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, 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 x  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	Smaller reporting company o
(Do not check if a smaller reporting company)

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 October 25, 2010
Common Stock, par value $.01	75,233,458 Shares

TABLE OF CONTENTS

Cautionary Note Regarding Forward-Looking Statements		ii
PART I — FINANCIAL INFORMATION
Item 1.	Consolidated Financial Statements
	Consolidated Statements of Operations — Three and nine months ended September 30, 2010 and 2009	1
	Consolidated Balance Sheets — September 30, 2010 and December 31, 2009	2
	Consolidated Statements of Changes in Equity — Nine months ended September 30, 2010 and 2009	3
	Consolidated Statements of Cash Flows — Nine months ended September 30, 2010 and 2009	4
	Notes to Consolidated Financial Statements	5
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	28
Item 3.	Quantitative and Qualitative Disclosures About Market Risk	48
Item 4.	Controls and Procedures	48
PART II — OTHER INFORMATION		49
Item 1.	Legal Proceedings	49
Item 1A.	Risk Factors	49
Item 5.	Other Information	62
Item 6.	Exhibits	63
SIGNATURES		64

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 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 the patent infringement lawsuits and other proceedings described in Note 12 to our Consolidated Financial Statements included in Part 1, Item 1 of this Quarterly Report on Form 10-Q;

·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;

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

ii

·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, and the patent infringement lawsuits and other proceedings described in Note 12 to our Consolidated Financial Statements included in Part 1, Item 1 of this Quarterly Report on Form 10-Q;

·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 GmbH and Ception Therapeutics, Inc.;

·adverse decisions of government entities and third-party payers regarding reimbursement for our products;

·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

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						Nine Months Ended
	September 30,						September 30,
	2010			2009			2010			2009
REVENUES:
Net sales	$	707,077		$	535,223		$	1,996,193		$	1,588,610
Other revenues	9,916			14,189			44,295			28,583
	716,993			549,412			2,040,488			1,617,193
COSTS AND EXPENSES:
Cost of sales	151,939			90,456			427,721			293,633
Research and development	110,966			99,157			317,604			304,266
Selling, general and administrative	226,791			194,068			689,900			618,314
Change in fair value of contingent consideration	5,247			—			6,314			—
Restructuring charges	2,313			1,062			7,638			3,944
Acquired in-process research and development	—			6,000			—			46,118
	497,256			390,743			1,449,177			1,266,275
INCOME FROM OPERATIONS	219,737			158,669			591,311			350,918
OTHER INCOME (EXPENSE):
Interest income	908			1,821			4,138			3,455
Interest expense	(24,989		)	(26,495		)	(78,895		)	(63,213		)
Other income (expense), net	(2,846		)	3,775			(19,449		)	42,418
	(26,927		)	(20,899		)	(94,206		)	(17,340		)
INCOME BEFORE INCOME TAXES	192,810			137,770			497,105			333,578
INCOME TAX EXPENSE	61,262			42,673			172,827			122,659
NET INCOME	131,548			95,097			324,278			210,919
NET LOSS (INCOME) ATTRIBUTABLE TO NONCONTROLLING INTEREST	952			7,625			7,851			35,150
NET INCOME ATTRIBUTABLE TO CEPHALON, INC.	$	132,500		$	102,722		$	332,129		$	246,069
BASIC INCOME PER COMMON SHARE ATTRIBUTABLE TO CEPHALON, INC.	$	1.76		$	1.38		$	4.42		$	3.44
DILUTED INCOME PER COMMON SHARE ATTRIBUTABLE TO CEPHALON, INC.	$	1.66		$	1.31		$	4.11		$	3.17
WEIGHTED AVERAGE NUMBER OF COMMON SHARES OUTSTANDING ATTRIBUTABLE TO CEPHALON, INC.	75,201			74,647			75,128			71,541
WEIGHTED AVERAGE NUMBER OF COMMON SHARES OUTSTANDING-ASSUMING DILUTION ATTRIBUTABLE TO CEPHALON, INC.	79,773			78,431			80,761			77,552

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

1

CEPHALON, INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

(In thousands, except share data)

(Unaudited)

	September 30,			December 31,
	2010*			2009*
CURRENT ASSETS:
Cash and cash equivalents	$	1,208,990		$	1,647,635
Receivables, net	450,614			376,076
Inventory, net	295,880			240,576
Deferred tax assets, net	225,031			243,246
Other current assets	66,787			58,423
Total current assets	2,247,302			2,565,956
INVESTMENTS	12,594			12,427
PROPERTY AND EQUIPMENT, net	500,013			451,879
GOODWILL	833,358			590,284
INTANGIBLE ASSETS, net	1,234,181			981,857
DEBT ISSUANCE COSTS	15,362			18,862
OTHER ASSETS	43,582			36,830
	$	4,886,392		$	4,658,095
CURRENT LIABILITIES:
Current portion of long-term debt, net	$	644,097		$	818,925
Accounts payable	100,917			88,829
Accrued expenses	507,408			430,209
Total current liabilities	1,252,422			1,337,963
LONG-TERM DEBT	384,638			363,696
DEFERRED TAX LIABILITIES, net	219,091			159,328
OTHER LIABILITIES	279,049			111,728
Total liabilities	2,135,200			1,972,715
COMMITMENTS AND CONTINGENCIES	—			—
REDEEMABLE EQUITY	178,245			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 shares authorized, 78,436,295 and 78,002,764 shares issued, and 75,212,508 and 74,916,920 shares outstanding	784			780
Additional paid-in capital	2,407,563			2,534,070
Treasury stock, at cost, 3,223,787 and 3,085,844 shares	(216,597		)	(208,427		)
Accumulated earnings (deficit)	153,470			(178,659		)
Accumulated other comprehensive income	164,888			114,194
Total Cephalon stockholders’ equity	2,510,108			2,261,958
Noncontrolling Interest	62,839			216,115
Total equity	2,572,947			2,478,073
	$	4,886,392		$	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

CEPHALON, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CHANGES IN EQUITY

(In thousands, except share data)

(Unaudited)

																	Total
														Accumulated			Stockholders
				Additional										Other			Equity
	Common Stock			Paid-in			Treasury Stock				Accumulated			Comprehensive			Attributable			Noncontrolling
	Shares	Amount		Capital			Shares	Amount			Deficit			Income			to Cephalon			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											246,069						246,069			$	(35,150	)	$	210,919
Foreign currency translation gains														71,184			71,184						71,184
Prior service costs and gains on retirement-related plans														(43		)	(43		)				(43		)
Other comprehensive losses														(625		)	(625		)				(625		)
Comprehensive income																	316,585			(35,150		)	281,435
Issuance of common stock upon conversions of convertible notes	54	—		—													—						—
Stock options exercised	139,035	1		6,700													6,701						6,701
Tax benefit from equity compensation				1,221													1,221						1,221
Stock-based compensation expense	1,250	—		36,710													36,710						36,710
Treasury stock acquired							377	(29		)							(29		)				(29		)
Adjustment to APIC for equity component of convertible debt				30,542													30,542						30,542
Ception noncontrolling interest upon consolidation																	—			306,500			306,500
Arana noncontrolling interest upon consolidation				0													—			104,730			104,730
Acquisition of Arana noncontrolling interest shares				(7,353		)											(7,353		)	(103,699		)	(111,052		)
Issuance of common stock in exchange for stock warrants	776,361	8		(8		)											—						—
Issuance of common stock	5,000,000	50		287,950													288,000						288,000
Issuance of convertible notes				147,650													147,650						147,650
Sale of warants	—	—		37,640													37,640						37,640
Purchase of convertible note hedge associated with convertible notes				(121,040		)											(121,040		)				(121,040		)
Tax benefit from purchase of convertible note hedge				(9,784		)											(9,784		)				(9,784		)
Deconsolidation of Acusphere																	—			10,634			10,634
Other				0													—			728			728
BALANCE, September 30, 2009	77,623,741	$	776	2,505,552			2,970,776	$	(201,734	)	$	(275,217	)	$	114,146		$	2,143,523		$	283,743		$	2,427,266

																	Total
														Accumulated			Stockholders
				Additional							Accumulated			Other			Equity
	Common Stock			Paid-in			Treasury Stock				Earnings/			Comprehensive			Attributable			Noncontrolling
	Shares	Amount		Capital			Shares	Amount			(Deficit)			Income			to Cephalon			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											332,129						332,129			(7,851		)	324,278
Foreign currency translation gains														50,766			50,766						50,766
Prior service costs and gains on retirement-related plans														(72		)	(72		)				(72		)
Other comprehensive losses																	—						—
Comprehensive income																	382,823			(7,851		)	374,972
Stock options exercised	294,738	3		15,180													15,183						15,183
Tax benefit from equity compensation				(559		)											(559		)				(559		)
Stock-based compensation expense	1,250	—		31,740													31,740						31,740
Treasury stock acquired							502	(33		)							(33		)				(33		)
Adjustment to APIC for equity component of convertible debt				29,062													29,062						29,062
Acquisition of Ception NCI				(210,072		)											(210,072		)	(183,919		)	(393,991		)
Issuance of common stock upon conversion and exchange of convertible notes	137,543	1		8,142													8,143						8,143
Exercise of convertible note hedge associated with conversion of convertible notes							137,441	(8,137		)							(8,137		)				(8,137		)
Mepha Pharma AG NCI upon acquisition																	—			38,902			38,902
Other																	—			(408		)	(408		)
BALANCE, September 30, 2010	78,436,295	$	784	$	2,407,563		3,223,787	$	(216,597	)	$	153,470		$	164,888		$	2,510,108		$	62,839		$	2,572,947

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,
	2010			2009
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income	$	324,278		$	210,919
Adjustments to reconcile net income to net cash provided by operating activities:
Deferred income tax expense (benefit)	(27,976		)	(40,182		)
Depreciation and amortization	163,049			136,403
Stock-based compensation expense	31,740			36,710
Amortization of debt discount and debt issuance costs	51,318			41,273
Loss (gain) on foreign exchange contracts	9,499			(26,754		)
Gain on acquisition of Arana	—			(10,008		)
IPR&D from Acusphere deconsolidation	—			8,366
Other	1,749			(5,079		)
Changes in operating assets and liabilities, net of acquisitions:
Receivables	(1,006		)	94,204
Inventory	31,967			(7,060		)
Other assets	7,480			32,206
Accounts payable, accrued expenses and deferred revenues	53,395			89,192
Other liabilities	5,047			(43,059		)
Net cash provided by operating activities	650,540			517,131
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of property and equipment	(34,989		)	(43,647		)
Proceeds from sale of property and equipment	4,748			—
Cash balance from consolidation of variable interest entity	—			52,563
Investment in Ception	—			(75,000		)
Acquistion of Arana, net of cash acquired	—			(232,527		)
Acquistion of Mepha, net of cash acquired	(549,463		)	—
Purchases of investments	(60		)	(9,292		)
(Cash settlements of) proceeds from foreign exchange contracts	(9,499		)	26,754
Sales and maturities of available-for-sale investments	—			5,074
Net cash used for investing activities	(589,263		)	(276,075		)
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from sale of common stock	—			288,000
Proceeds from exercises of common stock options	15,183			6,701
Windfall tax benefits from stock-based compensation	—			1,259
Acquisition of treasury stock	(33		)	(29		)
Acquisition of Ception NCI	(299,289		)	—
Payments on and retirements of long-term debt	(222,079		)	(11,246		)
Net proceeds from issuance of convertible subordinated notes	—			484,719
Proceeds from sale of warrants	—			37,640
Purchase of convertible note hedge	—			(121,040		)
Net cash (used for) provided by financing activities	(506,218		)	686,004
EFFECT OF EXCHANGE RATE CHANGES ON CASH AND CASH EQUIVALENTS	6,296			2,295
NET (DECREASE) INCREASE IN CASH AND CASH EQUIVALENTS	(438,645		)	929,355
CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD	1,647,635			524,459
CASH AND CASH EQUIVALENTS, END OF PERIOD	$	1,208,990		$	1,453,814

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 share and 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 January 1, 2010.

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. This guidance may impact the timing of revenue recognition related to certain arrangements.

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 will adopt this guidance beginning with agreements entered into after January 1, 2011. We are currently evaluating the impact of adoption on our consolidated financial statements.

2.   ACQUISITIONS AND TRANSACTIONS

Mepha GmbH

In April 2010, we acquired all of the issued share capital of Mepha GmbH (“Mepha”), a privately-held, Swiss-based pharmaceutical company, for CHF 622.5 million plus contractual purchase price adjustments of CHF 26.3 million for a total of CHF 648.8 million (or approximately US$605.4 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 markets its products in Europe, the Middle East, Africa, South and Central America as well as in Asia. Mepha has approximately 620 full-time employees, 500 of them in Switzerland, and approximately 200 contractors.  The acquisition of Mepha allows us to expand our geographic reach and to further diversify our business mix into the generic and branded generic arena.  Mepha is included in our European segment.

We applied the acquisition method of accounting to record the business combination. The following table summarizes the estimated fair values of the identified assets and acquired liabilities assumed on April 8, 2010, the acquisition date, as well as the fair value of the noncontrolling interest on the acquisition date:

5

	April 8, 2010
Cash and cash equivalents	$	38,818
Accounts receivable	72,185
Inventory	85,901
Other current assets	2,313
Property and equipment, net	89,458
Intangible assets	311,719
Goodwill	225,150
Other assets	477
Current portion of long term debt	468
Accounts payable	15,873
Accrued expenses	25,210
Long term debt	20,742
Other liabilities	53,891
Deferred tax liabilities	85,150
Noncontrolling interest	38,902

The acquisition accounting is being finalized based on fair values of the acquired assets and liabilities. The fair value of inventories acquired included a step-up in the value of inventories of $10.5 million. We recorded amortization of $5.0 million and $5.5 million of the inventory step-up in cost of sales during the second and third quarters of 2010, respectively.  Goodwill is attributable to revenue and operational synergies and is allocated to the European segment. There is no goodwill recognized or deductible for tax purposes.  The book value of the accounts receivable approximates their fair value and gross contractual value.

Acquisition costs of $10.3 million were expensed as incurred and are included in our statement of operations for the nine months ended September 30, 2010 and have been recorded in the European segment.

In accordance with local laws and regulations, we acquired and became the sponsor of a defined benefit pension plan in Switzerland in conjunction with the Mepha acquisition. For more information regarding the defined benefit pension plan, please see Note 14.

Mepha Pharma AG is a partially-owned Mepha subsidiary with primary operations in Switzerland.  Mepha has a 33.4% equity interest and a controlling voting interest in Mepha Pharma AG.  The noncontrolling interest in Mepha Pharma AG was recorded at fair value as part of the acquisition accounting.  The fair value of the noncontrolling interest in Mepha Pharma AG was estimated by applying the discounted cash flows method of the income approach. The fair value measurement is based on significant inputs not observable in the market and thus represents a Level 3 measurement. The estimate of the fair value of the noncontrolling interest is based on an assumed discount rate of 8.5%, a long term annual earnings growth rate of 3.0%, and assumed adjustments due to the lack of control that market participants would consider when estimating the fair value of the noncontrolling interest in Mepha Pharma AG.

The Mepha noncontrolling interest was a non recurring fair value measurement at the acquisition date. The following table sets forth the classification of the noncontrolling interest within the fair value hierarchy:

Description	April 8, 2010		Quoted Prices in Active Markets for Identical Assets (Level 1)	Significant Other Observable Inputs (Level 2)	Significant Unobservable Inputs (Level 3)
Mepha noncontrolling interest	$	38,902	—	—	38,902

We entered into foreign exchange forward contracts related to our Mepha transaction to protect against fluctuations between the Swiss Franc and the U.S. Dollar.  Changes in the value of these contracts were recognized within other

income. All foreign exchange contracts settled in the first half of 2010. Other income (expense), net includes $9.1 million of loss on these foreign exchange contracts for the nine months ended September 30, 2010.

The following unaudited pro forma information shows the results of our operations for the three and nine months ended September 30, 2010 and 2009 as though the Mepha acquisition had occurred at the beginning of the periods presented:

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	Three months ended		Nine months ended
	September 30,		September 30,
	2009		2010		2009
Revenues	$	634,314	$	2,137,789	$	1,885,180
Net income attributable to Cephalon, Inc.	102,320		336,477		244,491
Basic income per common share attributable to Cephalon, Inc.	$	1.37	$	4.48	$	3.42
Diluted income per common share attributable to Cephalon, Inc.	$	1.30	$	4.17	$	3.15

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.

Ception Therapeutics, Inc.

In January 2009, we entered into an option agreement (the “Ception Option Agreement”) with Ception Therapeutics, Inc., a privately-held company (“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 Ception $50.0 million (the “Ception Option Fee”) and paid Ception stockholders an aggregate of $50.0 million.

We determined that, because of our rights under the Ception Option Agreement, effective on January 13, 2009, Ception was a variable interest entity for which we were the primary beneficiary.  As a result, as of January 13, 2009, we included the financial condition and results of operations of Ception in our consolidated financial statements in the United States segment.  Prior to April 5, 2010, we did not have an equity interest in Ception and, therefore, we allocated the Ception losses to noncontrolling interest in the consolidated statement of operations.

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 (as a VIE):

	December 31, 2009
Cash and cash equivalents	$	52,500
Other current assets	193
Property and equipment, net	348
Goodwill	121,918
Intangible assets	199,400
Other assets	10
Current portion of long-term debt, net	3,763
Accounts payable	4,064
Accrued expenses	5,526
Deferred tax liabilities	61,911
Noncontrolling interest	188,105

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.  After completing certain closing conditions, including U.S. antitrust approval, in April 2010, we acquired Ception 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. In April 2010, Ception distributed the Ception Option Fee to its stockholders immediately prior to 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.

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As a result of acquiring the Ception noncontrolling interest in April 2010, we recognized a reduction of $210.1 million in Cephalon stockholders’ equity which reflects the difference between the fair value of all consideration paid and the balance of the noncontrolling interest on that date.

The acquisition of Ception’s noncontrolling interest includes a contingent consideration arrangement that may require additional consideration to be paid by the company in the form of milestone payments. It is currently estimated that milestone payments will occur in 2014 and 2015. The range of undiscounted amounts we could be required to pay under our agreement is between zero and $500.0 million. We determined the fair value of the liability for the contingent consideration based on a probability-weighted discounted cash flow analysis. This fair value measurement is based on significant inputs not observable in the market and thus represents a Level 3 measurement within the fair value hierarchy. The fair value of the contingent consideration liability associated with future milestone payments was based on several factors including:

·estimated cash flows projected from the success of unapproved product candidates in the U.S. and Europe;

·the probability of success for product candidates;

·the time and resources needed to complete the development and approval of product candidates;

·the life of the potential commercialized products and associated risks of obtaining regulatory approvals in the U.S. and Europe;

·the risk adjusted discount rate for fair value measurment; and

·risks associated with uncertainty, achievement and payment of milestone events.

The fair value of the liability for the contingent consideration recognized on the acquisition date of the Ception noncontrolling interest was $96.9 million. The contingent consideration payments have been recorded as a liability and the fair value will be evaluated quarterly or more frequently if circumstances dictate. Changes in the fair value of contingent consideration will be recorded in earnings. The change in fair value that was recognized as an operating expense for the three months ended September 30, 2010 was $5.2 million and for the period between April 5 and September 30, 2010 was $6.3 million. At September 30, 2010, the fair value of the liability was $103.2 million.

