward-looking statements. The factors that could cause actual results to differ from those expressed or implied by our forward-looking statements include, among others:

 

·                  the acceptance of our products by physicians and patients in the marketplace, particularly with respect to our recently launched products;

 

·                  our ability to obtain regulatory approvals to sell our product candidates, including any additional future indications for TREANDA, FENTORA and NUVIGIL, and to launch such products or indications successfully;

 

ii



Table of Contents

 

·                  scientific or regulatory setbacks with respect to research programs, clinical trials, manufacturing activities and/or our existing products;

 

·                  the timing and unpredictability of regulatory approvals;

 

·                  unanticipated cash requirements to support current operations, expand our business or incur capital expenditures;

 

·                  a finding that our patents are invalid or unenforceable or that generic versions of our marketed products do not infringe our patents or the “at risk” launch of generic versions of our products;

 

·                  the loss of key management or scientific personnel;

 

·                  the activities of our competitors in the industry;

 

·                  regulatory, legal or other setbacks or delays with respect to the settlement agreements with the USAO, the DOJ, the OIG and other federal entities, the state settlement agreements and corporate integrity agreement related thereto, the settlement agreements with the Offices of the Attorneys General of Connecticut and Massachusetts, our settlements of the PROVIGIL patent litigation and the ongoing litigation related to such settlements, the FENTORA patent infringement lawsuit we have filed against Watson, the AMRIX patent infringement lawsuits we have filed against Barr, Mylan, Impax and Anchen, and the NUVIGIL patent infringement lawsuits we have filed against Actavis, Lupin, Mylan, Sandoz, Teva and Watson;

 

·                  our ability to integrate successfully technologies, products and businesses we acquire and realize the expected benefits from those acquisitions, including our recent acquisitions of Mepha AG and Ception Therapeutics, Inc.;

 

·                  unanticipated conversion of our convertible notes by our note holders;

 

·                  market conditions generally or in the biopharmaceutical industry that make raising capital or consummating acquisitions difficult, expensive or both;

 

·                  the effect of volatility of currency exchange rates; and

 

·                  enactment of new government laws, regulations, court decisions, regulatory interpretations or other initiatives that are adverse to us or our interests.

 

We do not intend to update publicly any forward-looking statement, whether as a result of new information, future events or otherwise, except as required by law. We discuss in more detail the risks that we anticipate in Part II, Item 1A of this Quarterly Report on Form 10-Q. This discussion is permitted by the Private Securities Litigation Reform Act of 1995.

 

iii



Table of Contents

 

PART I — FINANCIAL INFORMATION

 

ITEM 1. CONSOLIDATED FINANCIAL STATEMENTS

 

CEPHALON, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS

 

(In thousands, except per share data)

(Unaudited)

 

 

 

Three months ended
March 31,

 

 

 

2010

 

2009

 

REVENUES:

 

 

 

 

 

Net Sales

 

$

576,681

 

$

514,366

 

Other revenues

 

19,904

 

5,602

 

 

 

596,585

 

519,968

 

 

 

 

 

 

 

COSTS AND EXPENSES:

 

 

 

 

 

Cost of sales

 

105,043

 

97,770

 

Research and development

 

105,377

 

103,024

 

Selling, general and administrative

 

204,641

 

200,590

 

Restructuring charges

 

744

 

1,637

 

Acquired in-process research and development

 

 

30,750

 

 

 

415,805

 

433,771

 

 

 

 

 

 

 

INCOME FROM OPERATIONS

 

180,780

 

86,197

 

 

 

 

 

 

 

OTHER INCOME (EXPENSE):

 

 

 

 

 

Interest income

 

1,930

 

704

 

Interest expense

 

(26,791

)

(16,604

)

Other income (expense), net

 

(7,271

)

6,539

 

 

 

(32,132

)

(9,361

)

 

 

 

 

 

 

INCOME BEFORE INCOME TAXES

 

148,648

 

76,836

 

 

 

 

 

 

 

INCOME TAX EXPENSE

 

48,311

 

33,054

 

 

 

 

 

 

 

NET INCOME

 

100,337

 

43,782

 

 

 

 

 

 

 

NET LOSS ATTRIBUTABLE TO NONCONTROLLING INTEREST

 

10,228

 

14,801

 

 

 

 

 

 

 

NET INCOME ATTRIBUTABLE TO CEPHALON, INC.

 

$

110,565

 

$

58,583

 

 

 

 

 

 

 

BASIC INCOME PER COMMON SHARE ATTRIBUTABLE TO CEPHALON, INC.

 

$

1.47

 

$

0.85

 

 

 

 

 

 

 

DILUTED INCOME PER COMMON SHARE ATTRIBUTABLE TO CEPHALON, INC.

 

$

1.35

 

$

0.75

 

 

 

 

 

 

 

WEIGHTED AVERAGE NUMBER OF COMMON SHARES OUTSTANDING

 

74,990

 

68,792

 

 

 

 

 

 

 

WEIGHTED AVERAGE NUMBER OF COMMON SHARES OUTSTANDING— ASSUMING DILUTION

 

81,811

 

77,993

 

 

The accompanying notes are an integral part of these consolidated financial statements.

 

1



Table of Contents

 

CEPHALON, INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

(In thousands, except share data)

(Unaudited)

 

 

 

March 31,

 

December 31,

 

 

 

2010 *

 

2009 *

 

ASSETS

 

 

 

 

 

CURRENT ASSETS:

 

 

 

 

 

Cash and cash equivalents

 

$

 1,874,453

 

$

 1,647,635

 

Receivables, net

 

349,271

 

376,076

 

Inventory, net

 

236,649

 

240,576

 

Deferred tax assets, net

 

232,900

 

243,246

 

Other current assets

 

65,920

 

58,423

 

Total current assets

 

2,759,193

 

2,565,956

 

 

 

 

 

 

 

INVESTMENTS

 

12,427

 

12,427

 

PROPERTY AND EQUIPMENT, net

 

432,212

 

451,879

 

GOODWILL

 

583,307

 

590,284

 

INTANGIBLE ASSETS, net

 

945,924

 

981,857

 

DEBT ISSUANCE COSTS

 

17,695

 

18,862

 

OTHER ASSETS

 

35,516

 

36,830

 

 

 

$

 4,786,274

 

$

 4,658,095

 

 

 

 

 

 

 

LIABILITIES AND EQUITY

 

 

 

 

 

CURRENT LIABILITIES:

 

 

 

 

 

Current portion of long-term debt, net

 

$

 827,594

 

$

 818,925

 

Accounts payable

 

99,191

 

88,829

 

Accrued expenses

 

451,720

 

430,209

 

Total current liabilities

 

1,378,505

 

1,337,963

 

 

 

 

 

 

 

LONG-TERM DEBT

 

369,805

 

363,696

 

DEFERRED TAX LIABILITIES, net

 

148,240

 

159,328

 

OTHER LIABILITIES

 

110,354

 

111,728

 

Total liabilities

 

2,006,904

 

1,972,715

 

 

 

 

 

 

 

COMMITMENTS AND CONTINGENCIES

 

 

 

 

 

 

 

 

 

 

 

REDEEMABLE EQUITY

 

196,562

 

207,307

 

 

 

 

 

 

 

EQUITY:

 

 

 

 

 

Cephalon stockholders’ equity:

 

 

 

 

 

Preferred stock, $0.01 par value, 5,000,000 shares authorized, 2,500,000 shares issued, and none outstanding

 

 

 

Common stock, $0.01 par value, 400,000,000 and 200,000,000 shares authorized, 78,270,902 and 78,002,764 shares issued, and 75,184,556 and 74,916,920 shares outstanding

 

783

 

780

 

Additional paid-in capital

 

2,567,453

 

2,534,070

 

Treasury stock, at cost, 3,086,346 and 3,085,844 shares

 

(208,460

)

(208,427

)

Accumulated deficit

 

(68,094

)

(178,659

)

Accumulated other comprehensive income

 

85,135

 

114,194

 

Total Cephalon stockholders’ equity

 

2,376,817

 

2,261,958

 

Noncontrolling interest

 

205,991

 

216,115

 

Total equity

 

2,582,808

 

2,478,073

 

 

 

$

 4,786,274

 

$

 4,658,095

 

 


*Amounts include assets and liabilities of our variable interest entities (VIEs). Our interests and obligations with respect to our VIEs’ assets and liabilities are limited to those accorded to us in our agreements with our VIEs. See Note 2 to these consolidated financial statements for amounts.

 

The accompanying notes are an integral part of these consolidated financial statements.

 

2



Table of Contents

 

CEPHALON, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CHANGES IN EQUITY

(In thousands, except share data)

(Unaudited)

 

 

 

Cephalon Stockholders’ Equity

 

Total

 

 

 

 

 

 

 

 

 

 

 

Additional

 

 

 

 

 

 

 

Accumulated
Other

 

Stockholders’
Equity

 

 

 

 

 

 

 

Common Stock

 

Paid-in

 

Treasury Stock

 

Accumulated

 

Comprehensive

 

Attributable to

 

Noncontrolling

 

 

 

 

 

Shares

 

Amount

 

Capital

 

Shares

 

Amount

 

Deficit

 

Income

 

Cephalon, Inc.

