Cephalon, Inc.

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Cephalon, Inc.

145 Brandywine Parkway
West Chester, Pennsylvania 19380
U.S.A.
Telephone: (610) 344-0200
Fax: (610) 738-6590
Web site: http://www.cephalon.com

Public Company
Incorporated: 1987
Employees: 650
Sales: $111.79 million (2000)
Stock Exchanges: NASDAQ
Ticker Symbol: CEPH
NAIC: 54171 Research and Development in the Physical, Engineering and Life Sciences

Cephalon, Inc. is an international biopharmaceutical company that specializes in drugs to treat neurological and sleep disorders. The company’s activities encompass the discovery, research, and development of new treatments as well as the sales and marketing of finished products.

Cephalon has three proprietary products that account for almost all of its sales revenue in the United States. The drug Provigil promotes daytime wakefulness and is used to treat narcolepsy, a disease characterized by a propensity to fall asleep during the day. Provigil is also used to combat fatigue associated with other disorders, such as depression and multiple sclerosis. A second product, Gabitril, treats partial seizures associated with epilepsy. Finally, the drug Actiq is prescribed to manage pain in cancer patients. Cephalon’s European headquarters in Guildford, England, manages the sale of eight products in the United Kingdom, France, Germany, Switzerland, and Austria. Branch offices are located in France and Germany. The company has also expanded its international reach through marketing collaboration agreements with pharmaceutical companies in Asia, Mexico, and Europe. Under the agreements, Cephalon is able to sell its products through a third party without having to maintain its own sales force abroad.

True to its roots as a small research house, Cephalon continues working to develop new treatments. Products currently under development include therapies for prostate and pancreatic cancer as well as Parkinson’s disease. The company is also working on finding new applications for its three centerpiece products. Meanwhile, sales and marketing has become an ever more prominent sector of the company’s operations. Of Cephalon’s 650 worldwide employees, about 250 work in the sales and marketing organizations.

A Small Research House: 1987-91

Cephalon was founded in 1987 by two venture capital firms, Burr, Egan, Deleage & Co. and Hambrecht & Quist Life Science Partners. The firms recruited Frank Baldino, Jr., a senior biologist who was conducting neuroscience research for DuPont, to head the company. In the early years, Baldino kept Cephalon focused on research. About 30 scientists worked in a 10,000-square-foot laboratory, specializing in the discovery of neurological growth factors that could be used to treat diseases such as multiple sclerosis, strokes, and amyotrophic lateral sclerosis (ALS, or Lou Gehrig’s disease). The chemicals under development were intended to prevent the brain cell death associated with the diseases.

As a small research house, Cephalon initially avoided involving itself in activities that would require maintaining a sales staff, managing clinical trials, and shepherding new drugs through the Food and Drug Administration (FDA) approval process. With no product to sell, Cephalon’s only asset was its scientific expertise. That expertise proved sufficient to attract investors, and the company managed to fund its operations through research grants and contracts with larger pharmaceutical firms. The 1990 discovery of an enzyme, Clipsin, that plays a major role in Alzheimer’s disease, for example, led to an agreement with Schering-Plough. Under the agreement, Schering-Plough provided Cephalon with $20 million to continue its Alzheimer’s research in exchange for exclusive worldwide rights to any technologies developed.

By the end of 1990, Cephalon had accumulated a deficit of $7.26 million since it began operating in November 1987. However, the company continued on a path of confident expansion. In March 1991 the staff had grown to 49 employees, who worked in an enlarged 31,000-square-foot lab. That April Cephalon completed its initial public offering, raising $59.4 million at a price of $18 a share. However, the share price dipped to $14.75 several weeks later amid general concern that biotechnology stocks were overvalued. The company would have to produce tangible results to retain investor confidence.

Banking on Myotrophin in the Mid-1990s

In late 1991 Cephalon received orphan drug approval for its product Myotrophin. Orphan drug status gives a company the right to market a product exclusively for seven years, and is granted for drugs not considered profitable enough to justify development without such a guarantee. Thus Cephalon began an eight-year, ultimately unsuccessful, occupation with Myotrophin. The drug, known as a neurotrophic factor, promoted the survival of neurons and was being developed as a treatment for ALS. Cephalon subsequently bought a plant in Maryland to manufacture Myotrophin for research purposes, and entered into an agreement with Chiron Corporation to manufacture the drug on a larger scale if it should be approved by the FDA.

Meanwhile, a successful $23 million equity offering in April 1993 showed that investors retained confidence in Cephalon. The company received $17 million in revenues that year from contracts with large pharmaceutical firms, and grew to 222 employees by year’s end. Besides Schering-Plough and Chiron, Cephalon worked with two other firms. In a collaboration with SmithKline Beecham, Cephalon was researching the use of protease inhibitors, chemicals that impede the process of cell death, to aid in the treatment of Alzheimer’s. It was also working with SmithKline Beecham on a line of drugs that had potential for stopping abnormal cell growth in cancer patients. With the Japanese firm Kyowa Hakko Kogyo Co. Ltd., Cephalon was developing chemicals to inhibit the action of kinases, a type of protein that causes cell death in Alzheimer’s and Parkinson’s patients. In addition, the first step toward the development of the narcolepsy treatment Provigil was taken in February 1993, when Cephalon bought from the French company Laboratoire L. Lafon all rights to develop, market, and sell Provigil’s main ingredient, modafinil. Such wide-ranging research efforts caused the accumulation of a $35.6 million deficit between 1987 and the end of 1993.