In April 2010, as a result of the exercise of the Ception Option, we began to integrate Ception into the Cephalon business and initiated restructuring efforts. This restructuring was completed and all payments were made in the second quarter of 2010. Nineteen jobs were eliminated for a total pre-tax cost of $3.2 million in the second quarter of 2010.

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. In October 2010, we exercised the option to acquire BDC following receipt of interim data from a Phase II placebo-controlled proof-of-concept study evaluating epidural administration of a tumor necrosis factor (TNF) inhibitor for the treatment of sciatica in 45 patients.  Upon the closing of the merger, we will purchase all of the outstanding capital stock of BDC for $12.5 million, subject to net working capital and debt adjustments set forth in the merger agreement.  BDC shareholders could receive additional payments related to regulatory and sales milestones.

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.   BDC did not have a material impact on our revenues or earnings attributable to our Cephalon shareholders for the period ended September 30, 2010 or on a pro forma basis for the periods ended September 30, 2010 and 2009.  BDC is included in our United States segment.

As a result of exercising our option to purchase BDC in October 2010, we expect to recognize a reduction of approximately $25 million in Cephalon stockholders’ equity for the fourth 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 BDC. 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.

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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 September 30, 2010:

	September 30, 2010		December 31, 2009
Cash and cash equivalents	$	5,346	$	9,854
Accounts receivable	3		69
Other current assets	19		27
Property and equipment, net	6		18
Goodwill	20,391		20,391
Intangible assets	48,000		48,000
Accounts payable	183		362
Accrued expenses	80		1,817
Deferred tax liabilities	17,329		18,171
Noncontrolling interest	26,172		28,009

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.  In 2009 and 2010, we eliminated a total of 81 jobs worldwide through a combination of voluntary resignations and terminations.  As of September 30, 2010, these restructuring efforts are complete.  The pre-tax costs of these restructuring efforts were $9.1 million.  Total estimated charges and payments 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			Nine months ended
	September 30, 2010
Restructuring reserves, beginning of period	$	1,453		$	7,862
Severance costs	226			607
Payments	(1,569		)	(8,359		)
Restructuring reserves, end of period	$	110		$	110

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:

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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 September 30, 2010, we have incurred a total of $17.2 million related to the restructuring plan.

Effective September 2, 2010, we sold the Eden Prarie facility and certain associated equipment for proceeds of $4.7 million.  We incurred $2.5 million in additional accelerated depreciation costs related to the facility sale during the three months ended September 30, 2010. Pursuant to the sales agreement, we are leasing the Eden Prarie facility and certain associated equipment from the buyer through December 31, 2011 with aggregate lease payments totaling $0.7 million.  Through September 30, 2010, we have incurred a total of $21.5 million in pre-tax, non-cash accelerated depreciation of plant and equipment related to the restructuring. We will continue to incur non-cash accelerated depreciation of equipment not associated with the sale through the completion of the restructuring project.

Total charges and payments related to the restructuring plan recognized in the consolidated statement of operations and included in the United States segment are as follows:

	Three months ended September 30,						Nine months endedSeptember 30,
	2010			2009			2010			2009
Restructuring reserves, beginning of period	$	8,214		$	5,258		$	7,083		$	3,733
Severance costs	534			909			1,511			2,722
Manufacturing and personnel transfer costs	1,553			153			2,341			1,222
Payments	(1,270		)	(190		)	(1,904		)	(1,547		)
Restructuring reserves, end of period	$	9,031		$	6,130		$	9,031		$	6,130

4.   ACQUIRED IN-PROCESS RESEARCH AND DEVELOPMENT EXPENSE

In 2009, we recognized acquired in-process research and development expense of:

·$9.4 million in exchange for the elimination of the $15.0 million milestone and royalty payments associated with the celecoxib license agreement and Acusphere patent rights relating to its HDDS technology;

·$30.0 million in exchange for the exclusive, worldwide license rights to LUPUZORTM, acquired from ImmuPharma;

·$0.8 million in exchange for exclusive sublicense rights to bendamustine hydrochloride in China and Hong Kong, acquired from SymBio; and

·$6.0 million in exchange for license rights to certain of XOMA Ltd.’s proprietary antibody library materials.

5.   OTHER INCOME (EXPENSE), NET

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

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	Three months ended					Nine months ended
	September 30,					September 30,
	2010			2009		2010			2009
Gains (losses) on foreign exchange derivative instruments	$	—		$	—	$	(9,069	)	$	19,022
Arana dividend income	—			—		—			1,567
Loss on Arana contingent consideration (90% ownership incentive payment)	—			—		—			(2,773		)
Gain on excess of Arana net assets over consideration	—			—		—			10,008
Gain on pre-bid Arana holdings	—			—		—			6,596
Foreign exchange gains (losses)	(2,846		)	3,775		(10,380		)	7,998
Other income (expense), net	$	(2,846	)	$	3,775	$	(19,449	)	$	42,418

In 2010, Cephalon entered into foreign exchange forward contracts related to our Mepha GmbH transaction.  These contracts protected against fluctuations between the Swiss Franc and the U.S. Dollar.  Changes in the value of these contracts were recognized within net income. All foreign exchange contracts have settled in the first half of 2010. Other income (expense), net includes $9.1 million of losses on these foreign exchange contracts for the nine months ended September 30, 2010.

In 2009, Cephalon entered into foreign exchange forward contracts 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.  Changes in the value of these contracts were recognized within net income. All foreign exchange contracts settled as of June 30, 2009. Other income (expense), net includes $19.0 million of gains on these foreign exchange contracts for the nine months ended September 30, 2009.

6.   COMPREHENSIVE INCOME

The components of Cephalon’s comprehensive income include:

	Three months ended						Nine months ended
	September 30,						September 30,
	2010			2009			2010			2009
Net income	$	132,500		$	102,722		$	332,129		$	246,069
Foreign currency translation gains	118,752			23,103			50,766			71,184
Net prior service costs on retirement-related plans	(23		)	(14		)	(72		)	(43		)
Unrealized investment losses	—			(891		)	—			(625		)
Comprehensive income	$	251,229		$	124,920		$	382,823		$	316,585

The components of accumulated other comprehensive income consisted of the following:

	September 30, 2010		December 31, 2009
Foreign currency translation gains	$	162,925	$	112,159
Prior service gains and losses on retirement-related plans	1,963		2,035
Accumulated other comprehensive income	$	164,888	$	114,194

Our noncontrolling interests do not have any accumulated other comprehensive income balances.

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7.  FAIR VALUE DISCLOSURES

Our non-current investments are recorded on a cost basis.  The carrying values of cash, cash equivalents, accounts receivable, accounts payable and accrued expenses approximate their respective fair values. Long-term liabilities recorded at fair-value include contingent consideration attributable to Ception. The Mepha noncontrolling interest was also recorded at fair value at the acquisition date. For details on our Ception and Mepha transactions and a description of the fair value methodologies utilized, see Note 2.

Current accounting guidance provides a three-tier fair value hierarchy, which prioritize the inputs used in measuring fair value as follows:

·    Level 1: Observable inputs such as quoted prices in active markets for identical assets and liabilities;

·    Level 2: Inputs, other than the quoted prices in active markets, that are observable either directly or indirectly; and

·    Level 3: Unobservable inputs in which there is little or no market data, which require the reporting entity to develop its own assumptions.

The following table sets forth the fair value hierarchy for financial assets and liabilities carried at fair value and measured on a recurring basis as of September 30, 2010.  There were no assets and liabilities recorded at fair value measured on a recurring basis at December 31, 2009.

			Fair Value Measurements at Reporting Date Using
Description	September 30, 2010		Quoted Prices in Active Markets for Identical Assets (Level 1)	Significant Other  Observable Inputs (Level 2)	Significant Unobservable Inputs (Level 3)
Ception contingent consideration	$	103,225	—	—	103,225

The table below reconciles the beginning and ending balances for assets and liabilities measured on a recurring basis using unobservable inputs (Level 3) during the period.

	Ception Contingent Consideration
Balance, January 1, 2010	$	—
Net transfer in to Level 3	96,911
Unrealized losses included in earnings	6,314
Ending Balance, September 30, 2010	$	103,225

See Note 2, for a description of Mepha’s assets and liabilities carried at fair value and measured on a non recurring basis.  There were no assets and liabilities recorded at fair value measured on a nonrecurring basis at December 31, 2009.

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 September 30, 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	$	1,164,687	$	641,755	$	820,000
2.5% convertible senior subordinated notes due May 1, 2014	563,650		381,744		500,000

^The fair value shown above represents the fair value of the total debt instrument, inclusive of both the liability and equity components, while the carrying value represents the carrying value of the liability .

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8.   INVENTORY, NET

Inventory, net consisted of the following:

	September 30, 2010		December 31, 2009
Raw materials	$	39,786	$	27,105
Work-in-process	143,813		144,145
Finished goods	112,281		69,326
Total inventory, net	$	295,880	$	240,576

We have committed to make future minimum payments to third parties for certain raw material inventories, including agreements to purchase minimum amounts of modafinil through 2012.  Over the past few years, we have developed 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 using this new process coupled with the launch of NUVIGIL, we reassess, as needed, the potential impact of these items on certain of our existing agreements to purchase modafinil and reserve for purchase commitments in excess of current expected need.  As of December 31, 2009, our aggregate future purchase commitments remaining totaled $15.9 million and our reserve balance for excess purchase commitments was $9.0 million.  In the second quarter of 2010, we reassessed our future modafinil needs and recorded a $9.4 million adjustment which increased the excess commitment reserve as well as a reserve for inventory on-hand of $7.6 million. As of September 30, 2010, our aggregate future purchase commitments remaining total $10.8 million and are fully reserved.

9.  GOODWILL

Goodwill consisted of the following:

	United States		Europe		Total
December 31, 2009	$	486,619	$	103,665	$	590,284
Foreign currency translation adjustment	—		17,924		17,924
Acquisition of Mepha GmbH	—		225,150		225,150
September 30, 2010	$	486,619	$	346,739	$	833,358

We completed our annual test of impairment of goodwill as of July 1, 2010 and concluded that goodwill was not impaired.

10.  INTANGIBLE ASSETS, NET

Intangible assets consisted of the following:

		September 30, 2010						December 31, 2009
	Estimated	Gross				Net		Gross				Net
	Useful	Carrying		Accumulated		Carrying		Carrying		Accumulated		Carrying
	Lives	Amount		Amortization		Amount		Amount		Amortization		Amount
Product Rights & Technology	5 - 20 years	$	1,150,375	$	519,124	$	631,251	$	898,325	$	458,886	$	439,439
IPR&D	Indefinite	379,977		—		379,977		341,206		—		341,206
Trademarks	10 - 20 years	264,934		44,426		220,508		223,383		34,013		189,370
Other agreements	1 - 2 years	28,093		25,648		2,445		22,203		10,361		11,842
		$	1,823,379	$	589,198	$	1,234,181	$	1,485,117	$	503,260	$	981,857

Intangible assets are amortized over their estimated useful economic life using the straight line method. Amortization expense was $31.4 million and $26.4 million for the three months ended September 30, 2010 and 2009, respectively, and $89.4 million and $70.6 million for the nine months ended September 30, 2010 and 2009, respectively.

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11.  LONG-TERM DEBT

Long-term debt consisted of the following:

	September 30,			December 31,
	2010			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	(178,245		)	(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	(118,256		)	(137,907		)
Zero Coupon convertible subordinated notes first putable June 2010	—			199,968
Debt discount on Zero Coupon convertible subordinated notes first putable June 2010	—			(5,771		)
Capital lease obligations	5,024			3,065
Ception Therapeutics, Inc. obligations	—			3,763
Other	212			1,039
Total debt	$	1,028,735		$	1,182,621
Less current portion	(644,097		)	(818,925		)
Total long-term debt	$	384,638		$	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. At September 30, 2010 and December 31, 2009, our stock price was $62.44 and $62.42, respectively, 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.

During the second quarter of 2010, we delivered a notice of redemption to the holders of our Zero Coupon Notes first putable June 2010 (the “2010 Notes”).  Prior to the redemption date, most of the 2010 Notes were converted.  Holders who converted their 2010 Notes received from us an aggregate of $170.2 million in cash and 137,543 shares of our common stock, under the terms of the 2010 Notes.  Concurrent with the conversion, we received from Credit Suisse (CSFB) 137,441 shares of our common stock in settlement of the convertible note hedge agreement associated with the 2010 Notes.  The warrant held by CSFB and associated with the 2010 Notes expired without exercise. The $29.3 million of 2010 Notes that were not converted were redeemed by us or tendered by the holder to us for cash of $29.4 million.

The conversion and redemption of the 2010 Notes reduced the liability component of our convertible debt, which was computed based on the fair value of a similar liability that does not include the conversion option, by $199.5 million. The fair value of the liability component was equal to the carrying value on the date of conversion. The debt discount and debt issuance costs associated with the 2010 Notes were fully amortized to interest expense by the date of conversion.  We recognized a $0.4 million gain related to the accreted premium on the 2010 Notes which were converted by the holders.

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.

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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, 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 $10.8 million as of September 30, 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 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.

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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, generic versions of modafinil were launched in Portugal, Sweden and Denmark.  We have filed lawsuits in each of these countries 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.

In July 2010, two purported stockholders of the company filed derivative suits on behalf of Cephalon in the EDPA naming each member of our Board of Directors as defendants. The two suits allege, 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 PROVIGIL, ACTIQ and GABITRIL and the execution of the PROVIGIL settlement agreements, and in failing to do so, violated their fiduciary duties to the stockholders. The complaints seek an unspecified amount of money damages, disgorgement of all compensation and other equitable relief.  We believe the allegations in these matters are without merit, and we intend to vigorously defend ourselves in these matters and in 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.

NUVIGIL Patent Litigation

In December 2009, January 2010, February 2010 and August 2010, we filed patent infringement lawsuits against seven companies—Teva, Actavis, Mylan, Watson, Sandoz, Lupin, and Apotex—based upon the ANDA filed by 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.  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, Lupin and Apotex 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.

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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.

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.

In October 2010, through our subsidiary Anesta AG, we entered into a settlement agreement with Eurand and Impax to settle the parties’ patent litigation concerning AMRIX.  Under the agreement, Anesta and Eurand will grant Impax a non-exclusive, royalty-bearing license to Eurand’s patent and other current and future Orange Book-listable patents to market and sell a generic version of AMRIX in the United States.  Impax’s license becomes effective one year prior to expiration of the Eurand Patent, which is currently expected to expire in February 2025, or earlier under certain circumstances. The settlement agreement does not affect the status of the separate patent litigations with Mylan, Barr and Anchen. We anticipate a decision by the U.S. District Court in Delaware by or in the second quarter of 2011 We anticipate a decision by the U.S. District Court in Delaware by or in the second quarter of 2011 with respect to the patents litigated in October 2010. In addition, we anticipate a separate trial regarding the recently issued additional pharmaceutical formulation patents covering AMRIX.

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.  In May 2010, the trial for the Watson FENTORA matter was completed.  We anticipate a decision by the U.S. District Court in Delaware in the fourth quarter of 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

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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 approved labels

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for each product. 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 and in August 2010, the EDPA dismissed the plaintiff’s appeal.

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 the first of the DURASOLV patents. We have requested reconsideration from the Board and are awaiting the Board’s response.  We have the right to appeal to the court from the Board’s decision if it is not favorable. A hearing before the Board with respect to our appeal regarding the second patent is scheduled for November 2010. 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, with the exception of the contingent consideration recorded upon acquisition of Ception. See Note 2 for details.  As of September 30, 2010, the potential milestone and other contingent payments due under current contractual agreements total $1.4 billion.

13.  STOCK-BASED COMPENSATION

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

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	Three months ended				Nine months ended
	2010		2009		2010		2009
Stock option expense	$	5,030	$	6,430	$	17,110	$	20,550
Restricted stock unit expense	$	5,080	$	5,440	$	14,630	$	16,160
Total stock-based compensation expense*	$	10,110	$	11,870	$	31,740	$	36,710
Total stock-based compensation expense after-tax	$	6,683	$	7,799	$	21,107	$	24,111

*For the three and nine months ended September 30, 2009 and 2010 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 nine months ended September 30, 2010 as compared to the three and nine months ended September 30, 2009 due to a higher level of forfeitures in 2010.

14.  PENSION AND OTHER POSTRETIREMENT BENEFITS

We have defined benefit pension plans covering eligible employees in certain of our international subsidiaries. Net periodic pension benefit cost is based on periodic actuarial valuations which use the projected unit credit method of calculation and is charged to expense on a systematic basis over the average remaining service lives of the current participants.  Prior to the acquisition of Mepha, our defined benefit pension obligations were not material to our operations.

The net cost for pension benefit plans consisted of the following components, attributable to our European segment:

	Three months endedSeptember 30,			Nine months endedSeptember 30,
	2010			2010
Service cost	$	1,258		$	2,592
Interest cost	859			1,747
Expected return on plan assets	(629		)	(1,194		)
Amortization of prior service credit	(22		)	(63		)
Net periodic benefit cost	$	1,466		$	3,082

Through September 30, 2010, contributions of $1.3 million have been made to all international pension plans and we anticipate additional contributions during the remainder of 2010 to total approximately $1.6 million.

Mepha Pension Benefits

In accordance with local laws and regulations, we acquired and became the sponsor of a defined benefit pension plan in Switzerland in conjunction with the Mepha acquisition.  At April 8, 2010, the date of acquisition, the projected benefit obligation and accumulated benefit obligation of the plan were $81.9 million and $75.4 million, respectively.  The fair value of plan assets on the date of acquisition was $67.3 million, resulting in a net obligation of $14.7 million.  Net periodic benefit costs from the acquisition date through December 31, 2010 are expected to be approximately $3.2 million.

The actuarial assumptions used to calculate the benefit obligation at April 8, 2010 and the net periodic expense for 2010 are as follows:

Discount rate	3.3	%
Expected long term rate of return	3.3	%
Rate of compensation increase	2.0	%

The expected long-term rate of return on plan assets is a long term assumption at the measurement date based upon historical experience and expected future performance, considering the company’s target and projected investment mix. The

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discount rate was selected using a method that matches expected benefit payments with high quality corporate bond yield curves in Switzerland at the plans’ measurement date.  Market conditions and other factors can vary over time that could affect our estimates of the expected long term rate of return on plan assets and the discount rates used to calculate our pension benefit obligations and our net periodic benefit costs for future years.

As of April 8, 2010, our pension plan asset allocations by category were:

Equity Securities	32.1	%
Debt Securities	49.9	%
Real Estate	5.0	%
Cash	13.0	%

The fundamental goal underlying the pension plan’s investment policy is to ensure that the assets of the plans are invested in a prudent manner to meet the obligations of the plans as these obligations come due. Investment practices must comply with applicable laws and regulations.  We establish strategic asset allocation percentage targets and appropriate benchmarks for each significant asset class to obtain a prudent balance between return and risk. The interaction between plan assets and benefit obligations is periodically studied to assist in the establishment of strategic asset allocation targets.

The following is a description of the valuation methodologies used for assets measured at fair value:

·Equity securities are valued at the latest quoted prices taken from the primary exchange on which the security trades. Included within equity securities, mutual funds and private equity funds are valued at the net asset value (NAV) of shares held at the acquisition date.

·Corporate debt securities are valued using market inputs such as reported trades, benchmark yields, broker/dealer quotes, issuer spreads, and other reference data including market research publications.

·Real estate investments are based on third party appraisals as of the acquisition date.