 

Interest

 

Total

 

BALANCE, JANUARY 1, 2009

 

71,707,041

 

$

717

 

$

2,095,324

 

2,970,399

 

$

(201,705

)

$

(521,286

)

$

43,630

 

$

1,416,680

 

$

 

$

1,416,680

 

Net income

 

 

 

 

 

 

 

 

 

 

 

58,583

 

 

 

$

58,583

 

$

(14,801

)

$

43,782

 

Foreign currency translation gains

 

 

 

 

 

 

 

 

 

 

 

 

 

(6,164

)

(6.164

)

 

(6,164

)

Net prior service costs on retirement-related plans

 

 

 

 

 

 

 

 

 

 

 

 

 

(21

)

(21

)

 

(21

)

Unrealized investment gains

 

 

 

 

 

 

 

 

 

 

 

 

 

2,165

 

2,165

 

 

2,165

 

Comprehensive income

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

54,563

 

(14,801

)

39,762

 

Issuance of common stock upon conversion of convertible notes

 

54

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Stock options exercised

 

94,035

 

1

 

4,539

 

 

 

 

 

 

 

 

 

4,540

 

 

 

4,540

 

Tax benefit from equity compensation

 

 

 

 

 

351

 

 

 

 

 

 

 

 

 

351

 

 

 

351

 

Stock-based compensation expense

 

1,250

 

 

11,560

 

 

 

 

 

 

 

 

 

11,560

 

 

 

11,560

 

Treasury stock acquired

 

 

 

 

 

 

 

377

 

(29

)

 

 

 

 

(29

)

 

 

(29

)

Change in redeemable equity associated with convertible notes

 

 

 

 

 

9,999

 

 

 

 

 

 

 

 

 

9,999

 

 

 

9,999

 

Purchase of share in noncontrolling interest

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

306,500

 

306,500

 

Other

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

416

 

416

 

BALANCE, MARCH 31, 2009

 

71,802,380

 

$

718

 

$

2,121,773

 

2,970,776

 

$

(201,734

)

$

(462,703

)

$

39,610

 

$

1,497,664

 

$

292,115

 

$

1,789,779

 

 

 

 

Cephalon Stockholders’ Equity

 

Total

 

 

 

 

 

 

 

 

 

Additional

 

 

 

 

 

Accumulated
Other

 

Stockholders’
Equity

 

 

 

 

 

 

 

Common Stock

 

Paid-in

 

Treasury Stock

 

Accumulated

 

Comprehensive

 

Attributable to

 

Noncontrolling

 

 

 

 

 

Shares

 

Amount

 

Capital

 

Shares

 

Amount

 

Deficit

 

Income

 

Cephalon, Inc.

 

Interest

 

Total

 

BALANCE, JANUARY 1, 2010

 

78,002,764

 

$

780

 

$

2,534,070

 

3,085,844

 

$

(208,427

)

$

(178,659

)

$

114,194

 

$

2,261,958

 

$

216,115

 

$

2,478,073

 

Net income

 

 

 

 

 

 

 

 

 

 

 

110,565

 

 

 

$

110,565

 

$

(10,228

)

$

100,337

 

Foreign currency translation gains

 

 

 

 

 

 

 

 

 

 

 

 

 

(29,034

)

(29,034

)

 

(29,034

)

Net prior service costs on retirement-related plans

 

 

 

 

 

 

 

 

 

 

 

 

 

(25

)

(25

)

 

(25

)

Unrealized investment gains

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Comprehensive income

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

81,506

 

(10,228

)

71,278

 

Stock options exercised

 

266,888

 

3

 

13,801

 

 

 

 

 

 

 

 

 

13,804

 

 

 

13,804

 

Tax benefit from equity compensation

 

 

 

 

 

7

 

 

 

 

 

 

 

 

 

7

 

 

 

7

 

Stock-based compensation expense

 

1,250

 

 

8,830

 

 

 

 

 

 

 

 

 

8,830

 

 

 

8,830

 

Treasury stock acquired

 

 

 

 

 

 

 

502

 

(33

)

 

 

 

 

(33

)

 

 

(33

)

Change in redeemable equity associated with convertible notes

 

 

 

 

 

10,745

 

 

 

 

 

 

 

 

 

10,745

 

 

 

10,745

 

Other

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

104

 

104

 

BALANCE, MARCH 31, 2010

 

78,270,902

 

$

783

 

$

2,567,453

 

3,086,346

 

$

(208,460

)

$

(68,094

)

$

85,135

 

$

2,376,817

 

$

205,991

 

$

2,582,808

 

 

The accompanying notes are an integral part of these consolidated financial statements.

 

3


 


Table of Contents

 

CEPHALON INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

(In thousands)

(Unaudited)

 

 

 

Three months ended

 

 

 

March 31,

 

 

 

2010

 

2009

 

CASH FLOWS FROM OPERATING ACTIVITIES:

 

 

 

 

 

Net income

 

$

100,337

 

$

43,782

 

Adjustments to reconcile net income to net cash provided by operating activities:

 

 

 

 

 

Deferred income tax benefit

 

(1,045

)

(9,036

)

Depreciation and amortization

 

48,353

 

41,952

 

Stock-based compensation expense

 

8,830

 

11,560

 

Amortization of debt discount and debt issuance costs

 

18,144

 

10,558

 

Loss (gain) on foreign exchange contracts

 

6,169

 

(13,084

)

Other

 

239

 

109

 

Changes in operating assets and liabilities:

 

 

 

 

 

Receivables

 

20,308

 

55,668

 

Inventory

 

(2,383

)

(7,697

)

Other assets

 

(348

)

9,683

 

Accounts payable, accrued expenses and deferred revenues

 

39,449

 

27,458

 

Other liabilities

 

(4,498

)

1,756

 

Net cash provided by operating activities

 

233,555

 

172,709

 

 

 

 

 

 

 

CASH FLOWS FROM INVESTING ACTIVITIES:

 

 

 

 

 

Purchases of property and equipment

 

(9,613

)

(14,958

)

Cash balance from consolidation of variable interest entity

 

 

52,563

 

Investment in Ception

 

 

(75,000

)

Purchases of investments

 

 

(9,082

)

(Cash Settlements of) proceeds from foreign exchange contract

 

(6,155

)

7,732

 

Purchases of available-for-sale investments

 

 

(41,390

)

Net cash used for investing activities

 

(15,768

)

(80,135

)

 

 

 

 

 

 

CASH FLOWS FROM FINANCING ACTIVITIES:

 

 

 

 

 

Proceeds from exercises of common stock options

 

13,804

 

4,540

 

Windfall tax benefits from stock-based compensation

 

23

 

351

 

Acquisition of treasury stock

 

(33

)

(29

)

Payments on and retirements of long-term debt

 

(2,577

)

(3,283

)

Net cash provided by financing activities

 

11,217

 

1,579

 

 

 

 

 

 

 

EFFECT OF EXCHANGE RATE CHANGES ON CASH AND CASH EQUIVALENTS

 

(2,186

)

(4,036

)

 

 

 

 

 

 

NET INCREASE IN CASH AND CASH EQUIVALENTS

 

226,818

 

90,117

 

 

 

 

 

 

 

CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD

 

1,647,635

 

524,459

 

 

 

 

 

 

 

CASH AND CASH EQUIVALENTS, END OF PERIOD

 

$

1,874,453

 

$

614,576

 

 

The accompanying notes are an integral part of these consolidated financial statements.

 

4



Table of Contents

 

CEPHALON, INC. AND SUBSIDIARIES

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(In thousands, except per share data)

(Unaudited)

 

1.  BASIS OF PRESENTATION

 

The accompanying unaudited consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America (“U.S. GAAP”) for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnote disclosures required by U.S. GAAP for complete financial statements. In the opinion of management, all adjustments (consisting only of normal recurring accruals) considered necessary for a fair presentation have been included. These financial statements should be read in conjunction with the consolidated financial statements and notes thereto included in our Annual Report on Form 10-K, filed with the U.S. Securities and Exchange Commission (the “SEC”), which includes audited financial statements as of December 31, 2009 and 2008 and for each of the three years in the period ended December 31, 2009. The results of our operations for any interim period are not necessarily indicative of the results of our operations for any other interim period or for a full year.

 

Recent Accounting Pronouncements

 

Effective January 1, 2010, we adopted the revised accounting guidance for consolidation of variable interest entities (“VIE”), which replaces the previous quantitative based risk and rewards calculation for determining the primary beneficiary of a VIE with an approach focused on identifying which enterprise has the power to direct the activities of a VIE that most significantly impact the entity’s economic performance and (1) the obligation to absorb losses or (2) the right to receive benefits.  The new guidance also requires ongoing reassessments of whether an enterprise is the primary beneficiary of a variable interest entity.  The new guidance has not changed our assessment of which entities are included in our consolidated financial statements. We adopted the additional disclosure requirements of this new standard effective with this Form 10-Q.

 

In October 2009, the FASB issued revised accounting guidance for multiple-deliverable arrangements.  The amendment requires that arrangement considerations be allocated at the inception of the arrangement to all deliverables using the relative selling price method and provides for expanded disclosures related to such arrangements.  It is effective for revenue arrangements entered into or materially modified in fiscal years beginning on or after June 15, 2010. We are currently evaluating the impact of adoption on our consolidated financial statements.

 

                In March 2010, the FASB issued revised accounting guidance for milestone revenue recognition. The new guidance recognizes the milestone method as an acceptable revenue recognition method for substantive milestones in research or development transactions. It is effective on a prospective basis to milestones achieved in fiscal years, and interim periods within those years, beginning on or after June 15, 2010.  We are currently evaluating the impact of adoption on our consolidated financial statements.

 

2.   ACQUISITIONS AND TRANSACTIONS

 

Ception Therapeutics, Inc.

 

In January 2009, we entered into an option agreement (the “Ception Option Agreement”) with Ception Therapeutics, Inc. (“Ception”).  Under the terms of the Ception Option Agreement, we had the irrevocable option (the “Ception Option”) to purchase all of the outstanding capital stock on a fully diluted basis of Ception within a specified period of time.  As consideration for the Ception Option, we paid $50.0 million to Ception and paid Ception stockholders an aggregate of $50.0 million.  In February 2010, we exercised the Ception Option based on our evaluation of the results of a Phase II clinical trial of Ception’s lead compound, CINQUIL™ (reslizumab) for the treatment of eosinophilic asthma.

 

We have determined that, because of our rights under the Ception Option Agreement, effective on January 13, 2009, Ception is a variable interest entity for which we are the primary beneficiary.  As a result, as of January 13, 2009 we have included the financial condition and results of operations of Ception in our consolidated financial statements.  However, we did not have an equity interest in Ception as of March 31, 2010 and, therefore, we allocated the Ception losses to noncontrolling interest in the consolidated statement of operations.

 

5



Table of Contents

 

After completing certain closing conditions, including U.S. antitrust approval, in April 2010, we acquired privately-held Ception Therapeutics, Inc. for $250.0 million.  We also advanced $25.0 million in financing to Ception prior to the acquisition, for which the Ception stockholders were not required to (and therefore did not) repay at the closing of the acquisition. Ception stockholders also could receive (i) additional payments related to clinical and regulatory milestones and (ii) royalties related to net sales of products developed from Ception’s program to discover small molecule, orally-active, anti-TNF (tumor necrosis factor) receptor agents.   We expect to begin a Phase III clinical trial for the treatment of eosinophilic asthma by the end of 2010.

