10-K

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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

FORM 10-K

(Mark One)
ý	ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 2005
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 (State or Other Jurisdiction of Incorporation or Organization)	23-2484489 (I.R.S. Employer Identification No.)
41 Moores Road P.O. Box 4011 Frazer, Pennsylvania (Address of Principal Executive Offices)	19355 (Zip Code)

Registrant's telephone number, including area code: (610) 344-0200

Securities registered pursuant to Section 12(b) of the Act:

Title of each class	Name of each exchange on which registered
None	None

Securities registered pursuant to Section 12(g) of the Act:

Common Stock, par value $.01 per share

(Title of Class)

        Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes ý    No o.

        Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes o    No ý.

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

        Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of the registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. o

        Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. Large accelerated filer ý    Accelerated filer o    Non-accelerated filer o.

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

        The aggregate market value of the voting stock held by non-affiliates of the registrant, as of June 30, 2005, was approximately $808 million. Such aggregate market value was computed by reference to the closing price of the Common Stock as reported on the Nasdaq National Market on June 30, 2005. For purposes of making this calculation only, the registrant has defined affiliates as including only directors and executive officers and shareholders holding greater than 10% of the voting stock of the registrant as of June 30, 2005.

        The number of shares of the registrant's Common Stock outstanding as of March 3, 2006 was 60,023,514.

DOCUMENTS INCORPORATED BY REFERENCE

        Portions of the registrant's definitive proxy statement for its 2006 annual meeting of stockholders are incorporated by reference into Items 10, 11, 12, 13, and 14 of Part III of this Form 10-K.

TABLE OF CONTENTS

		Page
Cautionary Note Regarding Forward-Looking Statements		ii
PART I
Item 1.	Business	1
Item 1A.	Risk Factors	27
Item 1B.	Unresolved Staff Comments	40
Item 2.	Properties	40
Item 3.	Legal Proceedings	40
Item 4.	Submission of Matters to a Vote of Security Holders	40
PART II
Item 5.	Market for Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities	43
Item 6.	Selected Financial Data	46
Item 7.	Management's Discussion and Analysis of Financial Condition and Results of Operations	47
Item 7A.	Quantitative and Qualitative Disclosures About Market Risk	73
Item 8.	Financial Statements and Supplementary Data	74
Item 9.	Changes in and Disagreements With Accountants on Accounting and Financial Disclosure	121
Item 9A.	Controls and Procedures	121
Item 9B.	Other Information	121
PART III
Item 10.	Directors and Executive Officers of the Registrant	122
Item 11.	Executive Compensation	122
Item 12.	Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters	122
Item 13.	Certain Relationships and Related Transactions	122
Item 14.	Principal Accounting Fees and Services	122
PART IV
Item 15.	Exhibits and Financial Statement Schedules	123
SIGNATURES		132

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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 constitute our expectations or forecasts of future events as of the date this report was filed with the SEC and are not statements of historical fact. You can identify these statements by the fact that they do not relate strictly to historical or current facts. Such statements may include words such as "anticipate," "will," "estimate," "expect," "project," "intend," "should," "plan," "believe," "hope," and other words and terms of similar meaning in connection with any discussion of, among other things, future operating or financial performance, strategic initiatives and business strategies, regulatory or competitive environments, our intellectual property and product development. In particular, these forward-looking statements include, among others, statements about:

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our dependence on sales of PROVIGIL® (modafinil) tablets [C-IV], ACTIQ® (oral transmucosal fentanyl citrate) [C-II] and GABITRIL® (tiagabine hydrochloride) in the United States and the market prospects and future marketing efforts for these products and for our near-term product candidates, if approved;



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any potential expansion of the authorized uses of our existing products or approval of our product candidates;



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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;



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the timing and unpredictability of regulatory approvals;



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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;



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



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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:

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the acceptance of our products by physicians and patients in our current markets and new markets;



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our ability to obtain regulatory approvals to sell our product candidates and to launch such products successfully;



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



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



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the inability to adequately protect our key intellectual property rights;

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the loss of key management or scientific personnel;



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



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regulatory setbacks with respect to our recent settlements of the PROVIGIL and ACTIQ patent litigations;



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unanticipated conversion of our convertible notes by our note holders;



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



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

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

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PART I

ITEM 1.    BUSINESS

Overview

        Cephalon is an international biopharmaceutical company dedicated to the discovery, development and marketing of innovative products in four core therapeutic areas: central nervous system ("CNS") disorders, pain, cancer and addiction. In addition to conducting an active research and development program, we market four products in the United States and numerous products in various countries throughout Europe.

        Our three most important products, PROVIGIL® (modafinil) Tablets [C-IV], ACTIQ® (oral transmucosal fentanyl citrate) [C-II] and GABITRIL® (tiagabine hydrochloride), comprised approximately 86% of our worldwide net sales for the year ended December 31, 2005, of which approximately 94% was in the U.S. market. Consistent with our core therapeutic areas, we also have aligned our U.S. field sales and sales management teams by area, with approximately 440 persons focused on CNS, 115 persons focused on pain, 30 persons focused on cancer and 135 persons focused on addiction. In Europe, we have a sales and marketing organization numbering approximately 360 persons that supports our presence in 18 European countries, including France, the United Kingdom, Germany, Italy and Spain.

        During 2006 and early 2007, we are seeking to attain U.S. Food and Drug Administration ("FDA") approval to market five product candidates. The following chart summarizes our progress with respect to these product opportunities, as well as our current expectations with respect to the timing of regulatory filings and possible launch dates, assuming FDA approval:

Product Candidate	Anticipated Indication	Anticipated Filing Date	Target Launch Date	Status
SPARLON™ (modafinil)*	ADHD in children and adolescents	Filed sNDA 4Q 2004	2Q 2006	Received approvable letter from FDA on October 20, 2005; FDA advisory panel scheduled for March 23, 2006
NUVIGIL™ (armodafinil)	Excessive sleepiness	Filed NDA 1Q 2005	Mid-2006	Current PDUFA date: April 30, 2006
VIVITROL™ (naltrexone for extended-release injectable suspension)*	Alcohol dependence	Filed NDA 1Q 2005	1st Half 2006	Received approvable letter from FDA on December 28, 2005.
fentanyl effervescent buccal tablets (FEBT)	Breakthrough cancer pain	Filed NDA 3Q 2005	Late 2006	Current PDUFA date: June 30, 2006
GABITRIL® (tiagabine hydrochloride)	Generalized Anxiety Disorder	2nd Half 2006	2nd Half 2007	Phase 3 clinical trial results expected 2Q 2006

*

We are a party to a co-promotion agreement with McNeil Consumer & Specialty Pharmaceuticals with respect to SPARLON and a license and collaboration agreement with Alkermes, Inc. with respect to VIVITROL.

        During 2005, we consummated a number of transactions that strengthened our therapeutic focus on cancer in the U.S. and Europe and gave us access to a new area—alcohol dependence. As a part of our business strategy, we expect to continue to consider and, as appropriate, consummate acquisitions of other technologies, products and businesses and enter into collaborative arrangements. We also

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made significant strides in 2005 toward final approval of our product candidates. Some notable achievements and transactions in 2005 included:

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acquiring Salmedix, Inc., including the rights to TREANDA, a product candidate in Phase 3 clinical trials for the treatment of indolent (slowly progressing) non-Hodgkin's lymphoma ("NHL"), a type of hematologic cancer;



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entering into a license and collaboration agreement with Alkermes, Inc. to develop and commercialize VIVITROL in the United States for the treatment of alcohol dependence in combination with a treatment program that includes psychosocial support;



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acquiring rights to TRISENOX, a product approved for marketing in the United States and Europe for the treatment of patients with relapsed or refractory acute promyelocytic leukemia ("APL"), a life threatening hematologic cancer;



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entering into a co-promotion agreement with McNeil Consumer & Specialty Pharmaceuticals Division of McNeil-PPC, Inc. with respect to SPARLON, under which McNeil will detail SPARLON in the United States primarily to pediatricians, psychiatrists and pediatric neurologists;



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acquiring Zeneus Holdings Limited to accelerate our entry into the European oncology market and bolster our sales and marketing presence in Europe;



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filing a New Drug Application ("NDA") with the FDA seeking approval to market fentanyl effervescent buccal tablets ("FEBT") for the management of breakthrough pain in patients with cancer who are tolerant to opioid therapy for their underlying persistent pain;



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filing an NDA with the FDA seeking approval to market NUVIGIL Tablets [C-IV] for the same labeled indications as PROVIGIL; and



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receiving approvable letters from the FDA for VIVITROL, for the treatment of alcohol dependence in combination with a treatment program that includes psychosocial support, and for SPARLON, for the treatment of ADHD in children and adolescents between the ages of six through 17.

        We also have significant discovery research programs focused on developing therapeutics to treat neurological and oncological disorders. Our technology principally focuses on an understanding of kinases and the role they play in cellular survival and proliferation. We have coupled this knowledge with a library of novel, small, synthetic molecules that are orally-active and inhibit the activities of specific kinases.

        As a biopharmaceutical company, our future success is highly dependent on obtaining and maintaining patent protection for our products and technology. We intend to vigorously defend the validity, and prevent infringement of, our patents. The loss of patent protection on any of our existing products, whether by third-party challenge, invalidation, circumvention, license or patent expiration, would materially impact our results of operations.

        In late 2005 and early 2006, we announced the settlement of four separate patent infringement lawsuits related to modafinil that we had filed against Teva Pharmaceuticals USA, Inc., Mylan Pharmaceuticals Inc., Ranbaxy Pharmaceuticals Inc., and Barr Laboratories, Inc. As part of these separate settlements, we agreed to grant to each of Teva, Mylan, Ranbaxy and Barr a non-exclusive royalty-bearing right to market and sell a generic version of PROVIGIL in the United States. These licenses will become effective in October 2011, unless we obtain a pediatric extension for PROVIGIL, which would permit entry in April 2012. An earlier entry may occur based upon the entry of another generic version of PROVIGIL.

        In connection with the Barr, Ranbaxy and Teva settlements, we also entered into a series of business arrangements related to modafinil with Barr, Ranbaxy and Teva. We received licenses to

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certain modafinil-related intellectual property developed by each party and in exchange for these licenses, we agreed to make payments to these three companies collectively totaling up to $136.0 million over the next several years, 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 will purchase an annual minimum amount of modafinil over a six year period beginning in 2006, with the aggregate payments over that period totaling approximately $82.6 million.

        In February 2006, we also announced that we had settled our pending United States patent infringement dispute with Barr related to its abbreviated new drug application ("ANDA") filed with the FDA seeking to sell a generic version of ACTIQ. Under the settlement, we will grant Barr an exclusive royalty bearing right to market and sell a generic version of ACTIQ in the United States, effective on December 6, 2006. Barr will pay specified royalties on net profits of a generic ACTIQ product for the period December 6, 2006 through February 3, 2007, subject to certain limitations. The patents covering the current formulation of the product are set to expire as early as September 5, 2006. If we are successful in our efforts to complete a clinical study of ACTIQ in pediatric patients prior to September 2006, the FDA could grant us six months of exclusivity beyond the September 5, 2006 patent expiration. Under the license and supply agreement we entered into with Barr in July 2004, we could face generic competition from Barr prior to December 6, 2006 if we receive FDA approval of FEBT before this date or if we are unable to complete the ongoing pediatric studies with ACTIQ prior to September 2006.

        Each of these settlements has been filed with both the United States Federal Trade Commission (the "FTC") and the Antitrust Division of the Department of Justice (the "DOJ") as required by the Medicare Prescription Drug, Improvement and Modernization Act of 2003 (the "Medicare Modernization Act").

        As a biopharmaceutical company, our activities and operations are subject to significant government regulations and oversight. In September 2004, we announced that we had received subpoenas from the U.S. Attorney's Office in Philadelphia. That same month, we received a voluntary request for information from the Office of the Connecticut Attorney General. Both the subpoenas and the voluntary request for information appear to be focused on our sales and promotional practices with respect to ACTIQ, GABITRIL and PROVIGIL, including the extent of off-label prescribing of our products by physicians. We are cooperating with the U.S. Attorney's Office and the Office of the Connecticut Attorney General, and are providing documents and other information to both offices in response to these and additional requests. These matters may involve the bringing of criminal charges and fines, and/or civil penalties. We cannot predict or determine the outcome of these matters or reasonably estimate the amount or range of amounts of any fines or penalties that might result from an adverse outcome. However, an adverse outcome could have a material adverse effect on our financial position, liquidity and results of operations.

        For the year ended December 31, 2005, our total revenues and net loss were $1.2 billion and $175.0 million, respectively. Our revenues from U.S. and European operations are detailed in Note 16 to our Consolidated Financial Statements included in Part II, Item 8 of this Annual Report on Form 10-K. 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, or to successfully develop or acquire and commercialize new product candidates.

        We are a Delaware corporation with our principal executive offices located at 41 Moores Rd., P.O. Box 4011, Frazer, Pennsylvania, 19355. Our telephone number is (610) 344-0200 and our web site address is http://www.cephalon.com. Our research and development headquarters are in West Chester,

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Pennsylvania and we also have offices in Salt Lake City, Utah, suburban Minneapolis-St. Paul, Minnesota, France, the United Kingdom, Denmark, Germany, Italy, the Netherlands, Poland, Spain and Switzerland. We operate manufacturing facilities in France for the production of modafinil, which is used in the production of in PROVIGIL, SPARLON and NUVIGIL. We also have manufacturing facilities in Salt Lake City, Utah, for the production of ACTIQ for worldwide distribution and sale, and Eden Prairie and Brooklyn Park, Minnesota, for the production of orally disintegrating versions of drugs for pharmaceutical company partners.

        Our Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K and all amendments to those reports are available free of charge through the Investor Relations section of our web site as soon as reasonably practicable after such material is electronically filed with or furnished to the Securities and Exchange Commission. We include our web site address in this Annual Report on Form 10-K only as an inactive textual reference and do not intend it to be an active link to our web site.

CENTRAL NERVOUS SYSTEM DISORDERS

        Our CNS disorders portfolio includes two marketed products: PROVIGIL, for improving wakefulness in patients with excessive daytime sleepiness associated with narcolepsy, obstructive sleep apnea/hypopnea syndrome ("OSA/HS") and shift work sleep disorder ("SWSD"), and GABITRIL, for use as adjunctive therapy in the treatment of partial seizures in epileptic patients. We also are seeking final approval from the FDA to market two additional products: NUVIGIL and SPARLON and are anticipating final FDA approval of both product candidates in the second quarter of 2006.

Modafinil Products

PROVIGIL

        Modafinil, the active ingredient in PROVIGIL is the first in a new class of wakefulness-promoting agents. While its exact mechanism of action remains to be fully elucidated, modafinil appears to act selectively in regions of the brain believed to regulate normal sleep and wakefulness. The FDA approved PROVIGIL to improve wakefulness in patients with excessive daytime sleepiness associated with narcolepsy, and we launched the product in the United States in February 1999. In January 2004, we received FDA approval to expand the label for PROVIGIL to include improving wakefulness in patients with excessive sleepiness associated with OSA/HS and SWSD. In clinical studies, PROVIGIL was found to be generally well-tolerated, with a low incidence of adverse events relative to placebo. The most commonly observed adverse events were headache, infection, nausea, nervousness, anxiety and insomnia.

        Outside of the U.S., modafinil currently is approved in more than 30 countries, including France, the United Kingdom, Ireland, Italy and Germany, for the treatment of excessive daytime sleepiness associated with narcolepsy. In certain of these countries, we also have approval to market modafinil to treat excessive daytime sleepiness in patients with OSA/HS and/or SWSD.

NUVIGIL

        An important focus of our modafinil strategy has been the development of next-generation compounds. NUVIGIL is a single-isomer formulation of modafinil. In March 2005, we filed an NDA with the FDA seeking approval to market NUVIGIL with the same labeled indications as PROVIGIL. The FDA has set April 30, 2006 as the action date for its review of the NDA. We expect to begin marketing NUVIGIL in the middle of 2006 upon receipt of approval from the FDA.

        In Phase 3 clinical trials of 150- and 250-milligram daily doses of NUVIGIL in patients suffering from excessive sleepiness associated with narcolepsy, SWSD or OSA/HS, results indicate that

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NUVIGIL significantly improves wakefulness and the overall clinical condition of patients as compared to placebo. The 12-week, double-blind, randomized, placebo-controlled Phase 3 studies of approximately 1,000 patients included one study of excessive sleepiness in narcolepsy, one study in SWSD and two studies in OSA/HS. The primary endpoints in each Phase 3 study were measures of objective sleep latency (Maintenance of Wakefulness Test or Multiple Sleep Latency Test) and the physician rating of Clinical Global Impression-Change. These primary endpoints are identical to those studied for the currently approved indications for PROVIGIL. In each Phase 3 study, patients treated with NUVIGIL showed a highly statistically significant improvement on both primary endpoints compared to placebo. In these studies, NUVIGIL was generally well-tolerated. The most common adverse effects observed included headache, nausea, dizziness, insomnia and anxiety.

SPARLON

        SPARLON is our proprietary dosage form of modafinil for the treatment of attention-deficit/hyperactivity disorder ("ADHD") in children and adolescents between the ages of six through 17. In October 2005, the FDA issued an approvable letter for the treatment of ADHD in children and adolescents between the ages of six through 17. On January 25, 2006, we announced that we do not expect final action from the FDA on our pending new drug application for SPARLON until after the completion of several FDA advisory committee meetings. Two of these panels, the first of which occurred on February 9, 2006 and the second of which is scheduled for March 22, 2006, address safety and risk management issues associated with products in the class of currently approved ADHD treatments. Since SPARLON is not an approved drug, the FDA has scheduled a separate advisory panel to review SPARLON on March 23, 2006. We are working closely with the FDA to obtain final approval and expect to launch this product in the second quarter of 2006.

        In three Phase 3, nine-week, double-blind, placebo-controlled studies, 600 children and adolescents between the ages of six and 17 with ADHD were randomized to receive either placebo or SPARLON. The primary endpoint in all studies was the teacher-completed school version of the ADHD Rating Scale IV. All of the SPARLON-treated groups showed a highly statistically significant improvement on the primary endpoint compared to placebo. SPARLON was generally well tolerated. The most common side effects observed in these studies were consistent with those observed in other studies of this compound and included insomnia, headache and loss of appetite.

Targeted Diseases/Disorders

Narcolepsy:    Narcolepsy is a debilitating, lifelong sleep disorder whose symptoms often first arise in late childhood. Its most common symptom is an uncontrollable propensity to fall asleep during the day. PROVIGIL has been recognized by the American Academy of Sleep Medicine as a standard of therapy for the treatment of excessive daytime sleepiness associated with narcolepsy.

OSA/HS:    Individuals with OSA/HS experience frequent awakenings, sometimes occurring hundreds of times during the night as a result of blockage of the airway passage, usually caused by the relaxation and collapse of the soft tissue in the back of the throat during sleep. Continuous positive airway pressure, or CPAP, a medical device that blows air through the nasal passage, is the primary treatment for OSA/HS. However, approximately 30 percent of patients that use CPAP continue to experience excessive sleepiness, for which PROVIGIL may be an appropriate adjunctive treatment.

SWSD:    SWSD is defined as a persistent or recurrent pattern of sleep disruption that leads to excessive sleepiness or insomnia due to a mismatch between the natural circadian sleep-wake pattern and the sleep-wake schedule required by a person's environment. SWSD particularly affects those who frequently rotate shifts or work at night, which is contrary to the body's natural circadian rhythms.

ADHD:    According to the National Institutes of Mental Health, ADHD is one of the most common psychiatric disorders among children, affecting approximately four million children in the

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United States. The most common ADHD behaviors fall into three categories: inattention, hyperactivity and impulsivity. A diagnosis of ADHD is generally made when these behaviors become excessive, long-term, and pervasive. Studies have shown that children with ADHD have higher medical costs than children without ADHD due to the risk of accidents and injury resulting from inattention, impulsivity and hyperactivity.

Intellectual Property Position

        We own various U.S. and foreign patent rights that expire between 2014 and 2015 and cover pharmaceutical compositions and uses of modafinil, specifically, certain particle sizes of modafinil contained in the pharmaceutical composition. We also hold rights to other patents and patent applications directed to polymorphs, manufacturing processes, formulations, and uses of modafinil and to next-generation modafinil products. We also own rights to PROVIGIL and other various trademarks for our pharmaceutical products containing the active drug substance modafinil. Ultimately, these patents and patents related to our other products and products candidates might be found invalid if challenged by a third party, or a potential competitor could develop a competing product or product formulation that avoids infringement of these patents.

        As of the filing date of this Annual Report on Form 10-K, we are aware of six ANDAs on file with the FDA for pharmaceutical products containing modafinil. Each of these ANDAs contains a Paragraph IV certification in which the ANDA applicant certified that the U.S. particle-size modafinil patent covering PROVIGIL either is invalid or will not be infringed by the ANDA product. In March 2003, we filed a patent infringement lawsuit in the U.S. District Court in New Jersey against four companies—Teva Pharmaceuticals USA, Inc., Mylan Pharmaceuticals, Inc., Ranbaxy Laboratories Limited and Barr Laboratories, Inc.—based upon the ANDAs 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 October 6, 2014 (subject to a six-month extension to April 6, 2015 upon acceptance by the FDA of the pediatric study data submitted by us on December 21, 2005). We believe that these four companies were the first to file ANDAs with Paragraph IV certifications and thus are eligible for the 180-day exclusivity provided by the provisions of the Federal Food, Drug and Cosmetic Act.

        In late 2005 and early 2006, we announced that we had entered into settlement agreements with each of these four defendants. As part of these separate settlements, we agreed to grant to each of Teva, Mylan, Ranbaxy and Barr a non-exclusive royalty-bearing right to market and sell a generic version of PROVIGIL in the United States. These licenses will become effective in October 2011, unless we obtain a pediatric extension for PROVIGIL, which would permit entry by these firms in April 2012. An earlier entry may occur based upon the entry of another generic version of PROVIGIL. Each of these settlements has been filed with both the FTC and the Antitrust Division of the DOJ as required by the Medicare Modernization Act. The FTC has requested from us, and we have provided, certain information in connection with its review of the settlements. The FTC, the DOJ, or a private party could challenge in an administrative or judicial proceeding any or all of the settlements if they believe that the agreements violate the antitrust laws. If the settlements are challenged, there is no assurance that we could successfully defend against such challenge and, in that case, we could be subject to, among other things, damages, fines and possible invalidation of the settlement agreements.