The methods described above may produce a fair value calculation that may not be indicative of net realizable value or reflective of future fair value.  Furthermore, while we believe its valuation methods are appropriate and consistent with other market participants, the use of different methodologies or assumptions to determine the fair value of certain financial instruments could result in different fair value measurements at the reporting date.

Pension assets are classified into three levels.  Level 1 asset values are derived from quoted prices which are available in active markets as of the report date.  Level 2 asset values are derived from other than quoted prices in active markets included in Level 1, which are either directly or indirectly observable as of the report date. Level 3 asset values are derived from unobservable pricing inputs that are not corroborated by market data or other objective sources.  The levels assigned to the defined benefit plan assets as of April 8, 2010 are summarized in the table below:

			Fair Value Measurements at Reporting Date Using
Description	Total		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
Cash and cash equivalents	$	7,202	$	7,202	$	—	$	—
Equity securities	25,145		24,173		972		—
Corporate debt securities	34,413		34,413		—		—
Real estate	502		—		—		502
Total	$	67,262	$	65,788	$	972	$	502

Expected 2010 contributions for the Mepha plan are $2.8 million.  Estimated Future Benefit Payments are as follows:

2010	$	2,430
2011	2,803
2012	2,701
2013	2,896
2014	3,064
2015 - 2019	15,664

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15.  INCOME TAXES

For the three months ended September 30, 2010, we recognized $61.3 million of income tax expense on income before income taxes of $192.8 million, resulting in an overall effective tax rate of  31.8 percent.  For the nine months ended September 30, 2010, we recognized $172.8 million of income tax expense on income before income taxes of $497.1 million, resulting in an overall effective tax rate of 34.8 percent.

The Internal Revenue Service (“IRS”) currently is examining Cephalon, Inc.’s 2006 and 2007 U.S. federal income tax returns.  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 our 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.

16.  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.

On May 20, 2010, the Board of Directors approved the Cephalon, Inc. 2010 Employee Stock Purchase Plan (“ESPP”).  The first offering period began September 1, 2010 and will end December 31, 2010.  The estimated impact is considered for diluted EPS using the treasury stock method. Our ESPP is considered non-compensatory and, accordingly, no compensation expense will be recorded for issuances under the ESPP. Eligible participants contribute 95% of the quarter-ending market price towards the purchase of each common share.

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

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	Three months ended				Nine months ended
	September 30,				September 30,
	2010		2009		2010		2009
Average market price per share of Cephalon stock	$	59.71	$	56.87	$	62.89	$	63.71
Shares included in diluted EPS calculation (in thousands):
2.0% Notes	3,826		3,140		4,520		4,688
2.5% Notes	—		—		—		—
2010 Notes	—		23		291		399
Warrants related to 2.0% Notes	—		—		—		—
Warrants related to 2.5% Notes	—		—		—		—
Warrants related to New Zero Coupon Notes	—		—		—		—
Other	—		1		1		1
Total	3,826		3,164		4,812		5,088

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				Nine months ended
	September 30,				September 30,
	2010		2009		2010		2009
Basic income per common share computation:
Numerator:
Net income used for basic income per common share	$	132,500	$	102,722	$	332,129	$	246,069
Denominator (in thousands):
Weighted average shares used for basic income per common share	75,201		74,647		75,128		71,541
Basic income per common share	$	1.76	$	1.38	$	4.42	$	3.44

	Three months ended				Nine months ended
	September 30,				September 30,
	2010		2009		2010		2009
Diluted income per common share computation:
Numerator:
Net income used for basic income per common share	$	132,500	$	102,722	$	332,129	$	246,069
Denominator (in thousands):
Weighted average shares used for diluted income per common share	75,201		74,647		75,128		71,541
Effect of dilutive securities:
Convertible subordinated notes and warrants	3,826		3,164		4,812		5,088
Employee stock options and restricted stock units	746		620		821		923
Employee stock purchase plan	—		—		—		—
Weighted average shares used for diluted income per common share	79,773		78,431		80,761		77,552
Diluted income per common share	$	1.66	$	1.31	$	4.11	$	3.17

23

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		Nine months ended
	September 30,		September 30,
	2010	2009	2010	2009
Weighted average shares excluded (in thousands):
Convertible subordinated notes and warrants	28,218	28,336	28,277	25,727
Employee stock options	4,753	4,142	4,865	3,980
	32,971	32,478	33,142	29,707

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17.  SEGMENT AND SUBSIDIARY INFORMATION

Revenues for the three months ended September 30:

	Three Months Ended
	September 30,
	2010									2009
	United States			Europe			Total			United States			Europe			Total
Sales:
CNS
Proprietary CNS
PROVIGIL*	$	267,751		$	13,279		$	281,030		$	241,301		$	16,693		$	257,994
NUVIGIL**	51,437			—			51,437			20,991			—			20,991
GABITRIL	9,577			1,025			10,602			11,560			1,340			12,900
Other Proprietary CNS	—			2,580			2,580			—			3,575			3,575
Generic CNS	—			8,609			8,609			—			2,642			2,642
CNS	328,765			25,493			354,258			273,852			24,250			298,102
Pain
Proprietary Pain
FENTORA***	37,368			5,549			42,917			35,779			1,201			36,980
AMRIX	26,784			—			26,784			26,703			—			26,703
Other Proprietary Pain	—			91			91			—			89			89
Generic Pain
ACTIQ	16,170			17,855			34,025			16,521			16,721			33,242
Generic OTFC	8,295			—			8,295			19,332			—			19,332
Other Generic Pain	—			19,040			19,040			—			2,360			2,360
Pain	88,617			42,535			131,152			98,335			20,371			118,706
Oncology
Proprietary Oncology
TREANDA	103,911			—			103,911			54,532			—			54,532
Other Proprietary Oncology	5,123			18,330			23,453			4,010			19,732			23,742
Generic Oncology	—			5,552			5,552			—			5,021			5,021
Oncology	109,034			23,882			132,916			58,542			24,753			83,295
Other
Other Proprietary	2,975			2,354			5,329			3,168			—			3,168
Other Generic	3,526			79,896			83,422			3,464			28,488			31,952
Other	6,501			82,250			88,751			6,632			28,488			35,120
Total Net Sales	532,917			174,160			707,077			437,361			97,862			535,223
Other Revenue	9,190			726			9,916			13,949			240			14,189
Total External Revenues	542,107			174,886			716,993			451,310			98,102			549,412
Inter-Segment Revenues	13,032			1,169			14,201			5,827			2,251			8,078
Elimination of Inter-Segment Revenues	(13,032		)	(1,169		)	(14,201		)	(5,827		)	(2,251		)	(8,078		)
Total Revenues	$	542,107		$	174,886		$	716,993		$	451,310		$	98,102		$	549,412

25

Revenues for the nine months ended September 30:

	Nine Months Ended
	September 30,
	2010									2009
	United States			Europe			Total			United States			Europe			Total
Sales:
CNS
Proprietary CNS
PROVIGIL*	$	780,902		$	47,409		$	828,311		$	726,313		$	47,111		$	773,424
NUVIGIL**	127,327			—			127,327			37,777			—			37,777
GABITRIL	28,994			3,511			32,505			37,058			3,871			40,929
Other Proprietary CNS	—			8,238			8,238			—			9,645			9,645
Generic CNS	—			19,494			19,494			—			8,078			8,078
CNS	937,223			78,652			1,015,875			801,148			68,705			869,853
Pain
Proprietary Pain
FENTORA***	114,709			14,939			129,648			99,686			2,438			102,124
AMRIX	80,467			—			80,467			83,807			—			83,807
Other Proprietary Pain	—			199			199			—			216			216
Generic Pain
ACTIQ	45,581			50,413			95,994			56,692			52,579			109,271
Generic OTFC	32,609			—			32,609			66,834			—			66,834
Other Generic Pain	—			42,738			42,738			—			6,259			6,259
Pain	273,366			108,289			381,655			307,019			61,492			368,511
Oncology
Proprietary Oncology
TREANDA	284,900			—			284,900			160,549			—			160,549
Other Proprietary Oncology	15,931			57,290			73,221			13,530			53,733			67,263
Generic Oncology	—			15,410			15,410			—			14,685			14,685
Oncology	300,831			72,700			373,531			174,079			68,418			242,497
Other
Other Proprietary	11,222			4,108			15,330			13,277			—			13,277
Other Generic	10,680			199,122			209,802			12,889			81,583			94,472
Other	21,902			203,230			225,132			26,166			81,583			107,749
Total Net Sales	1,533,322			462,871			1,996,193			1,308,412			280,198			1,588,610
Other Revenue	37,318			6,977			44,295			28,016			567			28,583
Total External Revenues	1,570,640			469,848			2,040,488			1,336,428			280,765			1,617,193
Inter-Segment Revenues	28,369			1,176			29,545			18,511			2,425			20,936
Elimination of Inter-Segment Revenues	(28,369		)	(1,176		)	(29,545		)	(18,511		)	(2,425		)	(20,936		)
Total Revenues	$	1,570,640		$	469,848		$	2,040,488		$	1,336,428		$	280,765		$	1,617,193

Europe- Primarily Europe, Middle East and Africa.

Proprietary products are products which are sold under patent coverage.

Generic products are products sold without patent coverage in the primary sales territory.

Patent coverage may exist in other territories.

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

** 2009 sales launched on June 1, 2009.

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

Revenues are attributable to geographic area based on the location of the customer or licensee.  Income (loss) before income taxes for the period ended September 30:

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	Three months ended				Nine months ended
	September 30,				September 30,
	2010		2009^		2010		2009^
United States	$	189,876	$	128,674	$	487,906	$	365,172
Europe	2,934		9,096		9,199		(31,594		)
Total	$	192,810	$	137,770	$	497,105	$	333,578

Total assets:

	September 30,		December 31,
	2010		2009
United States	$	3,243,792	$	3,896,131
Europe	1,642,600		761,964
Total	$	4,886,392	$	4,658,095

^ Certain reclassifications of prior year amounts have been made to conform to current year presentation.

18.  SUBSEQUENT EVENTS

BioAssets Development Corporation

In October 2010, we exercised the option to acquire privately-held BioAssets Development Corporation (“BDC”). Upon the closing of the merger, we will purchase all of the outstanding capital stock of BDC for $12.5 million, subject to net working capital and debt adjustments set forth in the merger agreement.   For more information on BDC, please see Note 2.

ChemGenex Pharmaceuticals Limited

In October, 2010, we signed a convertible note subscription agreement with ChemGenex Pharmaceuticals Limited, an Australian-based oncology focused biopharmaceutical company (“ChemGenex”).  Under the terms of the agreement, we will provide up to A$15 million to ChemGenex in return for a note that is convertible at A$0.50 per share.  This funding will support ChemGenex operations, including clinical activities to complete a planned New Drug Application submission to the U.S. Food and Drug Administration for omacetaxine for the treatment of chronic myelogenous leukemia (CML) patients who have failed two or more tyrosine kinase inhibitor (TKIs).  Separately, we also entered into option agreements with two of ChemGenex’s major shareholders, Stragen International N.V. and Merck Santé S.A.S.  Under those option agreements, we have the right to acquire up to 19.9 percent of ChemGenex’s outstanding shares at A$0.70 per share.  We have the right to exercise the options before the later of March 31, 2011, and ten business days after receipt of certain clinical trial data and related analyses from ChemGenex (the “Exercise Period”).  We have the right to convert the notes to ChemGenex shares at any time, subject to ChemGenex shareholder approval (to be sought by December 31, 2010) for conversion during the Exercise Period or if the options are exercised.

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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 numerous branded and generic products around the world. In total, Cephalon sells more than 150 products in nearly 100 countries.

Our most significant products are our wakefulness products, PROVIGIL® (modafinil) Tablets [C-IV] and NUVIGIL® (armodafinil) Tablets [C-IV].  PROVIGIL comprised 41% of our total consolidated net sales for the nine months ended September 30, 2010, of which 94% was in the U.S. market.  NUVIGIL comprised 6% of our total consolidated net sales for the nine months ended September 30, 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 met with the FDA in May 2010 to discuss the complete response letter, provided a formal written response to the FDA in June 2010 and anticipate a final decision from the FDA regarding our sNDA by the end of 2010.  In June 2010, we announced that the primary endpoint was not met for a Phase II study of NUVIGIL as an adjunctive therapy for the treatment of the negative symptoms of schizophrenia.  In October 2010, the FDA approved our Risk Evaluation and Mitigation Strategy programs for NUVIGIL and PROVIGIL.

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 nine months ended September 30, 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 plan to submit the StiL Group’s study results to support an sNDA for TREANDA for the treatment of front-line NHL in the first half of 2011.  Separately, we are enrolling patients in our own Phase III study of TREANDA for the treatment of front-line NHL.

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 13% of our total consolidated net sales for the nine months ended September 30, 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 beginning

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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 end 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 end of 2010.

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.  Since 2008, the U.S. Patent and Trademark Office (the “PTO”) issued two pharmaceutical formulation patents covering AMRIX, which expire in November 2023 and February 2025.  In the second quarter of 2010, the PTO issued notices of allowance for three additional pharmaceutical formulation patent applications covering AMRIX.  Two of these patents issued in September and October 2010, and we expect the other patent to issue by the end of the year. These additional patents should expire in 2023.

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.  In May 2010, the trial for the Watson FENTORA matter was completed.  We anticipate a decision by the U.S. District Court in Delaware in the fourth quarter of 2010.  In October 2010, through our subsidiary Anesta AG, we entered into a settlement agreement with Impax to settle the parties’ pending patent litigation concerning AMRIX.  The settlement agreement does not affect the status of the separate patent litigations with Mylan, Barr and Anchen. We anticipate a decision by the U.S. District Court in Delaware by or in the second quarter of 2011 with respect to the patents litigated in October 2010. In addition, we anticipate a separate trial regarding the recently issued additional pharmaceutical formulation patents covering AMRIX.  In the first quarter of 2010, generic versions of modafinil were launched in Portugal, Sweden and Denmark.  We have filed lawsuits in each of these countries. 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.

RECENT ACQUISITIONS AND TRANSACTIONS

Mepha GmbH

In April 2010, we acquired all of the issued share capital of Mepha GmbH (“Mepha”), a privately-held, Swiss-based pharmaceutical company, for CHF 622.5 million plus contractual purchase price adjustments of CHF 26.3 million for a total of CHF 648.8 million (or approximately US$605.4 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 markets its

29

products in Europe, the Middle East, Africa, South and Central America as well as in Asia. Mepha has approximately 620 full-time employees, 500 of them in Switzerland, and approximately 200 contractors.  The acquisition of Mepha allows us to expand our geographic reach and to further diversify our business mix into the generic and branded generic arena.  Mepha is included in our European segment. For more information regarding Mepha, please see Note 2 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.

Ception Therapeutics, Inc.

In January 2009, we entered into an option agreement (the “Ception Option Agreement”) with Ception Therapeutics, Inc., a privately-held company (“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 Ception $50.0 million (the “Ception Option Fee”) 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.  After completing certain closing conditions, including U.S. antitrust approval, in April 2010, we acquired Ception 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. In April 2010, Ception distributed the Ception Option Fee to its stockholders immediately prior to 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.  For more information regarding Ception, please see Note 2 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.

BioAssets Development Corporation

In October 2010, we exercised the option to acquire BioAssets Development Corporation (“BDC”) following receipt of interim data from a Phase II placebo-controlled proof-of-concept study evaluating epidural administration of a tumor necrosis factor (TNF) inhibitor for the treatment of sciatica in 45 patients.  Upon the closing of the merger, we will purchase all of the outstanding capital stock of BDC for $12.5 million, subject to net working capital and debt adjustments set forth in the merger agreement.  BDC shareholders could receive additional payments related to regulatory and sales milestones. BDC has an intellectual property estate around use of TNF inhibitors for sciatic pain in 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. For more information regarding BDC, please see Note 2 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.

Other Transactions

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 development for patients with certain inflammatory diseases; and (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.

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RESULTS OF OPERATIONS

(In thousands)

Three months ended September 30, 2010 compared to three months ended September 30, 2009:

	Three Months Ended												%
	September 30,												Increase
	2010						2009						(Decrease)
							United						United
	United States		Europe		Total		States		Europe		Total		States		Europe		Total
Sales:
CNS
Proprietary CNS
PROVIGIL*	$	267,751	$	13,279	$	281,030	$	241,301	$	16,693	$	257,994	11	%	(20	)%	9	%
NUVIGIL**	51,437		—		51,437		20,991		—		20,991		145		—		145
GABITRIL	9,577		1,025		10,602		11,560		1,340		12,900		(17	)	(24	)	(18	)
Other Proprietary CNS	—		2,580		2,580		—		3,575		3,575		—		(28	)	(28	)
Generic CNS	—		8,609		8,609		—		2,642		2,642		—		226		226
CNS	328,765		25,493		354,258		273,852		24,250		298,102		20		5		19
Pain
Proprietary Pain
FENTORA***	37,368		5,549		42,917		35,779		1,201		36,980		4		362		16
AMRIX	26,784		—		26,784		26,703		—		26,703		—		—		—
Other Proprietary Pain	—		91		91		—		89		89		—		2		2
Generic Pain
ACTIQ	16,170		17,855		34,025		16,521		16,721		33,242		(2	)	7		2
Generic OTFC	8,295		—		8,295		19,332		—		19,332		(57	)	—		(57	)
Other Generic Pain	—		19,040		19,040		—		2,360		2,360		—		707		707
Pain	88,617		42,535		131,152		98,335		20,371		118,706		(10	)	109		10
Oncology
Proprietary Oncology
TREANDA	103,911		—		103,911		54,532		—		54,532		91		—		91
Other Proprietary Oncology	5,123		18,330		23,453		4,010		19,732		23,742		28		(7	)	(1	)
Generic Oncology	—		5,552		5,552		—		5,021		5,021		—		11		11
Oncology	109,034		23,882		132,916		58,542		24,753		83,295		86		(4	)	60
Other
Other Proprietary	2,975		2,354		5,329		3,168		—		3,168		(6	)	100		68
Other Generic	3,526		79,896		83,422		3,464		28,488		31,952		2		180		161
Other	6,501		82,250		88,751		6,632		28,488		35,120		(2	)	189		153
Total Net Sales	532,917		174,160		707,077		437,361		97,862		535,223		22		78		32
Other Revenue	9,190		726		9,916		13,949		240		14,189		(34	)	203		(30	)
Total Revenues	$	542,107	$	174,886	$	716,993	$	451,310	$	98,102	$	549,412	20	%	78	%	31	%

Europe- Primarily Europe, Middle East and Africa

Proprietary products are products which are sold under patent coverage.

Generic products are products sold without patent coverage in the primary sales territory. Patent coverage may exist in other territories.

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

** 2009 sales launched on June 1, 2009.

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

31

Total net sales:

	Three months ended						% Increase		% Increase (Decrease due to		% Increase
	September 30,				% Increase		(Decrease) due to		Mergers &		(Decrease) due
	2010		2009		(Decrease)		Currency		Acquisitions		to Operations
United States	$	532,917	$	437,361	22	%	—	%	—	%	22	%
Europe	174,160		97,862		78	%	(9	)%	82	%	5	%
	$	707,077	$	535,223	32	%	(2	)%	15	%	19	%

Net sales- In the United States, we sell our proprietary products to pharmaceutical wholesalers, the largest three of which accounted for 72% of our total consolidated gross sales for the three months ended September 30, 2010.  Decisions made by these wholesalers regarding the levels of inventory they hold (and thus the amount of product they purchase from us) can materially affect the level of our sales in any particular period and thus may not necessarily correlate to the number of prescriptions written for our products as reported by IMS Health Incorporated.