 

As a result of exercising our option to purchase Ception in April 2010, we expect to recognize a reduction of approximately $200 million in Cephalon stockholders’ equity for the second quarter of 2010 which reflects the difference between the fair value of the consideration paid and the amount by which the noncontrolling interest will be adjusted to reflect the change in our ownership in Ception. The purchase price includes the estimated fair value of future milestone payments. The contingent consideration payments will be recorded as a liability and remeasured each quarter through earnings.

 

The following summarizes the carrying amounts and classification of Ception’s assets and liabilities included in our consolidated balance sheet as of December 31, 2009 and March 31, 2010:

 

 

 

December 31,
2009

 

March 31,
2010

 

Cash and cash equivalents

 

$

52,500

 

$

56,000

 

Other current assets

 

193

 

275

 

Property and equipment, net

 

348

 

294

 

Goodwill

 

121,918

 

121,918

 

Intangible assets

 

199,400

 

199,400

 

Other assets

 

10

 

10

 

Current portion of long-term debt, net

 

3,763

 

2,105

 

Accounts payable

 

4,064

 

1,450

 

Accrued expenses

 

5,526

 

9,150

 

Deferred tax liabilities

 

61,911

 

60,868

 

Noncontrolling interest

 

188,105

 

179,323

 

 

Although Ception is included in our consolidated financial statements, our interest in Ception’s assets is limited to that accorded to us in the agreements with Ception as described above.  For example, Ception’s cash and cash equivalents balance includes $50.0 million of Ception Option Agreement proceeds; Ception retained the right to distribute those cash proceeds to its current stockholders. In April 2010, Ception distributed the $50.0 million cash to its stockholders immediately prior to the closing of the acquisition.  Ception’s creditors have no recourse to the general credit of Cephalon.

 

BioAssets Development Corporation

 

Effective November 2009, we signed an agreement with BioAssets Development Corporation (“BDC”) that sets forth our option to acquire BDC.  Under the terms of the option agreement, we paid BDC an upfront payment of $30.0 million. If we exercise the option, we have agreed to pay a total of $12.5 million plus the value of BDC’s net working capital less the amount of any outstanding debt.  BDC stockholders could also receive additional future payments related to regulatory and sales milestones.  We may exercise our option at any time from the closing date of the option agreement until the date that is 60 days after receipt of one-month patient response data from BDC’s Phase II study of etanercept for the treatment of sciatica. Data are anticipated to be available in the second half of 2010.

 

We have determined that, because of our rights under the BDC option agreement, effective on November 18, 2009, BDC is a variable interest entity for which we are the primary beneficiary.  As a result, as of November 18, 2009 we have included the financial condition and results of operations of BDC in our consolidated financial statements.  However, we do not have an equity interest in BDC and, therefore, we have allocated the BDC losses to noncontrolling interest in the consolidated statement of operations.   If the BDC option expires unexercised, we will deconsolidate BDC and recognize a loss of $30.0 million, equal to our investment in BDC.  BDC did not have a material impact on our revenues or earnings attributable to our Cephalon shareholders for the period ended March 31, 2010 or on a pro forma basis for the periods ended March 31, 2010 and 2009.  BDC is included in our U. S. operating segment.

 

6



Table of Contents

 

The following summarizes the carrying amounts and classification of BDC’s assets and liabilities included in our consolidated balance sheet as of December 31, 2009 and March 31, 2010:

 

 

 

December 31,
2009

 

March 31,
2010

 

Cash and cash equivalents

 

$

9,854

 

$

6,707

 

Accounts receivable

 

69

 

3

 

Other current assets

 

27

 

19

 

Property and equipment, net

 

18

 

12

 

Goodwill

 

20,391

 

20,391

 

Intangible assets

 

48,000

 

48,000

 

Accounts payable

 

362

 

56

 

Accrued expenses

 

1,817

 

377

 

Deferred tax liabilities

 

18,171

 

18,032

 

Noncontrolling interest

 

28,009

 

26,668

 

 

Although BDC is included in our consolidated financial statements, our interest in BDC’s assets is limited to that accorded to us in the agreements with BDC as described above.  BDC’s creditors have no recourse to the general credit of Cephalon.

 

3.   RESTRUCTURING

 

2009 restructuring

 

In October 2009, we began to restructure our discovery research organization to focus on our pipeline opportunities, primarily in oncology, inflammatory diseases and pain, with an emphasis on our biologic opportunities, wind down our internal research efforts in CNS and reduce our overall cost structure.  As part of this restructuring, we have recently announced worldwide restructuring efforts. Beginning in 2009 and continuing in 2010, we expect to eliminate approximately 82 jobs worldwide through a combination of voluntary resignations and terminations.  As of March 31, 2010, 69 positions have been eliminated.  The total estimated pre-tax costs of these restructuring efforts are $9.7 million.  Total estimated charges and spending related to worldwide restructuring efforts recognized in the consolidated statement of operations and included primarily in the United States segment are as follows:

 

 

 

Three months
ended

March 31,

 

 

 

2010

 

Restructuring reserves as of January 1

 

$

7,862

 

Severance Costs

 

32

 

Payments

 

(6,673

)

Restructuring reserves as of March 31

 

$

1,221

 

 

CIMA restructuring

 

On January 15, 2008, we announced a restructuring plan under which we intend to (i) transition manufacturing activities at our CIMA LABS INC. (“CIMA”) facility in Eden Prairie, Minnesota, to our recently expanded manufacturing facility in Salt Lake City, Utah, and (ii) consolidate at CIMA’s Brooklyn Park, Minnesota, facility certain drug delivery research and development activities performed in Salt Lake City. The phased transition of manufacturing activities and the closure of the Eden Prairie facility are expected to be completed in 2011.  The consolidation of drug delivery research and development activities at Brooklyn Park was completed in 2008.  The plan is intended to increase efficiencies in manufacturing and research and development activities, reduce our cost structure and enhance competitiveness.

 

As a result of this plan, we will incur certain costs associated with exit or disposal activities.  As part of the plan, we estimate that approximately 90 jobs will be eliminated in total, with approximately 175 net jobs eliminated at CIMA and approximately 85 net jobs added in Salt Lake City.

 

The total estimated pre-tax costs of the plan are as follows:

 

7



Table of Contents

 

Severance costs

 

$

14-16 million

 

Manufacturing and personnel transfer costs

 

$

7- 8 million

 

Total

 

$

21-24 million

 

 

The estimated pre-tax costs of the plan are being recognized between 2008 and 2011 and are included in the United States segment.  Through March 31, 2010, we have incurred a total of $14.2 million related to the restructuring plan.  In addition to the costs described above, we have recognized pre-tax, non-cash accelerated depreciation of plant and equipment at the Eden Prairie facility, which we expect to total approximately $18 million to $20 million.  Through March 31, 2010, we have incurred a total of $15.4 million in accelerated depreciation charges.

 

 

 

Three months ended
March 31,

 

 

 

2010

 

2009

 

Restructuring reserves as of January 1

 

$

7,083

 

$

3,733

 

Severance costs

 

527

 

1,066

 

Manufacturing and personnel transfer costs

 

217

 

571

 

Payments

 

(473

)

(774

)

Restructuring reserves as of March 31

 

$

7,354

 

$

4,596

 

 

4.  ACQUIRED IN-PROCESS RESEARCH AND DEVELOPMENT EXPENSE

 

For the three months ended March 31, 2009, we incurred expense of $30.0 million in exchange for the exclusive, worldwide license rights to LUPUZORTM, acquired from ImmuPharma plc (“ImmuPharma”).  We also paid SymBio $0.8 million in exchange for the license rights to bendamustine hydrochloride in China and Hong Kong.

 

5.  OTHER INCOME (EXPENSE)

 

Other income (expense), net consisted of the following:

 

 

 

Three months ended
March 31,

 

 

 

2010

 

2009

 

Gains (losses) on foreign exchange derivative instruments

 

$

(6,169

)

$

5,352

 

Arana dividend income

 

 

1,567

 

Foreign exchange gains (losses)

 

(1,102

)

(380

)

Other income (expense), net

 

$

(7,271

)

$

6,539

 

 

In February 2010, Cephalon entered into a foreign exchange forward contract related to the Mepha AG transaction.  This contract protects against fluctuations between the Swiss Franc and the U.S. Dollar. For the period ended March 31, 2010, we recognized a loss of $6.2 million from the decrease in fair value of these foreign exchange contracts. For more information on our acquisition of Mepha, please see Note 17.

 

In March 2009, Cephalon entered into a foreign exchange forward contract and a foreign exchange option contract related to our Arana transaction.  Together, these contracts protected against fluctuations between the Australian Dollar and the U.S. Dollar.  For the period ended March 31, 2009, we recognized a gain of $5.4 million from the increase in fair value of these foreign exchange contracts.

 

6.  ACCUMULATED OTHER COMPREHENSIVE INCOME

 

The components of accumulated other comprehensive income, all of which apply to Cephalon, Inc., consisted of the following:

 

8



Table of Contents

 

 

 

March 31,
2010

 

December 31,
2009

 

Foreign currency translation gains

 

$

83,125

 

$

112,159

 

Prior service gains and losses on retirement-related plans

 

2,010

 

2,035

 

Accumulated other comprehensive income

 

$

85,135

 

$

114,194

 

 

7.  FAIR VALUE DISCLOSURES

 

Our non-current investments are recorded on a cost basis.  The carrying values of cash, cash equivalents, short-term investments, accounts receivable, accounts payable and accrued expenses approximate the respective fair values.  Except for our convertible notes, our debt instruments do not have readily ascertainable market values; however, the carrying values approximate the respective fair values. As of March 31, 2010, the fair value and carrying value of our convertible debt, based on quoted market prices was:

 

 

 

Fair Value

 

Carrying Value

 

Face Value

 

2.0% convertible senior subordinated notes due June 1, 2015

 

$

1,233,198

 

$

626,082

 

$

820,000

 

2.5% convertible senior subordinated notes due May 1, 2014

 

579,375

 

368,474

 

500,000

 

Zero Coupon convertible subordinated notes first putable June 2010

 

240,095

 

197,346

 

199,549

 

 

In February 2010, Cephalon entered into a foreign exchange forward contract related to the Mepha AG transaction.  The fair value of this forward contract as of March 31 2010 was immaterial.