        In early 2005, we also filed a patent infringement lawsuit in the U.S. District Court in New Jersey against Carlsbad Technology, Inc. based upon the Paragraph IV ANDA filed related to modafinil that Carlsbad filed with the FDA. Carlsbad has asserted counterclaims for non-infringement of the ‘516 Patent and invalidity of the ‘516 Patent. Carlsbad also has asserted a counterclaim for non-infringement of our U.S. Patent No. 4,927,855 (which we have not asserted against Carlsbad). We have moved to dismiss all of Carlsbad's counterclaims; Carlsbad has opposed the motion, and a decision is pending.

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Discovery in this action has only recently commenced. This ongoing litigation with Carlsbad is unaffected by each of the settlement agreements we have signed with Teva, Mylan, Ranbaxy and Barr.

        In late November 2005, we received notice that Caraco Pharmaceutical Laboratories, Ltd. also filed a Paragraph IV ANDA with the FDA seeking to market a generic form of PROVIGIL. We have not filed a patent infringement lawsuit against Caraco to date.

        The FDA has designated PROVIGIL as an orphan drug for use in treatment of excessive sleepiness associated with narcolepsy, which prevented the approval of an ANDA or NDA for modafinil in this indication until December 2005. In December 2005, we announced that we had submitted to FDA the results of clinical studies of PROVIGIL in pediatric patients in support of a six-month extension of our orphan drug exclusivity (to June 2006) and six months of exclusivity beyond the 2014 expiration of the particle-size patent term. We are awaiting a formal decision from FDA with respect to this pediatric extension.

        With respect to NUVIGIL, in addition to the particle size patent described above, we own composition of matter patents covering armodafinil, the active drug substance in NUVIGIL, that are set to expire in May 2007 in the United States and in January 2007 outside the United States. Assuming success in attaining FDA approval for this compound in mid-2006, we would expect to receive a three year period of marketing exclusivity (until mid-2009). In addition, assuming this same timetable for approval, we would anticipate that the term of this patent would be extended under the Hatch-Waxman Act until approximately mid-2009. If we perform an additional clinical study of this product in pediatric patients, the FDA could grant us six months of exclusivity beyond the expiration of the patent and the three-year period of marketing exclusivity (until late-2009). We intend to perform such a study once a mutually agreed upon clinical protocol is reached with the FDA. We also hold rights to other patent applications directed to polymorphs and manufacturing process related to armodafinil. We also own rights to the NUVIGIL trademark.

        For SPARLON, in addition to the particle size patent described above, we hold a patent covering a method of treating ADHD with modafinil, and patent applications covering the SPARLON formulation, that currently are set to expire in 2020 and 2023, respectively. Assuming FDA approval of SPARLON in the second quarter of 2006, we would expect to receive a three year period of marketing exclusivity for the use of SPARLON in ADHD (until mid-2009). We also hold rights to other patents and patent applications directed to polymorphs, manufacturing processes, formulations, and uses of modafinil and to next generation modafinil products. We also own rights to the SPARLON trademark.

Manufacturing and Product Supply

        At our manufacturing facility in Mitry-Mory, France, we produce modafinil for use in the production of PROVIGIL, NUVIGIL and SPARLON. We also have third party agreements with four companies to supply us with modafinil (which requirements include certain minimum purchase requirements) and two companies to supply us with finished commercial supplies of PROVIGIL. For SPARLON, two companies will manufacture SPARLON tablets, which will be subsequently packaged by three other companies. With respect to NUVIGIL, we have two third parties who will manufacture the active drug substance armodafinil and one qualified manufacturer of finished supplies of NUVIGIL tablets. We also are preparing to qualify an additional manufacturer to provide active drug substance and finished product following FDA approval of NUVIGIL. We seek to maintain inventories of active drug substance and finished products to protect against supply disruptions. Any future change in manufacturers or manufacturing processes requires regulatory approval.

Competition

        With respect to PROVIGIL, and, if approved, NUVIGIL, there are several other products used for the treatment of excessive sleepiness or narcolepsy in the United States. Many of these products,

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including methylphenidate products such as RITALIN® by Novartis, have been available for a number of years and are available in inexpensive generic forms.

        If we are successful in obtaining final FDA approval of SPARLON for the treatment of ADHD in children and adolescents, we will face significant competition from established stimulants such as RITALIN® by Novartis, STRATERRA® by Eli Lilly, and CONCERTA® by McNeil, as well as from amphetamines such as DEXEDRINE® by GlaxoSmithKline and ADDERALL® by Shire.

Co-Promotion Agreement with McNeil for SPARLON

        In August 2005, we entered into an agreement with McNeil Consumer & Specialty Pharmaceuticals Division of McNeil-PPC, Inc. concerning the co-promotion of SPARLON. Under the co-promotion agreement, McNeil has agreed to have at least 300 McNeil sales representatives co-promote and detail SPARLON upon FDA approval in the United States primarily to pediatricians, psychiatrists and pediatric neurologists. We will promote the product to psychiatrists, neurologists, primary care physicians, and other appropriate health care professionals. The parties have formed a joint commercialization committee to oversee the promotion of SPARLON. We retain all responsibility for the development, manufacture, distribution and sale of the product. We will pay McNeil commission fees calculated as a percentage of annual net sales of SPARLON during the term of the agreement and, if specified sales levels are reached in the final year of the agreement, during the three calendar years following the expiration of the agreement.

        McNeil may terminate the co-promotion agreement prior to the end of the three-year term of the agreement if "Lost CONCERTA Market Exclusivity" occurs, subject to the following conditions:

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Except as set forth in the next bullet point, McNeil may only terminate the co-promotion agreement effective on or after a date that is six months following the first commercial sale of SPARLON in the United States by providing us with at least 90 days' advance written notice of termination; and



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If Lost CONCERTA Market Exclusivity occurs prior to the first commercial sale of SPARLON in the United States, McNeil may terminate the Agreement on or after a date that is the later of (a) the four-month anniversary of Lost CONCERTA Market Exclusivity and (b) April 30, 2006, by providing us with at least 90 days' advance written notice of termination; provided that if the first commercial sale of the product occurs before the effective date of termination, then McNeil may only terminate the co-promotion agreement effective on or after a date that is at least six (6) months following the first commercial sale of SPARLON.

"Lost CONCERTA Market Exclusivity" will occur if a generic form of McNeil's ADHD product CONCERTA (methylphenidate HCl) Extended-release Tablets is sold in the United States for at least 60 days during the term of the co-promotion agreement. If McNeil exercises its option to terminate the co-promotion agreement because of the Lost CONCERTA Market Exclusivity, then we have the right to offer employment at that time to some or all of McNeil's sales force covered by the co-promotion agreement.

GABITRIL

        GABITRIL is a selective GABA (gamma-aminobutyric acid) reuptake inhibitor approved for use as adjunctive therapy in the treatment of partial seizures in epileptic patients. GABA is an important inhibitory transmitter in the central nervous system and is widely distributed in all regions of the brain. We currently have worldwide product rights to GABITRIL, excluding Canada and Latin America and we market GABITRIL in the United States, France, the United Kingdom and Germany, among other countries.

        While applicable laws and regulations prevent us from promoting our products for uses beyond those contained in the approved label, our analysis of prescription data in the United States for

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GABITRIL indicates that many physicians have elected to prescribe the product to treat conditions outside of its currently labeled indication, including generalized anxiety disorder and neuropathic pain. 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 non-induced patients without epilepsy. Following this update, we actively communicated this risk to physicians and otherwise limited our sales and marketing efforts for GABITRIL. As a result, sales in fiscal year 2005 of GABITRIL decreased 23% as compared fiscal year 2004. U.S. prescriptions for GABITRIL decreased by 19% from 2004 to 2005, according to IMS Health Incorporated ("IMS Health").

Epilepsy

        Epilepsy is a chronic disorder characterized by seizures that cause sudden, involuntary, time-limited alteration in behavior, including changes in motor activities, autonomic functions, consciousness or sensations, and accompanied by an abnormal electrical discharge in the brain. A partial seizure arises from a disorder emanating from a distinct, identifiable region of the brain and produces a given set of symptoms depending on the area of onset. A general seizure arises from a general dysfunction of biochemical mechanisms throughout the brain and may produce different types of convulsions. Epilepsy usually begins in early childhood, but can appear at any time during an individual's lifespan. It is estimated that more than one million adult Americans suffer from epilepsy.

Market expansion strategies

        Because GABITRIL works selectively to increase the amount of available GABA in the brain, it may be useful in treating conditions where additional GABA may prove effective. One such condition is generalized anxiety disorder ("GAD"). According to the National Institute of Mental Health ("NIMH"), GAD is characterized by chronic, exaggerated worry and tension that is unfounded or much more severe than the normal anxiety most people experience. Many people with GAD also have physical symptoms, such as fatigue, trembling, muscle tension, headaches, irritability or hot flashes. According to the NIMH, about 2.8% of U.S. adults have been diagnosed with GAD.

        We have completed enrollment in a 1,700 patient Phase 3 clinical program evaluating GABITRIL for the treatment of GAD and expect to announce results from these Phase 3 studies in the second quarter of 2006. If the results of the Phase 3 trials are positive, we expect to file an sNDA with the FDA in the second half of 2006 and are targeting a product launch in the second half of 2007. Our decision to move forward with a Phase 3 clinical program was based on data from an eight-week, double-blind, randomized, multi-center, placebo-controlled Phase 2 study with a flexible-dose design. The Phase 2 study included 260 adult patients with GAD and was designed to determine the dose, time of onset and magnitude of GABITRIL's effect in GAD. Statistically significant improvements were seen at weeks one and eight of the study in patients receiving GABITRIL, versus those receiving placebo, as measured by the Hamilton Anxiety Scale.

Intellectual Property Position

        GABITRIL is our trademark that is used in connection with pharmaceuticals containing tiagabine as the active drug substance. This product is covered by U.S. and foreign patents that are held by Novo-Nordisk A/S. The U.S. patents have been licensed in the United States exclusively to Abbott Laboratories. We have an exclusive sublicense from Abbott to these patents in the United States and exclusive licenses from Novo-Nordisk to corresponding foreign patents.

        There are four U.S. composition-of-matter patents covering the currently approved product: a patent claiming tiagabine, the active drug substance in GABITRIL; a patent claiming crystalline tiagabine hydrochloride monohydrate and its use as an anti-epileptic agent; a patent claiming the pharmaceutical formulation and a patent claiming anhydrous crystalline tiagabine hydrochloride and processes for its preparation. These patents currently are set to expire in 2011, 2012, 2016 and 2017,

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respectively. Supplemental Protection Certificates based upon corresponding foreign patents covering this product are set to expire in 2011. We also own rights to the GABITRIL trademark.

Manufacturing and Product Supply

        We have two third-party manufacturers of the active drug substance in GABITRIL and finished commercial supplies of the product in the United States and one third-party manufacturer of the active drug substance and finished commercial supplies outside the United States. We seek to maintain inventories of finished commercial supplies of GABITRIL to protect against supply disruptions.

Competition

        The pharmaceutical market for the treatment of partial seizures in epileptic patients generally is well served with a number of available therapeutics, several of which are recent entrants to the market. The market is dominated by Pfizer's NEURONTIN® (gabapentin). In addition, several treatments for partial seizures are available in inexpensive generic forms. Growth of pharmaceutical products in this market tends to be slow both because of the number of therapies available and also because physicians are unlikely to change the medication of a patient whose condition is well controlled.

PAIN

        Our pain therapeutics portfolio currently includes one marketed product, ACTIQ, and one product candidate, FEBT.

ACTIQ

        ACTIQ is approved in the United States for the management of breakthrough cancer pain in opioid tolerant patients. It was approved by the FDA in November 1998 and was launched in the United States in March 1999. Following our acquisition of Anesta Corp. in October 2000, we relaunched ACTIQ in February 2001. In October 2002, we reacquired rights to ACTIQ in 12 countries, principally in Europe, from Elan Pharma International Limited. While applicable laws and regulations prevent us from promoting our product for uses beyond those contained in the approved label, our analysis of prescription data for ACTIQ in the United States indicated that many physicians have elected to prescribe the product to treat conditions outside its labeled indication of breakthrough cancer pain.

        ACTIQ uses our proprietary oral transmucosal delivery system (OTS®) to deliver fentanyl citrate, a powerful, Schedule II opioid analgesic. The OTS delivery system consists of a drug matrix that is mounted on a handle. It is designed to achieve rapid absorption of fentanyl through the oral mucosa (the lining of the mouth) and into the bloodstream, with pain relief that may begin within 15 minutes. ACTIQ is available in six dosage strengths to allow individualization of dosing. Side effects of ACTIQ are typical of opioid products and include somnolence, nausea, vomiting and dizziness. The greatest risk from improper use of ACTIQ, as with all opioid-based products, is the potential for respiratory depression, which can be life-threatening. We market ACTIQ under a comprehensive risk management program of educational and safe use messages that inform health care professionals, patients and their families of proper use, storage, handling and disposal of the product.

Fentanyl effervescent buccal tablets

        Fentanyl effervescent buccal tablets ("FEBT") deliver the opioid fentanyl through the oral mucosa utilizing our proprietary, enhanced absorption technology, OraVescent. In the third quarter of 2005, we filed an NDA with the FDA seeking approval to market FEBT for the management of breakthrough pain in cancer patients who are tolerant to opioid therapy for their underlying persistent pain. Upon FDA approval, we intend to commercialize FEBT in multiple dosage strengths (100, 200, 400, 600 and 800 micrograms). We currently anticipate final FDA approval for FEBT in late 2006.

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        We also have initiated clinical programs to study FEBT for the management of breakthrough lower back pain and neuropathic pain, with the goal of expanding the FEBT labeled indication beyond breakthrough cancer pain.

Breakthrough Cancer Pain

        One of the most challenging components of cancer pain is breakthrough pain. Breakthrough pain is a flare of moderate to severe pain that "breaks through" the medication patients use to control their persistent pain. Breakthrough pain may be related to a specific activity, or may occur spontaneously and unpredictably. Breakthrough cancer pain typically develops rapidly and often reaches maximum intensity in three to five minutes. It has a duration that varies from minutes to several hours and can be extremely painful and debilitating. Cancer patients who suffer from breakthrough pain may suffer a number of episodes every day. The ideal management of breakthrough pain requires medication that has a rapid onset of action and the ability for dosing to be tailored to the individual characteristics of the breakthrough pain episodes, such as intensity and duration.

Licenses to Barr Laboratories, Inc. Related to ACTIQ

        In February 2006, we announced that we had agreed to settle with Barr our pending patent infringement dispute in the United States related to Barr's ANDA filed with the FDA seeking to sell a generic version of ACTIQ. Under the settlement, we will grant Barr an exclusive royalty bearing right to market and sell a generic version of ACTIQ in the United States, effective on December 6, 2006. Under the license and supply agreement we entered into with Barr to secure FTC clearance of the CIMA LABS acquisition in August 2004, we agreed to license to Barr our U.S. rights to any intellectual property related to ACTIQ. This license to ACTIQ could become effective prior to December 6, 2006 if we receive final FDA approval of FEBT before this date. In addition, this license could become effective on September 5, 2006, if we do not receive a pediatric extension of exclusivity for ACTIQ. Barr will pay specified royalties on net profits of a generic ACTIQ product for the period December 6, 2006 through February 3, 2007, subject to certain limitations. The patents covering the current formulation of ACTIQ are set to expire as early as September 5, 2006. If we are successful in our efforts to complete a specified clinical study of ACTIQ in pediatric patients, the FDA could grant us six months of exclusivity beyond the September 5, 2006 patent expiration. See also Note 12 of the Consolidated Financial Statements included in Part II, Item 8 of this Annual Report on Form 10-K. Under the license and supply agreement, Barr also may receive a license to the sugar-free formulation of ACTIQ that has been approved by the FDA; this license would become effective upon FDA approval of FEBT.

        Under the license and supply agreement, we also agreed to transfer to Barr our technological know-how and intellectual property related to ACTIQ and to sell to Barr, for period of up to three years, a generic form of ACTIQ for resale in the United States if Barr is unable to manufacture an FDA-approved generic version of ACTIQ by the date the license takes effect. In addition, we have agreed to forbear from asserting any remaining patent rights in ACTIQ against other parties beginning on the earlier of August 3, 2007 or six months following the effective date of Barr's license.

Intellectual Property Position

ACTIQ:    We hold an exclusive license to the U.S. patents covering the currently approved compressed powder pharmaceutical composition and the method for administering fentanyl via this composition that are set to expire in September 2006. If we are successful in our efforts to complete a clinical study of ACTIQ in pediatric patients prior to September 2006, the FDA could grant us six months of exclusivity beyond the September 2006 patent expiration. As described above, we have agreed to license to Barr our U.S. rights to any intellectual property related to ACTIQ. Corresponding patents covering the current formulation of ACTIQ in foreign countries expire between 2009 and 2010.

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Our patent protection with respect to the ACTIQ formulation we sold in the United States prior to June 2003 expired in May 2005.

        Other issued patents and pending patent applications in the United States and foreign countries that are owned or licensed by us are directed to various formulations (including a sugar-free formulation), processes for manufacturing the product, methods of using the product and disposable containers required by the FDA to be provided as part of the product. We also hold the rights to the ACTIQ trademark covering pharmaceuticals for oral transmucosal delivery containing fentanyl as the active drug substance.

FEBT:    We own formulation, method of treatment and manufacturing patents and patent applications expiring between 2019 and 2024 directed to FEBT. Assuming success in attaining FDA approval for this product in late 2006, we also would expect to receive a three-year period of marketing exclusivity that would extend until late 2009.

Manufacturing and Product Supply

        At our facility in Salt Lake City, Utah, we manufacture ACTIQ for sale in the United States and international markets. In 2004, we began a nearly $70 million, two-year capital expansion project at our Salt Lake City facility to increase our ACTIQ manufacturing and packaging capacity and provide us with flexibility to manufacture other products, including FEBT, at this facility. We anticipate completion of this project in the second half of 2006. If approved, we plan to manufacture FEBT at our facility in Eden Prairie, Minnesota, as well as at our Salt Lake City facility.

        Fentanyl, the active ingredient in ACTIQ and FEBT, is a Schedule II controlled substance under the Controlled Substances Act. Our purchases of fentanyl for use in the production of ACTIQ and FEBT are subject to quota that is approved by the U.S. Drug Enforcement Administration ("DEA"). Supply disruption could result from delays in obtaining DEA approvals or the receipt of approvals for quantities of fentanyl that are insufficient to meet current or projected product demand. The quota system also limits our ability to build inventories as a method of insuring against possible supply disruptions.

Competition

        Both long-acting and short-acting formulations are prescribed to treat cancer pain. Persistent pain is typically treated by around-the-clock administration of long- or short-acting opioids. Breakthrough cancer pain is usually treated with a short-acting product, such as ACTIQ, that is used in conjunction with an around-the-clock formulation.

        Long-acting products, which have a slower onset and longer duration of action relative to ACTIQ, are commonly prescribed to treat persistent pain. Three long-acting opioid analgesics and their generic equivalents currently marketed for chronic pain dominate this market: Johnson & Johnson's DURAGESIC® and Purdue Pharmaceuticals' OXYCONTIN® and MS-CONTIN®. Persistent cancer pain also is treated with short-acting opioid tablets, capsules and elixirs, as well as quick-acting invasive opioid delivery systems (i.e., intravenous, intramuscular and subcutaneous), many of which have been available for many years and are available in inexpensive generic form.

        The overwhelming majority of prescriptions written to treat breakthrough cancer pain are for short-acting opioids other than ACTIQ, such as morphine and combination products (with acetaminophen and oxycodone or hydrocodone), as well as quick-acting opioids delivered via invasive delivery systems. In some cases, physicians also may attempt to manage breakthrough pain by increasing the dose of a long-acting opioid.

        We are aware of numerous companies developing other technologies for rapid delivery of opioids to treat breakthrough pain, including transmucosal, transdermal, nasal spray, and inhaled delivery systems, among others. If these technologies are successfully developed and approved over the next few

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years, they could represent significant competition for ACTIQ and, if approved, FEBT. Even without new competitive products, we will face at least one generic competitor to ACTIQ in late 2006 as a result of the licenses we have granted to Barr, which will have a significant and negative impact on ACTIQ sales thereafter. The availability of inexpensive generic forms of ACTIQ also could potentially have a negative impact on sales of FEBT, if approved.

ONCOLOGY

        Our oncology portfolio includes one marketed product and two product candidates to treat patients with hematologic cancers: TRISENOX, an intravenous arsenic-based targeted therapy currently marketed in the U.S. and Europe; TREANDA® (bendamustine hydrochloride), a multi-functional hybrid cytotoxic; and CEP-701 (lestaurtinib), an oral small molecule tyrosine kinase inhibitor.

        With the acquisition of Zeneus Holdings Limited in December 2005, we have added two commercialized oncology products to our European portfolio: MYOCET® (liposomal doxorubicin), a cardio-protective chemotherapy agent used to treat late-stage breast cancer and TARGRETIN® (bexarotene), a treatment for cutaneous T-cell lymphoma. In addition, we acquired ABELCET® (amphotericin B lipid complex), an anti- fungal product used by cancer patients. For more information regarding Zeneus' products, see the section below entitled "European Operations."

TRISENOX

        On July 18, 2005, we completed the acquisition of substantially all assets related to the TRISENOX injection business from Cell Therapeutics, Inc. ("CTI") and CTI Technologies, Inc., a wholly-owned subsidiary of CTI, for $69.7 million in cash, funded from existing cash on hand. The acquisition agreement provides for contingent future cash payments to CTI, totaling up to $100.0 million, upon the achievement of certain label expansions and sales milestones for TRISENOX.

        TRISENOX was approved for marketing in the United States and Europe in 2000 and 2002, respectively, for the treatment of patients with relapsed or refractory acute promyelocytic leukemia ("APL"), a life threatening hematologic cancer. TRISENOX is a highly purified version of arsenic, a natural element. TRISENOX appears to have multiple targets and mechanisms of antileukemic activity; it degrades a protein that causes abnormal levels of immature white blood cells while simultaneously forcing immature cancer cells to self-destruct through a process called programmed cell death or apoptosis. Apoptosis is a normal part of a cell's life cycle. Because cancer is often associated with a malfunction of the normal process of apoptosis, drugs that can induce apoptosis offer the hope of affecting cancer cells more selectively without the typical toxic side effects of conventional treatments. Direct induction of apoptosis represents a relatively new method of killing tumor cells that is different than the majority of conventional cancer drugs. As a result, in addition to its use as a single-agent therapy, TRISENOX may work well when administered in combination with other cancer therapies to produce more durable response rates. We are currently investigating uses of TRISENOX, as a single agent or in combination with other treatments, to treat other forms of hematologic cancers.

