Annual Reports

 
Quarterly Reports

  • 10-Q (Aug 3, 2011)
  • 10-Q (May 9, 2011)
  • 10-Q (May 4, 2011)
  • 10-Q (Oct 29, 2010)
  • 10-Q (Jul 28, 2010)
  • 10-Q (May 5, 2010)

 
8-K

 
Other

Cephalon 10-Q 2006

 

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 September 30, 2006

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 Incorporation or
Organization)

 

(I.R.S. Employer Identification Number)

 

 

 

41 Moores Road, 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 is a large accelerated filer, an accelerated filer, or a non-accelerated filer (as defined in Rule 12b-2 of the Exchange Act). Large accelerated filer x Accelerated filer o Non-accelerated filer 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 November 1, 2006

Common Stock, par value $.01

 

60,965,523 Shares

 

 




TABLE OF CONTENTS

Cautionary Note Regarding Forward-Looking Statements

ii

 

 

 

 

PART I – FINANCIAL INFORMATION

 

 

 

 

 

 

Item 1.

Consolidated Financial Statements

 

 

 

 

 

 

 

Consolidated Balance Sheets - September 30, 2006 and December 31, 2005

1

 

 

 

 

 

 

Consolidated Statements of Operations - Three and nine months ended September 30, 2006 and 2005

2

 

 

 

 

 

 

Consolidated Statements of Stockholders’ Equity - September 30, 2006 and December 31, 2005

3

 

 

 

 

 

 

Consolidated Statements of Cash Flows - Nine months ended September 30, 2006 and 2005

4

 

 

 

 

 

 

Notes to Consolidated Financial Statements

5

 

 

 

 

 

Item 2.

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

18

 

 

 

 

 

Item 3.

Quantitative and Qualitative Disclosure About Market Risk

35

 

 

 

 

 

Item 4.

Controls and Procedures

36

 

 

 

 

PART II – OTHER INFORMATION

 

 

 

 

 

 

Item 1.

Legal Proceedings

37

 

 

 

 

 

Item 1A.

Risk Factors

37

 

 

 

 

 

Item 5.

Other Information

48

 

 

 

 

 

Item 6.

Exhibits

49

 

 

 

 

SIGNATURES

50

 

i




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 (the “SEC”) 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) [C-IV] in the United States and the market prospects and future marketing efforts for PROVIGIL, FENTORA™ (fentanyl buccal tablet) [C-II] and VIVITROL® (naltrexone for extended-release injectable suspension);

·      any potential approval of our product candidates, including NUVIGILÔ (armodafinil);

·      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;

·      the timing and unpredictability of regulatory approvals;

·      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 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; 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, particularly with respect to NUVIGIL, and to launch such products successfully;

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

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

·      the inability to adequately protect our key intellectual property rights;

·      the loss of key management or scientific personnel;

·      the activities of our competitors in the industry, including the impact of generic competition to ACTIQ;

·      regulatory or other setbacks with respect to our settlements of the PROVIGIL and ACTIQ patent litigations;

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

·      market conditions in the biopharmaceutical industry that make raising capital or consummating acquisitions

ii




difficult, expensive or both; 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 the section above included in Part II, Item 1A of this report. This discussion is permitted by the Private Securities Litigation Reform Act of 1995.

iii




PART I - FINANCIAL INFORMATION

ITEM 1. CONSOLIDATED FINANCIAL STATEMENTS

CEPHALON, INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

(In thousands, except share data)

(Unaudited)

 

 

September 30,

 

December 31,

 

 

 

2006

 

2005

 

ASSETS

 

 

 

 

 

 

 

 

 

 

 

CURRENT ASSETS:

 

 

 

 

 

Cash and cash equivalents

 

$

630,363

 

$

205,060

 

Investments

 

37,619

 

279,030

 

Receivables, net

 

234,675

 

199,086

 

Inventory, net

 

164,664

 

137,886

 

Deferred tax assets, net

 

170,131

 

187,436

 

Other current assets

 

43,937

 

40,339

 

Total current assets

 

1,281,389

 

1,048,837

 

 

 

 

 

 

 

PROPERTY AND EQUIPMENT, net

 

391,846

 

323,830

 

GOODWILL

 

472,152

 

471,051

 

INTANGIBLE ASSETS, net

 

799,756

 

742,874

 

DEFERRED TAX ASSETS, net

 

164,919

 

200,629

 

OTHER ASSETS

 

17,498

 

31,985

 

 

 

$

3,127,560

 

$

2,819,206

 

 

 

 

 

 

 

LIABILITIES AND STOCKHOLDERS’ EQUITY

 

 

 

 

 

 

 

 

 

 

 

CURRENT LIABILITIES:

 

 

 

 

 

Current portion of long-term debt

 

$

933,494

 

$

933,160

 

Accounts payable

 

63,492

 

53,699

 

Accrued expenses

 

245,011

 

291,744

 

Total current liabilities

 

1,241,997

 

1,278,603

 

 

 

 

 

 

 

LONG-TERM DEBT

 

762,404

 

763,097

 

DEFERRED TAX LIABILITIES, net

 

87,228

 

110,703

 

OTHER LIABILITIES

 

58,764

 

54,632

 

Total liabilities

 

2,150,393

 

2,207,035

 

 

 

 

 

 

 

COMMITMENTS AND CONTINGENCIES

 

 

 

 

 

 

 

 

 

STOCKHOLDERS’ EQUITY:

 

 

 

 

 

Preferred stock, $.01 par value, 5,000,000 shares authorized, 2,500,000 shares issued, and none outstanding

 

 

 

Common stock, $.01 par value, 200,000,000 shares authorized, 60,846,575 and 58,445,405 shares issued, and 60,468,051 and 58,072,562 shares outstanding

 

608

 

584

 

Additional paid-in capital

 

1,333,340

 

1,166,166

 

Treasury stock, at cost, 378,524 and 372,843 shares outstanding

 

(17,558

)

(17,125

)

Accumulated deficit

 

(420,347

)

(570,072

)

Accumulated other comprehensive income

 

81,124

 

32,618

 

Total stockholders’ equity

 

977,167

 

612,171

 

 

 

$

3,127,560

 

$

2,819,206

 

 

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

1




CEPHALON, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS

(In thousands, except per share data)

(Unaudited)

 

 

Three Months Ended

 

Nine Months Ended

 

 

 

September 30,

 

September 30,

 

 

 

2006

 

2005

 

2006

 

2005

 

REVENUES:

 

 

 

 

 

 

 

 

 

Sales

 

$

470,513

 

$

294,371

 

$

1,246,825

 

$

833,588

 

Other revenues

 

11,820

 

15,165

 

32,562

 

41,900

 

 

 

482,333

 

309,536

 

1,279,387

 

875,488

 

 

 

 

 

 

 

 

 

 

 

COSTS AND EXPENSES:

 

 

 

 

 

 

 

 

 

Cost of sales

 

62,356

 

37,629

 

189,848

 

114,093

 

Research and development

 

81,012

 

91,934

 

279,765

 

255,591

 

Selling, general and administrative

 

157,490

 

103,253

 

460,068

 

302,904

 