 

8.  INVENTORY, NET

 

Inventory, net consisted of the following:

 

 

 

March 31,
2010

 

December 31,
2009

 

Raw materials

 

$

29,024

 

$

27,105

 

Work-in-process

 

142,527

 

144,145

 

Finished goods

 

65,098

 

69,326

 

Total inventory, net

 

$

236,649

 

$

240,576

 

 

Over the past few years, we have been developing a manufacturing process for the active pharmaceutical ingredient in NUVIGIL that is more cost effective than our prior process of separating modafinil into armodafinil.  As a result of our plan to manufacture armodafinil in the future using this new process coupled the launch of NUVIGIL in 2009, we assessed the potential impact of these items on certain of our existing agreements to purchase modafinil and recorded a reserve in 2008 for purchase commitments for modafinil raw materials not expected to be utilized as a charge to cost of sales.  As of March 31, 2010, our aggregate future purchase commitments remaining total $15.3 million and our reserve balance for excess purchase commitments is $9.0 million.

 

9. GOODWILL

 

Goodwill consisted of the following:

 

9



Table of Contents

 

 

 

United
States

 

Europe

 

Total

 

December 31, 2009

 

$

486,619

 

$

103,665

 

$

590,284

 

Foreign currency translation adjustment

 

 

(6,977

)

(6,977

)

March 31, 2010

 

$

486,619

 

$

96,688

 

$

583,307

 

 

10.  INTANGIBLE ASSETS, NET

 

Intangible assets consisted of the following:

 

 

 

 

 

March 31, 2010

 

December 31, 2009

 

 

 

Estimated
Useful
Lives

 

Gross
Carrying
Amount

 

Accumulated
Amortization

 

Net
Carrying
Amount

 

Gross
Carrying
Amount

 

Accumulated
Amortization

 

Net
Carrying
Amount

 

Modafinil developed technology

 

15 years

 

$

99,000

 

$

54,450

 

$

44,550

 

$

99,000

 

$

52,800

 

$

46,200

 

DURASOLV technology

 

14 years

 

70,000

 

27,395

 

42,605

 

70,000

 

26,174

 

43,826

 

ACTIQ marketing rights

 

10 – 12 years

 

83,454

 

62,961

 

20,493

 

83,454

 

61,091

 

22,363

 

GABITRIL product rights

 

9 – 15 years

 

107,046

 

70,819

 

36,227

 

107,206

 

69,126

 

38,080

 

TRISENOX product rights

 

8 – 13 years

 

112,068

 

42,174

 

69,894

 

112,455

 

40,172

 

72,283

 

AMRIX product rights

 

18 years

 

99,303

 

23,300

 

76,003

 

99,303

 

22,027

 

77,276

 

MYOCET trademark

 

20 years

 

158,622

 

33,710

 

124,912

 

170,059

 

34,013

 

136,046

 

CINQUIL product rights

 

Indefinite

 

199,400

 

 

199,400

 

199,400

 

 

199,400

 

TNF inhibitor product rights

 

Indefinite

 

143,666

 

 

143,666

 

141,806

 

 

141,806

 

Cephalon Australia royalty agreements*

 

1 year

 

22,643

 

15,095

 

7,548

 

22,203

 

10,361

 

11,842

 

VOGALENE/VOGALIB trademark

 

10 years

 

53,324

 

1,270

 

52,054

 

53,324

 

 

53,324

 

Other product rights

 

5 – 20 years

 

316,333

 

187,761

 

128,572

 

326,907

 

187,496

 

139,411

 

 

 

 

 

$

1,464,859

 

$

518,935

 

$

945,924

 

$

1,485,117

 

$

503,260

 

$

981,857

 

 


* As of February 10, 2010, the name of Arana Therapeutics Pty. Ltd. was changed to Cephalon Australia Pty. Ltd.

 

Intangible assets are amortized over their estimated useful economic life using the straight line method. Amortization expense was $25.8 million and $21.2 million for the three months ended March 31, 2010 and 2009, respectively.

 

11.  LONG-TERM DEBT

 

Long-term debt consisted of the following:

 

 

 

March 31,
2010

 

December 31,
2009

 

2.0% convertible senior subordinated notes due June 1, 2015

 

$

820,000

 

$

820,000

 

Debt discount on 2.0% convertible senior subordinated notes due June 1, 2015

 

(193,918

)

(201,536

)

2.5% convertible senior subordinated notes due May 1,2014

 

500,000

 

500,000

 

Debt discount on 2.5% convertible senior subordinated notes due May 1, 2014

 

(131,526

)

(137,907

)

Zero Coupon convertible subordinated notes first putable June 2010

 

199,990

 

199,968

 

Debt discount on Zero Coupon convertible subordinated notes first putable June 2010

 

(2,644

)

(5,771

)

Capital lease obligations

 

2,828

 

3,065

 

Ception Therapeutics, Inc. obligations

 

2,105

 

3,763

 

Other

 

564

 

1,039

 

Total debt

 

1,197,399

 

1,182,621

 

Less current portion

 

(827,594

)

(818,925

)

Total long-term debt

 

$

369,805

 

$

363,696

 

 

Convertible Notes

 

The liability component of our convertible notes will be classified as current liabilities and presented in current portion of long-term debt and the equity component of our convertible debt will be considered a redeemable security and presented as redeemable equity on our consolidated balance sheet if our debt is considered current at the balance sheet date.

 

10



Table of Contents

 

At March 31, 2010, our stock price was $67.78 and, therefore, the 2.0% Notes are considered to be current liabilities based on conversion price and are presented in current portion of long-term debt on our consolidated balance sheet.  At March 31, 2010 and December 31, 2009, the 2010 Zero Coupon Notes are presented in current portion of long-term debt based on maturity date.  At December 31, 2009, our stock price was $62.42, and, therefore, the 2.0% Notes are considered to be current liabilities based on conversion price and are presented in current portion of long-term debt on our consolidated balance sheet.

 

On August 15, 2008, we established a $200 million, three-year revolving credit facility with JP Morgan Chase Bank, N.A. and certain other lenders.  The credit facility is available for letters of credit, working capital and general corporate purposes and is guaranteed by certain of our domestic subsidiaries.  The credit agreement contains customary covenants, including but not limited to covenants related to total debt to Consolidated EBITDA (as defined in the credit agreement), senior debt to Consolidated EBITDA, interest expense coverage and limitations on capital expenditures, asset sales, mergers and acquisitions, indebtedness, liens, and transactions with affiliates.  As of the date of this filing, we have not drawn any amounts under the credit facility.

 

In the event that a significant conversion of our convertible debt did occur, we believe that we have the ability to fund the payment of principal amounts due through a combination of utilizing our existing cash on hand, accessing our credit facility, raising money in the capital markets or selling our note hedge instruments for cash.

 

12.  LEGAL PROCEEDINGS AND OTHER MATTERS

 

PROVIGIL Patent Litigation and Settlements

 

In March 2003, we filed a patent infringement lawsuit against four companies—Teva Pharmaceuticals USA, Inc., Mylan Pharmaceuticals, Inc., Ranbaxy Laboratories Limited and Barr Laboratories, Inc.—based upon the abbreviated new drug applications (“ANDA”) filed by each of these firms with the FDA seeking approval to market a generic form of modafinil. The lawsuit claimed infringement of our U.S. Patent No. RE37,516 (the “‘516 Patent”) which covers the pharmaceutical compositions and methods of treatment with the form of modafinil contained in PROVIGIL and which expires on April 6, 2015. We believe that these four companies were the first to file ANDAs with Paragraph IV certifications and thus are eligible for the 180-day period of marketing exclusivity provided by the provisions of the Federal Food, Drug and Cosmetic Act. In early 2005, we also filed a patent infringement lawsuit against Carlsbad Technology, Inc. (“Carlsbad”) based upon the Paragraph IV ANDA related to modafinil that Carlsbad filed with the FDA.

 

In late 2005 and early 2006, we entered into settlement agreements with each of Teva, Mylan, Ranbaxy and Barr; in August 2006, we entered into a settlement agreement with Carlsbad and its development partner, Watson Pharmaceuticals, Inc., which we understand has the right to commercialize the Carlsbad product if approved by the FDA. As part of these separate settlements, we agreed to grant to each of these parties a non-exclusive royalty-bearing license to market and sell a generic version of PROVIGIL in the United States, effective in April 2012, subject to applicable regulatory considerations. Under the agreements, the licenses could become effective prior to April 2012 only if a generic version of PROVIGIL is sold in the United States prior to this date. Various factors could lead to the sale of a generic version of PROVIGIL in the United States at any time prior to April 2012, including if (i) we lose patent protection for PROVIGIL due to an adverse judicial decision in a patent infringement lawsuit; (ii) all parties with first-to file ANDAs relinquish their right to the 180-day period of marketing exclusivity, which could allow a subsequent ANDA filer, if approved by the FDA, to launch a generic version of PROVIGIL in the United States at-risk; (iii) we breach or the applicable counterparty breaches a PROVIGIL settlement agreement; or (iv) the FTC prevails in its lawsuit against us in the U.S. District Court for the Eastern District of Pennsylvania described below.

 

We also received rights to certain modafinil-related intellectual property developed by each party and in exchange for these rights, we agreed to make payments to Barr, Mylan, Ranbaxy and Teva collectively totaling up to $136.0 million, consisting of upfront payments, milestones and royalties on net sales of our modafinil products. In order to maintain an adequate supply of the active drug substance modafinil, we entered into agreements with three modafinil suppliers whereby we have agreed to purchase minimum amounts of modafinil through 2012, with aggregate remaining purchase commitments totaling $15.3 million as of March 31, 2010. See Note 8 for additional details.