Acute Promyelocytic Leukemia

        APL is one of eight subtypes of acute myeloid or myelogenous leukemia ("AML"). According to the American Cancer Society, approximately 12,000 patients are diagnosed with AML in the United States every year, 10 to 15 percent of whom will have the APL subtype. Research indicates that approximately 10 to 30 percent of patients with APL will not respond to, or will relapse from, first-line therapy.

Intellectual Property Position

        Through our acquisition of TRISENOX from CTI in July 2005, we own method of treatment patents and applications covering methods of treating APL with the active ingredient arsenic trioxide

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that protect this product until 2018. TRISENOX is also protected by orphan drug exclusivity until 2007. We also own rights to the TRISENOX trademark.

Manufacturing and Product Supply

        We have one third-party manufacturer that produces the active drug substance arsenic trioxide for us and two third-party manufacturers that provides finished commercial supplies of TRISENOX to us in the United States and Europe. We seek to maintain inventories of active drug substance and finished commercial supplies to protect against supply disruptions.

Competition

        The pharmaceutical market for the treatment of patients with relapsed or refractory APL is served by a number of available therapeutics, particularly those that are indicated for the treatment of hematologic cancers, such as THALOMID® by Celgene Corporation and VELCADE® by Millennium Pharmaceuticals, Inc.

CEP-701

        CEP-701 (lestaurtinib) is under development as a treatment for flt-3-mutated AML, a hematologic cancer characterized by uncontrolled growth of myeloid cells of the blood and bone marrow. According to the American Cancer Society, in 2005, an estimated 12,000 people in the United States will be diagnosed with AML and approximately 9,000 people will die from AML. Approximately 25 to 30 percent of AML patients have a flt-3 genetic mutation that is associated with a poorer prognosis for relapse and survival.

        We are currently conducting a Phase 2 study of approximately 200 patients with AML who bear a flt-3 activating mutation at first relapse from standard induction chemotherapy. As of January 31, 2006, 58 patients have been randomly assigned to one of two treatment arms in the clinical trial: standard chemotherapy alone, or chemotherapy followed two days later by a daily 80-mg orally administered dose of CEP-701, continued for up to 113 days. The preliminary data suggest that chemotherapy followed by the oral compound CEP-701 may offer a clinical benefit compared to chemotherapy alone. A clinical response has been achieved in all patients who showed an 85 percent or greater inhibition of flt-3 activity and baseline cellular sensitivity to CEP-701. Patients with low flt-3-inhibitory activity or cells insensitive to CEP-701 had a very low rate of clinical response. These data suggest that there may be the potential to predict which patients will respond positively to CEP-701. Preliminary safety analyses indicate that CEP-701 is generally well tolerated, with only a modest increase in gastrointestinal events such as nausea and dyspepsia reported. However, these side effects rarely resulted in discontinuation from the study. CEP-701 is not presently indicated or approved by the FDA for the treatment of any disease.

Intellectual Property Position

        We own a composition of matter patent directed to CEP-701 that is set to expire in 2008 in the United States. If we are successful in attaining FDA approval for this compound in 2008, we would anticipate that the term of this patent would be extended under the Hatch-Waxman Act until 2013. In addition, assuming this same timetable for approval, we would expect to receive a five year New Chemical Entity period of marketing exclusivity (until 2013) and a seven year Orphan Drug period of exclusivity (until 2015) for the treatment of AML. We also hold rights to other patent applications directed to methods of treatment, formulations and polymorphs for CEP-701.

Competition

        If approved, CEP-701 would compete with a number of available therapeutics, particularly those that are indicated for the treatment of hematologic cancers. We understand that Novartis and

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Millennium Pharmaceuticals are each developing drugs with a similar flt-3 mutation inhibiting mechanism.

TREANDA

        We obtained the rights to market TREANDA in our acquisition of Salmedix, Inc. on June 14, 2005 for $160.9 million in cash and future payments totaling up to $40 million upon achievement of certain regulatory milestones.

        TREANDA, an investigational therapeutic under development for the treatment of indolent (slowly progressing) non-Hodgkin's lymphoma ("NHL"), is a novel hybrid cytotoxic alkylating agent that differs from conventional compounds in its apparent multi-functional mechanism of action. In addition to killing cells by damaging their DNA and triggering apoptosis—which is typical of alkylating agents—researchers demonstrated that TREANDA also causes the disruption of cell division. Preclinical data suggest that TREANDA's multi-functional mechanism of action may derive from its chemical structure in which one molecular ring common to traditional alkylators is altered. Benadmustine hydrochloride is currently marketed in Germany by a third party for the treatment of NHL, chronic lymphocytic leukemia, multiple myeloma, metastatic breast cancer and other solid tumors.

        In a Phase 2 study of patients with advanced indolent NHL who were previously exposed to multiple courses of therapy, 74 percent responded to TREANDA, including 35 percent with a complete response. All study participants had progressive disease after prior treatment with the antibody therapy rituximab (Rituxan®); a subgroup also had not responded to traditional alkylating agents. Rituximab and alkylators are commonly prescribed to treat NHL. In another Phase 2 study, TREANDA in combination with rituximab in patients with refractory and relapsed NHL produced a high overall response rate (87 percent) with minimal toxicity and no hair loss. A Phase 3 trial of TREANDA in indolent NHL refractory to rituximab is ongoing at sites in the United States and Canada. If results from this study are positive, we would expect to file an NDA for TREANDA in the first half of 2007.

Non-Hodgkin's Lymphoma

        NHL, which according to the National Cancer Institute is the sixth most prevalent cancer in the United States, occurs when lymphatic cells divide too much and too fast. Growth control is lost, and the lymphatic cells may overcrowd, invade and destroy lymphoid tissues and spread to other organs. There are two broad subtypes of NHL—indolent, also referred to as slow growing or low-grade, and aggressive. Indolent disease may "transform" into a more aggressive condition. According to the American Cancer Society, there will be almost 59,000 new cases of NHL in the U.S. in 2006; nearly 19,000 die from the disease annually.

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Intellectual Property Position

        Through our acquisition of Salmedix in June 2005, we own method of treatment and formulation patent applications that, if issued, we expect will protect this product until 2025 and 2026, respectively. In addition, we expect to receive a five year New Chemical Entity exclusivity which prevents the FDA from accepting an ANDA for this product for a five years from approval. We also own rights to the TREANDA trademark.

Manufacturing and Product Supply

        We have one third party supplier of the active drug substance bendamustine hydrochloride and one third party supplier of finished supplies of TREANDA for our use in clinical trials. If TREANDA is approved by the FDA, we expect to qualify our current manufacturers of the active drug substance and the finished supplies and to qualify additional manufacturers as may be necessary to meet commercial demands and to protect against supply disruptions.

Competition

        If approved, TREANDA would compete with traditional methods of treating indolent NHL, including treatments involving chemotherapy with a combination of drugs such as cyclophosphamide, vincristine and prednisolone and with drugs currently marketed (such as BEXXAR® (131-I tositumomab) by GlaxoSmithKline) or being developed to treat indolent NHL refractory to rituximab.

ADDICTION

        Our addiction therapeutic focus currently consists of one product candidate, VIVITROL, an investigational drug that is under review by the FDA for the treatment of alcohol dependence for use in a treatment program that includes psychosocial support. VIVITROL utilizes Alkermes' proprietary Medisorb® drug delivery technology in a once-a-month injectable formulation of naltrexone. Naltrexone is an FDA-approved drug that is currently available in daily oral dosage form for the treatment of alcohol dependence and for the blockade of effects of exogenously administered opioids.

        In March 2005, Alkermes submitted an NDA to the FDA for VIVITROL and, in December 2005, received an approvable letter for VIVITROL from the FDA. In February 2006, Alkermes announced that it had submitted a complete repsonse to the FDA approvable letter; on March 1, 2006, the FDA notified Alkermes that the response was considered a complete, Class 1 response and assigned an action date of April 16, 2006. Assuming final FDA approval, we anticipate that VIVITROL will launch in the first half of 2006.

Alcohol Dependence

        In the United States, approximately 18 million people are dependent on or abuse alcohol and an estimated 2.3 million adults seek treatment each year. Even among individuals currently seeking treatment, the majority relapse. Taking prescribed medication, an important determinant in therapeutic outcomes, is particularly challenging for patients with addictive disorders such as alcohol dependence. Alcohol is causally related to more than 60 medical conditions, including heart disease, liver disease, infectious disease and cancer, and contributes to more than 100,000 deaths in the United States each year.

License and Collaboration Agreement with Alkermes

        In June 2005, we entered into a license and collaboration agreement with Alkermes to develop and commercialize VIVITROL in the United States for the treatment of alcohol dependence. Under the terms of the collaboration agreement, we made an initial payment of $160 million to Alkermes and will

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make an additional $110 million payment if VIVITROL is approved by the FDA. In addition, Alkermes could receive up to an additional $220 million in milestone payments that are contingent on attainment of certain agreed-upon sales levels of VIVITROL. We have formed a joint commercialization team with Alkermes, and the parties will share responsibility for developing the commercial strategy for VIVITROL. We will have primary responsibility for the marketing and sale of VIVITROL and Alkermes will augment this effort with a team of managers of market development. Alkermes also is responsible for obtaining marketing approval for VIVITROL for the treatment of alcohol dependence and for manufacturing the supply of VIVITROL. We will record net sales from VIVITROL in the United States upon commercial launch. Alkermes will be responsible for certain development and registration costs incurred up to VIVITROL's approval by the FDA. Until the later of December 31, 2007 or 18 months following FDA approval of VIVITROL, Alkermes is responsible for any cumulative losses up to $120 million and Cephalon is responsible for any cumulative losses in excess of $120 million. Pre-tax profit, as adjusted for certain items, and losses incurred after the later of December 31, 2007 or 18 months following FDA approval will be split equally between the parties.

Intellectual Property Position

        Through our collaboration with Alkermes, we have a license to several U.S. patents and patent applications directed to VIVITROL that will expire between 2013 and 2024. Most of the patents and patent applications are directed generally to the processes involved in the Alkermes microsphere technology, while several are directed to the naltrexone drug product and to the injectable solution.

Manufacturing and Product Supply

        Concurrent with the execution of the collaboration agreement, we entered into a supply agreement under which Alkermes will provide to us finished commercial supplies of VIVITROL. Alkermes has limited experience in manufacturing products for commercial sale. If Alkermes is unable to successfully manufacture VIVITROL at commercial scale, the commercial launch of VIVITROL could be delayed or there could be a shortage in supply of such product, which would have a negative impact on sales of VIVITROL. In addition, Alkermes is responsible for the entire supply chain for VIVITROL, including the sourcing of raw materials and active pharmaceutical agents from third parties. Alkermes has no previous experience in managing a complex, current Good Manufacturing Practice (cGMP) supply chain and any issues with its supply sources could have an adverse effect on the commercial prospects for VIVITROL.

Competition

        If approved, VIVITROL would face competition from CAMPRAL by Forest Laboratories and currently marketed drugs also formulated from naltrexone, such as REVIA® by Duramed Pharmaceuticals, NALOREX® by Bristol-Myers Squibb and DEPADE® by Mallinckrodt. Other pharmaceutical companies are investigating product candidates that have shown some promise in treating alcohol dependence and that, if approved by the FDA, would compete with VIVITROL.

EUROPEAN OPERATIONS

Commercial Products

        We market and sell over 25 products in 18 European markets. For the year ended December 31, 2005, aggregate worldwide net sales of these other products accounted for approximately 14% of our total net sales, with the majority of this revenue derived from sales of our products in France. In 2005, our five largest products in terms of net product sales in Europe were SPASFON® (phloroglucinol), PROVIGIL, NAXY® (clarithromycin), ACTIQ and FONZYLANE® (buflomedil). Together, these products accounted for 87% of our European sales.

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        With the acquisition of Zeneus Holdings Limited in December 2005, we have added the sales, marketing, regulatory and clinical infrastructure necessary to grow our commercial presence in Europe and have supplemented our growing presence in oncology. We also have further diversified our revenue stream and expect that 15 to 20 percent of our 2006 sales could be derived from our European operations. As a result of the acquisition of Zeneus, we now have a strong presence in the five key European pharmaceutical markets: France, Germany, Italy, Spain and the United Kingdom. Zeneus has added seventeen commercialized products to our European product portfolio, including MYOCET, a cardio-protective chemotherapy agent used to treat late-stage breast cancer; TARGRETIN, a treatment for cutaneous T-cell lymphoma; and ABELCET, an anti-fungal treatment, as well as several investigational compounds in development.

        The following is a summary of the most significant products we market and sell in Europe as of December 31, 2005:

Product	Indication	Key Market(s)
ABELCET (amphotericin B lipid complex)(1)	Anti-fungal	France, Germany, Italy, Spain, U.K.
ACTIQ (oral transmucosal fentanyl citrate)	Breakthrough cancer pain	France, Germany, the United Kingdom
FONZYLANE® (buflomedil)	Cerebral vascular disorders	France
GABITRIL (tiagabine hydrochloride)	Partial seizures	France, Germany, U.K.
MYOCET (liposomal doxorubicin)	Late stage breast cancer	France, Germany, Italy, Spain, U.K.
NAXY® and MONO-NAXY® (clarithromycin)(2)	Antibiotic	France
PROVIGIL (modafinil)(3)	Excessive sleepiness associated with narcolepsy and certain other conditions	France, Germany, U.K.
SPASFON® (phloroglucinol)	Biliary/urinary tract spasm and irritable bowel syndrome	France
TARGRETIN (bexarotene)(4)	Cutaneous T-cell lymphoma	France, Germany, U.K.

(1)

ABELCET is licensed from Bristol Myers Squibb.

(2)

NAXY and MONO-NAXY are licensed from Abbott France.

(3)

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

(4)

TARGRETIN is licensed from Ligand Pharmaceuticals.

        In early 2006, we and Novartis Pharma AG agreed to terminate our exclusive collaboration arrangement established in November 2000. Under this collaboration agreement, we had marketed PROVIGIL, TEGRETOL® (carbamazepine), RITALIN® (methylphenidate), ANAFRANIL® (clomipramine) and LIORESAL® (baclofen) in the United Kingdom and had shared with Novartis the earnings from sales of the four Novartis neurology products and PROVIGIL in the United Kingdom.

Manufacturing Operations

        At our manufacturing facility in Mitry-Mory, France, we produce modafinil, which is used in the production of PROVIGIL, NUVIGIL and SPARLON. We manufacture certain other products at this facility and at our other facilities in France for sale in Europe and also perform warehousing, packaging and distribution activities for certain products sold in France and other export territories from these facilities. NAXY, MONO-NAXY, MYOCET, ABELCET and TARGRETIN are manufactured for us by third party manufacturers. For these and most of our other European products, we depend on single

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sources for the manufacture of both the active drug substances contained in our products and for finished commercial supplies.

European Competitive and Regulatory Environment

        In Europe, we face competition from generic versions of a number of the branded products we market. In addition, European Union pricing laws also allow the parallel importation of branded drugs between member countries. Due to pricing variations within the European Union, it is possible that our overall margins on our branded drugs could be impacted negatively as a result of the importation of product from relatively lower-margin member countries to relatively higher-margin member countries.

        In addition, the manufacture and sale of our products in Europe are subject to extensive regulation by European governmental authorities. Government efforts to control healthcare costs may result in further growth of generic competition to our proprietary products or a decrease in the selling prices of any of our proprietary products due to associated decreases in the amount the government health care authority will reimburse for any of those products. For example, we have been informed by the French health care authority that the reimbursement price for SPASFON and FONZYLANE in 2006 will decrease 15% from the 2005 reimbursement prices.

DRUG DELIVERY OPERATIONS

        Through our wholly-owned subsidiary, CIMA LABS INC., we pursue collaborative relationships with pharmaceutical companies that leverage the capabilities of these partners with our drug delivery and manufacturing capabilities to deliver new products incorporating our OraSolv® or DuraSolv® orally disintegrating drug delivery technologies or our ORAVESCENT® drug delivery technology. Revenues from these arrangements consist of net sales of manufactured products to partners, product development and licensing fees and royalties. For the year ended December 31, 2005, revenues earned by CIMA LABS totaled $76.5 million, or 6.3% of our total revenue. CIMA LABS collaborates with many partners, including AstraZeneca, Novartis, Organon, Schering-Plough and Wyeth. We currently have three manufacturing lines at our Eden Prairie, Minnesota facility for product requiring blister packaging and a manufacturing line at our Brooklyn Park, Minnesota facility for bottled product. We also have granulation and taste masking capabilities at our Eden Prairie facility. We believe that our production capacity will be adequate to meet our partners' needs for the foreseeable future.

RESEARCH AND DEVELOPMENT

        In addition to our clinical programs supporting our marketed products, our research and development efforts focus primarily on two therapeutic areas: disorders of the central nervous system and cancers. For many years, our research efforts targeted a family of CNS disorders termed "Neurodegenerative disorders," which include Alzheimer's and Parkinson's diseases, among others. These disorders are characterized by the death of neurons, the specialized conducting cells of the nervous system, which, in turn, results in the loss of certain functions such as memory and motor coordination. Cancers are characterized by the uncontrolled survival and proliferation of cells that form tumors. Our research has focused on an understanding of kinases, integral to cellular integrity, and the role they play in cellular proliferation and survival. We have coupled this knowledge by developing a library of novel, small, orally-active synthetic modulators of kinases that allows us to either enhance neuronal survival or induce cellular death. In addition, we have recently expanded our therapeutic and research interests and are exploring new therapeutic approaches in sleep medicine, psychiatry, pain, ADHD and cognition. While these efforts are in the early phases of discovery research, we expect them to provide a risk balanced, expanded pipeline of therapeutic opportunity in the future.

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Neurodegenerative Diseases

        Within the category of CNS disorders, our research program in neurodegenerative diseases is our most advanced. The objective of this work is to discover therapies that will halt the progress of neurodegenerative disease. A growing body of evidence, substantiated by our own research findings, suggests that neuronal death is caused by a series of biochemical events that are themselves precipitated by the activation of intracellular signaling pathways. In addition, these intracellular signaling mechanisms are responsible for the inability of neurons to function normally which leads to clinical symptoms of disease. Our research has identified the stress activated protein kinase pathway as integral to the cell death process, identified the mixed lineage kinase family as integral to this process and has discovered proprietary compounds that are efficacious in pre-clinical models of degenerative disease. In addition, we are actively investigating other kinases involved in degenerative disease.

Oncology

        Our current oncology research program includes two main therapeutic targets: solid tumors, which are associated with a broad range of cancers, and hematological cancers, such as acute myeloid leukemia (AML).

        In normal tissues, cellular proliferation is balanced by cellular death. Generally, both processes are controlled in part by a class of molecules (known as growth factors) that bind to cell surface receptors (many of which are kinases). Kinases control the lifecycle of a cell by communicating when it should replicate, cease replication, perform its functions in a healthy state, or where appropriate, die. In cancer, normal mechanisms of cell death are blocked, allowing cells to escape their programmed death and leaving cell proliferation unchecked.

        Current cancer therapies are designed to arrest and kill rapidly dividing cells non-selectively. Thus, traditional chemotherapy and radiation therapy kill all rapidly dividing cells, including both normal and cancerous cells, and the benefits of these therapies are often limited by their toxicity to normal cells. We believe that by discovering the mechanisms blocking cell-death programs and developing compounds to inhibit those mechanisms, our researchers can deliver more selective therapies to the marketplace and reduce toxic side effects associated with current cancer treatments.

Solid Tumors

        Solid tumors account for roughly 80 to 90 percent of all cancers. Cancers of the lung, breast, colon, and prostate—each of which involves the formation and spread of tumors—are among the most prevalent and deadly forms of cancer. Given this broad impact, one of our current research efforts is the development of anti-angiogenic compounds for treatment of solid tumors. Angiogenesis, the natural process used by the human body to produce blood vessels, occurs as a pathological process in the development of solid tumors such as breast and lung cancers. All living organisms, including tumors, need blood vessels to supply nutrients to survive and grow.

        In studying the cell signaling pathways that regulate angiogenesis, in collaboration with Sanofi-Aventis, we have targeted a receptor family responsible for survival of individual capillary cells: a protein receptor kinase called VEGF. Our scientists have synthesized a number of proprietary, orally active molecules that are potent and selective inhibitors of the VEGF receptor. These molecules have been shown to inhibit the formation of blood vessels and thereby slow the growth of a variety of tumors in preclinical models.

        Our researchers also are investigating the Tie-2 receptor kinase as an anti-angiogenic target. The Tie-2 receptor kinase works in concert with VEGF receptor systems to form new blood vessels. Inhibition of this kinase may also become another important weapon used to fight tumor angiogenesis.

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        From this research, a potential drug candidate has been identified incorporating both of these important mechanisms. Pre-clinical development activities are underway with the expectation of initiating human trials of this candidate in 2007.

Hematological Cancers

        Hematologic (blood) cancers such as leukemia, lymphoma and multiple myeloma continue to have a significant impact on human life. Hematologic cancers arise due to errors in the genetic information of an immature blood cell. As a consequence of these errors, the cell's development is arrested so that it does not mature further, but is instead replicated over and over again, resulting in a proliferation of abnormal blood cells that eventually crowd out and destroy normal blood cells.

        For patients suffering from AML, a malignant cancer that originates in the bone marrow cells, there is an uncontrolled proliferation of myeloid cells of the blood and bone marrow. The lack of normal white cells impairs the body's ability to fight infections. A shortage of platelets results in bruising and easy bleeding. According to the American Cancer Society, in 2005, an estimated 12,000 people in the United States will be diagnosed with AML, making it the most common form of adult leukemia and the second most common childhood leukemia.

        Our researchers, with our collaborators, found that in a subset of patients, their AML is caused by a mutation in a kinase called flt-3. Normally, flt-3 is involved in the growth and maturation of healthy blood cells. In AML patients with flt-3 mutations, the cell signaling pathways promote uncontrolled cell growth. Our compound, CEP-701, has been shown to block the signaling ability of the mutant flt-3 kinase in preclinical studies. We are currently conducting Phase 2 clinical trials with CEP-701, in combination with other therapies, to study its effect in patients suffering from AML.