We have distribution service agreements with each of our wholesaler customers. These agreements obligate the wholesalers to provide us with periodic outbound sales information and current inventory levels for our products held at their warehouse locations; additionally, the wholesalers have agreed to manage the variability of their purchases and inventory levels within specified days on hand limits. Various factors can impact the decisions made by wholesalers and retailers regarding the levels of inventory they hold, including, among other factors, their assessment of anticipated demand for products, timing of sales made by them, their review of historical product usage trends, and their purchasing patterns.

As of September 30, 2010, we received information from substantially all of our U.S. wholesaler customers about the levels of inventory they held for our U.S. branded products. Based on this information, which we have not independently verified, we believe that total inventory held at these wholesalers is approximately two to three weeks supply of our U.S. branded products at our current sales levels.  Based on a retail inventory survey in June 2010, we believe that our generic OTFC inventory held at wholesalers and retailers is approximately four months. We do not expect that potential future fluctuations in inventory levels of generic OTFC held by retailers will have a significant impact on our financial position and results of operations.

For the three months ended September 30, 2010, in addition to the factors addressed below, net sales were also impacted by changes in the product sales allowances deducted from gross sales as described further below and by changes in the relative levels of the number of units of inventory held at wholesalers and retailers. Changes in foreign exchange rates versus the U.S. dollar caused a decrease of approximately 9% or $8.8 million in European net sales as compared to the three months ended September 30, 2009. The acquisition of Mepha GmbH (“Mepha”) caused an 82% increase in European net sales as compared to the three months ended September 30, 2009. The other key factors that contributed to the increase in sales, period to period, are summarized by therapeutic area as follows:

·In CNS, net sales increased 19 percent. U.S. results for our CNS products reflect pricing increases in November 2009 and May 2010.  NUVIGIL was launched in June 2009 and the 145% increase in net sales is due to promotional efforts and the increased acceptance of NUVIGIL.  For both PROVIGIL and GABITRIL, which are non-promoted products, price increases were offset by declines in unit sales.  The PROVIGIL decline in unit sales is due to the introduction of NUVIGIL and the transition of our marketing support from PROVIGIL to NUVIGIL.  For the three months ended September 30, 2010 NUVIGIL represented 35% of the combined NUVIGIL/PROVIGIL prescriptions in the U.S.  Europe net sales of PROVIGIL decreased 20% due to lower sales volumes and the unfavorable effect of exchange rates.   Generic CNS sales increased as a result of the inclusion of Mepha.

·In Pain, net sales increased 10 percent.  Net sales increased primarily due to the introduction of FENTORA into several European territories and increased unit sales period over period as well as the inclusion of Mepha in the other generic pain category. These increases were offset by a decrease in generic OTFC sales of 57% due to the expiration in September 2009 of our obligation to supply Barr with generic OTFC. Pricing increases for AMRIX and ACTIQ in the U.S. were offset by declining unit sales specifically resulting, in the case of ACTQ, from market share loss to generic competition.

·In Oncology, net sales increased 60 percent. This increase was attributable to increased acceptance of TREANDA.  Generic oncology sales increased as a result of the inclusion of Mepha.

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·Other generic net sales increased 161 percent due to the inclusion of Mepha product net sales of $54.1 million.

Other Revenues—The decrease of 30% from period to period is primarily due to a decline in license royalties earned by Cephalon Australia due to the expiration of royalty agreements in the third quarter of 2010.

Analysis of gross sales to net sales—The following table presents the product sales allowances deducted from gross sales to arrive at a net sales figure:

	Three Months Ended
	September 30,
	2010			2009			Change			% Change
Gross sales	$	820,085		$	614,010		$	206,075		34	%
Product sales allowances:
Prompt payment discounts	12,927			10,354			2,573			25
Wholesaler discounts	7,982			8,246			(264		)	(3	)
Returns	11,543			16,836			(5,293		)	(31	)
Coupons	10,737			3,532			7,205			204
Medicaid discounts	31,338			11,829			19,509			165
Managed care and governmental contracts	38,481			27,990			10,491			37
	113,008			78,787			34,221			43
Net sales	$	707,077		$	535,223		$	171,854		32	%
Product sales allowances as a percentage of gross sales	14		%	13		%

Prompt payment discounts increased for the three months ended September 30, 2010 as compared to the three months ended September 30, 2009 due to the increase in U.S. net sales. Wholesaler discounts decreased as product price increases in May 2010 produced wholesaler credits that partially offset the wholesaler discounts that would have otherwise been recorded for 2010. Returns decreased as a result of decreased returns experience related to ACTIQ, generic OTFC, and FENTORA. Coupons increased period over period as a result of increased NUVIGIL sales volumes resulting in increased utilization for the NUVIGIL coupon programs and increased utilization of the AMRIX coupon program.

Medicaid discounts increased for the three months ended September 30, 2010 as compared to the three months ended September 30, 2009 due to higher rebate rates for certain of our products resulting from product price increases in May 2010 and the $7.9 million effect from the recently-enacted U.S. health care reform law, which increased reimbursement rates from 15.1 to 23.1 percent, extended Medicaid rebates to managed care organizations and increased Public Health Service pricing discounts. Managed care and governmental contracts increased for the three months ended September 30, 2010 as compared to the three months ended September 30, 2009 due to increases in Federal Chargebacks from increases in sales of PROVIGIL and TREANDA, offset by a decrease in our DOD Tricare expense. In the future, we expect product sales allowances as a percentage of gross sales to trend upward due to the impact of price increases on Medicaid discounts and the effect of the recently-enacted U.S. health care reform law.

	Three Months Ended
	September 30,
	2010		2009		Change			% Change
Cost of sales	$	151,939	$	90,456	$	61,483		68	%
Research and development	110,966		99,157		11,809			12
Selling, general and administrative	226,791		194,068		32,723			17
Change in fair value of contingent consideration	5,247		—		5,247			100
Restructuring charges	2,313		1,062		1,251			118
Acquired in-process research and development	—		6,000		(6,000		)	(100	)
	$	497,256	$	390,743	$	106,513		27	%

Cost of Sales—The cost of sales was 21% of net sales for the three months ended September 30, 2010 and 17% of net sales for the three months ended September 30, 2009.  The increase in cost of sales for the three months ended September 30,

33

2010 is primarily due to Mepha, including $5.5 million in nonrecurring amortization of the revaluation of their inventory to fair value upon acquisition, and the recognition of $2.5 million in additional accelerated depreciation related to the sale of our Eden Prarie facility in the third quarter of 2010. In the third quarter of 2009, we recorded a $9.5 million gain in connection with our agreement with one of our modafinil suppliers to reduce our excess modafinil purchase commitments.  Changes in foreign exchange rates versus the U.S. dollar caused a decrease of approximately 6% or $3.4 million in European expenses as compared to the three months ended September 30, 2009. For the three months ended September 30, 2010 and 2009, we recognized $31.4 million and $26.4 million of amortization expense included in cost of sales, respectively. Amortization expense increased $5.0 million due to the increases in amortization recognized in connection with the acquisition of Mepha and VOGALENE/VOGALIB. We recorded accelerated depreciation charges of $4.2 million and $5.0 million in cost of sales in the third quarter of 2010 and 2009, respectively.

Research and Development Expenses—Research and development expenses increased $11.8 million, or 12%, for the three months ended September 30, 2010 as compared to the three months ended September 30, 2009. We experienced increased R&D expenditures from Mepha as well as an increase in clinical trial activity.  Changes in foreign exchange rates versus the U.S. dollar caused a decrease of approximately 6% or $0.8 million in European expenses as compared to the three months ended September 30, 2009. For the three months ended September 30, 2010 and 2009, we recognized $6.1 million and $7.3 million of depreciation expense included in research and development expenses, respectively.

Selling, General and Administrative Expenses—Selling, general and administrative expenses increased $32.7 million, or 17% for the three months ended September 30, 2010 as compared to the three months ended September 30, 2009, primarily due the inclusion of Mepha expenses and associated integration and transaction costs, increased legal expenditures, offset by lower selling and marketing expenses associated with AMRIX.  Changes in foreign exchange rates versus the U.S. dollar caused a decrease of approximately 6% or $3.4 million in European expenses as compared to the three months ended September 30, 2009.  For the three months ended September 30, 2010 and 2009, we recognized $7.9 million and $6.1 million of depreciation expense included in selling, general and administrative expenses, respectively.

Restructuring charges—For the three months ended September 30, 2010 and 2009, we recorded $2.3 million and $1.1 million, respectively, related to our restructuring plan to consolidate certain manufacturing and research and development activities primarily within our U.S. locations.  These charges primarily consist of costs associated with the transfer of technology, severance for employees who have or are expected to be terminated as a result of this restructuring plan.  For additional information, see Note 3 of the Consolidated Financial Statements included in Part I, Item 1 of this Report.

Acquired in-process research and development— For the three months ended September 30, 2009, we incurred expense of $6.0 million in exchange for license rights to certain of XOMA Ltd.’s proprietary antibody library materials.

Change in fair value of contingent consideration— For the three months ended September 30, 2010, we recorded a $5.2 million charge for the change in fair value on Ception contingent consideration. Changes in fair value during the third quarter reflect changes in our risk adjusted discount rate and accretion related to the passage of time as development work towards the achievement of the milestones progresses.

	Three Months Ended
	September 30,
	2010			2009			Change			% Change
Interest income	$	908		$	1,821		$	(913	)	-50	%
Interest expense	(24,989		)	(26,495		)	1,506			-6	%
Other income (expense), net	(2,846		)	3,775			(6,621		)	-175	%
	$	(26,927	)	$	(20,899	)	$	(6,028	)	29	%

Other Income (Expense)—Other income (expense) decreased $6.0 million, or 29%, for the three months ended September 30, 2010 as compared to the three months ended September 30, 2009. The change was attributable to the following factors:

·a $0.9 million decrease in interest income due to lower average investment balances;

·a $1.5 million decrease in interest expense due to the redemption of the Zero Coupon Notes in June 2010; and

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·a $6.6 million decrease in other income (expense), net due to $2.8 million in foreign exchange losses in 2010 as compared to $3.8 in foreign exchange gains in 2009 as a result of fluctuations in European currencies during those reporting periods.

	Three Months Ended
	September 30,
	2010		2009		Change		% Change
Income tax expense	$	61,262	$	42,673	$	18,589	44	%

Income Taxes— For the three months ended September 30, 2010, we recognized $61.3 million of income tax expense on income before income taxes of $192.8 million, resulting in an overall effective tax rate of 31.8 percent. This compared to income tax expense for the three months ended September 30, 2009 of $42.7 million on income before income taxes of $137.8 million, resulting in an effective tax rate of 31.0%, as we did not recognize tax benefit for losses attributable to non-controlling interest of $7.6 million. In August 2009 we recognized an additional tax benefit of $13.8 million over the benefits recorded at December 31, 2008, due to our closing agreement with the IRS in which both parties agreed that the nondeductible punitive portion of the settlement agreement with the U.S. Attorney’s Office is $152.3 million.

In the third quarter of 2010, the effective tax rate of 31.8 percent excludes certain benefits for 2010 U.S. federal research and development credits, due to tax law changes, and includes previously unrecognized tax benefits related to various tax audits and nondeductible transaction costs related to 2010 acquisitions.

	Three Months Ended
	September 30,
	2010		2009		Change			% Change
Net loss attributable to noncontrolling interest	$	952	$	7,625	$	(6,673	)	(88	)%

Noncontrolling Interest- For the three months ended September 30, 2010, we recorded a loss attributable to noncontrolling interest of $1.0 million related to our investment in BDC and Mepha Pharma AG. For the three months ended September 30, 2009, we recorded a loss attributable to noncontrolling interest of $7.6 million, related to our investment in Ception and Arana.  Arana and Ception became wholly owned subsidiaries in August 2009 and April 2010, respectively. For additional information, see Note 2 of the Consolidated Financial Statements included in Part I, Item 1 of this Quarterly Report on Form 10-Q.

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Nine months ended September 30, 2010 compared to nine months ended September 30, 2009:

													%
	Nine Months Ended												Increase
	September 30,												(Decrease)
	2010						2009						United
	United States		Europe		Total		United States		Europe		Total		States		Europe		Total
Sales:
CNS
Proprietary CNS
PROVIGIL*	$	780,902	$	47,409	$	828,311	$	726,313	$	47,111	$	773,424	8	%	1	%	7	%
NUVIGIL**	127,327		—		127,327		37,777		—		37,777		237		—		237
GABITRIL	28,994		3,511		32,505		37,058		3,871		40,929		(22	)	(9	)	(21	)
Other Proprietary CNS	—		8,238		8,238		—		9,645		9,645		—		(15	)	(15	)
Generic CNS	—		19,494		19,494		—		8,078		8,078		—		141		141
CNS	937,223		78,652		1,015,875		801,148		68,705		869,853		17		14		17
Pain
Proprietary Pain
FENTORA***	114,709		14,939		129,648		99,686		2,438		102,124		15		513		27
AMRIX	80,467		—		80,467		83,807		—		83,807		(4	)	—		(4	)
Other Proprietary Pain	—		199		199		—		216		216		—		(8	)	(8	)
Generic Pain
ACTIQ	45,581		50,413		95,994		56,692		52,579		109,271		(20	)	(4	)	(12	)
Generic OTFC	32,609		—		32,609		66,834		—		66,834		(51	)	0		(51	)
Other Generic Pain	—		42,738		42,738		—		6,259		6,259		0		583		583
Pain	273,366		108,289		381,655		307,019		61,492		368,511		(11	)	76		4
Oncology
Proprietary Oncology
TREANDA	284,900		—		284,900		160,549		—		160,549		77		—		77
Other Proprietary Oncology	15,931		57,290		73,221		13,530		53,733		67,263		18		7		9
Generic Oncology	—		15,410		15,410		—		14,685		14,685		—		5		5
Oncology	300,831		72,700		373,531		174,079		68,418		242,497		73		6		54
Other
Other Proprietary	11,222		4,108		15,330		13,277		—		13,277		(15	)	—		15
Other Generic	10,680		199,122		209,802		12,889		81,583		94,472		(17	)	144		122
Other	21,902		203,230		225,132		26,166		81,583		107,749		(16	)	149		109
Total Net Sales	1,533,322		462,871		1,996,193		1,308,412		280,198		1,588,610		17		65		26
Other Revenue	37,318		6,977		44,295		28,016		567		28,583		33		1131		55
Total Revenues	$	1,570,640	$	469,848	$	2,040,488	$	1,336,428	$	280,765	$	1,617,193	18	%	67	%	26	%

Europe- Primarily Europe, Middle East and Africa

Proprietary products are products which are sold under patent coverage.

Generic products are products sold without patent coverage in the primary sales territory. Patent coverage may exist in other territories.

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

** 2009 sales launched on June 1, 2009.

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

Total net sales:

	Nine Months						% Increase		% Increase (Decrease) due to		% Increase
	September 30,				% Increase		(Decrease) due to		Mergers &		(Decrease) due
	2010		2009		(Decrease)		Currency		Acquisitions		to Operations
United States	$	1,533,322	$	1,308,412	17	%	—	%	—	%	17	%
Europe	462,871		280,198		65	%	(2	)%	61	%	6	%
	$	1,996,193	$	1,588,610	26	%	—	%	11	%	15	%

Net sales— For the nine months ended September 30, 2010, in addition to the factors addressed below, net sales were also impacted by changes in the product sales allowances deducted from gross sales as described further below and by changes in the relative levels of the number of units of inventory held at wholesalers and retailers. Changes in foreign exchange rates versus the U.S. dollar caused a decrease of approximately 2% or $6.2 million in European net

36

sales as compared to the nine months ended September 30, 2009. The other key factors that contributed to the increase in sales, period to period, are summarized by therapeutic area as follows:

·In CNS, net sales increased 17 percent.  U.S. results for our CNS products reflect pricing increases in November 2009 and May 2010.  NUVIGIL was launched in June 2009 and the 237% increase in net sales is due to promotional efforts and the increased acceptance of NUVIGIL.  For both PROVIGIL and GABITRIL, which are non-promoted products,  price increases were offset by declines in unit sales.  The PROVIGIL decline in until sales is due to the introduction of NUVIGIL and the transition of our marketing support from PROVIGIL to NUVIGIL.  For the nine months ended September 30, 2010 NUVIGIL represented 30% of the combined NUVIGIL/PROVIGIL prescriptions in the U.S. Generic CNS sales increased as a result of the inclusion of Mepha.

·In Pain, net sales increased 4 percent.  Net sales of our pain products have been negatively impacted by an overall decline in the rapid onset opioid market.  With the exception of generic OTFC, sales of FENTORA, ACTIQ and AMRIX benefited from pricing increases in the U.S. in November 2009 and May 2010.  Net sales increases due to pricing for AMRIX and ACTIQ in the U.S. were offset by declining unit sales specifically resulting, in the case of ACTIQ, from market share loss to generic competition.  Generic OTFC net sales decreased 51% due to the expiration in September 2009 of our obligation to supply Barr with generic OTFC. In several European territories FENTORA sales increased due to the introduction of FENTORA into Europe and increased unit sales period over period.  Other generic pain sales increased as a result of the inclusion of Mepha.

·In Oncology, sales increased 54 percent. U.S. sales increased primarily due to increased acceptance of TREANDA.

·Other generic sales, which consist primarily of sales of other products and certain third party products, increased 122 percent, primarily due to the inclusion of Mepha sales.

Other Revenues—The increase of 55% from period to period is primarily due to an increase in license royalties recognized by Cephalon Australia as revenues in 2009 are recognized from the acquisition date of May 29, 2009, and by revenues earned from VOGALENE/VOGALIB, which we purchased from UCB Pharma France in December 2009.

Analysis of gross sales to net sales—The following table presents the product sales allowances deducted from gross sales to arrive at a net sales figure:

	Nine Months Ended
	September 30,
	2010			2009			Change			% Change
Gross sales	$	2,292,460		$	1,828,105		$	464,355		25	%
Product sales allowances:
Prompt payment discounts	36,566			31,873			4,693			15
Wholesaler discounts	14,305			21,388			(7,083		)	(33	)
Returns	32,687			48,556			(15,869		)	(33	)
Coupons	31,017			22,863			8,154			36
Medicaid discounts	61,640			32,421			29,219			90
Managed care and governmental contracts	120,052			82,394			37,658			46
	296,267			239,495			56,772			24
Net sales	$	1,996,193		$	1,588,610		$	407,583		26	%
Product sales allowances as a percentage of gross sales	13		%	13		%

Prompt payment discounts increased for the nine months ended September 30, 2010 as compared to the nine months ended September 30, 2009 due to the increase in U.S. net sales. Wholesaler discounts decreased as price increases in May 2010 and November 2009 produced wholesaler credits that partially offset the wholesaler discounts that would have otherwise been recorded in 2010. Returns decreased as a result of decreased returns experience related to ACTIQ, generic

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OTFC, and FENTORA. Coupons increased period over period as a result of increased NUVIGIL sales volume resulting in increased utilization for the NUVIGIL coupon programs, and increased utilization of the the AMRIX coupon program, partially offset by the termination of the PROVIGIL coupon program in the second quarter of 2009.