 

We filed each of the settlements with both the U.S. Federal Trade Commission (the “FTC”) and the Antitrust Division of the U.S. Department of Justice (the “DOJ”) as required by the Medicare Prescription Drug, Improvement and Modernization Act of 2003 (the “Medicare Modernization Act”). The FTC conducted an investigation of each of the PROVIGIL settlements and, in February 2008, filed suit against us in the U.S. District Court for the District of Columbia

 

11



Table of Contents

 

challenging the validity of the settlements and related agreements entered into by us with each of Teva, Mylan, Ranbaxy and Barr. We filed a motion to transfer the case to the U.S. District Court for the Eastern District of Pennsylvania (the “EDPA”), which was granted in April 2008. The complaint alleges a violation of Section 5(a) of the Federal Trade Commission Act and seeks to permanently enjoin us from maintaining or enforcing these agreements and from engaging in similar conduct in the future. We believe the FTC complaint is without merit. While we intend to vigorously defend ourselves and the propriety of the settlement agreements, these efforts will be both expensive and time consuming and, ultimately, due to the nature of litigation, there can be no assurance that these efforts will be successful.

 

Numerous private antitrust complaints have been filed in the EDPA, each naming Cephalon, Barr, Mylan, Teva and Ranbaxy as co-defendants and claiming, among other things, that the PROVIGIL settlements violate the antitrust laws of the United States and, in some cases, certain state laws. These actions have been consolidated into a complaint on behalf of a class of direct purchasers of PROVIGIL and a separate complaint on behalf of a class of consumers and other indirect purchasers of PROVIGIL. A separate complaint was filed by an indirect purchaser of PROVIGIL in September 2007. The plaintiffs in all of these actions are seeking monetary damages and/or equitable relief. In addition, in December 2009, we entered a tolling agreement with the Attorneys General of Arkansas, California, Florida, New York and Pennsylvania to suspend the running of the statute of limitations to any claims or causes of action relating to our PROVIGIL settlements pending the resolution of the FTC litigation described above.

 

Separately, in June 2006, Apotex, Inc., a subsequent ANDA filer seeking FDA approval of a generic form of modafinil, filed suit against us, also in the EDPA, alleging similar violations of antitrust laws and state law. Apotex asserts that the PROVIGIL settlement agreements improperly prevent it from obtaining FDA approval of its ANDA, and seeks monetary and equitable remedies. Apotex also seeks a declaratory judgment that the ‘516 Patent is invalid, unenforceable and/or not infringed by its proposed generic. In May 2009, Apotex also filed a declaratory judgment complaint in the EDPA that our U.S. Patent No. 7,297,346 (the “‘346 Patent”) is invalid, unenforceable and/or not infringed by its proposed generic. The ‘346 Patent covers pharmaceutical compositions of modafinil and expires in May 2024. Separately, in April 2008, the Federal Court of Canada dismissed our application to prevent regulatory approval of Apotex’s generic modafinil tablets in Canada. We have learned that Apotex has launched its generic modafinil tablets in Canada, and in April 2009 we filed a patent infringement lawsuit against Apotex in Canada. We believe that the private antitrust complaints described in the preceding paragraph and the Apotex antitrust and declaratory judgment complaints are without merit. While we intend to vigorously defend ourselves and the propriety of the settlement agreements, these efforts will be both expensive and time consuming and, ultimately, due to the nature of litigation, there can be no assurance that these efforts will be successful.

 

In August 2009, the private antitrust class (e.g. the direct and indirect purchasers), Apotex and the FTC filed amended complaints and, subsequently, we filed motions to dismiss each amended complaint. The private antitrust class, Apotex and the FTC have filed responses to our motions to dismiss. In March 2010, the EDPA denied our motions to dismiss each amended complaint. The EDPA has scheduled a trial for the Apotex matter to begin in March 2011.

 

In November 2005 and March 2006, we received notice that Caraco Pharmaceutical Laboratories, Ltd. (“Caraco”) and Apotex, respectively, also filed Paragraph IV ANDAs with the FDA in which each firm is seeking to market a generic form of PROVIGIL. We have not filed a patent infringement lawsuit in the United States against either Caraco or Apotex, although Apotex has filed suit against us, as described above. In early August 2008, we received notice that Hikma Pharmaceuticals plc (“Hikma Pharmaceuticals”) filed a Paragraph IV ANDA with the FDA in which it is seeking to market a generic form of PROVIGIL. We have not filed a patent infringement lawsuit against Hikma Pharmaceuticals.

 

In the first quarter 2010, we understand that generic versions of modafinil have been launched in Portugal, Sweden and Denmark.  We are currently investigating these launches and intend to vigorously enforce our intellectual property rights.

 

The EU Commission is conducting a pharmaceutical sector inquiry of over 100 companies regarding, among other matters, settlements by branded pharmaceutical companies (such as Cephalon) with generic pharmaceutical companies. We are cooperating with the EU Commission’s inquiry and have provided questionnaire responses regarding our business and documents related to our PROVIGIL settlement with Teva’s UK affiliate in 2005.

 

NUVIGIL Patent Litigation

 

In December 2009, January 2010 and February 2010, we filed patent infringement lawsuits against six companies—Teva, Actavis, Mylan, Watson, Sandoz and Lupin—based upon the abbreviated new drug applications (“ANDA”) filed by

 

12



Table of Contents

 

each of these firms with the FDA seeking approval to market a generic form of armodafinil. The lawsuits claimed infringement of our ‘570 Patent, ‘346 Patent and ‘516 Patent. Cephalon has a three-year period of marketing exclusivity for NUVIGIL that extends until June 15, 2010. In addition, including the six-month pediatric extension, the ‘516 Patent, the ‘346 Patent, and the ‘570 Patent expire on April 6, 2015, May 29, 2024, and June 18, 2024, respectively.

 

Under the provisions of the Hatch-Waxman Act, the filing of the Teva, Actavis, Mylan, Watson, Sandoz, and Lupin lawsuits stays any FDA approval of the applicable ANDA until the earlier of entry of a district court judgment in favor of the ANDA holder or 30 months from the date of our receipt of the respective Paragraph IV certification letter.  Assuming no earlier district court judgment, the earliest the 30-month stay will expire is in May 2012.

 

AMRIX Patent Litigation

 

In October 2008, Cephalon and Eurand, Inc. (“Eurand”), received Paragraph IV certification letters relating to ANDAs submitted to the FDA by Mylan and Barr, each requesting approval to market and sell a generic version of the 15 mg and 30 mg strengths of AMRIX. In November 2008, we received a similar certification letter from Impax Laboratories, Inc. Mylan and Impax each allege that the U.S. Patent Number 7,387,793 (the “Eurand Patent”), entitled “Modified Release Dosage Forms of Skeletal Muscle Relaxants,” issued to Eurand will not be infringed by the manufacture, use or sale of the product described in the applicable ANDA and reserves the right to challenge the validity and/or enforceability of the Eurand Patent. Barr alleges that the Eurand Patent is invalid, unenforceable and/or will not be infringed by its manufacture, use or sale of the product described in its ANDA. The Eurand Patent does not expire until February 26, 2025. In late November 2008, Cephalon and Eurand filed a lawsuit in U.S. District Court in Delaware against Mylan (and its parent) and Barr (and its parent) for infringement of the Eurand Patent. In January 2009, Cephalon and Eurand filed a lawsuit in U.S. District Court in Delaware against Impax for infringement of the Eurand Patent.  Trial for the Mylan, Barr and Impax matters is scheduled for September 2010.

 

In late May 2009, Cephalon and Eurand received a Paragraph IV certification letter relating to an ANDA submitted to the FDA by Anchen Pharmaceuticals, Inc. (“Anchen”) requesting approval to market and sell a generic version of the 15 mg and 30 mg strengths of AMRIX. Anchen alleges that the Eurand Patent is invalid, unenforceable and/or will not be infringed by its manufacture, use or sale of the product described in its ANDA. In July 2009, Cephalon and Eurand filed a lawsuit in U.S. District Court in Delaware against Anchen for infringement of the Eurand Patent.

 

Under the provisions of the Hatch-Waxman Act, the filing of the Mylan, Barr, Impax and Anchen lawsuits stays any FDA approval of the applicable ANDA until the earlier of entry of a district court judgment in favor of the ANDA holder or 30 months from the date of our receipt of the respective Paragraph IV certification letter.   Assuming no earlier district court judgment, the earliest the 30-month stay will expire is in April 2011.

 

FENTORA Patent Litigation

 

In April 2008, June 2008 and January 2010, we received Paragraph IV certification letters relating to ANDAs submitted to the FDA by Watson Laboratories, Inc., Barr and Sandoz, respectively, requesting approval to market and sell a generic equivalent of FENTORA. Both Watson and Barr allege that our U.S. Patent Numbers 6,200,604 and 6,974,590 covering FENTORA are invalid, unenforceable and/or will not be infringed by the manufacture, use or sale of the product described in their respective ANDAs. The 6,200,604 and 6,974,590 patents cover methods of use for FENTORA and do not expire until 2019. In June 2008, July 2008 and January 2010, we and our wholly-owned subsidiary, CIMA, filed lawsuits in U.S. District Court in Delaware against Watson, Barr and Sandoz for infringement of these patents.  Trial for the Watson matter is scheduled for May 2010.

 

In November 2009, we entered into a binding agreement-in-principle (the “Barr Agreement”) with Barr to settle its pending patent infringement lawsuit related to FENTORA. The Barr Agreement does not affect the status of our separate FENTORA patent litigation with Watson pending in the U.S. District Court in Delaware. In connection with the Barr Agreement, we will grant Barr a non-exclusive, royalty-free right to market and sell a generic version of FENTORA in the United States. Barr’s license will become effective in October 2018. If another generic version of FENTORA enters the U.S. market prior to October 2018, Barr may enter the U.S. market on the same date, subject to the expiration of any applicable regulatory exclusivities of any first filer with respect to FENTORA and subject, in certain circumstances, to the payment of royalties to us. Upon execution of the definitive written agreement giving effect to the terms of the Barr Agreement (the “Definitive Agreement”), the parties will file dismissals with prejudice with the United States District Court for the District

 

13



Table of Contents

 

of Delaware, which will conclude the pending FENTORA patent litigation with Barr. We have filed the Barr Agreement (and, once executed, will file the Definitive Agreement) with both the FTC and the Antitrust Division of the DOJ as required by the Medicare Prescription Drug, Improvement and Modernization Act of 2003. There can be no assurance that the FTC and/or the DOJ will not raise objections to, or request modifications to, the Barr Agreement and the Definitive Agreement; that any such modifications will be acceptable to the parties; or that the Barr Agreement and the Definitive Agreement will continue to be effective on the terms currently proposed or at all.