In 1994 failures at other clinics made Wall Street wary of biotechnology stocks, and Cephalon’s share price fell from a high of $19.50 in the first quarter of 1994 to $5.75 in mid-1995. But the company trusted in the potential of its own technologies. On June 12, Cephalon announced positive results of clinical tests of Myotrophin. The tests showed that Myotrophin appeared to slow the progression of ALS. Cephalon’s shares rose 400 percent on the news. Although European tests, announced in the fall, showed less conclusive results, the company’s stock continued to climb.

In 1995 Cephalon took a decisive step away from its research-only roots by establishing a sales force. Because Cephalon did not yet have a product to sell, the sales force sold other companies’ drugs. In an arrangement with Bristol-Myers Squibb, Cephalon sold the company’s drugs to neurologists, thus giving its own sales force the opportunity to establish the connections and experience that would pay off once Cephalon was marketing its own products.

The first major stumbling block for Myotrophin came at the beginning of 1996, when the FDA refused to allow Cephalon to expand tests of the drug. On January 19, shares fell 34 percent to $23.37 in reaction to the news. The FDA pointed to conflicting results between European and American tests as the basis for its decision. Critics of the tests also charged that the clinical trials of Myotrophin were poorly designed. The test groups were too small, they said, and records were kept in such a way that many patient deaths were not counted. Because the trials were testing disease progression, not mortality rates, patients who were taking Myotrophin were sometimes removed from the study before they died and hence were not included in the final statistics. The confusion over clinical trial results led a group of investors to file a suit against Cephalon charging that the company was misleading in its reporting of Myotrophin test results. The suit was eventually settled in August 1999 for $17 million, although Cephalon denied any wrongdoing.

In 1996 Cephalon sold the plant that it had been using to manufacture Myotrophin. However, Cephalon and its partner Chiron still hoped that the drug would gain final approval. In June 1996 the FDA made Myotrophin available to some ALS patients, but strongly urged the company to conduct a third study of the drug. Cephalon was reluctant to do so, however, since it had already invested $180 million in a drug with a fairly small potential market. More bad news came in May 1997, when an FDA advisory panel rejected Myotrophin as an ALS treatment. Once again Cephalon stock plummeted 35 percent to $13. Nevertheless, both Chiron and Cephalon planned to continue to pursue approval for Myotrophin, pointing out that the panel’s recommendation did not amount to a final decision by the FDA.

Company Perspectives:

Cephalon seeks to discover, develop and market innovative products to treat neurological and sleep disorders, cancer, and pain. The company is committed to providing patients and the medical community with novel therapies to treat unmet medical conditions through its proprietary research programs and by acquiring promising products for clinical development and commercial sale.

Our success is supported by a proven strategy of marketing high-growth, innovative products, building our worldwide marketing and distribution channels, and investing in research and development of unique compounds that may change the course of a disease.

In May 1998 the FDA ruled that Myotrophin was potentially approvable, contingent on additional clinical studies. However, Cephalon had already poured too many resources into Myotrophin to embark on another multi-year study. The company finally gave up on the drug in 1999, disappointing both the National ALS Association, which had hoped the drug could become an effective treatment, and ALS patients who had been given special access to Myotrophin. CEO Frank Baldino expressed regret that a potentially useful drug failed to gain FDA approval. He said additional tests would be justified for a drug designed to treat a disease that affected five or six million people, but only 25,000 to 30,000 people nationwide had ALS.

Developing a Solid Product Line: 1998-2001

Fortunately, Cephalon’s other drug development projects had been proceeding more successfully. The narcolepsy drug Provigil received preliminary approval from the FDA in December 1997 and final approval in December 1998. Company stock rose 12 percent as investors hoped the new product would make up for the Myotrophin fiasco. In February 1999 Provigil was launched in the United States. Sales of the drug exceeded expectations, reaching $25 million by the end of the year. Sales in 2000 were $72.1 million and 2001 sales were expected to reach $130 million.

Cephalon hoped to expand the applications for Provigil beyond narcolepsy. In January 2000 test results were announced showing that the drug was effective in warding off fatigue in multiple sclerosis patients and shift workers. According to test results released in October 2001, Provigil also increased daytime wakefulness in patients suffering from obstructive sleep apnea, a disorder causing a person to wake frequently throughout the night because of obstructed breathing passages. Tests in 2000, however, failed to demonstrate that the drug was effective in treating attention deficit hyperactivity disorder (ADHD). Use of Provigil also expanded geographically through marketing collaborations with foreign companies, including an October 1998 agreement with Mercke GmbH to market Provigil in Austria and Switzerland and a November 2000 agreement with Choongwae Pharma Corporation in Korea.