Depreciation and amortization

 

29,849

 

22,346

 

85,989

 

61,151

 

Impairment charge

 

 

 

12,417

 

 

Acquired in-process research and development

 

 

5,500

 

 

295,615

 

 

 

330,707

 

260,662

 

1,028,087

 

1,029,354

 

 

 

 

 

 

 

 

 

 

 

INCOME (LOSS) FROM OPERATIONS

 

151,626

 

48,874

 

251,300

 

(153,866

)

 

 

 

 

 

 

 

 

 

 

OTHER INCOME (EXPENSE):

 

 

 

 

 

 

 

 

 

Interest income

 

7,046

 

7,247

 

16,736

 

19,559

 

Interest expense

 

(4,749

)

(7,494

)

(13,523

)

(19,311

)

Write-off of deferred debt issuance costs

 

 

 

(13,105

)

 

Gain on early extinguishment of debt

 

 

2,085

 

 

2,085

 

Other income (expense), net

 

895

 

(38

)

(116

)

1,983

 

 

 

3,192

 

1,800

 

(10,008

)

4,316

 

 

 

 

 

 

 

 

 

 

 

INCOME (LOSS) BEFORE INCOME TAXES

 

154,818

 

50,674

 

241,292

 

(149,550

)

 

 

 

 

 

 

 

 

 

 

INCOME TAX EXPENSE

 

59,077

 

21,331

 

91,567

 

43,477

 

 

 

 

 

 

 

 

 

 

 

NET INCOME (LOSS)

 

$

95,741

 

$

29,343

 

$

149,725

 

$

(193,027

)

 

 

 

 

 

 

 

 

 

 

BASIC INCOME (LOSS) PER COMMON SHARE

 

$

1.58

 

$

0.51

 

$

2.48

 

$

(3.33

)

 

 

 

 

 

 

 

 

 

 

DILUTED INCOME (LOSS) PER COMMON SHARE

 

$

1.43

 

$

0.50

 

$

2.17

 

$

(3.33

)

 

 

 

 

 

 

 

 

 

 

WEIGHTED AVERAGE NUMBER OF COMMON SHARES OUTSTANDING

 

60,762

 

58,064

 

60,415

 

58,035

 

 

 

 

 

 

 

 

 

 

 

WEIGHTED AVERAGE NUMBER OF COMMON SHARES OUTSTANDING- ASSUMING DILUTION

 

67,072

 

59,398

 

68,921

 

58,035

 

 

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

2




CEPHALON, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY

(In thousands, except share data)

(Unaudited)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Accumulated

 

 

 

 

 

 

 

 

 

 

 

Additional

 

 

 

 

 

 

 

Other

 

 

 

Comprehensive

 

 

 

Common Stock

 

Paid-in

 

Treasury Stock

 

Accumulated

 

Comprehensive

 

 

 

Income (Loss)

 

Total

 

Shares

 

Amount

 

Capital

 

Shares

 

Amount

 

Deficit

 

Income

 

BALANCE, JANUARY 1, 2005

 

 

 

$

830,044

 

57,973,050

 

$

580

 

$

1,172,499

 

332,784

 

$

(14,860

)

$

(395,118

)

$

66,943

 

Net loss

 

$

(174,954

)

(174,954

)

 

 

 

 

 

 

 

 

 

 

(174,954

)

 

 

Foreign currency translation loss

 

(33,317

)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Unrealized investment losses

 

(1,008

)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Other comprehensive loss

 

(34,325

)

(34,325

)

 

 

 

 

 

 

 

 

 

 

 

 

(34,325

)

Comprehensive loss

 

$

(209,279

)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Sale of warrants associated with convertible subordinated notes

 

 

 

217,071

 

 

 

 

 

217,071

 

 

 

 

 

 

 

 

 

Purchase of convertible note hedge associated with convertible subordinated notes

 

 

 

(382,261

)

 

 

 

 

(382,261

)

 

 

 

 

 

 

 

 

Tax benefit from the purchase of convertible note hedge

 

 

 

133,791

 

 

 

 

 

133,791

 

 

 

 

 

 

 

 

 

Stock options exercised

 

 

 

11,460

 

346,730

 

3

 

11,457

 

 

 

 

 

 

 

 

 

Tax benefit from the exercise of stock options, net of adjustment

 

 

 

2,826

 

 

 

 

 

2,826

 

 

 

 

 

 

 

 

 

Restricted stock award plan

 

 

 

10,784

 

125,625

 

1

 

10,783

 

 

 

 

 

 

 

 

 

Treasury stock acquired

 

 

 

(2,265

)

 

 

 

 

 

 

40,059

 

(2,265

)

 

 

 

 

BALANCE, DECEMBER 31, 2005

 

 

 

612,171

 

58,445,405

 

584

 

1,166,166

 

372,843

 

(17,125

)

(570,072

)

32,618

 

Net income

 

$

149,725

 

149,725

 

 

 

 

 

 

 

 

 

 

 

149,725

 

 

 

Foreign currency translation gain

 

47,635

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Unrealized investment gains

 

871

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Other comprehensive gain

 

48,506

 

48,506

 

 

 

 

 

 

 

 

 

 

 

 

 

48,506

 

Comprehensive income

 

$

198,231

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Issuance of common stock upon conversion of convertible notes

 

 

 

56

 

943

 

 

 

56

 

 

 

 

 

 

 

 

 

Stock options exercised

 

 

 

112,794

 

2,400,227

 

24

 

112,770

 

 

 

 

 

 

 

 

 

Tax benefit from equity compensation

 

 

 

21,912

 

 

 

 

 

21,912

 

 

 

 

 

 

 

 

 

Stock-based compensation expense

 

 

 

32,436

 

 

 

 

 

32,436

 

 

 

 

 

 

 

 

 

Treasury stock acquired

 

 

 

(433

)

 

 

 

 

 

 

5,681

 

(433

)

 

 

 

 

BALANCE, SEPTEMBER 30, 2006

 

 

 

$

977,167

 

60,846,575

 

$

608

 

$

1,333,340

 

378,524

 

$

(17,558

)

$

(420,347

)

$

81,124

 

 

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

3




CEPHALON, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

(In thousands)

(Unaudited)

 

 

Nine Months Ended

 

 

 

September 30,

 

 

 

2006

 

2005

 

CASH FLOWS FROM OPERATING ACTIVITIES:

 

 

 

 

 

Net income (loss)

 

$

149,725

 

$

(193,027

)

Adjustments to reconcile net income (loss) to net cash provided by operating activities:

 

 

 

 

 

Deferred income tax expense

 

64,112

 

27,931

 

Tax benefit from stock-based compensation

 

 

3,956

 

Depreciation and amortization

 

94,828

 

70,966

 

Amortization of debt issuance costs

 

387

 

6,521

 

Write-off of debt issuance costs associated with Zero Coupon convertible subordinated notes

 

13,105

 

 

Stock-based compensation expense

 

32,436

 

7,631

 

Non-cash gain on early extinguishment of debt

 

 

(4,549

)

Loss on disposals of property and equipment

 

2,368

 

949

 

Impairment charge

 

12,417

 

 