        In addition, our researchers, in collaboration with Cell Therapeutics, are actively pursuing the development of novel inhibitors of the proteosome, a protease integral to normal cellular functioning. Clinical and pre-clinical studies provide a strong rationale for utility in hematological cancers. We have identified proprietary proteosome inhibitors that in preclinical models display greater efficacy and tolerability than currently available therapy and clinical investigations with at least one of these inhibitors are targeted for 2007.

Neurotrophic Factors

        Under a collaboration with Chiron Corporation that was terminated in February 2001, we conducted clinical trials using IGF-I, also known as MYOTROPHIN® (mecasermin) Injection, in patients in North America and Europe suffering from amyotrophic lateral sclerosis (ALS). ALS is a fatal disorder of the nervous system characterized by the chronic, progressive degeneration of motor neurons, which leads to muscle weakness, muscle atrophy and, eventually, to the patient's death. In February 1997, we submitted an NDA to the FDA for approval to market MYOTROPHIN in the United States for the treatment of ALS. In May 1998, the FDA issued a letter stating that the NDA was "potentially approvable," under certain conditions. We do not believe those conditions can be met without conducting an additional Phase 3 clinical study, and we have no plans to conduct such a study at this time. However, certain physicians have obtained governmental and non-governmental funding to be used to conduct such a study. We have agreed with these physicians to allow reference to our IND and have agreed to supply MYOTROPHIN in quantities sufficient for them to conduct the study in exchange for the right to use any clinical data generated by such study in support of FDA approval of our pending NDA. These physicians commenced the study in mid-2003 and enrollment was completed in August 2005. Even if positive, the results of this study may not be sufficient to obtain regulatory approval to market the product. Furthermore, we do not have a source for finished commercial supply of MYOTROPHIN in the event regulatory approval is obtained.

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Other Discovery Research Efforts

        Since our inception, we have been engaged in research to discover innovative medicines. This research has resulted in the discovery of compounds that could potentially be useful in treating important clinical conditions beyond those for which we have active development programs. In these and other cases, we often seek to establish collaborative partnerships with companies whose clinical development and marketing capabilities will maximize the value of these discoveries. For example, we have collaboration with Euroscreen s.a. to discover and develop small molecule therapeutics targeting G-Protein Coupled Receptors, or GPCR, a family of receptors that play a major role in cell signaling. This collaboration strengthens our internal efforts to provide a more diverse therapeutic breadth and depth to our research efforts. In addition, we have taken advantage of our expertise in angiogenesis and have a collaboration with Bausch and Lomb for the intraocular administration of anti-angiogenic agents for the treatment of age-related macular degeneration. We also sponsor a number of external research collaborations with academic laboratories to compliment our internal expertise.

DRUG DELIVERY TECHNOLOGIES

        Drug delivery technologies have been developed for a variety of therapeutic compounds, improving safety, efficacy, ease of patient use and patient compliance. In addition, drug delivery technologies can be used to expand markets for existing products, as well as to develop new products. We have focused our research and development efforts on developing new product applications using two primary drug delivery technologies: Orally Disintegrating Tablet ("ODT") technologies and Oral Transmucosal ("OTM") technologies.

ODT Technologies

        ODT technology has emerged as an important drug delivery technology that enables tablets to disintegrate quickly in the mouth without the use of water or chewing. ODT may improve compliance with a prescribed drug regimen, may improve dosing accuracy relative to liquid formulations and often is preferred by patients to conventional tablets and other formulations. Our two primary ODT technologies are OraSolv® and DuraSolv®. Our OraSolv technology incorporates taste masked active drug ingredients in orally disintegrating tablets. The low level of compaction pressure applied to OraSolv tablets allows higher porosity, faster disintegration time and larger amounts of taste masked active drug ingredients to be compressed into the tablets. The core U.S. patent for our OraSolv technology expires in 2010.

        Our DuraSolv technology uses higher compaction forces than OraSolv to produce orally disintegrating tablets incorporating active drug ingredients in a more durable orally disintegrating tablet. Due to their greater durability, DuraSolv tablets are easier to handle and package, and may cost less to produce and package. The core U.S. patent for our DuraSolv technology expires in 2018.

        In addition to our OraSolv and DuraSolv technologies, we continue to develop our LYOC technology to create ODT using freeze drying methods to manufacture tablets. We have a fully dedicated LYOC manufacturing site in Nevers, France, which we expect to expand to increase capacity. Once complete, we will have additional capacity for both in-house and third party manufacturing. We currently manufacture and sell several drugs in France using our LYOC technology, including SPASFON LYOC®, PARALYOC®, PROXALYOC®, and LOPERAMIDE LYOC®.

OTM Technologies

        OTM technologies are designed to increase the absorption of active drug ingredients across the mucosal membranes lining the oral cavity, gastrointestinal tract and colon. In the area of OTM technologies, we are investing in research and development of our proprietary ORAVESCENT technologies. Our ORAVESCENT drug delivery technologies include ORAVESCENT SL for drug

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delivery under the tongue ("sublingual") and ORAVESCENT BL for drug delivery between the gum and the cheek ("buccal"). We originally designed and continue to design our ORAVESCENT technologies to improve the transport of active drug ingredients across mucosal membranes in the oral cavity or the gastrointestinal tract. The core U.S. patents for our ORAVESCENT technology expire in 2019. In addition to our ORAVESCENT technologies, we continue to assess the potential uses of certain other proprietary buccal delivery systems in several therapeutic areas in which we focus.

CUSTOMERS

        Our principal customers are wholesale drug distributors. These customers comprise a significant part of the distribution network for all pharmaceutical products in the United States. Three large wholesale drug distributors, Cardinal Health, Inc., McKesson Corporation and AmerisourceBergen Corporation, control a significant share of this network. These three wholesale customers, in the aggregate, accounted for 86% of our worldwide net sales for the year ended December 31, 2005. The loss or bankruptcy of any of these customers could have an adverse affect on our results of operation and financial condition.

        Over the past two years, our wholesaler customers, as well as others in the industry, began modifying their business models from arrangements where they derive profits from the management of various discounts and rebates, to arrangements where they charge a fee for their services. In connection with this new wholesaler business model, we finalized wholesaler service agreements in the third quarter of 2005 with our major wholesaler customers. These agreements obligate the wholesalers to provide us with periodic retail demand 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 limits based on product demand.

COMPETITION

        We face intense competition and rapid technological change in the pharmaceutical marketplace. 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. In addition, many of the companies and institutions that compete against us 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. Our products also face potential competition from companies seeking to develop and sell generic formulations of our products at a substantial price discount to the current price of our products. 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 potentially could negatively affect sales of our products or make them obsolete. Advances in current treatment methods also may adversely affect the market for such products. In addition, 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.

        As discussed in more detail above, our products face competition in the marketplace. We cannot be sure that we will be able to demonstrate the potential advantages of our products to prescribing physicians and their patients on an absolute basis and/or in comparison to other presently marketed products. We also need to demonstrate to physicians, patients and third party payers that the cost of

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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.

GOVERNMENT REGULATION

        The manufacture and sale of therapeutics are subject to extensive regulation by U.S. and foreign governmental authorities. In particular, pharmaceutical products are subject to rigorous preclinical and clinical trials and other approval requirements as well as other post-approval requirements by the FDA under the Federal Food, Drug, and Cosmetic Act and by analogous agencies in countries outside the United States.

        As an initial step in the FDA regulatory approval process, preclinical studies are typically conducted in animals to identify potential safety problems and, in some cases, to evaluate potential efficacy. The results of the preclinical studies are submitted to regulatory authorities as a part of an IND that is filed with regulatory agencies prior to beginning studies in humans. However, for several of our drug candidates, no animal model exists that is potentially predictive of results in humans. As a result, no in vivo indication of efficacy is available until these drug candidates progress to human clinical trials.

        Clinical trials are typically conducted in three sequential phases, although the phases may overlap. Phase 1 typically begins with the initial introduction of the drug into human subjects prior to introduction into patients. In Phase 1, the compound is tested for safety, dosage tolerance, absorption, biodistribution, metabolism, excretion and clinical pharmacology, as well as, if possible, to gain early information on effectiveness. Phase 2 typically involves studies in a small sample of the intended patient population to assess the efficacy of the drug for a specific indication, determine dose tolerance and the optimal dose range, and to gather additional information relating to safety and potential adverse effects. Phase 3 trials are undertaken to further evaluate clinical safety and efficacy in an expanded patient population, generally at multiple study sites, to determine the overall risk-benefit ratio of the drug and to provide an adequate basis for product labeling. Each trial is conducted in accordance with certain standards under protocols that detail the objectives of the study, the parameters to be used to monitor safety and the efficacy criteria to be evaluated. In the United States, each protocol must be submitted to the FDA as part of the IND. Further, one or more independent Institutional Review Boards must evaluate each clinical study. The Institutional Review Board considers, among other things, ethical factors, the safety of the study, the adequacy of informed consent by human subjects and the possible liability of the institution. Similar procedures and requirements must be fulfilled to conduct studies in other countries. The process of completing clinical trials for a new drug is likely to take a number of years and require the expenditure of substantial resources.

        Promising data from preclinical and clinical trials are submitted to the FDA in an NDA for marketing approval and to foreign regulatory authorities under applicable requirements. Preparing an NDA or foreign application involves considerable data collection, verification, analyses and expense, and there can be no assurance that the applicable regulatory authority will accept the application or grant an approval on a timely basis, if at all. The marketing or sale of pharmaceuticals in the United States may not begin without FDA approval. The approval process is affected by a number of factors, including primarily the safety and efficacy demonstrated in clinical trials and the severity of the disease. Regulatory authorities may deny an application if, in their sole discretion, they determine that applicable regulatory criteria have not been satisfied or if, in their judgment, additional testing or information is required to ensure the efficacy and safety of the product. One of the conditions for initial marketing approval, as well as continued post-approval marketing, is that a prospective manufacturer's quality control and manufacturing procedures conform to the current Good Manufacturing Practice regulations of the regulatory authority. In complying with these regulations, a manufacturer must continue to expend time, money and effort in the area of production, quality control and quality assurance to ensure full compliance. Manufacturing establishments, both foreign

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and domestic, also are subject to inspections by or under the authority of the FDA and by other federal, state, local or foreign agencies. Discovery of previously unknown problems with a product or manufacturer may result in restrictions on such product or manufacturer, including withdrawal of the product from the market.

        After regulatory approval has been obtained, further studies, including Phase 4 post-marketing studies, may be required to provide additional data on safety, to validate surrogate efficacy endpoints, or for other reasons, and the failure of such studies can result in a range of regulatory actions, including withdrawal of the product from the market. Further studies will be required to gain approval for the use of a product as a treatment for clinical indications other than those for which the product was initially approved. Results of post-marketing programs may limit or expand the further marketing of the products. Further, if there are any modifications to the drug, including any change in indication, manufacturing process, labeling or manufacturing facility, it may be necessary to submit an application seeking approval of such changes to the FDA or foreign regulatory authority. Finally, the FDA can place restrictions on approval and marketing utilizing its authority under applicable regulations. For example, ACTIQ was approved under subpart H of FDA approval regulations, which gives the FDA the authority to pre-approve promotional materials and permits an expedited market withdrawal procedure if issues arise regarding the safe use of ACTIQ. Moreover, marketed products are subject to continued regulatory oversight by the Office of Medical Policy Division of Drug Marketing, Advertising, and Communications, and the failure to comply with applicable regulations could result in marketing restrictions, financial penalties and/or other sanctions.

        Whether or not FDA approval has been obtained, approval of a product by regulatory authorities in foreign countries must be obtained prior to the commencement of commercial sales of the product in such countries. The requirements governing the conduct of clinical trials and product approvals vary widely from country to country, and the time required for approval may be longer or shorter than that required for FDA approval. Although there are procedures for unified filings for most European countries, in general, each country also has its own additional procedures and requirements, especially related to pricing of new pharmaceuticals. Further, the FDA and other federal agencies regulate the export of products produced in the United States and, in some circumstances, may prohibit or restrict the export even if such products are approved for sale in other countries.

        In the United States, the Orphan Drug Act provides incentives to drug manufacturers to develop and manufacture drugs for the treatment of rare diseases, currently defined as diseases that affect fewer than 200,000 individuals in the United States, or for a disease that affects more than 200,000 individuals in the United States, where the sponsor does not realistically anticipate its product becoming profitable. The FDA has granted PROVIGIL orphan drug status for use in treating excessive daytime sleepiness associated with narcolepsy and has designated MYOTROPHIN as an orphan drug for use in treating ALS, because each indication currently affects fewer than 200,000 individuals in the United States. Under the Orphan Drug Act, a manufacturer of a designated orphan product can seek certain tax benefits, and the holder of the first FDA approval of a designated orphan product will be granted a seven-year period of marketing exclusivity for that product for the orphan indication. While the marketing exclusivity of an orphan drug would prevent other sponsors from obtaining approval of the same drug compound for the same indication unless the subsequent sponsors could demonstrate clinical superiority or a market shortage occurs, it would not prevent other sponsors from obtaining approval of the same compound for other indications or the use of other types of drugs for the same use as the orphan drug. Orphan drug designation generally does not confer any special or preferential treatment in the regulatory review process. The U.S. Congress has considered, and may consider in the future, legislation that would restrict the duration or scope of the market exclusivity of an orphan drug and, thus, we cannot be sure that the benefits of the existing statute will remain in effect. Additionally, we cannot be sure that other governmental regulations applicable to our products will not change.

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        In addition to the market exclusivity period under the Orphan Drug Act, the U.S. Drug Price Competition and Patent Term Restoration Act of 1984 permits a sponsor to apply for a maximum five-year extension of the term of a patent for a period of time following the initial FDA approval of an NDA for a New Chemical Entity ("NCE"). The statute specifically allows a patent owner acting with due diligence to extend the term of the patent for a period equal to one-half the period of time elapsed between the approval of the IND and the filing of the corresponding NDA, plus the period of time between the filing of the NDA and FDA approval, up to a maximum of five years of patent term extension. Any such extension, however, cannot extend the patent term beyond a maximum term of fourteen years following FDA approval and is subject to other restrictions. Additionally, under this statute, five years of marketing exclusivity is granted for the first approval of an NCE. During this period of exclusivity, sponsors generally may not file and the FDA may not approve an ANDA or a 505(b)(2) application for a drug product equivalent or identical to the NCE. An ANDA is the application form typically used by manufacturers seeking approval of a generic version of an approved drug. There is also a possibility that Congress will revise the underlying statute in the next few years, which may affect these provisions in ways that we cannot foresee. Additionally, the FDA regulates the labeling, storage, record keeping, advertising and promotion of prescription pharmaceuticals. Drug manufacturing establishments must register with the FDA and list their products with the FDA.

        The Controlled Substances Act imposes various registration, record-keeping and reporting requirements, procurement and manufacturing quotas, labeling and packaging requirements, security controls and a restriction on prescription refills on certain pharmaceutical products. A principal factor in determining the particular requirements of this act, if any, applicable to a product is its actual or potential abuse profile. A pharmaceutical product may be listed as a Schedule II, III, IV or V substance, with Schedule II substances considered to present the highest risk of substance abuse and Schedule V substances the lowest. Modafinil, the active drug substance in PROVIGIL, has been scheduled under the Controlled Substances Act as a Schedule IV substance. Schedule IV substances are allowed no more than five prescription refills during a six-month period and are subject to special handling procedures relating to the storage, shipment, inventory control and disposal of the product. Fentanyl, the active ingredient in ACTIQ and FEBT, is a Schedule II controlled substance. Schedule II substances are subject to even stricter handling and record keeping requirements and prescribing restrictions than Schedule III or IV products. In addition to federal scheduling, both PROVIGIL and ACTIQ are subject to state controlled substance regulation, and may be placed in more restrictive schedules than those determined by the U.S. Drug Enforcement Agency and FDA. However, to date, neither modafinil nor fentanyl has been placed in a more restrictive schedule by any state.

        In addition to the statutes and regulations described above, we also are subject to regulation under the Occupational Safety and Health Act, the Environmental Protection Act, the Toxic Substances Control Act, the Resource Conservation and Recovery Act and other federal, state and local regulations.

LEGAL MATTERS

        For a summary of legal matters, see Note 12 of the Consolidated Financial Statements included in Part II, Item 8 of this Annual Report on Form 10-K, which is incorporated herein by reference.

EMPLOYEES

        As of December 31, 2005, we had a total of 2,895 full-time employees, of which 2,027 were employed in the United States and 868 were located at our various facilities in Europe. We believe that we have been successful in attracting skilled and experienced personnel; however, competition for such personnel is intense.

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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 anticipated 2006 revenues is derived from our U.S. products, and our future success will depend on the continued acceptance and growth of these products.

        For the year ended December 31, 2005, approximately 86% of our worldwide net sales were derived from sales of PROVIGIL, ACTIQ and GABITRIL. We cannot be certain that these products will continue to be accepted in their markets. Specifically, the following factors, among others, could affect the level of market acceptance of PROVIGIL, ACTIQ and GABITRIL:

•

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



•

the level and effectiveness of our sales and marketing efforts;



•

any unfavorable publicity regarding these products or similar products;



•

the price of the product relative to other competing drugs or treatments;



•

the entrance of generic competition to ACTIQ in late 2006;



•

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.

        Any adverse developments with respect to the sale or use of PROVIGIL, ACTIQ and GABITRIL 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 indications for 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 approval for our near-term product candidates: NUVIGIL, SPARLON, FEBT, VIVITROL and GABITRIL for GAD. We do not know whether we or, in the case of VIVITROL, our partner, will succeed in obtaining final regulatory approval to market any of these products or what level of market acceptance these products may achieve. It is also possible that the sale of a generic version of ACTIQ by Barr in late 2006 could negatively impact sales of FEBT. For GABITRIL, we have not yet completed Phase 3 studies of the product for use in treating GAD. If the results of some of these additional studies are negative or adverse, this could undermine physician and patient comfort with the current product, limit its commercial success, and diminish its acceptance. Even if the results of these studies are positive, the impact on sales of GABITRIL may be minimal unless we are able to obtain regulatory approval to expand the authorized uses of this product. FDA regulations limit our ability to communicate the results of additional clinical studies to patients and physicians without first obtaining regulatory approval for any expanded uses.

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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.

PROVIGIL

        The U.S. composition of matter patent for modafinil expired in 2001. We own U.S. and foreign patent rights that expire between 2014 and 2015 and cover pharmaceutical compositions and uses of modafinil, specifically, certain particle sizes of modafinil contained in the pharmaceutical composition. Ultimately, these patents might be found invalid as the result of a challenge by a third party, or a potential competitor could develop a competing product or product formulation that avoids infringement of these patents. While we intend to vigorously defend the validity of these patents and prevent infringement, these efforts will be both expensive and time consuming and, ultimately, may not be successful. The loss of patent protection for PROVIGIL would significantly and negatively impact future PROVIGIL sales.

        As of the filing date of this Annual Report on Form 10-K, we are aware of six ANDAs on file with the FDA for pharmaceutical products containing modafinil. Each of these ANDAs contains a Paragraph IV certification in which the ANDA applicant certified that the U.S. particle-size modafinil patent covering PROVIGIL either is invalid or will not be infringed by the ANDA product. In March 2003, we filed a patent infringement lawsuit in the U.S. District Court in New Jersey against four companies—Teva Pharmaceuticals USA, Inc., Mylan Pharmaceuticals, Inc., Ranbaxy Laboratories Limited and Barr Laboratories, Inc.—based upon the ANDAs filed by each of these companies 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 October 6, 2014 (subject to a six-month extension to April 6, 2015 upon acceptance by the FDA of the pediatric study data submitted by us on December 21, 2005). We believe that these four companies were the first to file ANDAs with Paragraph IV certifications and thus are eligible for the 180-day exclusivity provided by the provisions of the Federal Food, Drug and Cosmetic Act.

        In late 2005 and early 2006, we announced that we had entered into settlement agreements with each of these four defendants. As part of these separate settlements, we agreed to grant to each of Teva, Mylan, Ranbaxy and Barr a non-exclusive royalty-bearing right to market and sell a generic version of PROVIGIL in the United States. These licenses will become effective in October 2011, unless we obtain a pediatric extension for PROVIGIL, which would permit entry by these firms in April 2012. An earlier entry may occur based upon the entry of another generic version of PROVIGIL. Each of these settlements has been filed with both the FTC and the Antitrust Division of the DOJ as required by the Medicare Modernization Act. The FTC has requested from us, and we have provided,

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certain information in connection with its review of the settlements. The FTC, the DOJ, or a private party could challenge in an administrative or judicial proceeding any or all of the settlements if they believe that the agreements violate the antitrust laws. If the settlements are challenged, there is no assurance that we could successfully defend against such challenge and, in that case, we could be subject to, among other things, damages, fines and possible invalidation of the settlement agreements.

        In early 2005, we also filed a patent infringement lawsuit in the U.S. District Court in New Jersey against Carlsbad Technology, Inc. based upon the Paragraph IV ANDA filed related to modafinil that Carlsbad filed with the FDA. Carlsbad has asserted counterclaims for non-infringement of the "516 Patent and invalidity of the "516 Patent. Carlsbad also has asserted a counterclaim for non-infringement of our U.S. Patent No. 4,927,855 (which we have not asserted against Carlsbad). We have moved to dismiss all of Carlsbad's counterclaims; Carlsbad has opposed the motion, and a decision is pending. Discovery in this action has only recently commenced. This ongoing litigation with Carlsbad is unaffected by each of the settlement agreements we have signed with Teva, Mylan, Ranbaxy and Barr.

        In late November 2005, we received notice that Caraco Pharmaceutical Laboratories, Ltd. also filed a Paragraph IV ANDA with the FDA seeking to market a generic form of PROVIGIL. We have not filed a patent infringement lawsuit against Caraco to date.

ACTIQ

        With respect to ACTIQ, we hold an exclusive license to U.S. patents covering the currently marketed compressed powder pharmaceutical composition and methods for administering fentanyl via this composition that are set to expire in September 2006. If we are successful in our efforts to complete a clinical study of ACTIQ in pediatric patients prior to September 2006, the FDA could grant us six months of exclusivity beyond this September 2006 patent expiration. Corresponding patents in foreign countries are set to expire between 2009 and 2010. Our patent protection with respect to the ACTIQ formulation we sold prior to June 2003 expired in May 2005.