Actiq, Cephalon’s second major proprietary drug, received FDA approval in November 1998 and was launched in the United States in March 1999. At the time, the drug was manufactured and marketed by Abbott Laboratories. Cephalon acquired worldwide product rights to the drug in October 2000 through its merger with Anesta Corporation of Salt Lake City.

Actiq is prescribed to treat pain in cancer patients. Specifically, the drug targets sporadic flare-ups, known as breakthrough cancer pain, that overcome the medication already being used to treat chronic pain. Actiq provides fast-acting, short-term relief from breakthrough pain, which can last from 30 minutes to several hours.

Besides the acquisition of a new product, Cephalon’s merger with Anesta gave the company access to a new drug-delivery technology, the Oral Transmucosal System. Using the OTS system, Actiq is absorbed through the mucous membranes of the cheek and passes directly into circulation without having to go through the liver. As a result, a flare-up of pain can be eased within 15 minutes. Sales of Actiq in 2000 were $15 million, and 2001 sales were expected to reach $45 or $50 million as Cephalon worked to establish the product as the medication of choice for breakthrough cancer pain.

Like Provigil, Actiq developed a worldwide reach. In October 2000 the drug was approved for sale in the United Kingdom, and in June 2001 the drug was granted marketing authorization in 16 other European counties. Through marketing collaborations with companies such as Swedish Orphan AB, Elan Pharmaceuticals Ltd. in the United Kingdom, and Grupo Ferrer Internacional SA in Spain, Cephalon planned to launch Actiq commercially throughout Europe. Cephalon also granted rights to Orphan Australia to market and distribute Actiq in Australia and New Zealand.

Cephalon acquired a third major product in January 2001. All rights to Gabitril, a treatment for partial seizures related to epilepsy, were bought from Abbott Laboratories for $100 million. The drug had been approved by the FDA in September 1997 and was launched in the United States in 1998. Numerous epilepsy drugs already on the market competed with Gabitril, but the drug nevertheless garnered $23 million in sales in 2000. In order to widen the market for the drug, Cephalon began investigating the use of Gabitril as a mood stabilizer for various psychiatric disorders.

Besides its three main products in the United States, Cephalon marketed seven products through its European subsidiary. In the United Kingdom, those products included Anafranil, a treatment for depression and obsessive compulsive disorder; Lioresal and ITB Therapy, treatments for spasticity; Ritalin, an ADHD drug; and Tegretol, for epilepsy. The company also marketed two Parkinson’s medications in Europe: Xilopar in Germany and Apokinon in France. A 30-person sales team in Europe supported Cephalon’s activities there.

Research and development remained central to ensuring Cephalon’s long-term profitability. In collaborations with such international partners as TAP Holdings, Kyowa Hakko Kogyo, H Lundbeck, and, as of December 2000, the R.W. Johnson Pharmaceutical Research Institute, the company was researching kinase inhibitors, compounds that either enhance cell survival or cause cell death. The compounds had potential for treating neurological and oncological diseases.

Key Dates:

1987:: Biologist Frank Baldino, Jr., founds Cephalon as a small research house.
1991:: Cephalon goes public with a $59.4 million IPO.
1994:: News of positive test results for Myotrophin send stock soaring.
1995:: Cephalon establishes a sales force.
1999:: Myotrophin is abandoned following difficulties gaining full FDA approval; Provigil and Actiq are launched.
2001:: Rights to Gabitril are acquired.

Cephalon’s extensive library of proprietary compounds provided ample fodder for research. Products under development in 2001 included CEP-701, a compound that had been shown to cause the death of cancer cells by inhibiting the activity of a certain kinase, or protein. The compound was being developed to treat prostate and pancreatic cancer. Phase one testing was also just beginning on a second compound, CEP-7055, which was found in preclinical studies to prevent the development of the blood supply required for tumors to grow. Cephalon hoped that the experience with Actiq would pave the way for success with these further cancer drugs. The company was also working on a compound, CEP-1347, that could inhibit the progression of Parkinson’s and Alzheimer’s.

The deals leading to the acquisition of Actiq and Gabitril, as well as the resources invested in continued research, contributed to Cephalon’s growing net loss. The company reported losses of $55.4 million for 1998, $70 million for 1999, and $101.1 million for 2000. But the establishment of three successful proprietary drugs finally gave Cephalon the prospect of stable sales revenue, while the products under development gave the company growth potential. CEO and founder Frank Baldino believed that the company was laying a solid foundation for profitability in the near future.

Principal Subsidiaries

Anesta Corporation; Cephalon (UK) Limited.

Principal Competitors

American Biogenetic; Amgen, Inc.; Athena Neurosciences; Cell Pathways; Cortex Pharmaceuticals; Draxis Health Inc.; Genset; GlaxoSmithKline; Builford Pharmaceuticals; NeoTherapeutics; Neurocrine; Orphan Medical; Sanofi-Sunthélabo.