 

Under the provisions of the Hatch-Waxman Act, the filing of the Watson, Barr and Sandoz lawsuits stays any FDA approval of the applicable ANDA until the earlier of entry of a district court judgment in favor of the ANDA holder or 30 months from the date of our receipt of the respective Paragraph IV certification letter.  Assuming no earlier district court judgment, the earliest the 30-month stay will expire is in October 2010.

 

While we intend to vigorously defend the NUVIGIL, AMRIX and FENTORA intellectual property rights, these efforts will be both expensive and time consuming and, ultimately, due to the nature of litigation, there can be no assurance that these efforts will be successful.

 

U.S. Attorney’s Office and Related Matters

 

In September 2008, we entered into a settlement agreement (the “Settlement Agreement”) with the DOJ, the USAO, the OIG, TRICARE Management Activity, the U.S. Office of Personnel Management (collectively, the “United States Government”) and the relators identified in the Settlement Agreement to settle the outstanding False Claims Act claims alleging off-label promotion of ACTIQ and PROVIGIL from January 1, 2001 through December 31, 2006 and GABITRIL from January 2, 2001 through February 18, 2005 (the “Claims”). As part of the Settlement Agreement we paid a total of $375 million (the “Payment”) plus interest of $11.3 million. Pursuant to the Settlement Agreement, the United States Government and the relators released us from all Claims and the United States Government agreed to refrain from seeking our exclusion from Medicare/Medicaid, the TRICARE Program or other federal health care programs. In connection with the Settlement Agreement, we pled guilty to one misdemeanor violation of the U.S. Food, Drug and Cosmetic Act and agreed to pay $50 million (in addition to the Payment). All of the payments described above were made in the fourth quarter of 2008.

 

As part of the Settlement Agreement, we entered into a five-year Corporate Integrity Agreement (the “CIA”) with the OIG. The CIA provides criteria for establishing and maintaining compliance. We are also subject to periodic reporting and certification requirements attesting that the provisions of the CIA are being implemented and followed. We also agreed to enter into a State Settlement and Release Agreement (the “State Settlement Agreement”) with each of the 50 states and the District of Columbia. Upon entering into the State Settlement Agreement, a state will receive its portion of the Payment allocated for the compensatory state Medicaid payments and related interest amounts. Each state also agrees to refrain from seeking our exclusion from its Medicaid program.

 

In September 2008, we entered into an Assurance of Voluntary Compliance (the “Connecticut Assurance”) with the Attorney General of the State of Connecticut and the Commissioner of Consumer Protection of the State of Connecticut (collectively, “Connecticut”) to settle Connecticut’s investigation of our promotion of ACTIQ, GABITRIL and PROVIGIL. Pursuant to the Connecticut Assurance, (i) we paid a total of $6.15 million to Connecticut and (ii) Connecticut released us from any claim relating to the promotional practices that were the subject of Connecticut’s investigation. We also entered into an Assurance of Discontinuance (the “Massachusetts Settlement Agreement”) with the Attorney General of the Commonwealth of Massachusetts (“Massachusetts”) to settle Massachusetts’ investigation of our promotional practices with respect to fentanyl-based products. Pursuant to the Massachusetts Settlement Agreement, (i) we paid a total of $0.7 million to Massachusetts and (ii) Massachusetts released us from any claim relating to the promotional practices that were the subject of Massachusetts’ investigation.

 

In late 2007, we were served with a series of putative class action complaints filed in the EDPA on behalf of entities that claim to have reimbursed for prescriptions of ACTIQ for uses outside of the product’s approved label in non-cancer patients. The complaints allege violations of various state consumer protection laws, as well as the violation of the common law of unjust enrichment, and seek an unspecified amount of money in actual, punitive and/or treble damages, with interest, and/or disgorgement of profits. In May 2008, the plaintiffs filed a consolidated and amended complaint that also alleges violations of RICO and conspiracy to violate RICO. The RICO allegations were dismissed with prejudice in May 2009. In February 2009, we were served with an additional putative class action complaint filed on behalf of two health and welfare trust funds that claim to have reimbursed for prescriptions of GABITRIL and PROVIGIL for uses outside the products

 

14



Table of Contents

 

approved labels. The complaint alleges violations of RICO and the common law of unjust enrichment and seeks an unspecified amount of money in actual, punitive and/or treble damages, with interest. We believe the allegations in the complaints are without merit, and we intend to vigorously defend ourselves in these matters and in any similar actions that may be filed in the future. These efforts will be both expensive and time consuming and, ultimately, due to the nature of litigation, there can be no assurance that these efforts will be successful.

 

Derivative Suit

 

In January 2008, a purported stockholder of the company filed a derivative suit on behalf of Cephalon in the U.S. District Court for the District of Delaware naming each member of our Board of Directors as defendants. The suit alleges, among other things, that the defendants failed to exercise reasonable and prudent supervision over the management practices and controls of Cephalon, including with respect to the marketing and sale of ACTIQ, and in failing to do so, violated their fiduciary duties to the stockholders. The complaint seeks an unspecified amount of money damages, disgorgement of all compensation and other equitable relief. In August 2009, our Motion for Judgment on the Pleadings was granted. The plaintiffs have appealed this ruling. We believe the plaintiff’s allegations in this matter are without merit and we intend to vigorously defend ourselves in this matter. These efforts will be both expensive and time consuming and, ultimately, due to the nature of litigation, there can be no assurance that these efforts will be successful.

 

DURASOLV

 

In the third quarter of 2007, the U.S. Patent and Trademark Office (“PTO”) notified us that, in response to re-examination petitions filed by a third party, the Examiner rejected the claims in the two U.S. patents for our DURASOLV ODT technology. We disagree with the Examiner’s position, and we filed notices of appeal to the Board of Patent Appeals of the PTO’s decisions in the fourth quarter of 2007 regarding one patent and in the second quarter of 2008 regarding the second patent. In September 2009, the Board affirmed the Examiner’s position with respect to one of the DURASOLV patents. We have requested reconsideration from the Board and are awaiting the Board’s response.  We have the right to appeal from the Board and, as of the filing date of this report, we are awaiting a hearing and a determination with respect to our appeal regarding the other patent. These efforts will be both expensive and time consuming and, ultimately, due to the nature of patent appeals, there can be no assurance that these efforts will be successful. The invalidity of the DURASOLV patents could reduce our ability to enter into new contracts with regard to our drug delivery business.

 

Other Matters

 

We are a party to certain other litigation in the ordinary course of our business, including, among others, European patent oppositions, patent infringement litigation and matters alleging employment discrimination, product liability and breach of commercial contract. We do not believe these matters, even if adversely adjudicated or settled, would have a material adverse effect on our financial condition, results of operations or cash flows.

 

Other Commitments

 

We have committed to make potential future “milestone” payments to third parties as part of our in-licensing and development programs primarily in the area of research and development agreements.  Payments generally become due and payable only upon the achievement of certain developmental, regulatory and/or commercial milestones.  Because the achievement of these milestones is neither probable or reasonably estimable, we have not recorded a liability on our balance sheet for any such contingencies.  As of March 31, 2010, the potential milestone and other contingency payments due under current contractual agreements are $1.7 billion.

 

13.  STOCK-BASED COMPENSATION

 

Total stock-based compensation expense recognized in the consolidated statement of operations is as follows:

 

15



Table of Contents

 

 

 

Three months ended
March 31,

 

 

 

2010

 

2009

 

Stock option expense

 

$

4,470

 

$

6,230

 

G Restricted stock unit expense

 

4,360

 

5,330

 

Total stock-based compensation*

 

$

8,830

 

$

11,560

 

Total stock-based compensation expense after-tax

 

$

5,801

 

$

7,514

 

 


*For the three months ended March 31, 2010 and 2009, total stock-based compensation is allocated 4% to cost of sales, 38% to research and development and 58% to selling, general and administrative expenses based on the employees’ compensation allocation between these line items.

 

Stock based compensation expense decreased for the three months ended March 31, 2010 as compared to the three months ended March 31, 2009 due to a higher level of forfeitures in the three months ended March 31, 2010.

 

14.    INCOME TAXES

 

For the three months ended March 31, 2010, we recognized $48.3 million of income tax expense on income before income taxes of $148.6 million, resulting in an overall effective tax rate of 32.5 percent.

 

The Internal Revenue Service (“IRS”) currently is examining Cephalon, Inc.’s 2006 and 2007 U.S. federal income tax returns.  Zeneus Pharma S.a.r.L. is under examination by the French Tax Authorities for 2003 and 2004, while Cephalon France SAS is also under examination by the French Tax Authorities for 2007 and 2008.  Cephalon Gmbh, in Germany, is under examination for 2004 to 2006.  Our filings in the United Kingdom remain open to examination for 2007 to 2009.  In other significant foreign jurisdictions, the tax years that remains open for potential examination range from 2001 to 2009.  We do not believe at this time that the results of these examinations will have a material impact on the financial statements.

 

In the regular course of business, various state and local tax authorities also conduct examinations of our state and local income tax returns.  Depending on the state, state income tax returns are generally subject to examination for a period of three to five years after filing.  The state impact of any federal changes that may result from the 2006 and 2007 IRS examination and the agreed to federal changes from the 2003 to 2005 IRS examination, settled in 2008, remain subject to examination by various states for a period of up to one year after formal notification to the states. We currently have several state income tax returns in the process of examination.

 

In 2010, we received $16.0 million in federal tax refunds of previously paid federal taxes.  This refund was due to the carryback of unused federal tax credits from the tax year ending December 31, 2008. In 2009, we received $67.3 million in federal tax refunds of previously paid federal taxes. This refund was principally due to the tax benefit relating to the termination of our collaboration with Alkermes and the settlement with the USAO.