Acquired in-process research and development

 

 

130,615

 

Changes in operating assets and liabilities, net of effect from acquisitions:

 

 

 

 

 

Receivables

 

(30,818

)

43,347

 

Inventory

 

(22,837

)

(37,084

)

Other assets

 

(5,133

)

910

 

Accounts payable, accrued expenses and deferred revenues

 

(45,820

)

21,671

 

Other liabilities

 

(13,580

)

(11,428

)

Net cash provided by operating activities

 

251,190

 

68,409

 

 

 

 

 

 

 

CASH FLOWS FROM INVESTING ACTIVITIES:

 

 

 

 

 

Purchases of property and equipment

 

(97,122

)

(63,951

)

Acquisition of Salmedix, net of cash acquired

 

 

(130,733

)

Acquisition of TRISENOX

 

 

(69,722

)

Acquisition of intangible assets

 

(115,000

)

(2,652

)

Sales and maturities of investments

 

244,165

 

90,361

 

Purchases of investments

 

(1,505

)

(104,474

)

Net cash provided by (used for) investing activities

 

30,538

 

(281,171

)

 

 

 

 

 

 

CASH FLOWS FROM FINANCING ACTIVITIES:

 

 

 

 

 

Proceeds from exercises of common stock options

 

112,794

 

2,247

 

Windfall tax benefits from stock-based compensation

 

21,912

 

 

Acquisition of treasury stock

 

(433

)

(32

)

Payments on and retirements of long-term debt

 

(2,528

)

(501,958

)

Net proceeds from issuance of convertible subordinated notes

 

 

891,949

 

Proceeds from sale of warrants

 

 

217,071

 

Purchase of convertible note hedge

 

 

(382,261

)

Net cash provided by financing activities

 

131,745

 

227,016

 

 

 

 

 

 

 

EFFECT OF EXCHANGE RATE CHANGES ON CASH AND CASH EQUIVALENTS

 

11,830

 

(3,222

)

 

 

 

 

 

 

NET INCREASE IN CASH AND CASH EQUIVALENTS

 

425,303

 

11,032

 

 

 

 

 

 

 

CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD

 

205,060

 

574,244

 

 

 

 

 

 

 

CASH AND CASH EQUIVALENTS, END OF PERIOD

 

$

630,363

 

$

585,276

 

 

 

 

 

 

 

Non-cash financing activities:

 

 

 

 

 

Tax benefit from the purchase of convertible note hedge

 

$

 

$

133,791

 

 

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

4




CEPHALON, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(In thousands, except per share data)

(Unaudited)

1. BASIS OF PRESENTATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

The accompanying unaudited consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America 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 accounting principles generally accepted in the United States of America for complete financial statements. In the opinion of management, all adjustments (consisting only of normal recurring accruals) considered necessary for a fair presentation have been included. These financial statements should be read in conjunction with the consolidated financial statements and notes thereto included in our Annual Report on Form 10-K, filed with the Securities and Exchange Commission, which includes audited financial statements as of December 31, 2005 and 2004 and for each of the three years in the period ended December 31, 2005. 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.

Reclassifications

Reclassifications of certain prior year amounts have been made to conform with the current year presentation.

Recent Accounting Pronouncements

In July 2006, the Financial Accounting Standards Board (“FASB”) issued FASB Interpretation No. 48, Accounting for Uncertainty in Income Taxes — an interpretation of FASB Statement No. 109 (“FIN 48”). FIN 48 clarifies the accounting for uncertainty in income taxes recognized in an enterprise’s financial statements. FIN 48 prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in the tax return. FIN 48 is effective for fiscal years beginning after December 15, 2006. We are currently evaluating the effect FIN 48 will have on the company’s financial position, liquidity and statement of operations. The cumulative effect of applying the provisions of FIN 48 will be reported as an adjustment to the opening balance of retained earnings upon adoption.

In September 2006, the FASB issued FASB Statement No. 157, “Fair Value Measurements” (“SFAS 157”). SFAS 157 clarifies the definition of fair value, establishes a framework for measuring fair value and expands the disclosures on fair value measurements. SFAS 157 is effective for fiscal years beginning after November 15, 2007. We are currently evaluating the impact of SFAS 157 adoption on our consolidated financial statements.

In September 2006, the FASB issued FASB Statement No. 158, “Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans — an amendment of FASB Statements No. 87, 88, 106, and 132(R)” (“SFAS 158”). SFAS 158 requires the recognition of the overfunded or underfunded status of a defined benefit postretirement plan (other than a multiemployer plan) as an asset or liability in its statement of financial position, the measurement of a plan’s assets and its obligations that determine its funded status as of the end of the employer’s fiscal year and the recognition of changes in that funded status in the year in which the changes occur through comprehensive income. SFAS 158 is effective for us as of December 31, 2006. We are currently evaluating the impact of SFAS 158 and we do not expect the adoption of this statement to have a material impact on our financial statements.

Revenue Recognition

The following is in addition to, and should be read in conjunction with, the revenue recognition significant accounting policy included in Part II, Item 8, footnote 1 of our Annual Report on Form 10-K for the year ended December 31, 2005.

We recognize revenue on new product launches when sales returns can be reasonably estimated and all other revenue recognition requirements have been met. When determining if returns can be estimated, we consider actual returns of similar products as well as sales returns with similar customers. In cases in which a new product is not an extension of an existing line of product or where the company has no history of experience with products in a similar therapeutic category such that we can not estimate expected returns of the new product, we defer recognition of revenue until the right of return no longer exists or until we have developed sufficient historical experience to estimate sales returns. In developing estimates for sales returns, we consider inventory levels in the distribution channel, shelf life of the product and expected demand based on market data and prescriptions.

5




On September 27, 2006, Barr began selling a generic version of oral transmucosal fentanyl citrate (“generic OTFC”) in the U.S. market.  On that same date, we also entered the market with a generic OTFC, utilizing Watson Pharma, Inc. as our sales agent in this effort.  As of the end of the third quarter of 2006, inventory held at the wholesalers of ACTIQ totaled approximately 0.4 million units and inventory held at the wholesalers and retailers of our generic OTFC totaled approximately 1.3 million units.  According to prescription data provided by IMS Health, the average demand for ACTIQ during the 12-month period between August 2005 and July 2006 was approximately 2.4 million units per month.

The terms of sale of Cephalon’s generic OTFC product to wholesalers and retailers provide for both the right of return of expired product and retroactive price reductions under certain conditions.  Given the limited sales data history for the generic OTFC products and the estimated level of inventory at the wholesalers and retailers, it is not possible at this time to assess the relative future market shares for each of the generic OTFC products and the branded ACTIQ product or the potential for further generic entrants into the market.  In light of these uncertainties, we do not believe that the price charged to wholesalers and retailers for the majority of our generic OTFC sold during the quarter was fixed or determinable.  As such, we have not recognized revenue during the quarter. We will continue to assess the development in the market and our ability to estimate returns and the final sales price.