        In February 2006, we announced that we had agreed to settle with Barr our pending patent infringement dispute in the United States related to Barr's ANDA filed with the FDA seeking to sell a generic version of ACTIQ. Under the settlement, we will grant Barr an exclusive royalty bearing right to market and sell a generic version of ACTIQ in the United States, effective on December 6, 2006. This license could become effective prior to December 6, 2006 if we receive final FDA approval of FEBT before this date or if we have not received a pediatric extension of exclusivity for ACTIQ. The entry of Barr with a generic form of ACTIQ likely will significantly and negatively impact future ACTIQ sales.

GABITRIL

        With respect to GABITRIL, we hold an exclusive sublicense to four U.S. composition-of-matter patents covering the currently approved product: a patent claiming tiagabine, the active drug substance contained in GABITRIL; a patent claiming crystalline tiagabine hydrochloride monohydrate and its use as an anti-epileptic agent; a patent claiming the pharmaceutical formulation; and a patent claiming anhydrous crystalline tiagabine hydrochloride and processes for its preparation. These patents currently are set to expire in 2011, 2012, 2016 and 2017, respectively. Supplemental Protection Certificates based upon corresponding foreign patents covering this product are set to expire in 2011.

        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

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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.

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.

        In September 2004, we announced that we had received subpoenas from the U.S. Attorney's Office in Philadelphia. That same month, we received a voluntary request for information from the Office of the Connecticut Attorney General. Both the subpoenas and the voluntary request for information appear to be focused on Cephalon's sales and promotional practices with respect to ACTIQ, GABITRIL and PROVIGIL, including the extent of off-label prescribing of our products by physicians. We are cooperating with the U.S. Attorney's Office and the Office of the Connecticut Attorney General and are providing documents and other information to both offices in response to these and additional requests. These matters may involve the bringing of criminal charges and fines, and/or civil penalties. We cannot predict or determine the outcome of these matters or reasonably estimate the amount or range of amounts of any fines or penalties that might result from an adverse outcome. However, an adverse outcome could have a material adverse effect on our financial position, liquidity and results of operations.

        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 our products PROVIGIL and ACTIQ and our product candidates SPARLON, NUVIGIL and FEBT contain active ingredients that are controlled substances, we are subject to regulation by the 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

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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 a foreign medical authority 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 cGMP regulations. In addition, we must comply with all applicable regulatory requirements of the DEA and analogous foreign authorities for certain of our products that contain controlled substances. 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.

        For certain of our products and near-term product candidates 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 European 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.

        With respect to VIVITROL, Alkermes is obligated to provide to us finished commercial supplies of the product under the terms of a supply agreement. While Alkermes has manufactured VIVITROL in small quantities for use in clinical trials, we cannot be sure that they will be able to successfully manufacture VIVITROL at a commercial scale in a timely or economical manner, or at all, if the product is approved by the FDA. If Alkermes is unable to successfully increase its manufacturing scale or capacity, the commercial launch of VIVITROL could be delayed or there could be a shortage in supply of the product, either of which could harm the commercial prospects for the product. In addition, Alkermes is responsible for the entire supply chain for VIVITROL, including the sourcing of raw materials and active pharmaceutical agents from third parties. Alkermes has no previous experience in managing a complex, cGMP supply chain and issues with its supply sources could impair its ability to supply VIVITROL under the supply agreement and have a material adverse effect on our commercial prospects for VIVITROL.

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As our products are used commercially, unintended side effects, adverse reactions or incidents of misuse may occur that could result in additional regulatory controls, 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 relatively limited commercial use to date. For example, 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 non-induced patients without epilepsy. 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 ACTIQ and PROVIGIL, which contain controlled substances. 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, ACTIQ has 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.

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 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. 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 we only have a few years of commercial history and 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, which may not meet with market expectations and which also may adversely affect our stock price. There are a number of other factors that could cause our financial results to fluctuate unexpectedly, including:

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cost of product sales;

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achievement and timing of research and development milestones;



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collaboration revenues;



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



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marketing and other expenses;



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manufacturing or supply disruptions; and



•

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

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

        During the fourth quarter of 2005, our 2.0% Notes became convertible and, in January 2006, our 2008 and 2010 Zero Coupon Notes also became convertible. As a result, the 2.0% Notes have been classified as a current liability on our balance sheet as of December 31, 2005 (see Note 9 of our Consolidated Financial Statements included in Part II, Item 8 of this Annual Report on Form 10-K for summary of our convertible debt, note hedges and call warrants) and, as of the filing date of this report, our Zero Coupon Notes are now also considered to be current liabilities. All of our convertible notes are presently convertible and, under the terms of the indentures governing the notes, we are obligated to repay in cash and common stock 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, 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.

Our research and development 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. For example, in the United States, we are party to an agreement with McNeil Consumer & Specialty Pharmaceuticals Division of McNeil-PPC, Inc. under which McNeil will co-promote SPARLON, our proprietary pediatric formulation of modafinil for ADHD, for up to three years following the commercial launch of the product, if approved by FDA. Our ability to successfully commercialize SPARLON will depend to a significant degree on the efforts of our partner. If McNeil fails to meet its obligations under the co-promotion agreement, is ineffective in its efforts, or determines to terminate the agreement prior to the end of its term, the launch and subsequent marketing of SPARLON could be materially and negatively impacted. Additionally, if McNeil elects to terminate the agreement early as provided for by the agreement, we may be unsuccessful in our efforts to hire the McNeil sales representatives, as permitted under the agreement, or in our efforts to promote SPARLON on our own.

        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;

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•

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. For example, we are aware of governmental efforts in France to limit or eliminate reimbursement for some of our products, particularly SPASFON and FONZYLANE, which could impact revenues from our French operations.

        In the United States, there have been, and we expect there will continue to be, various proposals to implement similar controls. 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 could focus 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 could negatively impact our product sales and profitability.

        On January 1, 2006, the U.S. Department of Health & Human Services began implementing Medicare Part D in accordance with the Medicare Modernization Act. Under this plan, voluntary prescription drug coverage, subsidized by Medicare, is offered to over 40 million Medicare beneficiaries through competing private prescription drug plans (PDPs) and Medicare Advantage (MA) plans. We cannot predict the potential impact that this program will have on our business, as it is not clear how the law will be implemented by regulators or received by consumers and physicians. While the overall usage of pharmaceuticals may increase as the result of the expanded access to prescription drugs afforded under Medicare Part D, this may be offset by reduced pharmaceutical prices resulting from limited coverage of particular products in a therapeutic category and the enhanced purchasing power of the Medicare Part D plan sponsors. In addition, it is unclear what impact this legislation will have on the pricing, rebates and discounts for our products.

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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. In addition, ACTIQ will face generic competition in late 2006.

        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, if approved, NUVIGIL, there are several other products used for the treatment of excessive sleepiness or narcolepsy in the United States, including methylphenidate products such as RITALIN® by Novartis, and in our other territories, many of which have been available for a number of years and are available in inexpensive generic forms. If we are successful in obtaining final FDA approval of SPARLON, we will face well established and intense competition from stimulants such as RITALIN® by Novartis, STRATERRA® by Eli Lilly, and CONCERTA® by McNeil, as well as from amphetamines such as DEXEDRINE® by GlaxoSmithKline and ADDERALL® by Shire. With respect to ACTIQ and, if approved, FEBT, 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, including transmucosal, transdermal, nasal spray and inhaled delivery systems, among others, that will compete against ACTIQ and, if approved, FEBT. With respect to GABITRIL, there are several products, including NEURONTIN® (gabapentin) by Pfizer, used as adjunctive therapy for the partial seizure market. In addition, several treatments for partial seizures are available in inexpensive generic forms. If we are successful in our efforts to expand the label of GABITRIL to include anxiety disorders, we will face significant competition from well-established Selective Serotonin Reuptake Inhibitor products such as Paxil®, Effexor XR® and Lexapro®. 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, particularly those that are indicated for the treatment of hematologic cancers, such as THALOMID® by Celgene and VELCADE® by Millennium Pharmaceuticals. 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 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. For example, in connection with our recent acquisitions of Zeneus, Salmedix and TRISENOX and the license and collaboration agreement with Alkermes, we estimated the values of these transactions by making certain assumptions about, among other things, likelihood of regulatory approval for unapproved products and the market potential for each of the marketed products and the product candidates. Ultimately, our assumptions may prove to be incorrect, which could cause us to fail to realize the anticipated benefits of these transactions.

        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. During the past year, we completed the acquisitions of Zeneus and Salmedix, purchased assets related to TRISENOX, entered into a license agreement with Alkermes for VIVITROL, and executed a co-promotion agreement with McNeil for SPARLON. 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, 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 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

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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 can take up to 12 years, or even 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 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, 2005 through February 28, 2006 our common stock traded at a high price of $80.93 and a low price of $37.35. Negative announcements, including, among others:

•

adverse regulatory decisions;



•

disappointing clinical trial results;



•

disputes and other developments concerning 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. The internal control report must contain an assessment by our management of the effectiveness of our internal control over financial reporting (including the

37

disclosure of any material weakness) and a statement that our independent auditors have attested to and reported on management's evaluation of such internal controls. The Sarbanes-Oxley Act requires, among other things, that we 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.

        In early 2006, we implemented a new worldwide financial reporting system that requires changes to certain aspects of our existing system of internal control over financial reporting. Due to the number of controls to be examined, both with respect to the new reporting system and our other internal controls over financial reporting, the complexity of these projects, and the subjectivity involved in determining the effectiveness of controls, 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 attest that our management's report is fairly stated or they are unable to express an opinion on our management's evaluation, we could be 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 year ended December 31, 2005, approximately 14.7% of our revenues were denominated in currencies other than the U.S. dollar. In 2006, we expect this percentage to increase as a result of the Zeneus acquisition. 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 86% of our worldwide net sales for the year ended December 31, 2005. 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. Furthermore, the loss or bankruptcy of any of these customers could materially and adversely affect our results of operations and financial condition.

38

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 certain litigation matters in addition to those matters specifically described in Note 12 of the Consolidated Financial Statements included in Part II, Item 8 of this Annual Report on Form 10-K. 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.

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 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 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.

39

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.

ITEM 1B.    UNRESOLVED STAFF COMMENTS

        None.

ITEM 2.    PROPERTIES

        We lease our corporate headquarters, which is located in Frazer, Pennsylvania and consists of approximately 190,000 square feet of administrative office space. We own approximately 160,000 square feet of research and office space in West Chester, Pennsylvania, at the site of our former corporate headquarters. We also lease approximately 154,000 square feet of office, administrative, research and warehouse space that is near our Frazer and West Chester facilities. In Salt Lake City, Utah, we house administrative, research, manufacturing and warehousing operations in approximately 123,000 square feet that we lease. In addition, we are completing construction of a 193,000 square feet facility located on approximately 20 acres of property adjoining our current facilities in Salt Lake City, which we plan to begin using in the second half of 2006 for shipping and receiving, quality control and packaging. At our CIMA LABS facilities in Eden Prairie and Brooklyn Park, Minnesota, we own approximately 200,000 square feet of space, most of which is dedicated to our manufacturing and warehousing operations.

        We lease office space for our European operations in the U.K. as well as space for our satellite offices in a number of major European countries. In France, we own administrative facilities, an executive and development facility, a manufacturing facility, a packaging facility and various warehouses totaling approximately 326,000 square feet. We also lease the site of our other manufacturing facility in France totaling approximately 29,000 square feet. We believe that our current facilities are adequate for our present purposes.

ITEM 3.    LEGAL PROCEEDINGS

        The information set forth in Note 12 of the Consolidated Financial Statements included in Part II, Item 8 of this Annual Report on Form 10-K is incorporated herein by reference.

ITEM 4.    SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

        We did not submit any matters to the vote of security holders during the fourth quarter of 2005.

40

Executive Officers of the Registrant

        The names, ages and positions held by our executive officers as of the filing date of this Annual Report on Form 10-K are as follows:

Name	Age	Position
Frank Baldino, Jr., Ph.D.	52	Chairman and Chief Executive Officer
Paul Blake, F.R.C.P.	58	Executive Vice President, Worldwide Medical and Regulatory Operations
J. Kevin Buchi	50	Executive Vice President and Chief Financial Officer
Peter E. Grebow, Ph.D.	59	Executive Vice President, Worldwide Technical Operations
John E. Osborn	48	Executive Vice President, General Counsel and Secretary
Robert P. Roche, Jr.	50	Executive Vice President, Worldwide Pharmaceutical Operations
Carl A. Savini	56	Executive Vice President and Chief Administrative Officer
Jeffry L. Vaught, Ph.D.	55	Executive Vice President and President, Research and Development

        All executive officers are elected by the Board of Directors to serve in their respective capacities until their successors are elected and qualified or until their earlier resignation or removal.

        Dr. Baldino founded Cephalon and has served as Chief Executive Officer and a director since its inception. He was appointed Chairman of the Board of Directors in December 1999. Dr. Baldino received his Ph.D. degree from Temple University, holds several adjunct academic appointments and is a trustee of Temple University. Dr. Baldino currently serves as a director of Pharmacopeia, Inc., a developer of proprietary technology platforms for pharmaceutical companies, Acusphere, Inc., a specialty pharmaceutical company, NicOx S.A., a company engaged in the research, development and commercialization of nitric oxide therapeutics and, until May 2006, ViroPharma, Inc., a biopharmaceutical company.

        Dr. Blake joined Cephalon in March 2001, and since February 2005, has served as Executive Vice President, Worldwide Medical and Regulatory Operations. From 1999 to 2001, Dr. Blake served as Chief Medical Officer for MDS Proteomics Inc., a Canadian health and life sciences company. From 1998 to 1999, he served as President and Chief Executive Officer of Proliance Pharmaceuticals, Inc., a drug development company. Prior to that, he spent six years with SmithKline Beecham Pharmaceuticals (currently, GlaxoSmithKline), most recently as Senior Vice President and Medical Director. Dr. Blake received his medical degree from London University, Royal Free Hospital and completed his clinical training in Internal Medicine and Cardiology. Dr. Blake is a fellow of the Royal College of Physicians (UK), a fellow of the Faculty of Pharmaceutical Medicine and a fellow of the American College of Clinical Pharmacology. He also serves on the board of directors of Protez Pharmaceuticals, a privately-held anti-infective discovery company, and ViaCell, Inc., a publicly-traded biotechnology company.

        Mr. Buchi joined Cephalon in March 1991 and since February 2006, he has held the position of Executive Vice President and Chief Financial Officer. From April 1996 through January 2006, Mr. Buchi was Senior Vice President and Chief Financial Officer, and he held several financial positions with the Company prior to April 1996. Between 1985 and 1991, Mr. Buchi served in a number of financial positions with E.I. du Pont de Nemours and Company. Mr. Buchi received a master of management degree from the J.L. Kellogg Graduate School of Management, Northwestern University in 1982. Mr. Buchi serves as a member of the board of directors of Lorus Therapeutics Inc., a publicly-traded Canadian biotechnology company, and Encysive Pharmaceuticals Inc., a publicly-traded pharmaceutical company.

41

        Dr. Grebow joined Cephalon in January 1991, and since February 2005 has served as Executive Vice President, Worldwide Technical Operations. Dr. Grebow also has served as Senior Vice President, Worldwide Technical Operations, Senior Vice President, Business Development, and Vice President, Drug Development. From 1988 to 1990, Dr. Grebow served as Vice President of Drug Development for Rorer Central Research, a division of Rhone-Poulenc Rorer Pharmaceuticals Inc., a pharmaceutical company. Dr. Grebow received a Ph.D. in chemistry from the University of California, Santa Barbara.

        Mr. Osborn joined Cephalon in March 1997 and was appointed Senior Vice President, General Counsel and Secretary in 1998, and Executive Vice President in 2006. From 1992 to 1997, Mr. Osborn was employed by The DuPont Merck Pharmaceutical Company, most recently as Vice President and Associate General Counsel. Prior to that, he served in the George H.W. Bush administration with the U.S. Department of State, practiced corporate law in Boston with the firm of Hale and Dorr, and clerked for a U.S. Court of Appeals judge. He holds a visiting research appointment in politics at Princeton University, and has been elected to membership in the American Law Institute and the Council on Foreign Relations. Mr. Osborn is a member of the board of governors of the East-West Center in Honolulu, an education and research organization established by the U.S. Congress to study the Asia Pacific region and its relationship with the United States. He also serves as a member of the board of directors of Incept BioSystems, Inc., a privately-held biomedical device company in Ann Arbor, Michigan. Mr. Osborn earned a law degree from the University of Virginia and a master's degree in international public policy from The Johns Hopkins University.

        Mr. Roche joined Cephalon in January 1995 and has served as Executive Vice President, Worldwide Pharmaceutical Operations since February 2005. From November 2000 to February 2005, Mr. Roche was Senior Vice President, Pharmaceutical Operations. In June 1999, he was appointed to Senior Vice President of Sales and Marketing, and prior to that was Vice President, Sales and Marketing. Previously, Mr. Roche served as Director and Vice President, Worldwide Strategic Product Development, for SmithKline Beecham's central nervous system and gastrointestinal products business, and held senior marketing and management positions with that company in the Philippines, Canada and Spain. Mr. Roche serves as a member of the board of directors of LifeCell Corporation, a publicly-traded biotechnology company. Mr. Roche graduated from Colgate University and received a master of business administration degree from The Wharton School, University of Pennsylvania.

        Mr. Savini joined Cephalon in June 1993, was appointed Senior Vice President in 1999, and has served as Executive Vice President and Chief Administrative Officer since February 2006. Mr. Savini has served in various capacities with the Company, including Senior Vice President, Administration and Senior Vice President, Human Resources. From 1983 to 1993, Mr. Savini was employed by Bristol-Myers Squibb Company and from 1981 to 1983 he was employed by Johnson & Johnson's McNeil Pharmaceuticals. Mr. Savini graduated from The Pennsylvania State University and received a master of business administration degree from La Salle College.

        Dr. Vaught joined Cephalon in August 1991, and since that time has been responsible for directing Cephalon's research operations. He currently serves as Executive Vice President and President, Research and Development. Prior to joining Cephalon, Dr. Vaught was employed by the R. W. Johnson Pharmaceutical Research Institute, a subsidiary of Johnson & Johnson. Dr. Vaught received a Ph.D. in pharmacology from the University of Minnesota.

42

PART II

ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES

        Our common stock is quoted on the NASDAQ National Market under the symbol "CEPH." The following table sets forth the range of high and low sale prices for the common stock as reported on the NASDAQ National Market for the periods indicated below.

		High		Low
2004
	First Quarter	$	60.98	$	48.10
	Second Quarter		60.10		50.54
	Third Quarter		54.96		41.58
	Fourth Quarter		51.73		44.68
2005
	First Quarter	$	52.24	$	45.44
	Second Quarter		47.54		37.35
	Third Quarter		48.75		38.24
	Fourth Quarter		66.92		43.50

        As of March 3, 2006 there were 553 holders of record of our common stock. On March 3, 2006, the last reported sale price of our common stock as reported on the NASDAQ National Market was $82.49 per share.

        We have not paid any dividends on our common stock since our inception and do not anticipate paying any dividends on our common stock in the foreseeable future.

Issuer Purchases of Equity Securities

Period	Total Number of Shares of Common Stock Purchased(1)	Average Price Paid Per Share(2)		Total Number of Shares of Common Stock Purchased as Part of Publicly Announced Plans or Programs	Approximate Dollar Value of Common Stock that May Yet Be Purchased Under the Plans or Programs
October 1–31, 2005	—		—	—	—
November 1–30, 2005	—		—	—	—
December 1–31, 2005	38,800	$	56.76	—	—
Total	38,800	$	56.76	—	—

(1)

Consists entirely of shares repurchased from employees. Under the terms of the 2004 Equity Compensation Plan, employees may elect to have shares withheld to satisfy income tax withholding obligations due upon vesting of a restricted stock award. Such repurchases are not part of a publicly announced plan or program.

(2)

Price paid per share is a weighted average based on the closing price of our common stock on the various vesting dates.

Securities Authorized for Issuance Under Equity Compensation Plans

        The following table gives information about our common stock that may be issued upon the exercise of options, warrants and rights under all of our existing equity compensation plans as of

43

December 31, 2005, including the 1987 Stock Option Plan (which expired in 1997) (the "1987 Plan"), the 2004 Equity Compensation Plan (the "2004 Plan") and the 2000 Equity Compensation Plan for Employees and Key Advisors (the "2000 Plan").

Equity Compensation Plan Information

Plan Category	(a) Number of Securities to be Issued Upon Exercise of Outstanding Options, Warrants and Rights(1)		(b) Weighted Average Exercise Price of Outstanding Options, Warrants and Rights(1)		(c) Number of Securities Remaining Available for Future Issuance (Excludes Securities Reflected in Column (a))(2)
Equity compensation plans approved by stockholders	6,635,866	(3)	$	42.85	156,744
Equity compensation plans not approved by stockholders(4)	3,880,175		$	56.66	203,500
Total	10,516,041		$	47.94	360,244

(1)

The foregoing does not include options assumed under the Anesta Corp. 1993 Stock Option Plan (the "Anesta Plan") as a result of our acquisition of Anesta Corp. in 2000. As of December 31, 2005, there were 64,438 shares of common stock subject to outstanding options under the Anesta Plan, with a weighted average exercise price of these options of $28.66 per share. No additional shares are reserved for issuance under the Anesta Plan.

(2)

The 2004 Plan permits our Board of Directors or the Stock Option and Compensation Committee of our Board to award stock awards to participants. Up to 12,409 of the securities remaining available for issuance under equity compensation plans approved by stockholders may be issued as restricted stock awards. Restricted stock awards are not permitted to be made under the terms of the 2000 Plan.

(3)

Includes awards covering 624,575 shares of unvested restricted stock that are outstanding under the 2004 Plan. Also includes 31,860 shares to be issued upon exercise of outstanding options granted under the 1987 Plan. There are no securities that remain available for grant under the 1987 Plan.

(4)

Issued under the 2000 Plan, which does not require the approval of, and has not been approved by, Cephalon stockholders.

2000 Equity Compensation Plan for Employees and Key Advisors

        On December 13, 2000, our Board of Directors adopted the 2000 Plan. The 2000 Plan has been amended several times since its adoption, with the most recent amendment to the 2000 Plan on July 25, 2002. The 2000 Plan provides that options may be granted to our employees who are not officers or directors of Cephalon and consultants and advisors who perform services for Cephalon. At the time of its initial approval, the 2000 Plan was not submitted to, nor was it required to be submitted to, our stockholders for approval. Amendments to the 2000 Plan, including amendments increasing the number of shares of Common Stock reserved for issuance under the 2000 Plan, also did not require approval of the Company's stockholders. In light of changes to the NASDAQ shareholder approval requirements for stock option plans, our Board of Directors has decided that it will not further increase the number of shares authorized for issuance under the 2000 Plan, but will continue to use any shares authorized for issuance under the 2000 Plan for future grants until the 2000 Plan expires according to its terms in 2010.