 

15.    EARNINGS PER SHARE (“EPS”)

 

Basic income per common share is computed based on the weighted average number of common shares outstanding during the period. Diluted income per common share is computed based on the weighted average number of common shares outstanding and, if there is net income during the period, the dilutive impact of common stock equivalents outstanding during the period.  Common stock equivalents are measured under the treasury stock method.

 

We have entered into convertible note hedge and warrant agreements that, in combination, have the economic effect of reducing the dilutive impact of the 2.0% Notes, 2.5% Notes and the 2010 Zero Coupon Notes. However, we are required to analyze separately the impact of the convertible note hedge and warrant agreements on diluted EPS. As a result, the purchases of the convertible note hedges are excluded because their impact will be anti-dilutive.  The impact of the warrants is computed using the treasury stock method.

 

The number of shares included in the diluted EPS calculation for the convertible subordinated notes and warrants is as follows:

 

 

 

Three months ended

 

 

 

March 31,

 

 

 

2010

 

2009

 

Average market price per share of Cephalon stock

 

$

67.43

 

$

72.24

 

 

 

 

 

 

 

Shares included in diluted EPS calculation:

 

 

 

 

 

2.0% Notes

 

5,398

 

6,208

 

Zero Coupon Notes

 

572

 

769

 

Warrants related to 2.0% Notes

 

 

1,178

 

Warrants related to 2010 Zero Coupon Notes

 

 

8

 

Other

 

1

 

1

 

Total

 

5,971

 

8,164

 

 

16



Table of Contents

 

The following is a reconciliation of net income and weighted average common shares outstanding for purposes of calculating basic and diluted income per common share:

 

 

 

Three months ended
March 31,

 

 

 

2010

 

2009

 

Basic income per common share computation:

 

 

 

 

 

Numerator:

 

 

 

 

 

Net income used for basic income per common share

 

$

110,565

 

$

58,583

 

Denominator:

 

 

 

 

 

Weighted average shares used for basic income per common share

 

74,990

 

68,792

 

 

 

 

 

 

 

Basic income per common share

 

$

1.47

 

$

0.85

 

 

 

 

Three months ended
March 31,

 

 

 

2010

 

2009

 

Diluted income per common share computation:

 

 

 

 

 

Numerator:

 

 

 

 

 

Net income used for basic income per common share

 

$

110,565

 

$

58,583

 

Denominator:

 

 

 

 

 

Weighted average shares used for basic income per common share

 

74,990

 

68,792

 

Effect of dilutive securities:

 

 

 

 

 

Convertible subordinated notes and warrants

 

5,971

 

8,164

 

Employee stock options and restricted stock units

 

850

 

1,037

 

Weighted average shares used for diluted income per common share

 

81,811

 

77,993

 

 

 

 

 

 

 

Diluted income per common share

 

$

1.35

 

$

0.75

 

 

The following reconciliation shows the shares excluded from the calculation of diluted income per common share as the inclusion of such shares would be anti-dilutive:

 

 

 

Three months ended

 

 

 

March 31,

 

 

 

2010

 

2009

 

Weighted average shares excluded:

 

 

 

 

 

Convertible subordinated notes and warrants

 

28,337

 

23,232

 

Employee stock options and restricted stock units

 

4,804

 

3,008

 

 

 

33,141

 

26,240

 

 

16.  SEGMENT AND SUBSIDIARY INFORMATION

 

Revenues for the three months ended March 31:

 

17



Table of Contents

 

 

 

2010

 

2009

 

 

 

United
States

 

Europe

 

Total

 

United
States

 

Europe

 

Total

 

Net Sales:

 

 

 

 

 

 

 

 

 

 

 

 

 

PROVIGIL*

 

$

244,601

 

$

17,850

 

$

262,451

 

$

238,429

 

$

14,933

 

$

253,362

 

NUVIGIL

 

34,922

 

 

34,922

 

 

 

 

GABITRIL

 

8,299

 

1,462

 

9,761

 

14,749

 

1,505

 

16,254

 

CNS

 

287,822

 

19,312

 

307,134

 

253,178

 

16,438

 

269,616

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

ACTIQ

 

14,940

 

18,491

 

33,431

 

21,412

 

16,752

 

38,164

 

Generic OTFC

 

12,779

 

 

12,779

 

24,112

 

 

24,112

 

FENTORA**

 

38,480

 

3,729

 

42,209

 

33,290

 

423

 

33,713

 

AMRIX

 

25,135

 

 

25,135

 

26,237

 

 

26,237

 

Pain

 

91,334

 

22,220

 

113,554

 

105,051

 

17,175

 

122,226

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

TREANDA

 

81,257

 

 

81,257

 

50,197

 

 

50,197

 

Other Oncology

 

4,555

 

24,198

 

28,753

 

5,326

 

21,032

 

26,358

 

Oncology

 

85,812

 

24,198

 

110,010

 

55,523

 

21,032

 

76,555

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Other

 

9,460

 

36,523

 

45,983

 

11,155

 

34,814

 

45,969

 

Total Net Sales

 

474,428

 

102,253

 

576,681

 

424,907

 

89,459

 

514,366

 

Other Revenues

 

15,784

 

4,120

 

19,904

 

5,623

 

(21

)

5,602

 

Total External Revenues

 

490,212

 

106,373

 

596,585

 

430,530

 

89,438

 

519,968

 

Inter-Segment Revenues

 

8,919

 

 

8,919

 

5,705

 

172

 

5,877

 

Elimination of Inter-Segment Revenues

 

(8,919

)

 

(8,919

)

(5,705

)

(172

)

(5,877

)

Total Revenues

 

$

490,212

 

$

106,373

 

$

596,585

 

$

430,530

 

$

89,438

 

$

519,968

 

 


* Marketed under the name MODIODAL® (modafinil) in France and under the name VIGIL® (modafinil) in Germany.

 

** Marketed under the name EFFENTORA® (fentanyl buccal tablet) in Europe.

 

Income (loss) before income taxes for the three months ended March 31:

 

 

 

2010

 

2009

 

United States

 

$

141,842

 

$

113,965

 

Europe

 

6,806

 

(37,129

)

Total

 

$

148,648

 

$

76,836

 

 

Total assets:

 

 

 

March 31,
2010

 

December 31,
2009

 

United States

 

$

4,038,223

 

$

3,896,131

 

Europe

 

748,051

 

761,964

 

Total

 

$

4,786,274

 

$

4,658,095

 

 

17.  SUBSEQUENT EVENTS

 

Mepha AG

 

In April 2010, we acquired all of the issued share capital of Mepha AG (“Mepha”), a privately-held, Swiss-based pharmaceutical company, for a final purchase price of CHF 622.5 million plus contractual purchase price adjustments of CHF 26.4 million for a total of CHF 648.9 million (or approximately US$606 million) in cash, funded from our available cash on hand.   Founded in 1949, Mepha markets branded and non-branded generics as well as specialty products in more than 50 countries. Mepha has operational subsidiaries in Portugal and the Baltics. Through partnerships, Mepha markets its products in other European countries, in the Middle East, Africa, South and Central America as well as in Asia. Mepha has approximately 700 full-time employees, 500 of them in Switzerland, and approximately 300 contractors.

 

18



Table of Contents

 

As of the date of this filing, we are still gathering information to allocate the purchase price to the assets acquired and liabilities assumed.

 

Ception Therapeutics, Inc.

 

In April 2010, we acquired privately-held Ception Therapeutics, Inc. for $250.0 million.  For more information on Ception, please see Note 2.

 

ITEM 2.  MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

 

Management’s Discussion and Analysis of Financial Condition and Results of Operations (“MD&A”) is intended to provide information to assist you in better understanding and evaluating our financial condition and results of operations. We encourage you to read this MD&A in conjunction with our consolidated financial statements included in Part I, Item 1 of this Quarterly Report on Form 10-Q, as well as our Annual Report on Form 10-K for the year ended December 31, 2009.

 

EXECUTIVE SUMMARY

 

Cephalon, Inc. is an international biopharmaceutical company dedicated to the discovery, development and commercialization of innovative products in four core therapeutic areas: central nervous system (“CNS”), pain, oncology and inflammatory disease. In addition to conducting an active research and development program, we market seven proprietary products in the United States and numerous products in various countries throughout Europe and the world.  Consistent with our core therapeutic areas, we have aligned our approximately 770-person U.S. field sales and sales management teams by area.  We have a sales and marketing organization numbering approximately 320 persons that supports our presence in nearly 50 countries in Europe, the Middle East and Africa and have a strong presence in the five key European pharmaceutical markets: France, Germany, Italy, Spain and the United Kingdom, and affiliates in Benelux and Poland.

 

In April 2010, we acquired all of the issued share capital of Mepha AG (“Mepha”), a privately-held, Swiss-based pharmaceutical company, for a final purchase price of CHF 622.5 million plus contractual purchase price adjustments of CHF 26.4 million for a total of CHF 648.9 million (or approximately US$606 million) in cash, funded from our available cash on hand.  Founded in 1949, Mepha markets branded and non-branded generics as well as specialty products in more than 50 countries. Mepha develops and manufactures its products in Aesch/Basel, Switzerland with a focus on Swiss-quality standards. Mepha’s research and development focuses on the development of improved and innovative generics providing additional benefits for patients. Mepha is also active in malaria research, offering innovative life-saving therapies for adults and children.  Mepha is the leading company on the Swiss generic market, with more than 120 products in over 500 packaging forms. Mepha has operational subsidiaries in Portugal and the Baltics. Through partnerships, Mepha markets its products in other European countries, in the Middle East, Africa, South and Central America as well as in Asia. Mepha has approximately 700 full-time employees, 500 of them in Switzerland, and approximately 300 contractors.

 

In April 2010, we acquired privately-held Ception Therapeutics, Inc. for $250.0 million.  We also advanced $25.0 million in financing to Ception prior to the acquisition, for which the Ception stockholders were not required to (and therefore did not) repay at the closing of the acquisition. Ception stockholders also could receive (i) additional payments related to clinical and regulatory milestones and (ii) royalties related to net sales of products developed from Ception’s program to discover small molecule, orally-active, anti-TNF (tumor necrosis factor) receptor agents.  A Phase II clinical trial of Ception’s lead compound, CINQUIL™ (reslizumab), in 106 patients demonstrated improved asthma control in adult patients with moderate to severe asthma and eosinophilic airway inflammation, as measured by the primary study endpoint, a change in Asthma-Control -Questionnaire or ACQ score (p=0.054). In addition, an analysis of the FEV1, a measure of lung function, showed a statistically significant improvement with CINQUIL compared to placebo (p= 0.002).  We expect to begin a Phase III clinical trial for the treatment of eosinophilic asthma by the end of 2010.