Medicaid discounts increased for the nine months ended September 30, 2010 as compared to the nine months ended September 30, 2009 due to higher rebate rates for certain of our products resulting from product price increases in May 2010 and November 2009 and the $11.0 million effect from the recently-enacted U.S. health care reform law, which increased reimbursement rates from 15.1 to 23.1 percent, extended Medicaid rebates to managed care organizations and increased Public Health Service pricing discounts. Managed care and governmental contracts increased for the nine months ended September 30, 2010 as compared to the nine months ended September 30, 2009 due to increases in Federal Chargebacks from increases in sales of PROVIGIL and TREANDA and an increase in our DOD Tricare expense. In the future, we expect product sales allowances as a percentage of gross sales to trend upward due to the impact of price increases on Medicaid discounts and the effect of the recently-enacted U.S. health care reform law.

	Nine Months Ended
	September 30,
	2010		2009		Change			% Change
Cost of sales	$	427,721	$	293,633	$	134,088		46	%
Research and development	317,604		304,266		13,338			4
Selling, general and administrative	689,900		618,314		71,586			12
Change in fair value of contingent consideration	6,314		—		6,314			100
Restructuring charges	7,638		3,944		3,694			94
Acquired in-process research and development	—		46,118		(46,118		)	(100	)
	$	1,449,177	$	1,266,275	$	182,902		14	%

Cost of Sales—The cost of sales was 21% of net sales for the nine months ended September 30, 2010 and 18% of net sales for the nine months ended September 30, 2009.  The increase in the cost of sales for the nine months ended September 30, 2010 was primarily due to Mepha, including $10.5 million in nonrecurring amortization of the revaluation of their inventory to fair value upon acquisition, and the recognition of $2.5 million in additional accelerated depreciation related to the sale of our Eden Prarie facility in the third quarter of 2010. In 2010 and 2009, we increased the reserve for excess modafinil purchase commitments by $9.4 million and $3.0 million, respectively, based on our analysis of estimated future requirements in association with the successful launch of NUVIGIL. During the third quarter of 2009, we recognized a $9.5 million gain in connection with our agreement with one of our modafinil suppliers to reduce our excess modafinil purchase commitments.  Changes in foreign exchange rates versus the U.S. dollar caused a decrease of approximately 4% or $2.0 million in European expenses as compared to the nine months ended September 30, 2009. For the nine months ended September 30, 2010 and 2009, we recognized $89.4 million and $70.6 million of amortization expense included in cost of sales, respectively. Amortization expense increased $18.7 million due to the increases in amortization recognized in connection with the acquisition of Mepha, Arana and VOGALENE/VOGALIB.  We recorded accelerated depreciation charges of $14.9 million and $14.0 million in the first nine months of 2010 and 2009, respectively.

Research and Development Expenses— Research and development expenses increased $13.3 million, or 4%, for the nine months ended September 30, 2010 as compared to the nine months ended September 30, 2009. We experienced increased R&D expenditures from Mepha and Cephalon Australia as well as an increase in clinical trial activity. Changes in foreign exchange rates versus the U.S. dollar caused an increase of approximately 1% or $0.2 million in European expenses as compared to the nine months ended September 30, 2009. For the nine months ended September 30, 2010 and 2009, we recognized $18.4 million and $20.4 million, respectively, of depreciation expense included in research and development expenses.

Selling, General and Administrative Expenses— Selling, general and administrative expenses increased $71.6 million, or 12%, for the nine months ended September 30, 2010 as compared to the nine months ended September 30, 2009, primarily due the inclusion of Mepha expenses and associated integration and transaction costs, increased legal expenditures, offset by lower selling and marketing expenses associated with AMRIX. Changes in foreign exchange rates versus the U.S. dollar caused a decrease of approximately 4% or $2.5 million increase in European expenses as compared to the nine months ended September 30, 2009.  For the nine months ended September 30, 2010 and 2009, we recognized $22.5 million and $18.3 million, respectively, of depreciation expense included in selling general and administrative expenses.

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Restructuring charges—For the nine months ended September 30, 2010 and 2009, we recorded $7.6 million and $3.9 million, respectively, related to our restructuring plan to consolidate certain manufacturing and research and development activities primarily within our U.S. locations.  These charges primarily consist of costs associated with the transfer of technology, severance for employees who have or are expected to be terminated as a result of this restructuring plan.  For additional information, see Note 3 of the Consolidated Financial Statements included in Part I, Item 1 of this Report.

Acquired in-process research and development— For the nine months ended September 30, 2009, we incurred expense of:

·$9.4 million in connection with Acusphere for the elimination of the $15 million milestone and royalty payments associated with the celecoxib license agreement and patent rights relating to their HDDS technology;

·$30.0 million in exchange for the exclusive, worldwide license rights to LUPUZOR, acquired from ImmuPharma plc.;

·$0.8 million in exchange for the exclusive sublicense to bendamustine hydrochloride in China and Hong Kong, acquired from SymBio Pharmaceuticals Limited (“SymBio”); and

·$6.0 million in exchange for license rights to certain of XOMA Ltd.’s proprietary antibody library materials.

Change in fair value of contingent consideration— For the nine months ended September 30, 2010, we recorded a $6.3 million charge for the change in fair value on Ception contingent consideration. Changes in fair value during 2010 reflect changes in our risk adjusted discount rate and accretion related to the passage of time as development work towards the achievement of the milestones progresses since the acquisition of the noncontrolling interest in Ception in April 2010.

	Nine Months Ended
	September 30,
	2010			2009			Change			% Change
Interest income	$	4,138		$	3,455		$	683		20	%
Interest expense	(78,895		)	(63,213		)	(15,682		)	25
Other income (expense), net	(19,449		)	42,418			(61,867		)	(146	)
	$	(94,206	)	$	(17,340	)	$	(76,866	)	443	%

Other Income (Expense)—Other income (expense) decreased $76.9 million for the nine months ended September 30, 2010 as compared to the nine months ended September 30, 2009. The change in expenses was attributable to the following factors:

·a $0.7 million increase in interest income due to higher average investment balances;

·a $15.7 million increase in interest expense due to the recognition of interest related to our 2.5% convertible senior subordinated notes due May 1, 2014 and tax related interest charges, offset by the redemption of the Zero Coupon Notes in June 2010; and

·a $61.9 million decrease in other income (expense), net due to the following expenses:

·In 2010,

·$9.1 million loss on foreign exchange contracts used to protect against currency fluctuations related to our acquisition of Mepha; and

·$10.3 million in foreign exchange losses resulting from fluctuations in European currencies during the period.

·In 2009,

·$6.6 million gain on pre-bid Arana holdings;

·$2.8 million loss on Arana contingent consideration (90% ownership incentive payment);

·$10.0 million gain on the excess of Arana net assets over consideration;

·$19.0 million gains on foreign exchange derivative instruments; and

·$8.1 million increase in foreign exchange gains primarily associated with holding Australian dollars in connection with our Arana transaction.

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	Nine Months Ended
	September 30,
	2010	2009	Change		% Change
Income tax expense	172,827	122,659	$	50,168	41	%

Income Taxes— For the nine months ended September 30, 2010, we recognized $172.8 million of income tax expense on income before taxes of $497.1 million, resulting in an overall effective tax rate of 34.8 percent. For the nine months ended September 30, 2009 we recognized $122.7 million of income tax expense on income before income taxes of $333.6 million, resulting in an overall effective tax rate of 36.8%, as we did not recognize tax benefits for losses attributable to non-controlling interest of $35.2 million.  In August 2009 we recognized an additional tax benefit of $13.8 million over the benefits recorded at December 31, 2008, due to our closing agreement with the IRS in which both parties agreed that the nondeductible punitive portion of the settlement agreement with the U.S. Attorney’s Office is $152.3 million.

For the nine months ended September 30, 2010, the effective tax rate of 34.8 percent excludes certain benefits for 2010 U.S. federal research and development credits, due to tax law changes, and includes previously unrecognized tax benefits related to various tax audits and nondeductible transaction costs related to 2010 acquisitions.

	Nine Months Ended
	September 30,
	2010	2009	Change			% Change
Net loss attributable to noncontrolling interest	7,851	35,150	$	(27,299	)	-78	%

Noncontrolling Interest- For the nine months ended September 30, 2010, we recorded a loss attributable to noncontrolling interest of $7.9 million, related to our investment in BDC, pre-acquisition Ception and Mepha Pharma AG. Ception noncontrolling interest was acquired in the second quarter of 2010. For the nine months ended September 30, 2009, we recorded a loss attributable to noncontrolling interest of $35.2 million, related to our investment in Ception, Acusphere and Arana.  Arana and Ception became wholly owned subsidiaries in August 2009 and April 2010, respectively. For additional information, see Note 2 of the Consolidated Financial Statements included in Part I, Item 1 of this Quarterly Report on Form 10-Q.

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LIQUIDITY AND CAPITAL RESOURCES

(In thousands)

	As of			As of
	September 30, 2010			December 31, 2009
Financial assets:
Cash and cash equivalents	$	1,208,990		$	1,647,635
Debt and Redeemable Equity:
Current portion of long-term debt- convertible notes	$	820,000		$	1,019,968
Current portion of long-term debt discount- convertible notes	(178,245		)	(207,307		)
Current portion of long-term debt- other debt	2,342			6,264
Long-term debt- convertible notes	500,000			500,000
Long-term debt discount- convertible notes	(118,256		)	(137,907		)
Long-term debt- other debt	2,894			1,603
Redeemable equity	178,245			207,307
Total debt and redeemable equity	$	1,206,980		$	1,389,928
Select measures of liquidity and capital resources:
Working capital surplus	$	994,880		$	1,227,993
Total cash, cash equivalents and short-term investments as a percentage of total assets	25		%	35		%

	Nine months ended
	September 30,
	2010			2009
Change in cash and cash equivalents
Net cash provided by operating activities	$	650,540		$	517,131
Net cash used for investing activities	(589,263		)	(276,075		)
Net cash provided by (used for) financing activities	(506,218		)	686,004
Effect of exchange rate changes on cash and cash equivalents	6,296			2,295
Net increase (decrease) in cash and cash equivalents	$	(438,645	)	$	929,355

Our working capital surplus is calculated as current assets less current liabilities. Our convertible notes contain conversion terms that will impact whether these notes are classified as current or long-term liabilities and consequently affect our working capital position.

Net Cash Provided by Operating Activities

Cash provided by operating activities is primarily driven by income from sales of our products offset by the timing of receipts and payments in the ordinary course of business.

Net income was $324.3 million in 2010 compared to $210.9 million in 2009 primarily due to increased sales of our products.  Also included within cash used for operating activities in 2009 are payments recorded as in-process research and development including a payment of $30.0 million in exchange for the exclusive, worldwide license rights to LUPUZOR, acquired from Immupharma and a payment of $0.8 million in exchange for the license rights to bedamustine hydrochloride in China and Hong Kong.

The change in receivables between periods is primarily due to an increase in trade receivables in 2010 from increased product sales as compared to a decrease in receivables in 2009 due to $67.3 million of federal tax refunds received for previously paid federal taxes.

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Net Cash Used for Investing Activities

Cash used in investing activities primarily relates to acquisitions of business, technologies, products and product rights and funds used for capital expenditures in property and equipment.

Net cash used for investing activities was $589.3 million in 2010 as compared to $276.1 million in 2009. The increase between periods is primarily attributable to the following activity in 2010:

·$549.5 million paid in conjunction with our acquisition of Mepha, net of cash acquired; and

·$9.5 million of funds used to settle foreign exchange contracts; offset by

·$4.7 million of proceeds received upon the sale of our Eden Prarie facility.

These items were partially offset by the following investing activity from 2009:

·$75.0 million paid as consideration for an option to purchase Ception;

·an equity investment of $9.1 million in SymBio;

·the initial variable interest entity consolidation of Ception’s cash and cash equivalent balances of $52.6 million;

·$232.5 million paid in conjunction with our acquisition of Arana, net of cash acquired; and

·$26.8 million of proceeds received upon settlement of a foreign exchange contract.

Net Cash Provided by (Used for) Financing Activities

Net cash used for financing activities was $506.2 million in 2010 as compared to net cash provided by financing activities of $686.0 million in 2009.

During the second quarter of 2010, we delivered a notice of redemption to the holders of our Zero Coupon Notes first putable June 2010 (the “2010 Notes”).  Prior to the redemption date, most of the 2010 Notes were converted.  Holders who converted their 2010 Notes received from us an aggregate of $170.2 million in cash and 137,543 shares of our common stock, under the terms of the 2010 Notes.  Concurrent with the conversion, we received from Credit Suisse First Boston (CSFB) 137,441 shares of our common stock in settlement of the convertible note hedge agreement associated with the 2010 Notes.  The warrant held by CSFB and associated with the 2010 Notes expired without exercise. The $29.3 million of 2010 Notes that were not converted were redeemed by us or tendered by the holder to us for cash of $29.4 million.

In April 2010, we paid $299.3 million to acquire the Ception non-controlling interest.

Cash provided by financing activities during 2009 primarily relates to proceeds received from the issuance of common stock and convertible debt. On May 27, 2009, Cephalon issued an aggregate of 5,000,000 shares of common stock, par value $0.01 per share, at a stock price of $60.00 per share, resulting in net cash proceeds of $288.0 million. Also on May 27, 2009, we issued through a public offering $500 million aggregate principal amount of 2.5% convertible senior subordinated notes due May 1, 2014 (the “2.5% Notes”).  Concurrent with the offering of the 2.5% Notes in May 2009, we purchased a convertible note hedge from Deutsche Bank AG (“DB”) at a cost of $121.0 million and sold to DB warrants to purchase an aggregate of 7,246,377 shares of our common stock and received net proceeds from the sale of these warrants of $37.6 million.

Both periods presented also reflect proceeds received from the exercise of stock options which will vary from period to period primarily due to the number of options exercised and fluctuations in the market value of our stock relative to the exercise price of such options.

Noncontrolling Interest

Although our VIE’s are included in our consolidated financial statements, our interest in our VIE’s assets are limited to those accorded to us in the agreements with our VIE’s as described in Note 2 of the Consolidated Financial Statements

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included in Part I, Item 1 of this Quarterly Report on Form 10-Q.  The creditors of our VIE’s have no recourse to the general credit of Cephalon.

Outlook

We expect to use our cash, cash equivalents, credit facility and investments for working capital and general corporate purposes, the acquisition of businesses, products, product rights, technologies, property, plant and equipment, the payment of contractual obligations, including scheduled interest payments on our convertible notes and regulatory or sales milestones that may become due, and/or the purchase, redemption or retirement of our convertible notes. We expect that net sales of our currently marketed products should allow us to continue to generate positive operating cash flow in 2010. At this time, however, we cannot accurately predict the effect of certain developments on our anticipated rate of sales growth in 2010 and beyond, such as the degree of market acceptance, patent protection and exclusivity of our products, the impact of competition, the effectiveness of our sales and marketing efforts and the outcome of our current efforts to develop, receive approval for and successfully launch our product candidates and new indications for existing products.

Based on our current level of operations, projected sales of our existing products and estimated sales from our product candidates, if approved, combined with other revenues and interest income, we also believe that we will be able to service our existing debt and meet our capital expenditure and working capital requirements in the near term. We do not expect any material changes in our capital expenditure spending during 2010. However, we cannot be sure that our anticipated revenue growth will be realized or that we will continue to generate significant positive cash flow from operations. We may need to obtain additional funding for future significant strategic transactions, to repay our outstanding indebtedness, particularly if such indebtedness is presented for conversion by holders (see “—Indebtedness” below), or for our future operational needs, and we cannot be certain that funding will be available on terms acceptable to us, or at all.

As part of our business strategy, we plan to consider and, as appropriate, make acquisitions of other businesses, products, product rights or technologies. Our cash reserves and other liquid assets may be inadequate to consummate such acquisitions and it may be necessary for us to issue stock or raise substantial additional funds to complete future transactions. In addition, as a result of our acquisition efforts, we are likely to experience significant charges to earnings for merger and related expenses (whether or not our efforts are successful) that may include transaction costs or closure costs.

U.S. Health Care Reform

We expect that the recently-enacted U.S. health care reform law will have certain negative effects and currently non-estimable positive effects upon our business.  In the first nine months of 2010, the U.S. health care reform law has resulted in a negative impact on net sales of $11 million.  For the remainder of 2010, we expect that the increase of the Medicaid rebate to 23.1%, combined with  the extension of rebates to Medicaid Managed Care Organizations and the incremental increase in PHS pricing discounts will have an estimated negative $5 — 7 million impact and, assuming no material changes in our product mix, an impact of between $22 - $26 million in 2011.  We also expect that we will be negatively affected by other provisions of the health reform law to be implemented in 2011, including:

·To expand Medicare Part D coverage, pharmaceutical companies will provide a 50% discount (increasing to 75% by 2020) for all Part D branded pharmaceutical products for Medicare beneficiaries in the coverage gap (commonly referred to as the “Doughnut Hole”); and

·Branded pharmaceutical companies will pay an annual fee based on all prior year product sales to U.S. government programs (such as TriCare, Medicaid, and Medicare Part D).

Based on our current understanding of these provisions and on expected product mix, we expect the Medicare Part D coverage provision to total between $10 - 12 million and the annual fee to total between $9 - 12 million in 2011. The U.S. government is currently drafting rules and regulations regarding these and many other of the law’s provisions, which, once finalized, will provide further guidance regarding the full extent of the effects of the U.S. health reform law on our business.  We also anticipate that one of the positive effects of this law is that more patients will become insured, providing, from the patient’s standpoint, greater and more cost-effective access to our products.  The benefits of this law upon our business are currently not estimable.

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Marketed Products and Product Candidates

Sales growth of our wakefulness products depends, in part, on the continued effectiveness of the various settlement agreements we entered into in late 2005 and early 2006, as well as our maintenance of protection in the United States and abroad of the modafinil particle-size patent through its expiration beginning in 2014 and our NUVIGIL polymorph patent through its expiration beginning in 2023. See Note 12 of the Consolidated Financial Statements included in Part I, Item 1of this Quarterly Report on Form 10-Q. During 2009 and in the nine months ended September 30, 2010, we experienced a 12% and 30% decline in prescriptions of PROVIGIL over prior year, respectively. Growth of our wakefulness product sales in the future may depend in part on our ability to build upon the June 2009 launch of NUVIGIL in the U.S., on our ability to secure additional indications for NUVIGIL, and on the strength of the patents covering NUVIGIL, particularly in light of the ANDAs filed by Actavis, Apotex, Lupin, Mylan, Sandoz, Teva and Watson.

Our future growth depends in large part on our ability to achieve continued sales growth with AMRIX and TREANDA, which we launched in October 2007 and April 2008, respectively. Growth of AMRIX sales will depend in part on the strength of the patent covering the product, particularly in light of the ANDAs filed by Barr, Mylan and Anchen, and a positive decision from the October 2010 trial related to the Barr, Mylan and Anchen ANDAs, which decision is expected by or in the second quarter of 2011, and a possible second trial related to recently issued additional pharmaceutical formulation patents covering AMRIX.

Our future growth also depends, in part, on our ability to successfully market FENTORA within its current indication and to secure FDA approval of a new broader label indication for the product outside of breakthrough cancer 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 end of 2010. For more information regarding our FENTORA REMS Program, please see “Executive Summary” of this Part I, Item 2 above.  Growth of FENTORA sales will also depend in part on the strength of the patents covering the product, particularly in light of the ANDAs filed by Watson, Barr and Sandoz, and a positive decision from the May 2010 trial related to the Watson ANDA which decision is expected in the fourth quarter of 2010.