        The purpose of the 2000 Plan is to promote our success by linking the personal interests of our non-executive employees and consultants and advisors to those of our stockholders and by providing

44

participants with an incentive for outstanding performance. The 2000 Plan currently authorizes the granting of "non-qualified stock options" ("NQSOs") only. The 2000 Plan is administered and interpreted by the Compensation Committee of the Board of Directors. The Compensation Committee determines the individuals who will receive a NQSO grant under the 2000 Plan, the number of shares of Common Stock subject to the NQSO, the period during which the NQSO becomes exercisable, the term of the NQSO (but not to exceed 10 years from the date of grant) and the other terms and conditions of the NQSO consistent with the terms of the 2000 Plan. All of the NQSOs that are currently outstanding under the 2000 Plan become exercisable ratably over a four-year period beginning on the date of grant and expire ten years from the date of grant. The exercise price of a NQSO granted under the 2000 Plan will be determined by the Compensation Committee, but may not be less than the fair market value of the underlying stock on the date of grant. A grantee may exercise a NQSO granted under the 2000 Plan by delivering notice of exercise to the Compensation Committee and pay the exercise price (i) in cash, (ii) with approval of the Compensation Committee, by delivering shares of Common Stock already owned by the grantee and having a fair market value on the date of exercise equal to the exercise price, or through attestation to ownership of such shares, or (iii) through such other method as the Compensation Committee may approve. In the event of a "Corporate Transaction," (e.g., a merger in which 50% or more of the common stock is transferred to a third party), all outstanding stock options will automatically accelerate and become immediately exercisable, subject to certain limitations.

        The Board of Directors has the authority to amend or terminate the 2000 Plan at any time without stockholder approval. The 2000 Plan will terminate on December 12, 2010, unless it is terminated earlier or extended by the Board of Directors. No amendment or termination of the 2000 Plan may adversely affect any option previously granted under the 2000 Plan without the written consent of the participant, unless required by applicable law.

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ITEM 6. SELECTED FINANCIAL DATA

        We completed the acquisitions of issued share capital of Zeneus Holdings Limited on December 22, 2005, substantially all assets related to the TRISENOX injection business from CTI and CTI Technologies, Inc., a wholly-owned subsidiary of CTI on July 18, 2005, outstanding capital stock of Salmedix, Inc. on June 14, 2005 and the outstanding shares of capital stock of CIMA LABS on August 12, 2004. These acquisitions have been accounted for either as business combinations or asset purchases.

	Year Ended December 31,
(In thousands, except per share data) Statement of operations data:
	2005			2004			2003			2002			2001
Sales	$	1,156,518		$	980,375		$	685,250		$	465,943		$	226,132
Other revenues		55,374			35,050			29,557			40,954			35,863
Total revenues		1,211,892			1,015,425			714,807			506,897			261,995
Acquired in-process research and development		(366,815	)		(185,700	)		—			—			(20,000	)
Debt exchange expense		—			(28,230	)		—			—			(52,444	)
Write-off of deferred debt issuance costs		(27,109	)		—			—			—			—
Impairment charges		(20,820	)		(30,071	)		—			—			—
Income tax benefit (expense), net		70,164			(45,629	)		(46,456	)		112,629			—
Income (loss) before cumulative effect of a change in accounting principle	$	(174,954	)	$	(73,813	)	$	83,858		$	175,062		$	(55,484	)
Cumulative effect of a change in accounting principle		—			—			—			(3,534	)		—
Net income (loss)		(174,954	)		(73,813	)		83,858			171,528			(55,484	)
Dividends on convertible exchangeable preferred stock		—			—			—			—			(5,664	)
Net income (loss) applicable to common shares	$	(174,954	)	$	(73,813	)	$	83,858		$	171,528		$	(61,148	)
Basic income (loss) per common share:
Income (loss) before cumulative effect of a change in accounting principle	$	(3.01	)	$	(1.31	)	$	1.49		$	3.14		$	(1.27	)
Cumulative effect of a change in accounting principle		—			—			—			(.06	)		—
	$	(3.01	)	$	(1.31	)	$	1.49		$	3.08		$	(1.27	)
Weighted average number of common shares outstanding		58,051			56,489			55,560			55,104			48,292
Diluted income (loss) per common share:
Income (loss) before cumulative effect of a change in accounting principle	$	(3.01	)	$	(1.31	)	$	1.42		$	2.82		$	(1.27	)
Cumulative effect of a change in accounting principle		—			—			—			(.05	)		—
	$	(3.01	)	$	(1.31	)	$	1.42		$	2.77		$	(1.27	)
Weighted average number of common shares outstanding—assuming dilution		58,051			56,489			64,076			66,856			48,292

	As of December 31,
(In thousands) Balance sheet data:
	2005			2004			2003			2002			2001
Cash, cash equivalents and investments	$	484,090		$	791,676		$	1,155,163		$	582,688		$	603,884
Total assets		2,819,206			2,396,922	*		2,381,656			1,689,090			1,446,408
Long-term debt		763,097			1,284,410			1,409,417			860,897			866,589
Accumulated deficit		(570,072	)		(395,118	)		(321,305	)		(405,163	)		(576,691	)
Stockholders' equity		612,171			830,044			770,370			642,585			398,731

*

Certain reclassifications of prior year amounts have been made to conform to the presentation for the year ended December 31, 2005.

46

ITEM 7.    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 II, Item 8 of this Annual Report on Form 10-K.

EXECUTIVE SUMMARY

        Cephalon is an international biopharmaceutical company dedicated to the discovery, development and marketing of innovative products in four core therapeutic areas: CNS disorders, pain, cancer and addiction. In addition to conducting an active research and development program in these areas, we market four products in the United States and numerous products in various countries throughout Europe.

        Our three most important products, PROVIGIL, ACTIQ and GABITRIL, comprised approximately 86% of our worldwide net sales for the year ended December 31, 2005, of which approximately 94% was in the U.S. market. Consistent with our core therapeutic areas, we have aligned our U.S. field sales and sales management teams by area, with approximately 440 persons focused on CNS, 115 persons focused on pain, 30 persons focused on cancer and 135 persons focused on addiction. In Europe, we have a sales and marketing organization numbering approximately 360 persons that supports our presence in 18 European countries, including France, the United Kingdom, Germany, Italy and Spain.

        During 2006 and early 2007, we are seeking to attain FDA approval to market five product candidates. The following chart summarizes our progress with respect to these product opportunities, as well as our current expectations with respect to the timing of regulatory filings and possible launch dates, assuming FDA approval:

Product Candidate	Anticipated Indication	Anticipated Filing Date	Target Launch Date	Status
SPARLON™ (modafinil)*	ADHD in children and adolescents	Filed sNDA 4Q 2004	2Q 2006	Received approvable letter from FDA on October 20, 2005; FDA advisory panel scheduled for March 23, 2006
NUVIGIL™ (armodafinil)	Excessive sleepiness	Filed NDA 1Q 2005	Mid-2006	Current PDUFA date: April 30, 2006
VIVITROL™ (naltrexone for extended-release injectable suspension)*	Alcohol dependence	Filed NDA 1Q 2005	1st Half 2006	Received approvable letter from FDA on December 28, 2005.
fentanyl effervescent buccal tablets (FEBT)	Breakthrough cancer pain	Filed NDA 3Q 2005	Late 2006	Current PDUFA date: June 30, 2006
GABITRIL® (tiagabine hydrochloride)	Generalized Anxiety Disorder	2nd Half 2006	2nd Half 2007	Phase 3 clinical trial results expected 2Q 2006

*

We are a party to a co-promotion agreement with McNeil Consumer & Specialty Pharmaceuticals with respect to SPARLON and a license and collaboration agreement with Alkermes, Inc. with respect to VIVITROL.

Acquisitions, Transactions and Regulatory Actions

        During 2005, we consummated a number of transactions that strengthened our therapeutic focus on cancer in the U.S. and Europe and gave us access to a new area—alcohol dependence. As a part of our business strategy, we expect to continue to consider and, as appropriate, consummate acquisitions of other technologies, products and businesses and enter into collaborative arrangements. We also

47

made significant strides in 2005 toward final approval of our product candidates. Some notable achievements and transactions in 2005 included:

•

acquiring Salmedix, Inc., including the rights to TREANDA, a product candidate in Phase 3 clinical trials for the treatment of indolent (slowly progressing) NHL, a type of hematologic cancer;



•

entering into a license and collaboration agreement with Alkermes, Inc. to develop and commercialize VIVITROL in the United States for the treatment of alcohol dependence in combination with a treatment program that includes psychosocial support;



•

acquiring rights to TRISENOX, a product approved for marketing in the United States and Europe for the treatment of patients with relapsed or refractory APL, a life threatening hematologic cancer;



•

entering into a co-promotion agreement with McNeil Consumer & Specialty Pharmaceuticals Division of McNeil-PPC, Inc. with respect to SPARLON, under which McNeil will detail SPARLON in the United States primarily to pediatricians, psychiatrists and pediatric neurologists;



•

acquiring Zeneus Holdings Limited to accelerate our entry into the European oncology market and bolster our sales and marketing presence in Europe;



•

filing an NDA with the FDA seeking approval to market FEBT for the management of breakthrough pain in patients with cancer who are tolerant to opioid therapy for their underlying persistent pain;



•

filing an NDA with the FDA seeking approval to market NUVIGIL Tablets [C-IV] for the same labeled indications as PROVIGIL; and



•

receiving approvable letters from the FDA for VIVITROL, for the treatment of alcohol dependence in combination with a treatment program that includes psychosocial support, and for SPARLON, for the treatment of ADHD in children and adolescents between the ages of six through 17.

Settlements of Patent Infringement Lawsuits

        As a biopharmaceutical company, our future success is highly dependent on obtaining and maintaining patent protection for our products and technology. We intend to vigorously defend the validity, and prevent infringement of, our patents. The loss of patent protection on any of our existing products, whether by third-party challenge, invalidation, circumvention, license or patent expiration, would materially impact our results of operations.

        In late 2005 and early 2006, we announced the settlement of four separate patent infringement lawsuits related to modafinil that we had filed against Teva Pharmaceuticals USA, Inc., Mylan Pharmaceuticals Inc., Ranbaxy Pharmaceuticals Inc., and Barr Laboratories, Inc. As part of these separate settlements, we agreed to grant to each of Teva, Mylan, Ranbaxy and Barr a non-exclusive royalty-bearing right to market and sell a generic version of PROVIGIL in the United States. These licenses will become effective in October 2011, unless we obtain a pediatric extension for PROVIGIL, which would permit entry in April 2012. An earlier entry may occur based upon the entry of another generic version of PROVIGIL.

        In connection with the Barr, Ranbaxy and Teva settlements, we also entered into a series of business arrangements related to modafinil with Barr, Ranbaxy and Teva. We received licenses to certain modafinil-related intellectual property developed by each party and in exchange for these licenses, we agreed to make payments to these three companies collectively totaling up to

48

$136.0 million over the next several years, 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 will purchase an annual minimum amount of modafinil over a six year period beginning in 2006, with the aggregate payments over that period totaling approximately $82.6 million.

        In February 2006, we also announced that we had settled our pending United States patent infringement dispute with Barr related to its abbreviated new drug application ("ANDA") filed with the FDA seeking to sell a generic version of ACTIQ. Under the settlement, we will grant Barr an exclusive royalty bearing right to market and sell a generic version of ACTIQ in the United States, effective on December 6, 2006. Barr will pay specified royalties on net profits of a generic ACTIQ product for the period December 6, 2006 through February 3, 2007, subject to certain limitations. The patents covering the current formulation of the product are set to expire as early as September 5, 2006. If we are successful in our efforts to complete a clinical study of ACTIQ in pediatric patients prior to September 2006, the FDA could grant us six months of exclusivity beyond the September 5, 2006 patent expiration. Under the license and supply agreement we entered into with Barr in July 2004, we could face generic competition from Barr prior to December 6, 2006 if we receive FDA approval of FEBT before this date or if we are unable to complete the ongoing pediatric studies with ACTIQ prior to September 2006.

        Each of these settlements has been filed with both the FTC and the Antitrust Division of the DOJ as required by the Medicare Modernization Act. The FTC has requested from us, and we have provided, certain information in connection with its review of the settlements. The FTC, the DOJ, or a private party could challenge in an administrative or judicial proceeding any or all of the settlements if they believe that the agreements violate the antitrust laws. If the settlements are challenged, there is no assurance that we could successfully defend against such challenge and, in that case, we could be subject to, among other things, damages, fines and possible invalidation of the settlement agreements.

Indebtedness

        We have significant levels of indebtedness outstanding, nearly all of which consists of convertible notes with restricted conversion prices lower than our stock price as of the filing date of this report. 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. For a more complete description of these notes, see Note 9 to our Consolidated Financial Statements included in Part II, Item 8 of this Annual Report on Form 10-K. We do not have available cash, cash equivalents and investments sufficient to repay all of the convertible notes, if presented. In addition, there are no restrictions on our use of this cash, and the cash available to repay indebtedness may decline over time.

        As of December 31, 2005 and as of the filing date of this report, the fair value of both the 2.0% Notes and the Zero Coupon Notes is greater than the value of the shares into which such notes are convertible. 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 or Zero Coupon Notes will present significant amounts of such notes for conversion. 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, raising money in the capital markets or selling our note hedge instruments for cash. 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.

49

        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, or to successfully develop or acquire and commercialize new product candidates.

RECENT ACQUISITIONS AND TRANSACTIONS

Zeneus Holdings Limited Acquisition

        On December 22, 2005, we completed our acquisition of all of the issued share capital of Zeneus Holdings Limited. Total consideration paid in connection with the acquisition was approximately $365.8 million, net of cash acquired.

TRISENOX Acquisition

        On July 18, 2005, we completed the acquisition of substantially all assets related to TRISENOX from CTI and CTI Technologies, Inc., a wholly-owned subsidiary of CTI, for $69.7 million in cash, funded from existing cash on hand. The acquisition agreement provides for contingent future cash payments to CTI, totaling up to $100.0 million, upon the achievement of certain label expansions and sales milestones. The results of operations of TRISENOX have been included in the consolidated statements of operations since the acquisition date.

VIVITROL License and Collaboration

        In June 2005, we entered into a license and collaboration agreement with Alkermes, Inc. to develop and commercialize VIVITROL in the United States. Concurrent with the execution of this agreement, we entered into a supply agreement under which Alkermes will provide to us finished commercial supplies of VIVITROL. We made an initial payment of $160 million to Alkermes upon execution of the agreement, all of which has been recorded as an IPR&D charge as the product has not yet received FDA approval. We also have agreed to make an additional payment of $110 million to Alkermes if VIVITROL is approved by the FDA. Alkermes also could receive up to an additional $220 million in milestone payments from us upon attainment of certain agreed-upon sales levels of VIVITROL. Until the later of December 31, 2007 or 18 months following FDA approval of the product, Alkermes is responsible for any cumulative losses up to $120 million, and we are responsible for any cumulative losses in excess of $120 million. Pre-tax profit, as adjusted for certain items, and losses incurred after the later of December 31, 2007 or 18 months following FDA approval will be split equally between the parties. We will recognize product sales upon commercial launch.

Salmedix, Inc. Acquisition

        On June 14, 2005, we completed our acquisition of Salmedix, Inc. Under the Agreement and Plan of Merger dated May 12, 2005, we acquired all of the outstanding capital stock of Salmedix for $160.9 million in cash and future payments totaling up to $40 million upon achievement of certain regulatory milestones. The acquisition was funded from our existing cash on hand and was accounted for as an asset acquisition, as Salmedix is a development stage company. As a result of the acquisition, we obtained the rights to market TREANDA™ (bendamustine hydrochloride). The results of operations for Salmedix have been included in our consolidated financial statements as of the acquisition date.

CIMA LABS INC. Acquisition

        On August 12, 2004, we completed our acquisition of CIMA LABS INC. For the period August 13, 2004 to December 31, 2004, revenues attributable to CIMA LABS totaled $28.4 million.

50

Under the Agreement and Plan of Merger dated November 3, 2003, we acquired each outstanding share of CIMA LABS common stock for $34.00 per share in cash. The total cash paid to CIMA LABS stockholders in the transaction was approximately $482.5 million, net of CIMA LABS' existing cash on hand, or $409.4 million, net of its cash, cash equivalents and investments. As a result of the acquisition, we obtained the rights to CIMA LABS' FEBT product candidate for which we have filed an NDA with the FDA.

Co-Promotion Agreement with McNeil

        In August 2005, we entered into an agreement with McNeil Consumer & Specialty Pharmaceuticals Division of McNeil-PPC, Inc. concerning the co-promotion of SPARLON. Under the co-promotion agreement, McNeil has agreed to have at least 300 McNeil sales representatives co-promote and detail SPARLON upon FDA approval in the United States primarily to pediatricians, psychiatrists and pediatric neurologists. We will promote the product to psychiatrists, neurologists, primary care physicians, and other appropriate health care professionals and will retain all responsibility for the development, manufacture, distribution and sale of the product. We will pay McNeil commission fees calculated as a percentage of annual net sales of SPARLON during the term of the agreement and, if specified sales levels are reached in the final year of the agreement, during the three calendar years following the expiration of the agreement. Commission fees will be recognized as Sales and Marketing expenses in the same period that the related net sales are recognized.

        McNeil may terminate the co-promotion agreement prior to the end of the three-year term of the agreement if "Lost CONCERTA Market Exclusivity" occurs, subject to the following conditions:

•

Except as set forth in the next bullet point, McNeil may only terminate the co-promotion agreement effective on or after a date that is six months following the first commercial sale of SPARLON in the United States by providing us with at least 90 days' advance written notice of termination; and



•

If Lost CONCERTA Market Exclusivity occurs prior to the first commercial sale of SPARLON in the United States, McNeil may terminate the Agreement on or after a date that is the later of (a) the four-month anniversary of Lost CONCERTA Market Exclusivity and (b) April 30, 2006, by providing us with at least 90 days' advance written notice of termination; provided that if the first commercial sale of the product occurs before the effective date of termination, then McNeil may only terminate the co-promotion agreement effective on or after a date that is at least six (6) months following the first commercial sale of SPARLON.

        "Lost CONCERTA Market Exclusivity" will occur if a generic form of McNeil's ADHD product CONCERTA (methylphenidate HCl) Extended-release Tablets is sold in the United States for at least 60 days during the term of the co-promotion agreement. If McNeil exercises its option to terminate the co-promotion agreement because of the Lost CONCERTA Market Exclusivity, then we have the right to offer employment at that time to some or all of McNeil's sales force covered by the co-promotion agreement.

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RESULTS OF OPERATIONS
(Dollar amounts in thousands)

Year ended December 31, 2005 compared to year ended December 31, 2004:

		2005						2004						% Increase (Decrease)
		United States		Europe		Total		United States		Europe		Total		United States		Europe		Total
Sales:
	PROVIGIL	$	475,557	$	37,248	$	512,805	$	406,238	$	33,429	$	439,667	17	%	11	%	17	%
	ACTIQ		394,676		17,102		411,778		337,072		7,925		344,997	17	%	116	%	19	%
	GABITRIL		66,517		5,741		72,258		87,349		6,815		94,164	(24	)%	(16	)%	(23	)%
	Other		49,695		109,982		159,677		13,270		88,277		101,547	274	%	25	%	57	%
Total Sales			986,445		170,073		1,156,518		843,929		136,446		980,375	17	%	25	%	18	%
Other Revenues			47,587		7,787		55,374		28,749		6,301		35,050	66	%	24	%	58	%
Total Revenues		$	1,034,032	$	177,860	$	1,211,892	$	872,678	$	142,747	$	1,015,425	18	%	25	%	19	%

Sales—In the United States, we sell our products to pharmaceutical wholesalers, the largest three of which accounted for 86% of our worldwide net sales for the year ended December 31, 2005. 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 ("IMS Health"). We believe that speculative buying of product, particularly in anticipation of possible price increases, has been the historic practice of many pharmaceutical wholesalers. In past years, we attempted to minimize these fluctuations both by providing, from time to time, discounts to our customers to stock normal amounts of inventory (which we had historically defined as approximately one month's supply at our current sales level) and by canceling orders if we believe a particular customer is speculatively buying inventory in anticipation of possible price increases.

        Over the past two years, our wholesaler customers, as well as others in the industry, began modifying their business models from arrangements where they derive profits from the management of various discounts and rebates, to arrangements where they charge a fee for their services. In connection with this new wholesaler business model, we finalized wholesaler service agreements in the third quarter of 2005 with our major wholesaler customers. These agreements obligate the wholesalers to provide us with periodic retail demand 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 limits based on product demand.

        As of December 31, 2005, we received information from our three largest U.S. wholesaler customers about the levels of inventory they held for our products. Based on this information, which we have not independently verified, we believe that total inventory held at these wholesalers is approximately 2 to 3 weeks supply at our current sales levels.

        For the year ended December 31, 2005, total sales increased by 18% over the prior period. The factors that contributed to the increase in sales are summarized as follows:

•

Sales of PROVIGIL increased 17% as compared to the same period last year. Demand for PROVIGIL increased as evidenced by an increase in U.S. prescriptions for PROVIGIL of 16%, according to IMS Health. For the year ended December 31, 2005, sales of PROVIGIL also were impacted by domestic price increases of approximately 21% from period to period, offset by a decrease in the number of units of inventory held by U.S. wholesalers and an increase in product sales allowances.

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•

Sales of ACTIQ increased 19% as compared to the same period last year. Demand for ACTIQ increased as evidenced by an increase in U.S. prescriptions for ACTIQ of 8%, according to IMS Health. For the year ended December 31, 2005, sales of ACTIQ also were impacted by an increase in domestic prices of approximately 18% from period to period, offset by a decrease in the number of units of inventory held by U.S. wholesalers as well as an increase in product sales allowances.



•

Sales of GABITRIL decreased 23% as compared to the same period last year. U.S. prescriptions for GABITRIL decreased 19% according to IMS Health. This decrease was driven primarily by our decision to reduce our sales and marketing efforts following an update in February 2005 to the label information for GABITRIL. For the year ended December 31, 2005, sales of GABITRIL also were impacted by domestic price increases of approximately 32% from period to period, offset by a decrease in the number of units held by U.S. wholesalers as well as an increase in product sales allowances.