 

We also have recently completed other transactions designed to build a portfolio of potential products targeted to treat inflammatory diseases.  In 2009, we (i) acquired Arana Therapeutics Limited, an Australian company, whose lead human framework domain antibody construct compound, CEP-37247, is in Phase II development for patients with certain inflammatory diseases; (ii) acquired an exclusive, worldwide license to the ImmuPharma investigational compound, LUPUZOR™, which is in Phase IIb development for the treatment of systemic lupus erythematosus; and (iii) purchased an option to acquire privately-held BioAssets Development Corporation, which has an intellectual property estate around use of TNF inhibitors for sciatic pain in

 

19



Table of Contents

 

patients with intervertebral disk herniation, as well as other spinal disorders, which intellectual property we expect to utilize to develop CEP-37247 as a possible treatment of sciatica.

 

Our most significant products are our wakefulness products, PROVIGIL® (modafinil) Tablets [C-IV] and NUVIGIL® (armodafinil) Tablets [C-IV].  PROVIGIL comprised 46% of our total consolidated net sales for the three months ended March 31, 2010, of which 93% was in the U.S. market.  NUVIGIL comprised 6% of our total consolidated net sales for the three months ended March 31, 2010, all of which were in the U.S. market. In June 2007, we secured final U.S. Food and Drug Administration (the “FDA”) approval of the NUVIGIL indication for the treatment of excessive sleepiness associated with narcolepsy, obstructive sleep apnea/hypopnea syndrome (“OSA/HS”) and shift work sleep disorder (“SWSD”). We launched NUVIGIL on June 1, 2009.  In March 2009, we announced positive results from a Phase II clinical trial of NUVIGIL as adjunctive therapy for treating major depressive disorder in adults with bipolar I disorder and our plan to advance to Phase III trials for this indication.  In April 2009, we announced positive results from a Phase III clinical trial of NUVIGIL as a treatment for excessive sleepiness associated with jet lag disorder and filed a supplemental new drug application (an “sNDA”) for this indication with the FDA in June 2009.  Together with the FDA, we designed a special protocol assessment (“SPA”) intended to evaluate the experience of a typical eastbound airline traveler.  We believe the results of the Phase III clinical trial met the requirements of the SPA.  In March 2010, we received a complete response letter from the FDA that raised questions regarding the robustness of the Patient Global Impression of Severity (PGI-S) data, one of the two primary endpoints set forth in the SPA for this clinical trial. We have scheduled a meeting with the FDA in May 2010 to discuss the complete response letter.  In May 2009, we announced positive results from a Phase IV study of NUVIGIL in obstructive sleep apnea and co-morbid major depressive disorder requiring ongoing antidepressant therapy.

 

On a combined basis, our two next most significant products are FENTORA® (fentanyl buccal tablet) [C-II] and ACTIQ® (oral transmucosal fentanyl citrate) [C-II] (including our generic version of ACTIQ (“generic OTFC”)).  Together, these products comprise 15% of our total consolidated net sales for the three months ended March 31, 2010, of which 75% was in the U.S. market.   In October 2006, we launched FENTORA in the United States.  FENTORA is indicated for the management of breakthrough pain in patients with cancer who are already receiving and are tolerant to opioid therapy for their underlying persistent cancer pain.  In April 2008, we received marketing authorization from the European Commission for EFFENTORA™ for the same indication as FENTORA and launched the product in certain European countries in January 2009. We have focused our clinical strategy for FENTORA on studying the product in opioid-tolerant patients with breakthrough pain associated with chronic pain conditions, such as neuropathic pain and back pain.  In November 2007, we submitted an sNDA to the FDA seeking approval to market FENTORA for the management of breakthrough pain in opioid tolerant patients with chronic pain conditions.  In early April 2009, we submitted a Risk Evaluation and Mitigation Strategy (the “REMS Program”) with respect to FENTORA. Subject to the timing and nature of further discussions with the FDA, we expect to receive a response from the FDA regarding the FENTORA REMS Program by the middle of 2010.  With respect to ACTIQ, its sales have been meaningfully eroded by the launch of FENTORA and by generic OTFC products sold since June 2006 by Barr Laboratories, Inc. and by us through our sales agent, Watson Pharmaceuticals, Inc.  We expect this erosion will continue.  In September 2009, our obligation to supply Barr with generic OTFC ended pursuant to the terms of a license and supply agreement we entered into with Barr in July 2004.  We understand that in October 2009 the FDA approved ANDAs by Barr and by Covidien to market and sell generic OTFC and that Covidien launched its generic OTFC in the United States in March 2010.  We submitted our REMS Program for ACTIQ and generic OTFC in early April 2009.  We expect to receive a response from the FDA by the middle of 2010.

 

In March 2008, the FDA granted approval for TREANDA® (bendamustine hydrochloride) for the treatment of patients with chronic lymphocytic leukemia (“CLL”) and, in April 2008, the product was launched.  In October 2008, we received FDA approval of TREANDA for treatment of patients with indolent B-cell non-Hodgkin’s lymphoma (“NHL”) who have progressed during or within six months of treatment with rituximab or a rituximab-containing regimen.  TREANDA comprised 14% of our total consolidated net sales for the three months ended March 31, 2010, all of which were in the U.S. market.  While not a currently approved indication by the FDA, TREANDA was recently listed in the 2010 NCCN clinical practice guidelines as a front-line treatment for NHL.  We believe the guidelines listing was the result of an independent Phase III clinical study conducted by the German Study Group for Indolent Lymphomas (“StiL Group”) in Giessen, Germany.  The StiL Group’s study results announced in December 2009 indicated better tolerability and more than a 20-month improvement in median progression free survival in patients treated with TREANDA in combination with rituximab versus cyclophosphamide, doxorubicin, vincristine, and prednisolone (commonly known as CHOP) in combination with rituximab for the first-line treatment of patients with advanced follicular, indolent, and mantle cell lymphomas, each of which is not currently an FDA-approved indication. We are working with the StiL Group to determine if its study results can be filed with the FDA to support an sNDA for TREANDA for the treatment of front-line NHL.  Separately, we have begun enrolling patients in our own Phase III study of TREANDA for the treatment of front-line NHL.

 

20



Table of Contents

 

In August 2007, we acquired exclusive North American rights to AMRIX® (cyclobenzaprine hydrochloride extended-release capsules) from E. Claiborne Robins Company, Inc., a privately-held company d/b/a ECR Pharmaceuticals (“ECR”).  Two dosage strengths of AMRIX (15 mg and 30 mg) were approved in February 2007 by the FDA for short-term use as an adjunct to rest and physical therapy for relief of muscle spasm associated with acute, painful musculoskeletal conditions.  We made the product available in the United States in October 2007 and commenced a full U.S. launch in November 2007.  In June 2008, the U.S. Patent and Trademark Office (the “PTO”) issued a pharmaceutical formulation patent for AMRIX, which expires in February 2025.  In July 2009, the PTO issued a notice of allowance for an additional pharmaceutical formulation patent application for AMRIX.  In October 2009, after further review, the PTO rejected that patent application.  We have appealed that decision.

 

We are or may become a party to litigation in the ordinary course of our business, including, among others, matters alleging employment discrimination, product liability, patent or other intellectual property rights infringement, patent invalidity or breach of commercial contract.  In particular, as a biopharmaceutical company, our future success is highly dependent on obtaining and maintaining patent protection or regulatory exclusivity for our products and technology. In that regard, we are currently engaged in lawsuits with respect to generic company challenges to the validity and/or enforceability of our patents covering AMRIX, FENTORA and NUVIGIL. Trials for the Watson FENTORA ANDA matter and the Mylan, Barr and Impax AMRIX ANDA matters are scheduled for May 2010 and September 2010, respectively. In the first quarter of 2010, we understand that generic versions of modafinil have been launched in Portugal, Sweden and Denmark.  We intend to vigorously defend and enforce the validity, and prevent infringement, of our patents. The loss of patent protection or regulatory exclusivity on any of our existing products, whether by third-party challenge, invalidation, circumvention, license or expiration, could materially impact our results of operations.   For more information regarding these matters, please see Note 12 to our Consolidated Financial Statements included in Part I, Item 1 of this Quarterly Report on Form 10-Q, which is incorporated herein by reference.

 

While we seek to increase profitability and cash flow from operations, we will need to continue to achieve growth of product sales and other revenues sufficient for us to attain these objectives. The rate of our future growth will depend, in part, upon our ability to obtain and maintain adequate intellectual property protection for our currently marketed products, and to successfully develop or acquire and commercialize new product candidates.

 

RESULTS OF OPERATIONS

(In thousands)

 

Three months ended March 31, 2010 compared to three months ended March 31, 2009:

 

 

 

Three months ended

 

 

 

 

 

 

 

 

 

March 31,

 

 

 

 

 

 

 

 

 

2010

 

2009

 

% Increase (Decrease)

 

 

 

United
States

 

Europe

 

Total

 

United
States

 

Europe

 

Total

 

United
States

 

Europe

 

Total

 

Net Sales:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

PROVIGIL*

 

$

244,601

 

$

17,850

 

$

262,451

 

$

238,429

 

$

14,933

 

$

253,362

 

3

%

20

%

4

%

NUVIGIL

 

34,922

 

 

34,922

 

 

 

 

 

 

 

GABITRIL

 

8,299

 

1,462

 

9,761

 

14,749

 

1,505

 

16,254

 

(44

)

(3

)

(40

)

CNS

 

287,822

 

19,312

 

307,134

 

253,178

 

16,438

 

269,616

 

14

 

17

 

14

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

ACTIQ

 

14,940

 

18,491

 

33,431

 

21,412

 

16,752

 

38,164

 

(30

)

10

 

(12