Clinical Studies

Over the past few years, we have incurred significant expenditures related to conducting clinical studies to develop new pharmaceutical products and to explore the utility of our existing products in treating disorders beyond those currently approved in their respective labels. In 2010, we expect to continue to incur significant levels of research and development expenditures. We also expect to continue or begin a number of significant clinical programs including: clinical studies evaluating  TREANDA as a treatment for front-line NHL; clinical studies evaluating LUPUZOR for the treatment of systemic lupus erythematosus; clinical studies evaluating CINQUIL for the treatment of eosonophilic asthma; clinical studies of tamper-resistant hydrocodone; clinical programs with respect to certain oncology and inflammatory diseases; and clinical program with NUVIGIL focused on adjunctive treatment for bi-polar depression.

Manufacturing, Selling and Marketing Efforts

In 2010, we expect to continue to incur significant expenditures associated with manufacturing, selling and marketing our products. We expect to continue in 2010 a capital expenditure project related to the transfer of manufacturing activities from our facility in Eden Prairie, Minnesota to our facility in Salt Lake City, Utah; we expect this phased transfer to be completed in 2011. In the third quarter 2010, we sold the Eden Prarie facility and certain associated equipment for proceeds of $4.7 million.  Pursuant to the sale agreement, we are leasing the Eden Prarie facility from the buyer until December 2011.

We have committed to make future minimum payments to third parties for certain raw material inventories, including agreements to purchase minimum amounts of modafinil through 2012.  Over the past few years, we have developed 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 using this new process coupled with the launch of NUVIGIL, we reassess, as needed, the potential impact of these items on certain of our existing agreements to purchase modafinil and reserve for purchase commitments in excess of current expected need.  As of December 31, 2009, our aggregate future purchase commitments remaining totaled $15.9 million and our reserve balance for excess purchase commitments was $9.0 million.  In the second quarter of 2010 we reassessed our future modafinil needs and recorded a $9.4 million adjustment

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which increased the excess commitment reserve as well as a reserve for inventory on-hand. As of September 30, 2010, our aggregate future purchase commitments remaining total $10.8 million and are fully reserved.

We have also initiated a search for a potential acquiror of our manufacturing facility in Mitry-Mory, France where we produce modafinil. As of September 30, 2010, we had $7.5 million of property and equipment related to the Mitry-Mory facility included on our balance sheet. The resolution of these assessments could have a negative impact on our results of operations in future periods.

Indebtedness

We have significant indebtedness outstanding, consisting principally of indebtedness on convertible subordinated notes. The following table summarizes the principal terms of our most significant convertible subordinated notes outstanding as of September 30, 2010:

Security	Outstanding		Conversion Price			Redemption Rights and Obligations
	(in millions)
2.5% Convertible Senior Subordinated Notes due May  2014 (the “2.5% Notes”)	$	500.0	$	69.00	*	Generally not redeemable by the holder prior to November 2013.
2.0% Convertible Senior Subordinated Notes due June 2015 (the “2.0% Notes”)	$	820.0	$	46.70	**	Generally not redeemable by the holder prior to December 2014.

*Stated conversion price as per the terms of the notes; subject to adjustment (equivalent to a conversion rate of approximately 14.4928 shares per $1,000 principal amount of Notes.)  However, each convertible note contains certain terms restricting a holder’s ability to convert the notes, including that a holder may only convert if any of the following conditions is satisfied: (1) during any calendar quarter commencing after September 30, 2009, the closing sale price of our common stock for at least 20 trading days in the period of 30 consecutive trading days ending on the last trading day of the calendar quarter immediately preceding the calendar quarter in which the conversion occurs, is more than 130% of the conversion price per share ($89.70 based on the initial conversion price) of the notes in effect on that last trading day; (2) during the 10 consecutive trading-day period that follows any five consecutive trading-day period in which the trading price for the notes for each such trading day was less than 98% of the closing sale price of our common stock on such date multiplied by the then current conversion rate; or (3) if we make certain significant distributions to holders of our common stock, we enter into specified corporate transactions or our common stock is not listed on a U.S. national securities exchange.

**Stated conversion prices as per the terms of the notes. However, each convertible note contains certain terms restricting a holder’s ability to convert the notes, including that a holder may only convert if the closing price of our stock on the day prior to conversion is higher than $56.04 with respect to the 2.0% Notes. For a more complete description of these notes, including the associated convertible note hedge, see Note 13 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, 2009.

During the second quarter of 2010, we delivered a notice of redemption to the holders of our Zero Coupon Notes first putable June 2010 (the “2010 Notes”).  All outstanding 2010 Notes were redeemed, converted or tendered in June 2010. For more information regarding these matters, please see Note 11 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.

As of September 30, 2010, our closing stock price was $62.44, and therefore the 2.0% Notes were convertible as of September 30, 2010. Under the terms of the indentures governing the notes, we are obligated to repay in cash the aggregate principal balance of any such notes presented for conversion. As of the filing date of this Quarterly Report on Form 10-Q, we do not have available cash, cash equivalents and investments sufficient to repay all of the convertible notes, if presented. In addition, other than the restrictive covenants contained in our credit agreement, there are no restrictions on our use of this cash and the cash available to repay indebtedness may decline over time. If we do not have sufficient funds available to repay any principal balance of notes presented for conversion, we will be required to raise additional funds. Because the financing markets may be unwilling to provide funding to us or may only be willing to provide funding on terms that we would consider unacceptable, we may not have cash available or be able to obtain funding to permit us to meet our repayment obligations, thus adversely affecting the market price for our securities.

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As of September 30, 2010, our 2.0% Notes have been classified as current liabilities on our consolidated balance sheet.  We believe that the share price of our common stock would have to significantly increase over the market price as of the filing date of this report before the fair value of the convertible notes would be less than the value of the common stock shares underlying the notes and, as such, we believe it is highly unlikely that holders of the 2.0% Notes will present significant amounts of such notes for conversion under the current terms. In the unlikely event that a significant conversion did occur, we believe that we have the ability to raise sufficient cash to repay the 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.

The annual interest payments on our 2.0% Notes as of September 30, 2010 are $16.4 million, payable semi-annually on June 1 and December 1. The annual interest payments on our 2.5% Notes as of September 30, 2010 are $12.5 million, payable semi-annually on May 1 and November 1. In the future, we may agree to exchanges of the notes for shares of our common stock or debt, or may determine to use a portion of our existing cash on hand to purchase or retire all or a portion of the outstanding convertible notes.

Our 2.0% Notes, 2.5% Notes and 2010 Zero Coupon Notes each 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 our common stock during the period, and include that number in the total diluted shares figure for the period. At the time we sold our 2.0% Notes, 2.5% Notes and 2010 Zero Coupon Notes we entered into convertible note hedge and warrant agreements that together are intended to have the economic effect of reducing the net number of shares that will be issued upon conversion of the notes by increasing the effective conversion price for these notes, from our perspective, to $67.92, $100.00 and $72.08, respectively. However, from an accounting principles generally accepted in the United States of America perspective, since the impact of the convertible note hedge agreements is always anti-dilutive we exclude from the calculation of fully diluted shares the number of shares of our common stock that we would receive from the counterparties to these agreements upon settlement.

Under the treasury stock method, changes in the share price of our common stock can have a significant impact on the number of shares that we must include in the fully diluted earnings per share calculation. The following table provides examples of how changes in our stock price will require the inclusion of additional shares in the denominator of the fully diluted earnings per share calculation (“Total Treasury Stock Method Incremental Shares”). The table also reflects the impact on the number of shares we could expect to issue upon concurrent settlement of the convertible notes, the warrant and the convertible note hedge (“Incremental Shares Issued by Cephalon upon Conversion”):

Share Price		Convertible Notes Shares	Warrant Shares	Total Treasury Stock Method Incremental Shares(1)	Shares Due to Cephalon under Note Hedge		Incremental Shares Issued by Cephalon upon Conversion(2)
$	55.00	2,650	—	2,650	(2,650	)	—
$	65.00	4,944	—	4,944	(4,944	)	—
$	75.00	7,206	1,658	8,864	(7,206	)	1,658
$	85.00	9,276	3,528	12,804	(9,276	)	3,528
$	95.00	10,910	5,005	15,915	(10,910	)	5,005
$	105.00	12,233	6,546	18,779	(12,233	)	6,546

(1)Represents the number of incremental shares that must be included in the calculation of fully diluted shares under U.S. GAAP.

(2)Represents the number of incremental shares to be issued by us upon conversion of the convertible notes, assuming concurrent settlement of the convertible note hedges and warrants.

On May 18, 2009, in association with our equity offering, we exchanged 2.1 million warrants associated with our 2.0% Notes for 776,361 shares of common stock.

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 borrowing conditions and 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

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filing, we have not drawn any amounts under the credit facility.

Acquisition Strategy

As part of our business strategy, we plan to consider and, as appropriate, make acquisitions of other businesses, products, product rights or technologies. Our cash reserves and other liquid assets may be inadequate to consummate such acquisitions and it may be necessary for us to issue stock or raise substantial additional funds to complete future transactions. In addition, as a result of our acquisition efforts, we are likely to experience significant charges to earnings for merger and related expenses (whether or not our efforts are successful) that may include transaction costs, closure costs or acquired in-process research and development charges.

Other

We may experience significant fluctuations in quarterly results based primarily on the level and timing of:

·cost of product sales;

·achievement and timing of research and development milestones;

·collaboration revenues;

·cost and timing of clinical trials, regulatory approvals and product launches;

·marketing and other expenses;

·manufacturing or supply disruptions;

·unanticipated conversions of our convertible notes; and

·costs associated with the operations of recently-acquired businesses and technologies.

CRITICAL ACCOUNTING POLICIES AND ESTIMATES

(In thousands)

Management’s Discussion and Analysis of Financial Condition and Results of Operations discusses our consolidated financial statements, which we have prepared in accordance with U.S. GAAP. In preparing these financial statements, we must make estimates and assumptions that affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities at the date of the financial statements, and the reported amounts of revenues and expenses during the reporting period. We develop and periodically change these estimates and assumptions based on historical experience and on various other factors that we believe are reasonable under the circumstances. Actual results may differ from these estimates under different assumptions or conditions. A summary of significant accounting policies and a description of accounting policies that are considered critical may be found in Part II, Item 7 of our Annual Report on Form 10-K for the year ended December 31, 2009 in the “Critical Accounting Policies and Estimates” section and the “Recent Accounting Pronouncements” section.

Product Sales Allowances—We record product sales net of the following significant categories of product sales allowances, each of which is described in more detail included in Part II, Item 7 of our Annual Report on Form 10-K for the year ended December 31, 2009: prompt payment discounts, wholesaler discounts, returns, coupons, Medicaid discounts, Medicare Part D discounts and managed care and governmental contracts. Calculating each of these items involves significant estimates and judgments and requires us to use information from external sources. In certain of the product sales allowance categories, we have calculated the impact of changes in our estimates, which we believe represent reasonably likely changes to these estimates based on historical data adjusted for certain unusual items such as changes in government contract rules.

The following table summarizes activity in each of the above categories for the nine months ended September 30, 2010:

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	Prompt Payment Discounts			Wholesaler Discounts			Returns*			Coupons			Medicaid Discounts			Managed Care & Governmental Contracts			Total
Balance at January 1, 2010	$	(4,489	)	$	(57	)	$	(66,034	)	$	(14,272	)	$	(21,554	)	$	(56,462	)	$	(162,868	)
Provision:
Current period	(36,566		)	(14,306		)	(33,735		)	(31,880		)	(61,955		)	(120,137		)	(298,579		)
Prior periods	—			1			1,048			863			315			85			2,312
Total	(36,566		)	(14,305		)	(32,687		)	(31,017		)	(61,640		)	(120,052		)	(296,267		)
Actual:
Current period	31,547			9,147			—			18,644			16,979			78,832			155,149
Prior periods	4,489			56			15,333			13,408			19,666			33,281			86,233
Total	36,036			9,203			15,333			32,052			36,645			112,113			241,382
Balance at September 30, 2010	$	(5,019	)	$	(5,159	)	$	(83,388	)	$	(13,237	)	$	(46,549	)	$	(64,401	)	$	(217,753	)

*Given our return goods policy, we assume that all returns in a current year relate to prior period sales.

ITEM 3.  QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

We could enter into foreign exchange agreements to hedge foreign exchange risk associated with significant acquisitions denominated in foreign currencies. We do not currently hold any of these instruments. Our exposure to market risk for a change in interest rates relates to our investment portfolio, since all of our outstanding debt is fixed rate. Our investments are classified as short-term and as “available for sale.” We do not believe that short-term fluctuations in interest rates would materially affect the value of our securities.

ITEM 4.  CONTROLS AND PROCEDURES

(a)  Evaluation of Disclosure Controls and Procedures

Our management, with the participation of our Chief Operating Officer and Chief Financial Officer, evaluated the effectiveness of our disclosure controls and procedures as of the end of the period covered by this Quarterly Report on Form 10-Q. Based on that evaluation, the Chief Operating Officer and Chief Financial Officer concluded that our disclosure controls and procedures as of the end of the period covered by this Report have been designed and are functioning effectively to provide reasonable assurance that the information required to be disclosed by us in reports filed under the Securities Exchange Act of 1934 is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms. We believe that a controls system, no matter how well designed and operated, cannot provide absolute assurance that the objectives of the controls system are met, and no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within a company have been detected.

(b)  Change in Internal Control over Financial Reporting

There have been no changes in our internal control over financial reporting during our most recent fiscal quarter that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

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PART II — OTHER INFORMATION

ITEM 1.  LEGAL PROCEEDINGS

The information required by this Item is incorporated by reference to Note 12 of the Consolidated Financial Statements included in Part I, Item 1 of this Report.

ITEM 1A.  RISK FACTORS

You should carefully consider the risks described below, in addition to the other information contained in this report, before making an investment decision. Our business, financial condition or results of operations could be harmed by any of these risks. The risks and uncertainties described below are not the only ones we face. Additional risks not presently known to us or other factors not perceived by us to present significant risks to our business at this time also may impair our business operations.

A significant portion of our revenue is derived from five products, and our future success will depend on the aggregate growth of NUVIGIL and PROVIGIL, the continued acceptance of FENTORA, and the growth of AMRIX and TREANDA.

For the nine months ended September 30, 2010, approximately 41%, 14%, 6%, 6% and 4% of our total consolidated net sales were derived from sales of PROVIGIL, TREANDA, FENTORA, NUVIGIL and AMRIX, respectively. With respect to PROVIGIL, we cannot be certain that it will continue to be accepted in its market. With respect to NUVIGIL, we cannot be sure that our sales and marketing efforts will be successful or that it will be accepted in the market.  It is possible that CNS net sales could decrease in the future as a result of the decline in PROVIGIL marketing efforts associated with the launch of NUVIGIL. NUVIGIL is currently selling at a price below that of PROVIGIL.  As a result, it is possible that CNS net sales could decline if we are unable to achieve sufficient prescription growth for PROVIGIL and NUVIGIL in the aggregate.  With respect to AMRIX and TREANDA, we cannot be certain that they will continue to be accepted in their markets or that we will be able to achieve projected levels of sales growth.

To counter the impact from existing and potential generic competition for ACTIQ, we need FENTORA to continue to be accepted in the market.  We expect to initiate a REMS Program for FENTORA to mitigate serious risks associated with the use of FENTORA.  We submitted our REMS Program to the FDA in early April 2009.  Subject to the timing and nature of further discussions with the FDA, we expect to receive a response from the FDA by the end of 2010.  It is possible that the REMS Program could have a negative impact on sales of FENTORA.

For consolidated net sales to grow over the next several years, we will need our three newest branded products in the United States, NUVIGIL, AMRIX and TREANDA, to achieve projected levels of growth.  Specifically, the following factors, among others, could affect the level of market acceptance of these products, as well as PROVIGIL and FENTORA:

·a change in the perception of the healthcare community of the safety and efficacy of the products, both in an absolute sense and relative to that of competing products;

·the level and effectiveness of our sales and marketing efforts;

·the extent to which the products are studied in clinical trials in the future and the results of any such studies;

·any unfavorable publicity regarding these or similar products;

·the price of the products relative to the benefits they convey and to other competing drugs or treatments, including the impact of the availability of generic versions of our products on the market acceptance of those products;

·any changes in government and other third-party payer reimbursement policies and practices; and

·regulatory developments affecting the manufacture, marketing or use of these products.

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Any adverse developments with respect to the sale or use of these products could significantly reduce our product revenues and have a material adverse effect on our ability to generate net income and positive net cash flow from operations.

We may be unsuccessful in our efforts to obtain regulatory approval for new products or for new formulations or expanded indications of our existing products, which would significantly hamper future sales and earnings growth.

Our long-term prospects, particularly with respect to the growth of our future sales and earnings, depend to a large extent on our ability to obtain FDA approvals of new product candidates (including product candidates for which we have an option-to-acquire) or of expanded indications of our existing products such as TREANDA, FENTORA and NUVIGIL.

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 plan to submit the StiL Group’s study results to support an sNDA for TREANDA for the treatment of front-line iNHL in the first half of 2011. Separately, we have begun enrolling patients in our own Phase III study of TREANDA for the treatment of front-line NHL.

In May 2008, an FDA Advisory Committee voted not to recommend approval of the FENTORA sNDA.  In September 2008, we received a complete response letter, in which the FDA requested that we implement and demonstrate the effectiveness of proposed enhancements to the current FENTORA risk management program.  In December 2008, we also received a supplement request letter from the FDA requesting that we submit a Risk Evaluation and Mitigation Strategy (the “REMS Program”) with respect to FENTORA. We submitted our REMS Program to the FDA in early April 2009. To address the FDA’s requests in its September 2008 and December 2008 letters, we plan to implement SECURE Access™, a first-of-its-kind initiative designed to minimize the potential risk of overdose from an opioid through appropriate patient selection, as part of our REMS Program.  In July 2009, we exchanged correspondence with the FDA regarding elements of our REMS Program for FENTORA and have been engaged in ongoing discussions with the agency. Subject to the timing and nature of further discussions with the FDA, we expect to receive a response from the FDA by the end of 2010.  We believe that, by working with the FDA, we can design and implement a REMS Program to meet the FDA’s requests and possibly to provide a potential avenue for approval of the sNDA.  While we plan to initiate the REMS Program upon receipt of approval from the FDA, we may be unsuccessful, ultimately, in designing and implementing a REMS Program acceptable to the FDA.

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 an sNDA for this indication with the FDA in June 2009. 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 met with the FDA in May 2010 to discuss the complete response letter, provided a formal written response to the FDA in June 2010 and anticipate a final decision from the FDA regarding our sNDA by the end of 2010.  In June 2010, we announced that the primary endpoint was not met for a Phase II study of NUVIGIL as an adjunctive therapy for the treatment of the negative symptoms of schizophrenia.

There can be no assurance that our applications to market for these new indications or for product candidates will be submitted or reviewed in a timely manner or that the FDA will approve the new indications or product candidates on the basis of the data contained in the applications.  Even if approval is granted to market a new indication or a product candidate, there can be no assurance that we will be able to successfully commercialize the product in the marketplace or achieve a profitable level of sales.

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We may not be able to maintain adequate protection for our intellectual property or market exclusivity for our key products and, therefore, competitors may develop competing products, which could result in a decrease in sales and market share, cause us to reduce prices to compete successfully and limit our commercial success.