•

Other sales, which consist primarily of sales of other products and certain third party products, increased 57% as compared to the same period last year. The most significant increases in this category are sales of products manufactured and sold to pharmaceutical partners by CIMA LABS, which we acquired in August 2004, sales of NAXY® (clarithromycin), which we acquired in December 2004 and sales of TRISENOX® which we acquired in July 2005.

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:

		For the year ended
		December 31,
										% Change
		2005			2004			Change
Gross sales:		$	1,335,602		$	1,080,408		$	255,194	24	%
Product sales allowances:
	Prompt payment discounts		22,284			18,443			3,841	21	%
	Wholesaler discounts		24,373			—			24,373	100	%
	Returns		15,853			11,247			4,606	41	%
	Coupons		23,313			16,521			6,792	41	%
	Medicaid discounts		67,245			41,274			25,971	63	%
	Managed care and governmental contracts		26,016			12,548			13,468	107	%
			179,084			100,033			79,051
Net sales		$	1,156,518		$	980,375		$	176,143	18	%
Product sales allowances as a percentage of gross sales			13.4	%		9.3	%

        Increases in the product sales allowances as a percentage of gross sales from 2004 to 2005 primarily reflect the establishment of a wholesaler discount reserve in 2005 to provide for fees consistent with the terms of the wholesaler service agreements, increased Medicaid discounts resulting from both increased usage and increased rebate percentages due to price increases, and additional rebates for certain governmental programs. In the future, we expect product sales allowances as a percentage of gross sales to continue to trend upward due to the impact of potential future price increases on Medicaid discounts and potential increases related to Medicaid, managed care and governmental contracts sales.

Other Revenues—The increase of 58% from period to period is primarily due to the inclusion of product development and licensing fees and royalties attributable to CIMA LABS of $33.8 million for

53

the year ended December 31, 2005, compared to $15.1 million from the acquisition date of August 12, 2004 to December 31, 2004.

	For the year ended
	December 31,
								% Change
	2005		2004		Change
Costs and expenses:
Cost of sales	$	164,223	$	119,973	$	44,250		37	%
Research and development		354,826		273,972		80,854		30	%
Selling, general and administrative		443,861		339,477		104,384		31	%
Depreciation and amortization		84,305		52,798		31,507		60	%
Impairment charges		20,820		30,071		(9,251	)	(31	)%
Acquired in-process research and development		366,815		185,700		181,115		98	%
	$	1,434,850	$	1,001,991	$	432,859		43	%

Cost of Sales—The cost of sales was approximately 14% of net sales in 2005 and 12% of net sales in 2004. The increase is primarily due the inclusion of twelve months of CIMA LABS' product sales for which the margin is lower than our other products instead of only approximately 4.5 months in 2004. This increase was also impacted by the net effect of price increases on our three major US products effective February 2005 and July 2005 and increases in our product sales allowances.

Research and Development Expenses—Research and development expenses increased $80.9 million, or 30%, in 2005 as compared to 2004. Of this increase, $50.0 million is due to an increase in headcount and headcount-related expenditures necessary to support higher levels of clinical activities and expenditures. The remainder of the increase is largely due to increased research and development expenditures related to the exploration of the utility of GABITRIL in GAD and Phase 3 studies of FEBT, increased research and development expenditures related to facilities and operations and the inclusion of a full year of CIMA LABS. These increases were partially offset by a decrease in clinical research costs due to the conclusion in 2005 of four double-blind studies in our NUVIGIL program.

Selling, General and Administrative Expenses—Selling, general and administrative expenses increased $104.4 million, or 31%, in 2005 as compared to 2004, primarily due expenditures associated with an increase in headcount, the inclusion of a full year of CIMA LABS, which was acquired in August 2004 and increased sales and marketing costs in France to support NAXY® and MONO-NAXY®, which we acquired from Sanofi-Synthelabo France in December 2004. These increases were partially offset by a reduction in GABITRIL marketing activity.

Depreciation and Amortization Expenses—Depreciation and amortization expenses increased $31.5 million, or 60%, in 2005 as compared to 2004. This increase is primarily the result of increased capital investments in software, buildings, and leasehold and laboratory improvements at our West Chester and Frazer locations, increased spending on manufacturing equipment at our Salt Lake City location and the acquisition of property, plant and equipment associated with the CIMA LABS acquisition. Amortization expense increased due to the amortization of technology, trademark and marketing rights acquired from CIMA LABS in the third quarter of 2004, the amortization of French marketing rights to NAXY® and MONO-NAXY® and the amortization of TRISENOX technology acquired in July 2005.

Impairment charges—In 2005, we recorded an impairment charge of $20.8 million for the write-off of an intangible asset resulting from the termination of a distribution agreement in the United Kingdom in March 2006. In 2004, we recorded an impairment charge of $30.1 million for the write-off of an investment in MDS Proteomics, Inc.

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Acquired in-process research and development—Acquired in-process research and development increased $181.1 million, or 98%, in 2005 as compared to 2004. The increase in acquired in-process research and development expense in 2005 as compared to 2004 is primarily due to our acquisitions of Zeneus and Salmedix and the license and collaboration agreement we entered into with Alkermes for VIVITROL. In 2005, we recorded acquired in-process research and development expense of $71.2 million for Zeneus, $130.1 million for Salmedix and $160 million for VIVITROL. In 2004, in connection with our acquisition of CIMA LABS in August 2004, we allocated approximately $185.7 million of purchase price to in-process research and development projects.

		For the year ended
		December 31,
											% Change
		2005			2004			Change
Other income and (expense):
	Interest income	$	26,171		$	16,486		$	9,685		59	%
	Interest expense		(25,235	)		(22,186	)		(3,049	)	(14	)%
	Debt exchange expense		—			(28,230	)		28,230		100	%
	Write-off of deferred debt issuance costs		(27,109	)		—			(27,109	)	(100	)%
	Gain (charge) on early extinguishment of debt		2,085			(2,313	)		4,398		190	%
	Other income (expense), net		1,928			(5,375	)		7,303		136	%
		$	(22,160	)	$	(41,618	)	$	19,458		47	%

Other Income and (Expense)—Other income and (expense), net increased $19.5 million, or 47%, in the year ended December 31, 2005 from the year ended December 31, 2004. The increase was attributable to the following factors:

•

a $9.7 million increase in interest income in 2005 due to higher investment returns partially offset by lower average investment balances. This increase was partially offset by a $3.0 million increase in interest expense due to higher average debt balances.



•

a $28.2 million decrease in debt exchange expense which was recognized in 2004 related to the exchange of $78.3 million of our 2.5% convertible subordinated notes.



•

a $27.1 million increase in write-off of deferred debt issuance costs were recognized in 2005 related to the 2.0% convertible senior subordinated notes.



•

a net gain (charge) on early extinguishment of debt of $2.1 million in 2005 compared to ($2.3) million in 2004. The net gain in 2005 includes a $7.4 million gain on the repurchase of approximately $512 million of the 2.5% convertible subordinated notes and a net loss of $5.3 million on the termination of the interest rate swap agreement associated with $200 million notional amount of the 2.5% convertible subordinated notes. The charge in 2004 relates to the repurchase of $10.0 million and $33.0 million of our 3.875% convertible subordinated notes in private transactions in March 2004 and August 2004, respectively.



•

a $7.3 million increase in other income period over period primarily due to gains recorded in foreign currency transactions.

	For the year ended
	December 31,
	2005		2004			Change		% Change
Income tax benefit (expense)	$	70,164	$	(45,629	)	$	115,793	254	%

Income Taxes—During 2005, we recognized $70.2 million of income tax benefit on a loss before income taxes of $245.1 million, resulting in an overall effective tax rate of (28.6)%. This compared to

55

2004 tax expense of $45.6 million on a loss before income taxes of $28.2 million, yielding an effective tax rate of 162%. The change in effective tax rates between 2005 and 2004 is primarily due to $201.3 million non-deductible acquired in-process research and development charges related to the Salmedix and Zeneus acquisitions for which no tax benefit was recorded. For tax reporting purposes, these acquisitions were treated as stock purchases. In addition, we recorded a decrease in the valuation allowance by $46.0 million and recognized a research and development tax credit of $11.8 million.

Year ended December 31, 2004 compared to year ended December 31, 2003

		2004						2003						% Increase (Decrease)
		United States		Europe		Total		United States		Europe		Total		United States		Europe		Total
Sales:
	PROVIGIL	$	406,238	$	33,429	$	439,667	$	264,324	$	26,141	$	290,465	54	%	28	%	51	%
	ACTIQ		337,072		7,925		344,997		234,111		3,356		237,467	44	%	136	%	45	%
	GABITRIL		87,349		6,815		94,164		57,774		5,925		63,699	51	%	15	%	48	%
	Other		13,270		88,277		101,547		—		93,619		93,619	100	%	(6	)%	8	%
Total Sales			843,929		136,446		980,375		556,209		129,041		685,250	52	%	6	%	43	%
Other Revenues			28,749		6,301		35,050		20,118		9,439		29,557	43	%	(33	)%	19	%
Total Revenues		$	872,678	$	142,747	$	1,015,425	$	576,327	$	138,480	$	714,807	51	%	3	%	42	%

Sales—In the United States, we sell our products to pharmaceutical wholesalers, the largest three of which accounted for 87% of our worldwide net sales for the year ended December 31, 2004. 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. We believe that speculative buying of product, particularly in anticipation of possible price increases, had been the historic practice of many pharmaceutical wholesalers during this period. In past years, we attempted to minimize these fluctuations both by providing, from time to time, discounts to our customers to stock normal amounts of inventory (which we had historically defined as approximately one month's supply at our current sales level) and by canceling orders if we believe a particular customer is speculatively buying inventory in anticipation of possible price increases.

        As of December 31, 2004, we received information from our three largest U.S. wholesaler customers about the levels of inventory they held for our products. Based on this information, which we have not independently verified, we believe that total inventory held at these wholesalers was approximately one month's supply.

        For the year ended December 31, 2004, total sales increased by 43% over the prior period. The factors that contributed to the increase in sales are summarized as follows:

•

At the beginning of 2004, we consolidated our two former U.S. sales forces into a single unit that detailed all three products to a broader group of physicians, including primary care physicians (e.g. internists, general practitioners and family practitioners). In addition, we expanded this combined force to approximately 500 persons. We believe this substantially larger sales force, coupled with focused marketing efforts designed to educate physicians and communicate the benefits of our products, contributed to the increases in total sales for the year ended December 31, 2004.



•

An expanded U.S. label for PROVIGIL received from the FDA in early 2004 was a key factor in contributing to the year over year increase in PROVIGIL sales. U.S. prescriptions for PROVIGIL increased by 35%, according to IMS Health. The period-to-period change was also impacted by lower sales recorded in the first quarter of 2003 as a result of the depletion of

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inventory levels at certain wholesalers. Additionally, domestic price increases of approximately 8% period over period contributed to higher 2004 sales.

•

Sales of ACTIQ increased 45% as compared to last year. U.S. prescriptions for ACTIQ increased by 34%, according to IMS Health. In addition, domestic prices increased approximately 7% from period to period.



•

Sales of GABITRIL increased 48% as compared to last year. U.S. prescriptions for GABITRIL increased by 41%, according to IMS Health. An increase in domestic prices of approximately 9% period over period also contributed to higher sales recorded in 2004.



•

Other sales consist of (1) sales of other products and certain third party products in various international markets, principally in France and (2) sales of products manufactured by CIMA LABS and sold to its pharmaceutical partners. The most significant products in this other sales category are SPASFON® (phloroglucinol) with total 2004 sales of $58.3 million and FONZYLANE® (buflomedil) with total 2004 sales of $16.3 million, both of which are sold by Cephalon France.

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:

		For the year ended
		December 31,
										% Change
		2004			2003			Change
Gross sales:		$	1,080,408		$	747,060		$	333,348	45	%
Product sales allowances:
	Prompt payment discounts		18,443			12,202			6,241	51	%
	Returns		11,247			7,973			3,274	41	%
	Coupons		16,521			9,349			7,172	77	%
	Medicaid discounts		41,274			25,760			15,514	60	%
	Managed care and governmental contracts		12,548			6,526			6,022	92	%
			100,033			61,810			38,223
Net sales		$	980,375		$	685,250		$	295,125	43	%
Product sales allowances as a percentage of gross sales			9.3	%		8.3	%

        Increases in the product sales allowances as a percentage of gross sales from 2003 to 2004 primarily reflect increases in gross sales during the period and corresponding increases in discounts, expected returns and coupon usage, and participation in managed care, Medicaid, and other governmental programs. The change in the product sales allowances as a percentage of gross sales is primarily driven by higher Medicaid discounts, and managed care and governmental contract discounts and chargebacks resulting from the impact of price increases and increased participation.

Other Revenues—The increase in other revenues of 19% from period to period is primarily due to the inclusion of product development and licensing fees and royalties of $15.1 million attributable to CIMA LABS partially offset by a decrease in partner reimbursements on both our CEP-7055 program and our CEP-1347 program and a reduction in earnings recognized under our collaboration agreement with Novartis Pharma AG. The level of other revenue recognized from period to period may continue

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to fluctuate based on the status and activity of each related project and terms of each collaboration agreement. Therefore, past levels of other revenues may not be indicative of future levels.

	For the year ended
	December 31,
							% Change
	2004		2003		Change
Costs and expenses:
Cost of sales	$	119,973	$	92,375	$	27,598	30	%
Research and development		273,972		168,222		105,750	63	%
Selling, general and administrative		339,477		254,088		85,389	34	%
Depreciation and amortization		52,798		44,073		8,725	20	%
Impairment charge		30,071		—		30,071	100	%
Acquired in-process research and development		185,700		—		185,700	100	%
	$	1,001,991	$	558,758	$	443,233	79	%

Cost of Sales—The cost of sales was approximately 12% of net sales in 2004 and 13% of net sales in 2003. The decrease is primarily due to cost savings realized from our transfer of U.S. ACTIQ manufacturing from Abbott Laboratories to our Salt Lake City facility beginning in June 2003, partially offset by higher costs related to other products sold in France and to CIMA LABS cost of sales for which there are no comparable data for 2003 and for which the margin is higher than other Cephalon products.

Research and Development Expenses—Research and development expenses increased $105.8 million, or 63%, in 2004 as compared to 2003. Of this increase, $71.1 million is due to clinical research costs including expenditures associated with increased headcount necessary to support higher levels of clinical activities and expenditures associated with (1) additional clinical studies initiated in 2004 to explore the utility of GABITRIL beyond its current indication, (2) costs incurred with Phase 3 clinical programs for SPARLON which began in late 2003, and (3) costs incurred with our Phase 3 studies of NUVIGIL which began in the fourth quarter of 2003. The increase in 2004 also was impacted by higher costs incurred during 2004 associated with supplying materials for our clinical trials in process, developing new or improved production processes for our currently marketed products and products in development, and by the inclusion of CIMA LABS.

Selling, General and Administrative Expenses—Selling, general and administrative expenses increased $85.4 million, or 34%, in 2004 as compared to 2003. The increase is predominantly the result of the expansion of our European and U.S. field sales forces, additional product promotional expenses and an increased number of educational programs. In addition, a portion of the increase is due to higher administrative expenses associated with an increase in headcount, costs associated with complying with the requirements of the Sarbanes-Oxley Act, and higher accruals for bonus expenses resulting from a shift away from a stock option-based incentive compensation plan to a cash-based incentive compensation plan. These increases were partially offset by the recognition of a gain of $4.2 million in 2004 as a result of retiree medical benefit changes for current employees at Cephalon France.

Depreciation and Amortization Expenses—Depreciation and amortization expenses increased by $8.7 million, or 20%, in 2004 as compared to 2003. Depreciation expense increased period over period primarily as a result of increased capital investments in software, building and laboratory improvements at our West Chester location, increased spending on manufacturing equipment at our Salt Lake City location and the acquisition of property, plant and equipment associated with the CIMA LABS acquisition. Amortization expense increased due to the amortization of technology, trademark and marketing rights acquired from CIMA LABS.

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Impairment charge—During 2004, we recorded an impairment charge of $30.1 million for the write-off of our investment in MDS Proteomics Inc.

Acquired in-process research and development—In connection with our acquisition of CIMA LABS, we allocated approximately $185.7 million of the purchase price to in-process research and development projects. At the acquisition date, CIMA LABS' ongoing research and development initiatives were focused on the development and commencement of Phase 3 clinical trials of FEBT, and several other minor ongoing research and development projects. These costs were charged to expense in the third quarter of 2004 since, at the date of acquisition, the development of these projects had not yet reached technological feasibility, and the research and development in progress had no alternative future uses.

		For the year ended
		December 31,
											% Change
		2004			2003			Change
Other income and (expense):
	Interest income	$	16,486		$	11,298		$	5,188		46	%
	Interest expense		(22,186	)		(28,905	)		6,719		23	%
	Debt exchange expense		(28,230	)		—			(28,230	)	(100	)%
	Charge on early extinguishment of debt		(2,313	)		(9,816	)		7,503		76	%
	Other income (expense), net		(5,375	)		1,688			(7,063	)	(418	)%
		$	(41,618	)	$	(25,735	)	$	(15,883	)	(62	)%

Other Income and (Expense)—Other income and (expense), net decreased $15.9 million, or 62%, in the year ended December 31, 2004 from the year ended December 31, 2003. The decrease was attributable to the following factors:

•

Interest income increased by $5.2 million in 2004 due to higher average investment balances as well as slightly higher average investment returns.



•

Interest expense decreased by $6.7 million due primarily to a decrease in interest and amortization expense resulting from the repurchases and redemptions of a portion of our convertible subordinated notes during 2003 and 2004 partially offset by an increase in amortization expense associated with debt issuance costs from the June 2003 sales of our Zero Coupon Convertible Subordinated Notes.



•

In July 2004, a holder of our 2.5% convertible subordinated notes approached us, and we agreed, to exchange $78.3 million of these outstanding notes into 1,518,169 shares of our common stock. We recognized debt exchange expense of $28.2 million in the third quarter of 2004 relating to this exchange in accordance with SFAS No. 84, "Induced Conversion of Convertible Debt."



•

In March 2004 and August 2004, we repurchased for cash $10.0 million (at a price of 109.5% of the face amount) and $33.0 million (at a price of 104% of the face amount), respectively, of the 3.875% convertible subordinated notes in private transactions. As a result, during 2004, we recognized $2.3 million in our financial statements as a charge on early extinguishment of debt. In July 2003, we redeemed for cash all of the $174.0 million outstanding 5.25% notes at a redemption price of 103.15% per $1,000 aggregate principal amount of notes and we purchased $12.0 million of the 3.875% notes from one of the holders in a private transaction at a price of 106% of the face amount of the notes. As a result, during 2003, $9.8 million was recognized in our financial statements as a charge on early extinguishment of debt.

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•

Other income decreased by $7.1 million in 2004 primarily due to a $4.1 million gain on the increase in the fair value of a foreign currency derivative instrument in 2003 and losses on the disposal of fixed assets related to the renovation of our facilities in 2004.

	For the year ended
	December 31,
								% Change
	2004		2003		Change
Income tax expense	$	45,629	$	46,456	$	(827	)	(2	)%

Income Taxes—During 2004, we recognized $45.6 million of income tax expense on a loss before income taxes of $28.2 million, resulting in an overall effective tax rate of 162%. This compared to 2003 tax expense of $46.5 million on income before income taxes of $130.3 million, yielding an effective tax rate of 36%. The change in effective tax rates between 2004 and 2003 is primarily due to the $185.7 million acquired in-process research and development charge that was not tax deductible and, therefore, no tax benefit was recorded for this item. In addition, we recorded a decrease in the valuation allowance account of $7.1 million and recognized a research and development tax credit of $11.9 million, which were partially offset by alternative minimum tax expense.

LIQUIDITY AND CAPITAL RESOURCES

        Cash, cash equivalents and investments at December 31, 2005 were $484.1 million, representing 17% of total assets, down from $791.7 million, representing 33% of total assets, at December 31, 2004 and down from $1.2 billion, representing 49% of total assets, at December 31, 2003. The change in cash and cash equivalents is as follows:

	2005			2004			2003
	(In thousands)
Net cash provided by operating activities	$	185,731		$	178,604		$	200,241
Net cash used for investing activities		(780,480	)		(685,214	)		(17,592	)
Net cash provided by (used for) financing activities		231,841			(41,022	)		437,927
Effect of exchange rate changes on cash and cash equivalents		(6,276	)		6,177			9,026
Net increase (decrease) in cash and cash equivalents	$	(369,184	)	$	(541,455	)	$	629,602

        The decrease in cash and cash equivalents is due primarily to our investments in businesses and product rights including Salmedix, VIVITROL product rights, TRISENOX and Zeneus for $726.2 million, net of cash acquired, in 2005 and CIMA LABS for $409.4 million, net of cash, cash equivalents and investments, in 2004. For a more complete description of these acquisitions, see Note 2 of our Consolidated Financial Statements included in Part II, Item 8 of this Annual Report on Form 10-K.

        Working capital, which is calculated as current assets less current liabilities, decreased to $(229.8) million at December 31, 2005 compared to $937.0 million at December 31, 2004 primarily due to the reclassification of $920.0 million of our 2.0% convertible senior subordinated notes from long-term liabilities to current liabilities as these notes were convertible at December 31, 2005.

Net Cash Provided by Operating Activities

        Net cash provided by operating activities increased to $185.7 million for the year ended December 31, 2005 as compared to $178.6 million for 2004. The increase was driven by the growth in income from sales, partially offset by the non-recurring payment of $160.0 million in June 2005 to Alkermes under the VIVITROL license and collaboration agreement. The payment to Alkermes has been recorded as an IPR&D charge as the product has not yet received FDA approval.

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        Net cash provided by operating activities was $178.6 million for the year ended December 31, 2004 as compared to $200.2 million for 2003. The decrease in 2004 is primarily a result of increases in current assets, particularly trade receivables, partially offset by increases in current liabilities. Our loss of $73.8 million in 2004 includes non-cash expenditures of $185.7 million of acquired in-process research and development expense, $30.1 million of impairment expense and $28.2 million of debt exchange expense.