2. ACQUISITIONS AND TRANSACTIONS

VIVITROL LICENSE AND COLLABORATION

In June 2005, we entered into a license and collaboration agreement with Alkermes, Inc. to develop and commercialize VIVITROL® (naltrexone for extended-release injectable suspension) in the United States. In April 2006, the U.S. Food and Drug Administration (“FDA”) approved VIVITROL for the treatment of alcohol dependent patients who are able to abstain from drinking in an outpatient setting and are not actively drinking when initiating treatment and, in June 2006, we launched the product.

Concurrent with the execution of this agreement, we entered into a supply agreement under which Alkermes provides to us finished commercial supplies of VIVITROL. We made an initial payment of $160 million cash to Alkermes upon execution of this agreement, all of which was recorded as an in-process research and development charge (“IPR&D”) as the product had not yet received FDA approval. In April 2006, we made an additional cash payment of $110 million to Alkermes upon FDA approval of the product. This payment has been capitalized and is being amortized over the life of the agreement. Alkermes also could receive up to an additional $220 million in milestone payments from us upon attainment of certain agreed-upon sales levels of VIVITROL.

Cephalon and Alkermes have formed a joint steering committee that shares responsibility for the commercialization, development and supply strategy for VIVITROL. We have primary responsibility for the commercialization of VIVITROL, while Alkermes is responsible for manufacturing the product. Until December 31, 2007, Alkermes is responsible for any cumulative losses up to $120 million and we are responsible for any cumulative losses in excess of $120 million. Pre-tax profit, as adjusted for certain items, and losses incurred after December 31, 2007 will be split equally between the parties. We began recognizing revenue for VIVITROL effective in the third quarter of 2006.

In October 2006, Cephalon and Alkermes amended the existing license and collaboration agreement to provide that Cephalon would be responsible for its own VIVITROL-related costs during the period August 1, 2006 through December 31, 2006 and, for that period, such costs will not be chargeable to the collaboration and against the $120 million cumulative loss cap.  The parties also agreed to amend the existing supply agreement to provide that Cephalon will purchase from Alkermes two VIVITROL manufacturing lines (and related equipment).  As of the filing date of this report, Alkermes has spent approximately $19 million on construction of these two manufacturing lines and will be reimbursed by Cephalon for these expenditures and for certain future capital improvements related to these two manufacturing lines.  Cephalon also has granted Alkermes an option, exercisable after two years, to purchase these manufacturing lines at the then-current net book value of the assets.

ZENEUS HOLDINGS LIMITED

On December 22, 2005, we completed our acquisition of all of the issued share capital of Zeneus Holdings Limited (“Zeneus”). Total consideration paid in connection with the acquisition was $365.8 million. Total purchase price after transaction costs and other working capital adjustments was $385.6 million, which included payment for $19.8 million of cash acquired. Zeneus, a European specialty pharmaceutical company headquartered in the United Kingdom, has three key products that are currently marketed in key European countries: Myocet, used in the treatment of metastatic breast cancer; Abelcet, used as an antifungal treatment; and Targretin, used to treat the skin manifestations of cutaneous T-cell lymphoma. Key customer targets are oncologists, hematologists and dermatologists.

6




The total purchase price of $385.6 million consists of $375.5 million for all the outstanding shares of Zeneus and $10.1 million paid for transaction costs and the settlement of other seller related liabilities. The acquisition was funded from our existing cash and short-term investments.

The following table summarizes the estimated fair values of assets acquired and liabilities assumed at the date of acquisition:

 

At December 22,

 

 

 

2005

 

Cash and cash equivalents

 

$

19,792

 

Receivables

 

29,577

 

Inventory

 

12,085

 

Other current assets

 

6,316

 

Property, plant and equipment

 

1,319

 

Intangible assets

 

224,100

 

Acquired in-process research and development

 

71,200

 

Goodwill

 

106,706

 

Total assets acquired

 

471,095

 

Other liabilities

 

(34,303

)

Deferred tax liability

 

(51,214

)

Total liabilities assumed

 

(85,517

)

Net assets acquired

 

$

385,578

 

 

The purchase price allocation was finalized during the third quarter of 2006. We did not make any significant adjustments to the purchase price allocation during the third quarter of 2006. During the second quarter of 2006, we finalized the Zeneus integration plan as it relates to employee severance costs and recorded a reserve for employee termination benefits of $3.4 million. This reserve is for employee severance costs related to 31 employees throughout the organization including finance, legal, clinical and regulatory, sales and marketing and general administration. The termination of these employees is substantially complete as of September 30, 2006. Severance payments are expected to be completed by the end of 2007.

As part of our purchase price allocation, during the second quarter of 2006, we finalized our valuation of the Zeneus intellectual property and, as a result of this review, we have reduced the net book value of the Myocet intellectual property by $12.2 million. Also during the second quarter of 2006, we reduced the net deferred tax liability by $19.7 million. This adjustment was to record the deferred tax effect on deferred revenue and intellectual property adjustments described above as well as the finalization of our assessment of the deductibility of previously acquired intangible assets.

The following unaudited pro forma information shows the results of our operations for the three and nine months ended September 30, 2005 as though the acquisition had occurred as of the beginning of the period presented:

 

For the three

 

For the nine

 

 

 

months ended

 

months ended

 

 

 

September 30, 2005

 

September 30, 2005

 

Total revenues

 

$

332,319

 

$

946,280

 

Net income (loss)

 

$

27,637

 

$

(199,411

)

Basic and diluted net income (loss) per common share:

 

 

 

 

 

Basic income (loss) per common share

 

$

0.48

 

$

(3.44

)

Diluted income (loss) per common share

 

$

0.47

 

$

(3.44

)

 

The pro forma results have been prepared for comparative purposes only and are not necessarily indicative of the actual results of operations had the acquisition taken place as of the beginning of the periods presented, or the results that may occur in the future. Furthermore, the pro forma results do not give effect to all cost savings or incremental costs that may occur as a result of the integration and consolidation of the acquisition.

CO-PROMOTION AGREEMENT WITH TAKEDA

On June 12, 2006, we entered into a co-promotion agreement with a three-year term effective July 1, 2006 with Takeda Pharmaceuticals North America, Inc. (“Takeda”) with respect to PROVIGIL in the United States.

Under the co-promotion agreement, Takeda agreed to have at least 500 of its sales representatives promote PROVIGIL to primary care physicians and other appropriate health care professionals in the United States. Effective on January 1, 2007, Takeda will have 750 sales representatives promoting PROVIGIL. Together with our sales representatives, there will be nearly 1,200 sales representatives promoting PROVIGIL as of January 1, 2007. We also have an option to utilize the Takeda sales force for the promotion of NUVIGIL, assuming FDA approval of this product candidate. The parties have formed a joint commercialization committee to manage the promotion of PROVIGIL. We have retained all responsibility for the development, manufacture, distribution and sale of the product.

We will pay Takeda a royalty based on certain sales criteria for PROVIGIL and NUVIGIL during the three-year term and, if specified sales levels are reached, during the three calendar years following the expiration of the co-promotion agreement.