We place considerable importance on obtaining patent protection for new technologies, products and processes. To that end, we file applications for patents covering the compositions or uses of our drug candidates or our proprietary processes. The patent positions of pharmaceutical and biotechnology companies can be highly uncertain and involve complex legal, scientific and factual questions. Accordingly, the patents and patent applications relating to our products, product candidates and technologies may be challenged, invalidated or circumvented by third parties and might not protect us against competitors with similar products or technology. Patent disputes in our industry are frequent and can preclude commercialization of products. If we ultimately engage in and lose any such disputes, we could be subject to competition or significant liabilities, we could be required to enter into third party licenses or we could be required to cease using the technology or product in dispute. In addition, even if such licenses are available, the terms of any license requested by a third party could be unacceptable to us.

Competition from generic manufacturers is a particularly significant risk to our business.  Upon the expiration of, or successful challenge to, our patents covering a product, generic competitors may introduce a generic version of that product at a lower price.  Some generic manufacturers have also demonstrated a willingness to launch generic versions of branded products before the final resolution of related patent litigation (known as an “at-risk launch”).  A launch of a generic version of one of our products could have a material adverse effect on our business and we could suffer a significant loss of sales and market share in a short period of time.

We also rely on trade secrets, know-how and continuing technological advancements to support our competitive position. Although we have entered into confidentiality and invention rights agreements with our employees, consultants, advisors and collaborators, these parties could fail to honor such agreements or we could be unable to effectively protect our rights to our unpatented trade secrets and know-how. Moreover, others could independently develop substantially equivalent proprietary information and techniques or otherwise gain access to our trade secrets and know-how. In addition, many of our scientific and management personnel have been recruited from other biotechnology and pharmaceutical companies where they were conducting research in areas similar to those that we now pursue. As a result, we could be subject to allegations of trade secret violations and other claims.

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. While we intend to vigorously defend the validity, and prevent infringement, of our patents, 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. 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 legal proceedings and others, 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.

In late 2005 and early 2006, we entered into PROVIGIL patent settlement agreements with certain generic pharmaceutical companies. 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 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 challenging the validity of the settlements and related agreements.  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

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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.  For more information regarding our PROVIGIL settlements and related litigation, please see Note 12 to the Consolidated Financial Statements included in Part I, Item 1 of this Quarterly Report on Form 10-Q, which is incorporated herein by reference.

Our activities and products are subject to significant government regulations and approvals, which are often costly and could result in adverse consequences to our business if we fail to comply.

We currently have a number of products that have been approved for sale in the United States, foreign countries or both. All of our approved products are subject to extensive continuing regulations relating to, among other things, testing, manufacturing, quality control, labeling, and promotion. The failure to comply with any rules and regulations of the FDA or any foreign medical authority, or the post-approval discovery of previously unknown problems relating to our products, could result in, among other things:

·fines, recalls or seizures of products;

·total or partial suspension of manufacturing or commercial activities;

·non-approval of product license applications;

·restrictions on our ability to enter into strategic relationships; and

·criminal prosecution.

Over the past few years, a significant number of pharmaceutical and biotechnology companies have been the target of inquiries and investigations by various federal and state regulatory, investigative, prosecutorial and administrative entities, including the DOJ and various U.S. Attorney’s Offices, the Office of Inspector General of the Department of Health and Human Services, the FDA, the FTC and various state Attorneys General offices.  These investigations have alleged violations of various federal and state laws and regulations, including claims asserting antitrust violations, violations of the Food, Drug and Cosmetic Act, the False Claims Act, the Prescription Drug Marketing Act, anti-kickback laws, and other alleged violations in connection with off-label promotion of products, pricing and Medicare and/or Medicaid reimbursement.

Because of the broad scope and complexity of these laws and regulations, the high degree of prosecutorial resources and attention being devoted to the sales practices of pharmaceutical companies by law enforcement authorities, and the risk of potential exclusion from federal government reimbursement programs, numerous companies have determined that it is highly advisable that they enter into settlement agreements in these matters, particularly those brought by federal authorities.  Companies that have chosen to settle these alleged violations have typically paid multi-million dollar fines to the government and agreed to abide by corporate integrity agreements.

In September 2008, as part of our settlement with the U.S. government regarding their investigation of our promotional practices with respect to ACTIQ, GABITRIL and PROVIGIL, we entered into a five-year Corporate Integrity Agreement (the “CIA”) with the Office of Inspector General of the Department of Health and Human Services.  The CIA provides criteria for establishing and maintaining compliance with federal laws governing the marketing and promotion of our products.  We are also subject to periodic reporting and certification requirements attesting that the provisions of the CIA are being implemented and followed.  For more information regarding our settlement with the U.S. government and the CIA, please see Note 12 to the Consolidated Financial Statements included in Part I, Item 1 of this Quarterly Report on Form 10-Q, which is incorporated herein by reference.

Although we have resolved the previously outstanding federal and state government investigations into our sales and promotional practices, there can be no assurance that there will not be regulatory or other actions brought by governmental entities who are not party to the settlement agreements we have entered.  We may also become subject to claims by private parties with respect to the alleged conduct which was the subject of our settlements with the federal and state governmental entities.  In addition, while we intend to comply fully with the terms of the settlement agreements, the settlement agreements provide for sanctions and penalties for violations of specific provisions therein. We cannot predict when or if any such actions may occur or reasonably estimate the amount of any fines, penalties, or other payments or the possible effect of any non-monetary restrictions that might result from either settlement of, or an adverse outcome from, any such actions.    Further, while we have initiated, and will initiate, compliance programs to prevent conduct similar to the alleged conduct

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subject to these agreements, we cannot provide complete assurance that conduct similar to the alleged conduct will not occur in the future, subjecting us to future claims and actions.  Failure to comply with the terms of the CIA could result in, among other things, substantial civil penalties and/or our exclusion from government health care programs, which could materially reduce our sales and adversely affect our financial condition and results of operations.

It is both costly and time-consuming for us to comply with these inquiries and with the extensive regulations to which we are subject. Additionally, incidents of adverse drug reactions, unintended side effects or misuse relating to our products could result in additional regulatory controls or restrictions, or even lead to withdrawal of a product from the market.

With respect to our product candidates, we conduct research, preclinical testing and clinical trials, each of which requires us to comply with extensive government regulations. We cannot market these product candidates or these new indications in the United States or other countries without receiving approval from the FDA or the appropriate foreign medical authority. The approval process is highly uncertain and requires substantial time, effort and financial resources. Ultimately, we may never obtain approval in a timely manner, or at all. Without these required approvals, our ability to substantially grow revenues in the future could be adversely affected.

In addition, because PROVIGIL, NUVIGIL, FENTORA, EFFENTORA, ACTIQ and generic OTFC contain active ingredients that are controlled substances, we are subject to regulation by the U.S. Drug Enforcement Agency (“DEA”) and analogous foreign organizations relating to the manufacture, shipment, sale and use of the applicable products. These regulations also are imposed on prescribing physicians and other third parties, making the storage, transport and use of such products relatively complicated and expensive. With the increased concern for safety by the FDA and the DEA with respect to products containing controlled substances and the heightened level of media attention given to this issue, it is possible that these regulatory agencies could impose additional restrictions on marketing or even withdraw regulatory approval for such products. In addition, adverse publicity may bring about a rejection of the product by the medical community. If the DEA, FDA or analogous foreign authorities withdrew the approval of, or placed additional significant restrictions on the marketing of any of our products, our ability to promote our products and product sales could be substantially affected.

We rely on third parties for the timely supply of specified raw materials, equipment, contract manufacturing, formulation or packaging services, product distribution services, customer service activities and product returns processing. Although we actively manage these third party relationships to ensure continuity and quality, some events beyond our control could result in the complete or partial failure of these goods and services. Any such failure could have a material adverse effect on our financial condition and result of operations.

Manufacturing, supply and distribution problems may create supply disruptions that could result in a reduction of product sales revenue and an increase in costs of sales, and damage commercial prospects for our products.

The manufacture, supply and distribution of pharmaceutical products, both inside and outside the United States, is highly regulated and complex. We, and the third parties we rely upon for the manufacturing and distribution of our products, must comply with all applicable regulatory requirements of the FDA and foreign authorities, including current Good Manufacturing Practice regulations.

We also must comply with all applicable regulatory requirements of the DEA and analogous foreign authorities for certain of our products that contain controlled substances. The DEA also has authority to grant or deny requests for quota of controlled substances such as the fentanyl that is the active ingredient in FENTORA and EFFENTORA or the fentanyl citrate that is the active ingredient in ACTIQ and generic OTFC.

The facilities used to manufacture, store and distribute our products also are subject to inspection by regulatory authorities at any time to determine compliance with regulations. These regulations are complex, and any failure to comply with them could lead to remedial action, civil and criminal penalties and delays in production or distribution of material.  With respect to our transition of manufacturing activities from our Eden Prairie, Minnesota facilty to our Salt Lake City, Utah facility, it is possible that we may not complete the transition on a timely basis or to the satisfaction of our third party partners or relevant regulatory agencies.

We rely on third parties for the timely supply of specified raw materials, equipment, contract manufacturing, formulation or packaging services, product distribution services, customer service activities and product returns processing. Although we actively manage these third party relationships to ensure continuity and quality, some events beyond our control

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could result in the complete or partial failure of these goods and services. Any such failure could have a material adverse effect on our financial condition and result of operations.

For certain of our products in the United States and abroad, we depend upon single sources for the manufacture of both the active drug substances contained in our products and for finished commercial supplies. The process of changing or adding a manufacturer or changing a formulation requires prior FDA and/or analogous foreign medical authority approval and is very time-consuming. If we are unable to manage this process effectively or if an unforeseen event occurs at any facility, we could face supply disruptions that would result in significant costs and delays, undermine goodwill established with physicians and patients, damage commercial prospects for our products and adversely affect operating results.

As our products are used commercially, unintended side effects, adverse reactions or incidents of misuse may occur that could result in additional regulatory controls, changes to product labeling, adverse publicity and reduced sales of our products.

During research and development, the use of pharmaceutical products, such as ours, is limited principally to clinical trial patients under controlled conditions and under the care of expert physicians. The widespread commercial use of our products could identify undesirable or unintended side effects that have not been evident in our clinical trials or the commercial use as of the filing date of this report. For example, in September 2007, we issued a letter to healthcare professionals to clarify the appropriate patient selection, design and administration for FENTORA, following reports of serious adverse events in connection with the use of the product.  Likewise, in February 2005, working with the FDA, we updated our prescribing information for GABITRIL to include a bolded warning describing the risk of new onset seizures in patients without epilepsy. As described above, we are also in process of developing REMS Programs for certain of our products to mitigate serious risks associated with the use of certain of our products.  In October 2010, the FDA approved our REMS Programs for PROVIGIL, NUVIGIL and GABITRIL. In addition, in patients who take multiple medications, drug interactions could occur that can be difficult to predict. Additionally, incidents of product misuse, product diversion or theft may occur, particularly with respect to products such as FENTORA, EFFENTORA, ACTIQ, generic OTFC, NUVIGIL and PROVIGIL, which contain controlled substances.

In July 2010, the Committee for Medicinal Products for Human Use (“CHMP”), the scientific committee of the European Medicines Agency (“EMEA”), issued a recommendation to restrict the use of modafinil in the European Union only to the treatment for sleepiness associated with narcolepsy.  The CHMP recommendation does not appear to be supported by, or based on, any new, adverse safety or efficacy data.  Based on broad scientific evidence, clinical experience and patient use, we do not agree with the CHMP recommendation and will request a re-examination of the CHMP recommendation.  While we disagree with the CHMP recommendation, there can be no assurance that our request for a re-examination will be granted, that the CHMP recommendation will not ultimately be adopted by the EMEA or that the FDA or other regulatory agencies will also review in the future the risk/benefit profile for our modafinil-based products, PROVIGIL and NUVIGIL, or, for that matter, any of our products generally.

In April 2009, we received approval from the FDA for our sNDA to update the prescribing information for TREANDA.  We finalized and implemented the updated prescribing information for TREANDA in May 2009.   We identified two postmarketing cases of Stevens Johnson Syndrome (“SJS”)/toxic epidermal necrolysis (“TEN”) in patients treated concomitantly with TREANDA and allopurinol; one of these cases was fatal. Allopurinol is known to cause SJS/TEN. In the non-fatal case, the patient also received other drugs that can cause SJS.  TREANDA’s prescribing information has been updated to include these serious skin reactions.  These updates communicate safety warnings when TREANDA is used in combination with allopurinol.  Although the relationship between TREANDA and SJS/TEN cannot be determined, there may be an increased risk of severe skin toxicity when TREANDA and allopurinol are administered concomitantly.  This update is similar to the labeling that currently exists with certain other agents used to treat indolent non-Hodgkin’s lymphoma and/or chronic lymphocytic leukemia, such as RITUXAN® (rituximab), REVLIMID® (lenalidomide) and cyclophosphamide, all of which also reference SJS/TEN in their current respective prescribing information.

These events, among others, could result in adverse publicity that harms the commercial prospects of our products or lead to additional regulatory controls that could limit the circumstances under which the product is prescribed or even lead to the withdrawal of the product from the market. In particular, FENTORA and ACTIQ have been approved under regulations concerning drugs with certain safety profiles, under which the FDA has established special restrictions to ensure safe use. Any violation of these special restrictions could lead to the imposition of further restrictions or withdrawal of the product from the market.

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We face significant product liability risks, which may have a negative effect on our financial performance.

The administration of drugs to humans, whether in clinical trials or commercially, can result in product liability claims whether or not the drugs are actually at fault for causing an injury. Furthermore, our products may cause, or may appear to have caused, adverse side effects (including death) or potentially dangerous drug interactions that we may not learn about or understand fully until the drug has been administered to patients for some time. As our products are used more widely and in patients with varying medical conditions, the likelihood of an adverse drug reaction, unintended side effect or incidence of misuse may increase. Product liability claims can be expensive to defend and may result in large judgments or settlements against us, which could have a negative effect on our financial performance. The cost of product liability insurance has increased in recent years, and the availability of coverage has decreased. Nevertheless, we maintain product liability insurance and significant self-insurance retentions held by our wholly-owned Bermuda-based insurance captive in amounts we believe to be commercially reasonable but which would be unlikely to cover the potential liability associated with a significant unforeseen safety issue. Product liability coverage maintained by our captive is reserved for, based on Cephalon’s historical claims as well as historical claims within the industry. Reserves held by the captive are fully funded. Any claims could easily exceed our current coverage limits. Even if a product liability claim is not successful, the adverse publicity and time and expense of defending such a claim may interfere with our business.

Our product sales and related financial results will fluctuate, and these fluctuations may cause our stock price to fall, especially if investors do not anticipate them.

A number of analysts and investors who follow our stock have developed models to attempt to forecast future product sales and expenses, and have established earnings expectations based upon those models. These models, in turn, are based in part on estimates of projected revenue and earnings that we disclose publicly. Forecasting future revenues is difficult, especially when the level of market acceptance of our products is changing rapidly. As a result, it is reasonably likely that our product sales will fluctuate to an extent that may not meet with market expectations and that also may adversely affect our stock price. There are a number of other factors that could cause our financial results to fluctuate unexpectedly, including:

·cost of product sales;

·achievement and timing of research and development milestones;

·collaboration revenues;

·cost and timing of clinical trials, regulatory approvals and product launches;

·marketing and other expenses;

·manufacturing or supply disruptions;

·unanticipated conversion of our convertible notes; and

·costs associated with the operations of recently-acquired businesses and technologies.

We may be unable to repay our substantial indebtedness and other obligations.

All of our convertible notes outstanding contain restricted conversion prices.  As of September 30, 2010, our 2.0% Notes are convertible because the closing price of our common stock on that date was higher than the restricted conversion prices of these notes.  As a result, our 2.0% Notes have been classified as current liabilities on our consolidated balance sheet as of September 30, 2010.  Under the terms of the indentures governing the notes, we are obligated to repay in cash the aggregate principal balance of any such notes presented for conversion. As of the filing date of this report, we do not have available cash, cash equivalents and investments sufficient to repay all of the convertible notes, if presented. In addition, other than the restrictive covenants contained in our credit agreement, there are no restrictions on our use of this cash and the cash available to repay indebtedness may decline over time. If we do not have sufficient funds available to repay the principal balance of notes presented for conversion, we will be required to raise additional funds. Because the financing markets may be unwilling to provide funding to us or may only be willing to provide funding on terms that we would consider unacceptable, we may not have cash available or be able to obtain funding to permit us to meet our repayment obligations, thus adversely affecting the market price for our securities.

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The restrictive covenants contained in our credit agreement may limit our activities.

With respect to our $200 million, three-year revolving credit facility, the credit agreement contains restrictive covenants which affect, and in many respects could limit or prohibit, among other things, our ability to:

·incur indebtedness;

·create liens;

·make investments or loans;

·engage in transactions with affiliates;

·pay dividends or make other distributions on, or redeem or repurchase, our capital stock;

·enter into various types of swap contracts or hedging agreements;

·make capital contributions;

·sell assets; or

·pursue mergers or acquisitions.

Failure to comply with the restrictive covenants in our credit agreement could preclude our ability to borrow or accelerate the repayment of any debt outstanding under the credit agreement. Additionally, as a result of these restrictive covenants, we may be at a disadvantage compared to our competitors that have greater operating and financing flexibility than we do.

Our research and development, manufacturing and marketing efforts are often dependent on corporate collaborators and other third parties who may not devote sufficient time, resources and attention to our programs, which may limit our efforts to develop and market potential products.

To maximize our growth opportunities, we have entered into a number of collaboration agreements with third parties.  In certain countries outside the United States, we have entered into agreements with a number of partners with respect to the development, manufacturing and marketing of our products. In some cases, our collaboration agreements call for our partners to control:

·the supply of bulk or formulated drugs for use in clinical trials or for commercial use;

·the design and execution of clinical studies;

·the process of obtaining regulatory approval to market the product; and/or

·marketing and selling of an approved product.

In each of these areas, our partners may not support fully our research and commercial interests because our program may compete for time, attention and resources with the internal programs of our corporate collaborators. As such, our program may not move forward as effectively, or advance as rapidly, as it might if we had retained complete control of all research, development, regulatory and commercialization decisions. We also rely on some of these collaborators and other third parties for the production of compounds and the manufacture and supply of pharmaceutical products. Additionally, we may find it necessary from time to time to seek new or additional partners to assist us in commercializing our products, though we ultimately might not be successful in establishing any such new or additional relationships.

The efforts of government entities and third party payers to contain or reduce the costs of health care may adversely affect our sales and limit the commercial success of our products.

In certain foreign markets, pricing or profitability of pharmaceutical products is subject to various forms of direct and indirect governmental control, including the control over the amount of reimbursements provided to the patient who is prescribed specific pharmaceutical products.

In the United States, there have been, and we expect there will continue to be, various proposals to implement similar controls. Certain members of Congress have introduced legislation to restrict or significantly limit branded pharmaceutical companies’ ability to enter into patent litigation settlement agreements with generic companies.  For example, the U.S. health care reform law will have certain estimable negative effects and possible, non-estimable effects on our

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business. Congress is also considering legislation to provide for FDA approval of generic versions of branded biologic products.  The commercial success of our products could be limited if federal or state governments adopt any such proposals. In addition, in the United States and elsewhere, sales of pharmaceutical products depend in part on the availability of reimbursement to the consumer from third party payers, such as government and private insurance plans. These third party payers are increasingly utilizing their significant purchasing power to challenge the prices charged for pharmaceutical products and seek to limit reimbursement levels offered to consumers for such products. Moreover, many governments and private insurance plans have instituted reimbursement schemes that favor the substitution of generic pharmaceuticals for more expensive brand-name pharmaceuticals. In the United States in particular, generic substitution statutes have been enacted in virtually all states and permit or require the dispensing pharmacist to substitute a less expensive generic drug instead of an original branded drug. These third party payers are focusing their cost control efforts on our products, especially with respect to prices of and reimbursement levels for products prescribed outside their labeled indications. In these cases, their efforts may negatively impact our product sales and profitability.

We experience intense competition in our fields of interest, which may adversely affect our business.

Large and small companies, academic institutions, governmental agencies and other public and private research organizations conduct research, seek patent protection and establish collaborative arrangements for product development in competition with us. Products developed by any of these entities may compete directly with those we develop or sell.

The conditions that our products treat, and some of the other disorders for which we are conducting additional studies, are currently treated with many drugs, several of which have been available for a number of years or are available in inexpensive generic forms. With respect to PROVIGIL and  NUVIGIL, there are several other products used for the treatment of excessive sleepiness or narcolepsy in the United States, including methylphenidate products, and in our other territories, many of which have been available for a number of years and are available in inexpensive generic forms. With respect to AMRIX, we face significant competition from SKELAXIN®, FLEXERIL® and other inexpensive generic forms of muscle relaxants.  With respect to FENTORA, we face competition from numerous short-and long-acting opioid products, including three products—Johnson & Johnson’s DURAGESIC® and Purdue Pharmaceutical’s OXYCONTIN® and MS-CONTIN®—that dominate the market. In addition, we are aware of numerous other companies developing other technologies for rapidly delivering opioids to treat breakthrough pain that will compete against FENTORA in the market for breakthrough cancer pain in opioid-tolerant patients.  ONSOLIS® is approved for this indication.  It also is possible that the existence of generic OTFC could negatively impact the growth of FENTORA.  With respect to ACTIQ, generic competition from Barr has meaningfully eroded branded ACTIQ sales and impacted sales of our own generic OTFC through Watson.  Our generic sales also could be significantly impacted by the entrance into the market of additional generic OTFC products, which could occur at any time.  In October 2009, we understand that the FDA approved ANDAs by Barr and Covidien to market and sell generic OTFC and that Covidien launched its generic OTFC in the United States in March 2010. With respect to TREANDA, we face competition from LEUKERAN®, CAMPATH® and the combination therapy of fludarabine, cyclophosphamide and rituximab.  With respect to TRISENOX, the pharmaceutical market for the treatment of patients with relapsed or refractory APL is served by a number of available therapeutics, such as VESANOID® by Roche in combination with chemotherapy.

For all of our products, we need to demonstrate to physicians, patients and third party payers that the cost of our products is reasonable and appropriate in the light of their safety and efficacy, the price of competing products and the related health care benefits to the patient.

Many of our competitors have substantially greater capital resources, research and development staffs and facilities than we have, and substantially greater experience in conducting clinical trials, obtaining regulatory approvals and manufacturing and marketing pharmaceutical products. These entities represent significant competition for us. In addition, competitors who are developing products for the treatment of neurological or oncological disorders might succeed in developing technologies and products that are more effective than any that we develop or sell or that would render our technology and products obsolete or noncompetitive. Competition and innovation from these or other sources, including advances in current treatment methods, could potentially affect sales of our products negatively or make our products obsolete. Furthermore, we may be at a competitive marketing disadvantage against companies that have broader product lines and whose sales personnel are able to offer more complementary products than we can. Any failure to maintain our competitive position could adversely affect our business and results of operations.

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We plan to consider and, as appropriate, make acquisitions of technologies, products and businesses, which may subject us to a number of risks and/or result in us experiencing significant charges to earnings that may adversely affect our stock price, operating results and financial condition.

As part of our efforts to acquire businesses or to enter into other significant transactions, we conduct business, legal and financial due diligence with the goal of identifying and evaluating material risks involved in the transaction. Despite our efforts, we ultimately may be unsuccessful in ascertaining or evaluating all such risks and, as a result, we might not realize the intended advantages of the acquisition. If we fail to realize the expected benefits from acquisitions we have consummated or may consummate in the future, whether as a result of unidentified risks, integration difficulties, regulatory setbacks or other events, our business, results of operations and financial condition could be adversely affected. In connection with an acquisition, we must estimate the value of the transaction by making certain assumptions about, among other things, likelihood of regulatory approval for unapproved products and the market potential for marketed products and/or product candidates. Ultimately, our assumptions may prove to be incorrect, which could cause us to fail to realize the anticipated benefits of a transaction.  As part of our efforts to hedge risks associated with the uncertainty of acquisitions generally and pharmaceutical development specifically, we have structured certain transactions as options-to-acquire.  Pursuant to this structure, we typically make an upfront payment to secure the option, set forth the appropriate “trigger” for the option in an option agreement and, should we exercise the option, make a subsequent payment to finalize the product or company acquisition.  Our option transaction with BDC is an example of this option structure.  While we believe that this structure helps us to manage risk appropriately, it is possible that we will not “trigger” an option-to-acquire, and therefore receive nothing of tangible value in return for our upfront payment to secure the option-to-acquire.

In addition, we have experienced, and will likely continue to experience, significant charges to earnings related to our efforts to consummate acquisitions. For transactions that ultimately are not consummated, these charges may include fees and expenses for investment bankers, attorneys, accountants and other advisers in connection with our efforts. Even if our efforts are successful, we may incur as part of a transaction substantial charges for closure costs associated with the elimination of duplicate operations and facilities and acquired in-process research and development charges. In either case, the incurrence of these charges could adversely affect our results of operations for particular quarterly or annual periods.

We may be unable to successfully consolidate and integrate the operations of businesses we acquire, which may adversely affect our stock price, operating results and financial condition.

We must consolidate and integrate the operations of acquired businesses with our business. Integration efforts often take a significant amount of time, place a significant strain on our managerial, operational and financial resources and could prove to be more difficult and expensive than we predicted. The diversion of our management’s attention and any delays or difficulties encountered in connection with these recent acquisitions, and any future acquisitions we may consummate, could result in the disruption of our ongoing business or inconsistencies in standards, controls, procedures and policies that could negatively affect our ability to maintain relationships with customers, suppliers, employees and others with whom we have business dealings.

The results and timing of our research and development activities, including future clinical trials, are difficult to predict, subject to potential future setbacks and, ultimately, may not result in viable pharmaceutical products, which may adversely affect our business.

In order to sustain our business, we focus substantial resources on the search for new pharmaceutical products. These activities include engaging in discovery research and process development, conducting preclinical and clinical studies and the development of new indications for our existing products and seeking regulatory approval in the United States and abroad. In all of these areas, we have relatively limited resources and compete against larger, multinational pharmaceutical companies. Moreover, even if we undertake these activities in an effective and efficient manner, regulatory approval for the sale of new pharmaceutical products remains highly uncertain because the majority of compounds discovered do not enter clinical studies and the majority of therapeutic candidates fail to show the human safety and efficacy necessary for regulatory approval and successful commercialization.

In the pharmaceutical business, the research and development process generally takes 12 years or longer, from discovery to commercial product launch. During each stage of this process, there is a substantial risk of failure. Preclinical testing and clinical trials must demonstrate that a product candidate is safe and efficacious. The results from preclinical testing and early clinical trials may not be predictive of results obtained in subsequent clinical trials, and these clinical trials may not demonstrate the safety and efficacy necessary to obtain regulatory approval for any product candidates. A number of

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companies in the biotechnology and pharmaceutical industries have suffered significant setbacks in advanced clinical trials, even after obtaining promising results in earlier trials. For ethical reasons, certain clinical trials are conducted with patients having the most advanced stages of disease and who have failed treatment with alternative therapies. During the course of treatment, these patients often die or suffer other adverse medical effects for reasons that may not be related to the pharmaceutical agent being tested. Such events can have a negative impact on the statistical analysis of clinical trial results.

The completion of clinical trials of our product candidates may be delayed by many factors, including the rate of enrollment of patients. Neither we nor our collaborators can control the rate at which patients present themselves for enrollment, and the rate of patient enrollment may not be consistent with our expectations or sufficient to enable clinical trials of our product candidates to be completed in a timely manner or at all. In addition, we may not be permitted by regulatory authorities to undertake additional clinical trials for one or more of our product candidates. Even if such trials are conducted, our product candidates may not prove to be safe and efficacious or receive regulatory approvals. Any significant delays in, or termination of, clinical trials of our product candidates could impact our ability to generate product sales from these product candidates in the future.

The price of our common stock has been and may continue to be highly volatile, which may make it difficult for stockholders to sell our common stock when desired or at attractive prices.

The market price of our common stock is highly volatile, and we expect it to continue to be volatile for the foreseeable future. For example, from January 1, 2009 through October 25, 2010 our common stock traded at a high price of $81.35 and a low price of $52.55. Negative announcements, including, among others:

·adverse regulatory decisions;

·disappointing clinical trial results;

·legal challenges, disputes and/or other adverse developments impacting our patents or other proprietary products; or

·sales or operating results that fall below the market’s expectations

could trigger significant declines in the price of our common stock. In addition, external events, such as news concerning economic conditions, our competitors or our customers, changes in government regulations impacting the biotechnology or pharmaceutical industries or the movement of capital into or out of our industry, also are likely to affect the price of our common stock, regardless of our operating performance.

Our internal controls over financial reporting may not be considered effective, which could result in possible regulatory sanctions and a decline in our stock price.

Section 404 of the Sarbanes-Oxley Act of 2002 requires us to furnish annually a report on our internal controls over financial reporting and to maintain effective disclosure controls and procedures and internal controls over financial reporting. In order for management to evaluate our internal controls, we must regularly review and document our internal control processes and procedures and test such controls. Ultimately, we or our independent auditors could conclude that our internal control over financial reporting may not be effective if, among others things:

·any material weakness in our internal controls over financial reporting exist; or

·we fail to remediate assessed deficiencies.

We have implemented a number of information technology systems, including SAP®, to assist us to meet our internal controls for financial reporting.   While we believe our systems are effective for that purpose, we cannot be certain that they will continue to be effective in the future or adaptable for future needs.  Due to the number of controls to be examined, the complexity of our processes, the subjectivity involved in determining the effectiveness of controls, and, more generally, the laws and regulations to which we are subject as a global company, we cannot be certain that, in the future, all of our controls will continue to be considered effective by management or, if considered effective by our management, that our auditors will agree with such assessment.

If, in the future, we are unable to assert that our internal control over financial reporting is effective, or if our auditors are unable to express an opinion on the effectiveness of our internal control over financial reporting, we could be

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subject to regulatory sanctions or lose investor confidence in the accuracy and completeness of our financial reports, either of which could have an adverse effect on the market price for our securities.

A portion of our revenues and expenses is subject to exchange rate fluctuations in the normal course of business, which could adversely affect our reported results of operations.

Historically, a portion of our revenues and expenses has been earned and incurred, respectively, in currencies other than the U.S. dollar. For the three and nine months ended September 30, 2010, 25% and 23% of our revenues were denominated in currencies other than the U.S. dollar, respectively.  With our acquisition of Mepha GmbH, the percentage of revenues denominated in foreign currencies has increased, thereby increasing our exposure to foreign currency exchange risk.  We translate revenues earned and expenses incurred into U.S. dollars at the average exchange rate applicable during the relevant period. A weakening of the U.S. dollar would, therefore, increase both our revenues and expenses. Fluctuations in the rate of exchange between the U.S. dollar and the euro and other currencies may affect period-to-period comparisons of our operating results. Historically, we have not hedged our exposure to these fluctuations in exchange rates.

Our customer base is highly concentrated.

Our principal customers are wholesale drug distributors. These customers comprise a significant part of the distribution network for pharmaceutical products in the United States. Three large wholesale distributors, Cardinal Health, Inc., McKesson Corporation and AmerisourceBergen Corporation, control a significant share of this network. These three wholesaler customers, in the aggregate, accounted for 72% of our total consolidated gross sales for the nine months ended September 30, 2010. Fluctuations in the buying patterns of these customers, which may result from seasonality, wholesaler buying decisions or other factors outside of our control, could significantly affect the level of our net sales on a period to period basis. Because of this, the amounts purchased by these customers during any quarterly or annual period may not correlate to the level of underlying demand evidenced by the number of prescriptions written for such products, as reported by IMS Health Incorporated.

We are involved, or may become involved in the future, in legal proceedings that, if adversely adjudicated or settled, could materially impact our financial condition.

As a biopharmaceutical company, 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 general, litigation claims can be expensive and time consuming to bring or defend against and could result in settlements or damages that could significantly impact results of operations and financial condition. We currently are vigorously defending ourselves against those matters specifically described in Note 12 of the Consolidated Financial Statements included in Part I, Item 1 of this Quarterly Report on Form 10-Q, as well as numerous other litigation matters. While we currently do not believe that the settlement or adverse adjudication of these other litigation matters would materially impact our results of operations or financial condition, the final resolution of these matters and the impact, if any, on our results of operations, financial condition or cash flows is unknown but could be material.

Unfavorable general economic conditions could adversely affect our business.

Our business, financial condition and results of operations may be affected by various general economic factors and conditions.  Periods of economic slowdown or recession in any of the countries in which we operate could lead to a decline in the use of our products and therefore could have an adverse effect on our business.  In addition, if we are unable to access the capital markets due to general economic conditions, we may not have the cash available or be able to obtain funding to permit us to meet our business requirements and objectives, thus adversely affecting our business and the market price for our securities.

Our dependence on key executives and scientists could impact the development and management of our business.

We are highly dependent upon our ability to attract and retain qualified scientific, technical and managerial personnel. There is intense competition for qualified personnel in the pharmaceutical and biotechnology industries, and we cannot be sure that we will be able to continue to attract and retain the qualified personnel necessary for the development and management of our business. Although we do not believe the loss of one individual would materially harm our business, our business might be harmed by the loss of the services of multiple existing personnel, as well as the failure to recruit additional

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key scientific, technical and managerial personnel in a timely manner. Much of the know-how we have developed resides in our scientific and technical personnel and is not readily transferable to other personnel. While we have employment agreements with our key executives, we do not ordinarily enter into employment agreements with our other key scientific, technical and managerial employees. We do not maintain “key man” life insurance on any of our employees.

We may be required to incur significant costs to comply with environmental laws and regulations, and our related compliance may limit any future profitability.

Our research and development activities involve the controlled use of hazardous, infectious and radioactive materials that could be hazardous to human health and safety or the environment. We store these materials, and various wastes resulting from their use, at our facilities pending ultimate use and disposal. We are subject to a variety of foreign, federal, state and local laws and regulations governing the use, generation, manufacture, storage, handling and disposal of these materials and wastes, and we may be required to incur significant costs to comply with related existing and future environmental laws and regulations.

While we believe that our safety procedures for handling and disposing of these materials comply with foreign, federal, state and local laws and regulations, we cannot completely eliminate the risk of accidental injury or contamination from these materials. In the event of an accident, we could be held liable for any resulting damages, which could include fines and remedial costs. These damages could require payment by us of significant amounts over a number of years, which could adversely affect our results of operations and financial condition.

Anti-takeover provisions may delay or prevent changes in control of our management or deter a third party from acquiring us, limiting our stockholders’ ability to profit from such a transaction.

Our Board of Directors has the authority to issue up to 5,000,000 shares of preferred stock, $0.01 par value, of which 1,000,000 have been reserved for issuance in connection with our stockholder rights plan, and to determine the price, rights, preferences and privileges of those shares without any further vote or action by our stockholders. Our stockholder rights plan could have the effect of making it more difficult for a third party to acquire a majority of our outstanding voting stock.

We are subject to the anti-takeover provisions of Section 203 of the Delaware General Corporation Law, which prohibits us from engaging in a “business combination” with an “interested stockholder” for a period of three years after the date of the transaction in which the person becomes an interested stockholder, unless the business combination is approved in a prescribed manner. The application of Section 203 could have the effect of delaying or preventing a change of control of Cephalon. Section 203, the rights plan, and certain provisions of our certificate of incorporation, our bylaws and Delaware corporate law, may have the effect of deterring hostile takeovers, or delaying or preventing changes in control of our management, including transactions in which stockholders might otherwise receive a premium for their shares over then-current market prices.

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ITEM 5.  OTHER INFORMATION

Computation of Ratios of Earnings to Fixed Charges

	Year ended December 31,												Nine months ended September 30,
	2005			2006		2007			2008		2009		2010
Determination of Earnings
Income (Loss) Before Income Taxes and Non-Controlling Interest	$	(264,506	)	$	192,166	$	(123,276	)	$	134,070	$	289,407	$	497,105
Add:
Amortization of interest capitalized in current or prior periods	—			52		98			250		265		199
Fixed charges:	81,007			97,054		79,993			84,762		99,453		92,029
Total Earnings	$	(183,499	)	$	289,272	$	(43,185	)	$	219,082	$	389,125	$	589,333
Fixed charges:
Interest expense and amortization of debt discount and premium on all indebtedness	75,257			87,805		70,866			75,233		90,336		85,209
Appropriate portion of rentals	5,750			9,249		9,127			9,529		9,117		6,820
Preferred stock dividend requirements of consolidated subsidiaries	—			—		—			—		—		—
Fixed charges	81,007			97,054		79,993			84,762		99,453		92,029
Capitalized interest	1,044			1,766		768			77		—		—
Total Fixed Charges	$	82,051		$	98,820	$	80,761		$	84,839	$	99,453	$	92,029
Ratio of earnings to fixed charges (1)				2.93					2.58		3.91		6.40
Deficiency of earnings to fixed charges	$	265,550				$	123,946

(1)For the years ended December 31, 2005 and 2007, no ratios are provided because earnings were insufficient to cover fixed charges.

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ITEM 6.  EXHIBITS

Exhibit No.	Description
31.1*	Certification of J. Kevin Buchi, Chief Operating Officer of the Company, as required pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
31.2*	Certification of Wilco Groenhuysen, Executive Vice President and Chief Financial Officer of the Company, as required pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
32.1#	Certification of J. Kevin Buchi, Chief Operating Officer of the Company, as required pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
32.2#	Certification of Wilco Groenhuysen, Executive Vice President and Chief Financial Officer of the Company, as required pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
101	The following financial statements, formatted in XBRL: (i) Consolidated Statements of Operations- three and nine months ended September 30, 2010 and 2009, (ii) Consolidated Balance Sheets- September 30, 2010 and December 31, 2009, (iii) Consolidated Statements of Changes in Equity- nine months ended September 30, 2010 and 2009, (iv) Consolidated Statements of Cash Flows- nine months ended September 30, 2010 and 2009, and (v) Notes to Consolidated Financial Statements, tagged as blocks of text.

*Filed herewith.

#This exhibit shall not be deemed “filed” for purposes of Section 18 of the Securities Exchange Act of 1934, as amended, or otherwise subject to the liability of that section. Further, this exhibit shall not be deemed to be incorporated by reference in any document filed under the Securities Act of 1933, as amended, or the Securities Exchange Act of 1934, as amended.

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SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

	CEPHALON, INC.
	(Registrant)
October 29, 2010	By	/s/ J. KEVIN BUCHI
		J. Kevin Buchi
		Chief Operating Officer
		(Principal executive officer)
	By	/s/ WILCO GROENHUYSEN
		Wilco Groenhuysen
		Executive Vice President and Chief Financial Officer
		(Principal financial and accounting officer)

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