 

7




3. STOCK-BASED COMPENSATION

 

Equity Compensation Plans

We have established equity compensation plans for our employees, directors and certain other individuals. All grants and terms are authorized by the Stock Option and Compensation Committee of our Board of Directors. We may grant non-qualified stock options under the Cephalon, Inc. 2004 Equity Compensation Plan (the “2004 Plan”) and the Cephalon, Inc. 2000 Equity Compensation Plan (the “2000 Plan”), and also may grant incentive stock options and restricted stock awards under the 2004 Plan. Options and restricted stock awards generally become exercisable or vest ratably over four years from the grant date, and options must be exercised within ten years of the grant date. There are currently 11.5 million and 4.3 million shares authorized for issuance under the 2004 Plan and the 2000 Plan, respectively. At September 30, 2006, the shares available for future grants of stock options or restricted stock awards were 1,961,944, of which up to 607,409 may be issued as restricted stock awards.

Prior to the January 1, 2006 adoption of the FASB Statement No. 123(R), “Share Based Payment” (“SFAS 123(R)”), we accounted for stock option plans and restricted stock award plans in accordance with Accounting Principles Board Opinion (“APB”) No. 25, “Accounting for Stock Issued to Employees.” Accordingly, no compensation expense has been recognized for stock options since all options granted had an exercise price equal to the market value of the underlying stock on the grant date. Restricted stock awards have been recorded as compensation cost over the requisite vesting periods based on the market value on the date of grant. As permitted by SFAS No. 123, “Accounting for Stock-Based Compensation (“SFAS 123”), stock-based compensation was presented as a pro forma disclosure in the notes to the consolidated financial statements.

Effective January 1, 2006, we adopted the fair value recognition provisions of SFAS 123(R), using the modified-prospective transition method. Under this transition method, stock-based compensation is recognized in the consolidated financial statements for stock granted. Compensation expense recognized in the financial statements includes estimated expense for stock options granted after December 31, 2005, based on the grant date fair value estimated in accordance with the provisions of SFAS 123(R), and the estimated expense for the options granted prior to, but not vested as of January 1, 2006, based on the grant date fair value estimated in accordance with the original provisions of SFAS 123. SFAS 123(R) also requires us to estimate forfeitures in calculating the expense relating to stock-based compensation as opposed to only recognizing forfeitures and the corresponding reduction in expense as they occur. We recorded an adjustment for this cumulative effect for restricted stock awards and recognized a reduction in stock-based compensation in the first quarter of 2006 consolidated statements of operations allocated evenly between research and development and selling, general and administrative expenses based on the employees’ compensation allocation between these line items. The adjustment was not significant to the consolidated statement of operations.

Total stock-based compensation expense recognized in the consolidated statement of operations for the three months ended September 30, 2006 was $9.7 million before income taxes or $6.2 million after-tax. The impact of stock-based compensation expense on basic income per common share and diluted income per common share was $0.10 and $0.09, respectively. Stock-based compensation expense consisted of stock option and restricted stock expense of $6.7 million and $3.0 million, respectively. Total stock-based compensation expense recognized in the consolidated statement of operations for the nine months ended September 30, 2006 was $32.4 million before income taxes or $20.5 million after-tax.  The impact of stock-based compensation expense on basic income per common share and diluted income per common share was $0.34 and $0.30, respectively.  Stock-based compensation expense consisted of stock option and restricted stock expense of $23.9 million and $8.5 million, respectively. This expense was recognized evenly between research and development and selling, general and administrative expenses based on the employees’ compensation allocation between these line items. Compensation expense is recognized in the period the employee performs the service in accordance with FASB Interpretation Accounting for Stock Appreciation Rights and Other Variable Stock Option or Award Plans (“FIN 28”). The impact of capitalizing stock-based compensation was not significant at September 30, 2006.

During the second quarter of 2006, we elected to adopt the short-cut method of FASB Staff Position (“FSP”) No. FAS 123(R)-3 “The Transition Election Related to Accounting for the Tax Effects of Share Based Payment Awards” to determine our pool of windfall tax benefits under FAS 123(R).  Under the short-cut method, our historical pool of windfall tax benefits was calculated as cumulative net increases to additional paid in capital related to tax benefits from stock-based compensation after the election date of FAS 123 less the product of cumulative FAS 123 compensation cost, as adjusted, multiplied by the blended statutory tax rate at adoption of FAS 123(R).  Using this calculation, we determined our historical windfall tax pool was zero as of January 1, 2006. Following the guidance within FSP FAS 123(R)-3, we retrospectively applied the short-cut method to our consolidated financial statements for the three months ended March 31, 2006.  Under the transition provisions of the short-cut method, for awards fully vested at the adoption date of FAS 123(R) and subsequently settled, the pool of windfall tax benefits is equal to the total tax benefit recognized in additional paid in capital upon settlement.  Prior to the election of the short-cut method, we accounted for the on-going income tax effects for partially or

8




fully vested awards as of the date of FAS 123(R) adoption using the “as if” method of accounting required by the long-form method under FAS 123(R).  The retrospective application adjustments to our consolidated financial statements for the three months ended March 31, 2006 had no impact on our financial position or results of operations.  For the three months ended March 31, 2006, there was no change to our total net cash flows; however, our net cash used for operating activities increased by $21.5 million to $33.6 million and our net cash provided by financing activities increased by $21.5 million to $127.9 million.  Upon adoption during the second quarter of 2006, the impact of the election was not significant to our consolidated financial statements.  The cumulative pool of windfall tax benefits was $21.9 million as of September 30, 2006

Based on our historical experience of option pre-vesting forfeitures, we have assumed an expected forfeiture rate of 12% over the four year life of the option for all new options granted. Under the provisions of SFAS 123(R), we will record additional expense if the actual pre-vesting forfeiture rate is lower than we estimated and will record a recovery of prior expense if the actual forfeitures are higher than our estimate. As of January 1, 2006, the memo cumulative after-tax effect of this change in accounting for forfeitures for option awards, if this adjustment were recorded, would have been to increase stock-based compensation by $0.6 million.

Our expected term of options granted was derived from the average midpoint between vesting and the contractual term, as described in SEC’s Staff Accounting Bulletin No. 107, “Share-Based Payment.”  For 2006, expected volatilities are based on a combination of implied volatilities from traded options on our stock and the historical volatility of our stock for the related vesting period. The risk-free interest rate is based on the implied yield available on U.S. Treasury zero-coupon issues with an equivalent remaining term. We have not paid dividends in the past and do not plan to pay any dividends in the foreseeable future.

The following table illustrates the effect on pro forma net income (loss) and earnings per share if we had applied the fair value recognition provisions of SFAS 123:

 

 

For the three
months ended
September 30, 2005

 

For the nine
months ended
September 30, 2005

 

Net income (loss), as reported

 

$

29,343

 

$

(193,027

)

Add: Stock-based compensation expense included in net income (loss), net of related tax effects

 

1,473

 

5,099

 

Deduct: Total stock-based employee compensation expense determined under fair value based method for all awards, net of related tax effects

 

(6,514

)

(22,664

)

Pro forma net income (loss)

 

$

24,302

 

$

(210,592

)

 

 

 

 

 

 

Earnings per share:

 

 

 

 

 

Basic income (loss) per share, as reported

 

$

0.51

 

$

(3.33

)

Basic income (loss) per share, pro forma

 

$

0.42

 

$

(3.63

)

 

 

 

 

 

 

Diluted income (loss) per share, as reported

 

$

0.50

 

$

(3.33

)

Diluted income (loss) per share, pro forma

 

$

0.42

 

$

(3.63

)

 

The fair value of each option grant at the grant date is calculated using the Black-Scholes option-pricing model with the following weighted average assumptions:

 

For the three months ended

 

For the nine months ended

 

 

 

September 30,

 

September 30,

 

 

 

2006

 

2005

 

2006

 

2005

 

 

 

 

 

(Pro forma)

 

 

 

(Pro forma)

 

Risk free interest rate

 

4.90

%

4.19

%

4.98

%

3.81

%

Expected term (years)

 

6.25

 

6.50

 

5.74

 

6.50

 

Expected volatility

 

48.7

%

45.0

%

51.3

%

52.1

%

Expected dividend yield

 

%

%

%

%

 

 

 

 

 

 

 

 

 

 

Estimated fair value per option granted

 

$

35.51

 

$

21.67

 

$

33.22

 

$

24.52

 

 

9




Stock Options

The following tables summarize the aggregate option activity under the plans for the nine months ended September 30, 2006:

 

Shares

 

Weighted
Average
Exercise Price

 

Weighted
Average
Remaining
Contractual
Life (years)

 

Aggregate
Intrinsic Value

 

Outstanding, January 1, 2006

 

9,955,904

 

$

50.84

 

 

 

 

 

Granted

 

148,300

 

61.90

 

 

 

 

 

Exercised

 

(2,400,227

)

46.88

 

 

 

 

 

Forfeited

 

(246,125

)

50.01

 

 

 

 

 

Expired

 

(32,699

)

49.80

 

 

 

 

 

Outstanding, September 30, 2006

 

7,425,153

 

$

52.33

 

6.4

 

$

83,738

 

Vested options at end of period

 

4,520,567

 

$

53.96

 

5.4

 

$

48,812

 

 

 

Options Outstanding

 

Vested Options

 

Range of Exercise Price

 

Shares

 

Weighted
Average
Remaining
Contractual
Life (years)

 

Weighted
Average
Exercise
Price

 

Shares

 

Weighted
Average
Exercise
Price

 

$6.00-$14.99

 

274,550

 

1.8

 

$

9.47

 

274,550

 

$

9.47

 

$15.00-$29.99

 

166,401

 

2.8

 

26.50

 

166,401

 

26.50

 

$30.00-$50.99

 

2,443,652

 

7.4

 

47.62

 

899,165

 

47.08

 

$51.00-$59.99

 

2,870,175

 

6.6

 

51.72

 

1,592,976

 

52.14

 

$60.00-$71.96

 

1,670,375

 

5.5

 

69.88

 

1,587,475

 

70.26

 

 

 

7,425,153

 

6.4

 

52.33

 

4,520,567

 

53.96

 

 

As of September 30, 2006, there was approximately $28.3 million of total unrecognized compensation cost related to outstanding options that is expected to be recognized over a weighted-average period of 1.3 years. For the nine months ended September 30, 2006 and 2005, we received net proceeds of $112.8 million and $2.2 million, respectively, from the exercise of stock options.

The intrinsic value of stock options exercised during the third quarter of 2006 and 2005 was $1.4 million and $0.4 million, respectively. The estimated fair value of shares that vested during the third quarter of 2006 and 2005 was $0.8 million for both periods.

Restricted Stock

The following table summarizes restricted stock award activity for the nine months ended September 30, 2006:

 

Shares

 

Weighted Average
Fair Value

 

Nonvested, January 1, 2006

 

624,575

 

$

49.52

 

Granted

 

5,000

 

70.50

 

Vested

 

 

 

Forfeited

 

(55,775

)

49.47

 

Nonvested, September 30, 2006

 

573,800

 

$

49.71

 

Intrinsic Value as of September 30, 2006

 

$

35,432,150

 

 

 

 

As of September 30, 2006, there was approximately $12.6 million of total unrecognized compensation cost related to nonvested restricted stock awards that is expected to be recognized over a weighted-average period of 1.4 years. Total compensation for restricted stock was $3.0 million and $2.5 million, respectively, for the three months ended September 30, 2006 and 2005 and $8.5 million and $7.6 million, respectively, for the nine months ended September 30, 2006 and 2005.

There were no restricted stock awards shares released from restriction during the third quarter of 2006 and 2005.

10




4. INVENTORY, NET

 

Inventory consisted of the following:

 

September 30,

 

December 31,

 

 

 

2006

 

2005

 

Raw materials

 

$

103,066

 

$

67,164

 

Work-in-process

 

20,636

 

28,430

 

Finished goods

 

40,962

 

42,292

 

 

 

$

164,664

 

$

137,886

 

 

We capitalize inventory costs associated with marketed products and certain products prior to regulatory approval and product launch, based on management’s judgment of probable future commercial use and net realizable value. We could be required to expense previously capitalized costs related to pre-approval or pre-launch inventory upon a change in such judgment, due to a denial or delay of approval by regulatory bodies, a delay in commercialization, or other potential factors. At September 30, 2006, we had $83.2 million of capitalized inventory costs related to NUVIGIL, net of reserves of $5.0 million, as we do not expect that certain batches in inventory will be sold prior to their expiration date.

On August 9, 2006, we announced that we received a letter from the FDA stating that our supplemental new drug application (“sNDA”) for SPARLON™ (modafinil) Tablets [C-IV], a proprietary dosage form of modafinil for the treatment of attention-deficit/hyperactivity disorder (“ADHD”) in children and adolescents, is not approvable. In consideration of the FDA’s decision, we have determined that we will not pursue further development of SPARLON.  Prior to the FDA’s decision that the sNDA for SPARLON is not approvable, we had net capitalized inventory costs related to SPARLON of $8.6 million. In light of the FDA’s decision, we have fully reserved all of these capitalized inventory costs related to SPARLON as of June 30, 2006.

We received FDA approval of FENTORA™ (fentanyl buccal tablet) [C-II] in late September 2006 and launched the product in the United States in early October.  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.

At December 31, 2005, we had $44.6 million, $5.9 million and $0.6 million of capitalized inventory costs related to NUVIGIL, SPARLON and other pre-launch products, respectively.

5. INTANGIBLE ASSETS, NET

Intangible assets consisted of the following:

 

 

 

 

September 30, 2006

 

December 31, 2005

 

 

 

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

 

$

31,350

 

$

67,650

 

$

99,000

 

$

26,400

 

$

72,600

 

DuraSolv® technology

 

14 years

 

70,000

 

10,348

 

59,652

 

70,000

 

6,696

 

63,304

 

ACTIQ marketing rights

 

10 years

 

75,465

 

37,097

 

38,368

 

75,465

 

31,359

 

44,106

 

GABITRIL product rights

 

9-15 years

 

105,380

 

44,581

 

60,799

 

115,371

 

38,053

 

77,318

 

TRISENOX product rights

 

8-13 years

 

113,515

 

11,324

 

102,191

 

112,942

 

4,494

 

108,448

 

VIVITROL product rights

 

15 years

 

110,000

 

3,667

 

106,333

 

 

 

 

Myocet trademark

 

20 years

 

185,890

 

6,971

 

178,919

 

182,500

 

 

182,500

 

Other product rights

 

5-20 years

 

256,207

 

70,363

 

185,844

 

243,465

 

48,867

 

194,598

 

 

 

 

 

$

1,015,457

 

$

215,701

 

$

799,756

 

$

898,743

 

$

155,869

 

$

742,874

 

 

Intangible assets are amortized over their estimated useful economic life using the straight line method. Amortization expense was $20.8 million and $15.5 million for the three months ended September 30, 2006 and 2005, respectively, and $60.8 million and $42.2 million for the nine months ended September 30, 2006 and 2005, respectively.

In June 2006, we announced that data from our Phase 3 clinical program evaluating GABITRIL for the treatment of generalized anxiety disorder (“GAD”) did not reach statistical significance on the primary study endpoints. We have no further plans to continue studying GABITRIL for the treatment of GAD. As a result, we performed a test of impairment on the carrying value of our investment in GABITRIL product rights and recorded an impairment charge of $12.4 million in the second quarter of 2006 related to our European rights.

11




During the second quarter of 2006, we finalized our valuation of the Zeneus intellectual property and, as a result of this review, we reduced the net book value of the Myocet intellectual property by $12.2 million.

6. LONG-TERM DEBT

Long-term debt consisted of the following:

 

September 30,

 

December 31,

 

 

 

2006

 

2005

 

2.0% convertible senior subordinated notes due June 1, 2015

 

$

920,000

 

$

920,000

 

2.5% convertible subordinated notes due December 2006

 

10,007

 

10,007

 

Zero Coupon convertible subordinated notes first putable June 2008 (Old)

 

265

 

313

 

Zero Coupon convertible subordinated notes first putable June 2010 (Old)

 

97

 

99

 

Zero Coupon convertible subordinated notes first putable June 2008 (New)

 

375,157

 

374,958

 

Zero Coupon convertible subordinated notes first putable June 2010 (New)

 

375,196

 

375,070

 

Mortgage and building improvement loans

 

8,482

 

8,975

 

Capital lease obligations

 

3,872

 

3,658

 

Other

 

2,822

 

3,177

 

Total debt

 

1,695,898

 

1,696,257

 

Less current portion

 

(933,494

)

(933,160

)

Total long-term debt

 

$

762,404

 

$

763,097

 

 

In January 2006, our 2008 and 2010 Zero Coupon Notes (collectively, the “Zero Coupon Notes”) became convertible and the related deferred debt issuance costs of $13.1 million were written off. Our convertible notes will be classified as current liabilities and presented in current portion of long-term debt if our stock price is above the restricted conversion prices of $56.04, $71.40 or $67.80 with respect to the 2.0% convertible senior subordinated notes due June 1, 2015 (the “2.0% Notes”), the 2008 Zero Coupon Notes or the 2010 Zero Coupon Notes, respectively at the balance sheet date. As of September 30, 2006, our 2.0% Notes are considered to be current liabilities and are presented in current portion of long-term debt in our consolidated balance sheet. For a more complete description of these notes, including the associated convertible note hedge, see Note 9 to our Consolidated Financial Statements included in Part II, Item 8 of our Annual Report on Form 10-K for the year ended December 31, 2005.

In the event that a significant conversion 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, raising money in the capital markets or selling our note hedge instruments for cash.

7. LEGAL PROCEEDINGS

PROVIGIL Patent Litigation and Settlements

In March 2003, we filed a patent infringement lawsuit in the U.S. District Court in New Jersey 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 exclusivity provided by the provisions of the Federal Food, Drug and Cosmetic Act.

In late 2005 and early 2006, we entered into settlement agreements with each of Teva, Mylan, Ranbaxy and Barr. As part of these separate settlements, we agreed to grant to each of these parties a non-exclusive royalty-bearing right to market and sell a generic version of PROVIGIL in the United States. These licenses will become effective in April 2012. An earlier entry may occur based upon the entry of another generic version of PROVIGIL. Each of these settlements has been filed with both the United States Federal Trade Commission (the “FTC”) and the Antitrust Division of the Department of Justice (the “DOJ”) as required by the Medicare Prescription Drug, Improvement and Modernization Act of 2003 (the “Medicare Modernization Act”). The FTC has requested from us, and we have provided, certain information in connection with its review of the PROVIGIL settlements. In July 2006, the FTC requested that we voluntarily submit additional information and documents in connection with its investigation of this matter. We are cooperating fully with this request. The FTC could challenge in an administrative or judicial proceeding any or all of the settlements if they believe that the agreements violate the antitrust laws.

We also are aware of a number of civil antitrust complaints, purportedly filed as class actions, recently filed by private parties in U.S. District Court for the Eastern District of Pennsylvania, each naming Cephalon, Barr, Mylan, Teva and

12




Ranbaxy as co-defendants and claiming, among other things, that the patent litigation settlements concerning PROVIGIL violate the antitrust laws of the United States and certain state laws. The proposed consolidated class action complaints have been designated by plaintiffs, each of which seeks to certify separate, purported classes of plaintiffs: direct purchasers of PROVIGIL, and consumers and other indirect purchasers of PROVIGIL. The plaintiffs in both cases are seeking monetary damages and/or equitable relief. 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 U.S. District Court for the Eastern District of Pennsylvania 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, including a declaratory judgment that the ‘516 Patent is invalid and unenforceable. We filed a motion to dismiss the Apotex case in late September 2006.  We believe that both the class action cases and the Apotex case 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 early 2005, we also filed a patent infringement lawsuit in the U.S. District Court in New Jersey against Carlsbad Technology, Inc. based upon the Paragraph IV ANDA filed related to modafinil that Carlsbad filed with the FDA. Carlsbad has asserted counterclaims for non-infringement of the ‘516 Patent and invalidity of the ‘516 Patent. In early 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 FDA. As part of this settlement, we agreed to grant to Watson a non-exclusive royalty-bearing right to market and sell a generic version of PROVIGIL in the United States. This license will become effective on or after April 6, 2012, subject to applicable regulatory considerations. An earlier entry may occur based upon the entry of another generic version of PROVIGIL. This agreement has been filed with both the FTC and DOJ, as required by the Medicare Modernization Act.

In November 2005 and March 2006, we received notice that Caraco Pharmaceutical Laboratories, Ltd. and Apotex, Inc., 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 against either Caraco or Apotex as of the filing date of this report, although Apotex has brought an antitrust action against us, as described above.

ACTIQ Patent Litigation and Settlement

In February 2006, we also announced that we had agreed to settle with Barr our pending patent infringement dispute in the United States related to Barr’s ANDA filed with the FDA seeking to sell generic OTFC. Under the settlement, we granted to Barr an exclusive royalty bearing right to market and sell generic OTFC in the United States.  The settlement with Barr related to ACTIQ has been filed with both the FTC and the Antitrust Division of the DOJ as required by the Medicare Modernization Act. The FTC has requested from us, and we have provided, certain information in connection with its review of this settlement. The FTC, the DOJ, or a private party could challenge in an administrative or judicial proceeding the settlement with Barr if they believe that the agreement violates the antitrust laws. If the settlement is challenged, there is no assurance that we could successfully defend against such challenge and, in that case, we could be subject to, among other things, damages, fines and possible invalidation of the settlement agreement.

U.S. Attorney’s Office Investigation

In September 2004, we announced that we had received subpoenas from the U.S. Attorney’s Office in Philadelphia with respect to PROVIGIL, ACTIQ and GABITRIL. This investigation is ongoing and appears to be focused on our sales and promotional practices. We are cooperating with the investigation and are providing documents to the U.S. Attorney’s Office. In September 2004, we received a voluntary request for information from the Office of the Connecticut Attorney General asking us to provide information generally relating to our sales and promotional practices for our U.S. products. We have agreed to comply with this voluntary request and are engaged in ongoing discussions with that office. These matters may involve the bringing of criminal charges and fines, and/or civil penalties. We cannot predict or determine the outcome of these matters or reasonably estimate the amount or range of amounts of any fines or penalties that might result from an adverse outcome. However, an adverse outcome could have a material adverse effect on our financial position, liquidity and results of operations.

Other Matters

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

13




8. COMPREHENSIVE INCOME (LOSS)

 

Our comprehensive income (loss) includes net income (loss), unrealized gains and (losses) from foreign currency translation adjustments and unrealized investment gains (losses). Our total comprehensive income (loss) is as follows:

 

 

Three months ended
September 30,

 

Nine months ended
September 30,

 

 

 

2006

 

2005

 

2006

 

2005

 

Net income (loss)

 

$

95,741

 

$

29,343

 

$

149,725

 

$

(193,027

)

 

 

 

 

 

 

 

 

 

 

Foreign currency translation gain (loss)

 

13,209

 

(539

)

47,635

 

(27,427

)

Unrealized investment gains (losses)

 

(159

)

(1,037

)

871

 

(1,658

)

Other comprehensive gain (loss)

 

13,050

 

(1,576

)

48,506

 

(29,085

)

 

 

 

 

 

 

 

 

 

 

Comprehensive income (loss)

 

$

108,791

 

$

27,767

 

$

198,231

 

$

(222,112

)

 

9. EARNINGS PER SHARE (“EPS”)

We compute income per common share in accordance with SFAS No. 128, “Earnings Per Share” (“SFAS 128”). 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 the dilutive impact of common stock equivalents outstanding during the period. The dilutive effect of employee stock options, restricted stock awards, the Zero Coupon Convertible Notes issued in December 2004 (the “New Zero Coupon Notes”), the 2.0% Notes and the warrants are measured using the treasury stock method. The dilutive effect of our other convertible notes, including the remaining outstanding portions of the 2.5% Notes and the Zero Coupon Convertible Notes issued in June 2003 (the “Old Zero Coupon Notes”), are measured using the “if-converted” method. Common stock equivalents are not included in periods where there is a loss, as they are anti-dilutive.

The 2.0% Notes and New Zero Coupon Notes each are considered to be instrument C securities as defined by Emerging Issues Task Force Issue No. 90-19, “Convertible Bonds with Issuer Option to Settle for Cash upon Conversion” (“EITF 90-19”); therefore, these notes are included in the dilutive earnings per share calculation using the treasury stock method. Under the treasury stock method, we must calculate the number of shares issuable under the terms of these notes based on the average market price of the stock during the period, and include that number in the total diluted shares figure for the period. Since the average share price of our stock during the three months ended September 30, 2006 exceeded the conversion price of $46.70 for the 2.0% Notes and $56.50 and $59.50 for each series of the New Zero Coupon Notes, the impact of these notes during the period was an additional 4.4 million and 0.5 million of incremental shares, respectively, included to calculate diluted EPS. Since the average share price of our stock during the nine months ended September 30, 2006 exceeded the conversion price of $46.70 for the 2.0% Notes and $56.50 and $59.50 for each series of the New Zero Coupon Notes, the impact of these notes during the period was an additional 5.4 million and 1.3 million of incremental shares, respectively, included to calculate diluted EPS.

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 and the New Zero Coupon Notes by increasing the effective conversion price for these notes, from our perspective, to $67.92 and $72.08, respectively. SFAS No. 128, however, requires us 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 always be anti-dilutive. SFAS No. 128 further requires that the impact of the sale of the warrants be computed using the treasury stock method. For example, using the treasury stock method, if the average price of our stock during the period ended December 31, 2005 had been $65.00, $75.00, $85.00 or $95.00, the shares from the warrants to be included in diluted EPS would have been zero, 2.4 million, 5.9 million and 8.7 million shares, respectively. The total number of shares that could potentially be included under the warrants is 32.6 million. Since the average share price of our stock during the three and nine months ended September 30, 2006 did not exceed the effective conversion prices of the 2.0% Notes and each series of the New Zero Coupon Notes, there was no impact of the warrants on diluted shares or diluted EPS during the periods.

14




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

 

Three months ended

 

Nine months ended

 

 

 

September 30,

 

September 30,

 

 

 

2006

 

2005

 

2006

 

2005

 

Basic income (loss) per common share computation:

 

 

 

 

 

 

 

 

 

Numerator:

 

 

 

 

 

 

 

 

 

Net income (loss) used for basic income (loss) per common share

 

$

95,741

 

$

29,343

 

$

149,725

 

$

(193,027

)

Denominator:

 

 

 

 

 

 

 

 

 

Weighted average shares used for basic income (loss) per common share

 

60,762

 

58,064

 

60,415

 

58,035

 

 

 

 

 

 

 

 

 

 

 

Basic income (loss) per common share

 

$

1.58

 

$

0.51

 

$

2.48

 

$

(3.33

)

 

 

 

 

 

 

 

 

 

 

Diluted income (loss) per common share computation:

 

 

 

 

 

 

 

 

 

Numerator:

 

 

 

 

 

 

 

 

 

Net income (loss) used for basic income (loss) per common share

 

$

95,741

 

$

29,343

 

$

149,725

 

$

(193,027

)

Interest on convertible notes (net of tax) per common share

 

40

 

240

 

121

 

 

Net income (loss) used for diluted income (loss) per common share

 

$

95,781

 

$

29,583

 

$

149,846

 

$

(193,027

)

Denominator:

 

 

 

 

 

 

 

 

 

Weighted average shares used for basic income (loss) per common share

 

60,762

 

58,064

 

60,415

 

58,035

 

Effect of dilutive securities:

 

 

 

 

 

 

 

 

 

Convertible subordinated notes and warrants

 

5,070

 

825

 

6,798

 

 

Employee stock options and restricted stock awards

 

1,240

 

509

 

1,708

 

 

Weighted average shares used for diluted income (loss) per common share

 

67,072

 

59,398

 

68,921

 

58,035

 

 

 

 

 

 

 

 

 

 

 

Diluted income (loss) per common share

 

$

1.43

 

$

0.50

 

$

2.17

 

$

(3.33

)

 

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

 

Three months ended

 

Nine months ended

 

 

 

September 30,