Net Cash Used for Investing Activities

        Net cash used for investing activities was $780.5 million for the year ended December 31, 2005 as compared to $685.2 million for 2004. During 2005, our primary uses of cash for investing activities were related to our acquisition of Salmedix in June 2005 for $130.7 million, net of cash acquired, our acquisition of TRISENOX in July 2005 for $69.7 million, and our of acquisition of Zeneus in December 2005 for $365.8 million, net of cash acquired. In addition, we are currently investing funds to make facilities improvements at our new corporate headquarters in Frazer, Pennsylvania and at our West Chester, Salt Lake City and France locations to accommodate our growth, and we are purchasing manufacturing equipment at our Salt Lake City location for the production of ACTIQ and other products, including FEBT, if approved, for the U.S. and European markets.

        Net cash used for investing activities was $685.2 million for the year ended December 31, 2004 as compared to $17.6 million for 2003. The change is primarily due to our acquisition of CIMA LABS in August 2004 for $482.5 million, net of cash acquired (or $409.4 million, net of cash, cash equivalents and investments acquired) and the increase of purchases of available-for-sale investments in order to benefit from rising interest rates on longer term investments. In addition, in the fourth quarter of 2004, we purchased the French marketing rights to NAXY and MONO-NAXY from Sanofi-Synthelabo France for $44.3 million. Net cash used for investing activities in 2003 included the purchase of non-marketable securities totaling $33.0 million, which included $30.0 million for the purchase of securities of MDS Proteomics Inc. (MDSP), a privately-held Canadian company. The carrying value of the investment in MDSP was written off as an impairment charge in the second quarter of 2004.

Net Cash Provided by (Used for) Financing Activities

        Net cash provided by financing activities was $231.8 million for the year ended December 31, 2005, as compared to net cash used for financing activities of $41.0 million in 2004. We received net proceeds in 2005 of $892.0 million from the sale of 2.0% convertible senior subordinated notes. Concurrent with the sale of the 2.0% notes, we purchased a Convertible Note Hedge for $382.3 million and sold warrants to purchase an aggregate of 19,700,214 shares of our common stock for net proceeds of $217.1 million. In July 2005, we completed a tender offer to purchase our outstanding 2.5% convertible subordinated notes for $499.0 million in cash. During 2004, we repurchased $43.0 million of the 3.875% convertible subordinated notes.

        Net cash used for financing activities was $41.0 million for the year ended December 31, 2004, as compared to net cash provided by financing activities of $437.9 million in 2003. The change is primarily the result of net proceeds of $727.1 million received in 2003 from the sale of zero coupon convertible subordinated notes. Concurrent with the private placement of the notes, we purchased a convertible note hedge for $258.6 million and sold warrants for $178.3 million. During 2003, we repurchased $183.0 million of the 5.25% convertible subordinated notes and $12.0 million of the 3.875% convertible subordinated notes.

        The volume of exercises of common stock options decreased in 2005 as compared to 2004. The volume of exercises of common stock options increased in 2004 as compared to 2003. The extent and timing of option exercises are primarily dependent upon the market price of our common stock and general financial market conditions, as well as the exercise prices and expiration dates of the options.

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Commitments and Contingencies

—Legal Proceedings

        For a complete description of legal proceedings, see Note 12 of the Consolidated Financial Statements included in Part II, Item 8 of this Annual Report on Form 10-K.

—Other Commitments and Contingencies

        The following table summarizes our obligations to make future payments under current contracts (in thousands):

	Payments due by period
Contractual obligations	Total		2006		2007 and 2008		2009 and 2010		2011 and thereafter
Debt obligations	$	12,152	$	1,460	$	4,286	$	3,716	$	2,690
Convertible notes		1,680,447		930,007		375,271		375,169		—
Purchase obligations		83,303		18,381		35,685		24,237		5,000
Capital lease obligations		3,658		1,693		1,965		—		—
Interest payments on debt		167,645		19,329		37,612		37,054		73,650
Operating leases		43,040		12,364		13,668		6,298		10,710
Total contractual cash obligations	$	1,990,245	$	983,234	$	468,487	$	446,474	$	92,050

        As of the filing date of this report, our 2.0% Notes and Zero Coupoon Notes are considered to be current liabilities and will be presented in current portion of long-term debt in our March 31, 2006 consolidated balance sheet unless our stock price decreases to a level where these notes are no longer convertible. For a discussion of our obligations under the convertible notes, see "—Outlook—Indebtedness" below.

        In addition to the above, 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 nor reasonably estimable, we have not recorded a liability on our balance sheet for any such contingencies. As of December 31, 2005, the potential milestone and other contingency payments due under current contractual agreements are approximately $681.5 million.

Outlook

        We expect to use our remaining cash, cash equivalents and investments for working capital and general corporate purposes, including the acquisition of businesses, products, product rights, or technologies, the payment of contractual obligations, including scheduled interest payments on our convertible notes and regulatory or sales milestones that may become due to CTI, Alkermes, or the former stockholders of Salmedix, among others, and/or the purchase, redemption or retirement of our convertible notes. However, in 2006, we expect that sales of our currently marketed products, together with sales of our near-term product candidates, assuming approval in the anticipated time frames, should allow us to generate positive cash flow from operations. At this time, we cannot accurately predict the effect of certain developments on the rate of sales growth in 2007 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 near-term product candidates.

        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

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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. 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.

Marketed Products

        Continued sales growth of PROVIGIL beyond the June 2006 expiration of orphan drug exclusivity 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 maintaining protection in the United States and abroad of the modafinil particle-size patent through its expiration beginning in 2014. See Note 2 to the Consolidated Financial Statements included in Part II, Item 8 of this Annual Report on Form 10-K. Future growth of modafinil-based product sales in 2006 and beyond also will depend in part on our ability to achieve final FDA approval of NUVIGIL and SPARLON, which we anticipate in the second quarter of 2006.

        Our sales of ACTIQ depend on our existing patent protection for the approved compressed powder formulation, which expires in the U.S. in September 2006. The patent covering the previous formulation of ACTIQ expired in May 2005. See "Certain Risks Related to our Business" below. If we are successful in our efforts to complete clinical studies in pediatric patients prior to September 2006, the FDA could grant us six months of exclusivity beyond the September 2006 compressed powder patent expiration. However, even with this additional exclusivity, Barr's license to the ACTIQ patents could become effective as early as December 6, 2006 or the date of launch of FEBT (expected in late 2006). The entry of Barr with a generic form of ACTIQ later this year likely will significantly and negatively impact future ACTIQ sales.

Clinical Studies

        Over the past few years, we have incurred significant expenditures related to conducting clinical studies to develop new pharmaceutical products and exploring the utility of our existing products in treating disorders beyond those currently approved in their respective labels. For 2006, we expect to continue to incur significant levels of research and development expenditures. We expect to continue the following significant clinical programs, among others, in 2006: a Phase 3 program evaluating GABITRIL for the treatment of generalized anxiety disorder; a Phase 3 program evaluating TREANDA for the treatment of NHL; and a Phase 2 program evaluating CEP-701 for the treatment of AML. We may seek to mitigate the risk in our research and development programs by seeking sources of funding for a portion of these expenses through collaborative arrangements with third parties. However, we intend to retain a portion of the commercial rights to these programs and, as a result, we still expect to spend significant funds on our share of the cost of these programs, including the costs of research, preclinical development, clinical research and manufacturing.

Manufacturing, Selling and Marketing Efforts

        In 2006, we expect to incur significant expenditures associated with manufacturing, selling and marketing our products. The aggregate amount of our sales and marketing expenses in 2006 will likely be significantly higher than that incurred in 2005, primarily as a result of higher expenses associated with an increase in the size of our sales force and planned product launches for SPARLON, NUVIGIL, and FEBT, if approved. In 2006, we expect to continue in-process capital expenditure projects at our research and development facilities in France and West Chester and at our Salt Lake City manufacturing facility.

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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 December 31, 2005:

Security	Outstanding (in millions)		Conversion Price		Redemption Rights and Obligations
2.0% Convertible Senior Subordinated Notes due June 2015 (the "2.0% Notes")	$	920.0	$	46.70*	Generally not redeemable by the holder prior to December 2014.
Zero Coupon Convertible Notes due June 2033, first putable June 15, 2008 (the "2008 Zero Coupon Notes")	$	374.8	$	59.50*	Redeemable on June 15, 2008 at either option of holder or us at a redemption price of 100.25% of the principal amount redeemed.
Zero Coupon Convertible Notes due June 2033, first putable June 15, 2010 (the "2010 Zero Coupon Notes")	$	374.9	$	56.50*	Redeemable on June 15, 2010 at either option of holder or us at a redemption price of 100.25% of the principal amount redeemed.

*

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, $71.40 or $67.80 with respect to the 2.0% Notes, the 2008 Zero Coupon Notes or the 2010 Zero Coupon Notes, respectively. As of the filing date of this Annual Report on Form 10-K, the restrictions on conversion have been satisfied and the aggregate outstanding principal balance of such affected notes are considered to be current liabilities and will be presented in current portion of long-term debt in our March 31, 2006 consolidated balance sheet unless our stock price decreases to a level where these notes are no longer convertible. For a more complete description of these notes, including the associated Convertible Note Hedge, see Note 9 to our Consolidated Financial Statements included in Part II, Item 8 of this Annual Report on Form 10-K.

        As of the filing date of this Annual Report on Form 10-K, we have approximately $1,680.4 million of convertible notes outstanding, all of which is are considered to be current liabilities and will be presented in current portion of long-term debt in our March 31, 2006 consolidated balance sheet unless our stock price decreases to a level where these notes are no longer convertible. Our 2.0% and Zero Coupon Notes are presently convertible and, 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 Annual Report on Form 10-K, we do not have available cash, cash equivalents and investments sufficient to repay all of the convertible notes, if presented. In addition, 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.

        The current portion of our long term indebtedness increased by $928 million compared to 2004. During the fourth quarter of 2005, our 2.0% Notes became convertible and, in January 2006, our 2008 and 2010 Zero Coupon Notes also became convertible. As a result, the 2.0% Notes have been classified as a current liability on our balance sheet as of December 31, 2005 (see Note 9 of our Consolidated

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Financial Statements included in Part II, Item 8 of this Annual Report on Form 10-K for summary of our convertible debt, note hedge and call warrant) and, as of the filing date of this report, our Zero Coupon Notes are now also considered to be current liabilities. As of December 31, 2005 and as of the filing date of this report, the fair value of both the 2.0% Notes and the Zero Coupon Notes is greater than the value of the shares into which such notes are convertible. 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 or Zero Coupon Notes will present significant amounts of such notes for conversion. 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, raising money in the capital markets or selling our note hedge instruments for cash.

        The annual interest payments on our convertible notes outstanding as of December 31, 2005 are $18.7 million, payable at various dates throughout the year. 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 and 2008 and 2010 Zero Coupon Notes each are considered instrument C securities as defined by EITF 90-19, "Convertible Bonds with Issuer Option to Settle for Cash upon Conversion"; therefore, these notes are included in the dilutive earnings per share calculation using the treasury stock method. Under the treasury stock method, we must calculate the number of shares issuable under the terms of these notes based on the average market price of 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% Notes and 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 and $72.08, respectively. However, from a U.S. GAAP perspective, SFAS No. 128 considers only the impact of the convertible notes and the warrant agreements; since the impact of the convertible note hedge agreements is always anti-dilutive, SFAS No. 128 requires that 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

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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)
$65.00	6,947	—	6,947	(6,947	)	—
$75.00	10,374	2,363	12,737	(10,374	)	2,363
$85.00	12,993	5,926	18,919	(12,993	)	5,926
$95.00	15,061	8,738	23,799	(15,061	)	8,738
$105.00	16,735	11,014	27,749	(16,735	)	11,014

(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.

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 in the future 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 approvals;



•

marketing and other expenses;



•

manufacturing or supply disruptions; and



•

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

CRITICAL ACCOUNTING POLICIES AND ESTIMATES

        Management's Discussion and Analysis of Financial Condition and Results of Operations discusses our consolidated financial statements, which we have prepared in accordance with accounting principles generally accepted in the United States. 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

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reasonable under the circumstances. Actual results may differ from these estimates under different assumptions or conditions.

        Our significant accounting policies are described in Note 1 to our Consolidated Financial Statements for the year ended December 31, 2005 included in Part II, Item 8 of this Annual Report on Form 10-K. The SEC defines critical accounting policies as those that are, in management's view, most important to the portrayal of the company's financial condition and results of operations and most demanding of their judgment. Management considers the following policies to be critical to an understanding of our consolidated financial statements and the uncertainties associated with the complex judgments made by us that could impact our results of operations, financial position and cash flows.

Revenue recognition—In the United States, we sell our products to pharmaceutical wholesalers, the largest three of which account for 86% of our worldwide net sales for the year ended December 31, 2005. Decisions made by these wholesalers regarding the levels of inventory they hold (and thus the amount of product they purchase from us) may have materially affected the level of our sales in any particular period and thus our sales may not correlate to the number of prescriptions written for our products as reported by IMS Health. We believe that speculative buying of product, particularly in anticipation of possible price increases, has been the historic practice of many pharmaceutical wholesalers. In past years, we attempted to minimize these fluctuations both by providing, from time to time, discounts to our customers to stock normal amounts of inventory (which we had historically defined as approximately one month's supply at our current sales level) and by canceling orders if we believe a particular customer is speculatively buying inventory in anticipation of possible price increases.

        Over the past two years, our wholesaler customers, as well as others in the industry, began modifying their business models from arrangements where they derive profits from the management of various discounts and rebates, to arrangements where they charge a fee for their services. In connection with this new wholesaler business model, we finalized wholesaler service agreements in the third quarter of 2005 with our major wholesaler customers. These agreements obligate the wholesalers to provide us with periodic retail demand 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 limits based on product demand.

        As of December 31, 2005, we received information from our three largest U.S. wholesaler customers about the levels of inventory they held for our products. Based on this information, which we have not independently verified, we believe that total inventory held at these wholesalers is approximately 2 to 3 weeks supply at our current sales levels.

        Product sales are recognized upon the transfer of ownership and risk of loss for the product to the customer. In the United States, we sell all commercial products F.O.B. shipping point. Transfer of ownership and risk of loss for the product pass to the customer at the point that the product is picked up by a common carrier for shipment to the customer. In Europe, product sales are recognized predominantly upon customer receipt of the product, except in certain contractual arrangements where different terms may be specified.

        Payments under co-promotional or managed services agreements are recognized over the period when the products are sold or the promotional activities are performed. The portion of the payments that represent reimbursement of our expenses is recognized as an offset to those expenses in our results of operations.

Product Sales Allowances—We record product sales net of the following significant categories of product sales allowances: prompt payment discounts, returns, coupons, Medicaid discounts and managed care and governmental contracts. In addition to these product sales allowances, in the first quarter of 2005 we also began recording an allowance to product sales for wholesaler discount reserves.

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Calculating each of these items involves significant estimates and judgments and requires us to use information from external sources.

        1)    Prompt payment discounts—We offer our U.S. wholesaler customers a 2% prompt-pay cash discount as an incentive to remit payment within the first thirty days after the date of the invoice. Prompt-pay discount calculations are based on the gross amount of each invoice. We account for these discounts by reducing sales by the 2% discount amount when product is sold, and apply earned cash discounts at the time of payment. Since we began selling our products commercially in 1999, our customers have routinely taken advantage of this discount. Based on common industry practices and our customers' overall payment performance, we accrue for cash discounts on all U.S. sales recorded during the period. We adjust the accrual to reflect actual experience as necessary and, as a result, the actual amount recognized in any period may be slightly different from our accrual amount.

        2)    Wholesaler discounts—In the third quarter of 2005, we finalized wholesaler service agreements with a number of our wholesaler customers that provide our wholesalers with the opportunity to earn up to 2% in additional discounts in exchange for the performance of certain services. These agreements are effective from January 1, 2005. We have therefore recorded a provision equal to 2% of U.S. gross sales for the twelve months ended December 31, 2005. In addition, at our discretion, we may provide additional discounts to wholesalers such as the discounts of $2.2 million that were provided and recorded during the first quarter of 2005. Actual discounts provided could therefore exceed historical experience and our estimates of expected discounts. If these discounts were to increase by 1.0% of 2005 gross sales from our four products marketed in the U.S., then an additional provision of $11.1 million would result.

        3)    Returns—Customers can return short-dated or expired product that meets the guidelines set forth in our return goods policy. Product shelf life from the date of manufacture for PROVIGIL is 3 years, GABITRIL is 2 to 3 years, depending on product strength, and ACTIQ is 2 to 3 years. Returns are accepted from wholesalers and retail pharmacies. Wholesaler customers can return short dated product with six months or less shelf life remaining and expired product within twelve months following the expiration date. Retail pharmacies are not permitted to return short-dated product but can return full or partial quantities of expired product only within twelve months following the expiration date. We base our estimates of product returns for each of our products on the percentage of returns that we have experienced historically. Notwithstanding this, we may adjust our estimate of product returns if we are aware of other factors that we believe could meaningfully impact our expected return percentages. These factors could include, among others, our estimates of inventory levels of our products in the distribution channel, known sales trends and existing or anticipated competitive market forces such as product entrants and/or pricing changes.

        In 2005, we recorded a provision for returns at a weighted average rate of 1.2% of gross sales, which is consistent with our actual historical return percentages. The other factors described above did not have a significant impact in 2005 on our estimate of product returns. Actual returns could exceed historical experience and our estimates of expected future returns activity because of several factors, including, among other things, wholesaler and retailer stocking patterns and/or competition. If the returns provision percentage were to increase by 0.5% of 2005 gross sales from our four products marketed in the U.S., then an additional provision of $5.6 million would result.

        Based on fourth quarter sales, we believe a reasonable estimate of our maximum exposure for potential returns related to product in our supply pipeline as of December 31, 2005 is approximately $50.0 million for PROVIGIL, $49.0 million for ACTIQ and $7.0 million for GABITRIL.

        4)    Coupons—We offer patients the opportunity to obtain free samples of our products through a program whereby physicians provide coupons to qualified patients for redemption at retail pharmacies. We reimburse retail pharmacies for the cost of these products through a third party administrator. We recognize the estimated cost of this reimbursement as a reduction of gross sales when product is sold.

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In addition, we maintain an accrual for unused coupons based on inventory in the distribution channel and historical coupon usage rates and adjust this accrual whenever changes in such coupon usage rates occur.

        In 2005, we recorded a provision for coupons at a weighted average rate of 1.7% of gross sales. Actual coupon usage could exceed historical experience and our estimates of expected future coupon activity. If the coupons provision percentage were to increase by 0.5% of 2005 gross sales from our four products marketed in the U.S., then an additional provision of $5.6 million would result.

        5)    Medicaid discounts—We record accruals for rebates to be provided through governmental rebate programs, such as the Medicaid Drug Rebate Program, as a reduction of sales when product is sold. These reductions are based on historical rebate amounts and trends of sales eligible for these governmental programs for a period, as well as any expected changes to the trends of our total product sales. In addition, we estimate the expected unit rebate amounts to be used and adjust our rebate accruals based on the expected changes in rebate pricing. Rebate amounts are generally invoiced and paid quarterly in arrears, so that our accrual consists of an estimate of the amount expected to be incurred for the current quarter's activity, plus an accrual for prior quarters' unpaid rebates and an accrual for inventory in the distribution channel.

        In 2005, we recorded a provision for Medicaid discounts at a weighted average rate of 5.0% of gross sales. Actual Medicaid discounts could exceed historical experience and our estimates of expected future Medicaid patient activity or unit rebate amounts. If the Medicaid discounts provision percentage were to increase by 0.5% of 2005 gross sales from our four products marketed in the U.S., then an additional provision of $5.6 million would result. In 2006, certain Medicaid Drug Rebate Program participants will be transitioned to the part D of the Medicare Prescription Drug Improvement and Modernization Act of 2003. We believe the impact of this transition will not have a significant impact on our 2006 consolidated financial statements.

        6)    Managed care and governmental contracts—We have entered into agreements with certain managed care customers whereby we provide agreed-upon discounts to such entities based on sales volume. We record accruals for these discounts as a reduction of sales when product is sold based on the discount rates and expected levels of sales volume of these managed care customers during a period. We estimate eligible sales based on historical amounts and trends of sales by these entities and on any expected changes to the trends of our product sales. Discounts are generally invoiced and paid quarterly in arrears, so that our accrual consists of an estimate of the amount expected to be incurred for the current quarter's activity, plus an accrual for prior quarters' unpaid rebates and an accrual for inventory in the distribution channel.

        We have entered into agreements with certain governmental customers (other than Medicaid) whereby we provide legislatively mandated discounts and rebates to such entities. We record accruals for these discounts and rebates as a reduction of sales when product is sold based on the discount amounts and expected levels of performance of these governmental customers during a period. We estimate eligible sales based on historical sales amounts and trends of sales by these entities and on any expected changes to the trends of our product sales. Generally, discounts are granted to governmental customers by our wholesalers at time of purchase. In other cases, rebates are paid directly to governmental customers based on reported levels of patient usage. Wholesalers charge these discounts and rebates back to us generally within one to three months. We record accruals for our estimate of unprocessed chargebacks related to sales made during the period based on an estimate of the amount expected to be incurred for the current quarter's sales, plus an accrual based on the amount of inventory in the distribution channel.

        In 2005, we recorded a provision for managed care and governmental contracts at a weighted average rate of 1.9% of gross sales. Actual chargebacks and rebates could exceed historical experience and our estimates of expected future participation in these programs. If the chargebacks and rebates

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provision percentage were to increase by 0.5% of 2005 gross sales from our four products marketed in the U.S., then an additional provision of $5.6 million would result.

        The following table summarizes activity in each of the above categories for the years ended December 31, 2004 and 2005 (in thousands):

	Prompt Payment Discounts			Wholesaler Discounts			Returns*			Coupons			Medicaid Discounts			Managed Care & Governmental Contracts			Total
Balance at January 1, 2004	$	(1,108	)	$	—		$	(7,121	)	$	(2,175	)	$	(10,038	)	$	(1,692	)	$	(22,134	)
Provision:
Current period		(18,443	)		—			(12,822	)		(16,521	)		(41,027	)		(12,263	)		(101,076	)
Prior periods		—			—			1,575			—			(247	)		(285	)		1,043
Total		(18,443	)		—			(11,247	)		(16,521	)		(41,274	)		(12,548	)		(100,033	)
Actual:
Current period		15,497			—			—			13,538			25,321			8,118			62,474
Prior periods		1,155			—			6,641			993			7,916			1,713			18,418
Total		16,652			—			6,641			14,531			33,237			9,831			80,892
Balance at December 31, 2004	$	(2,899	)	$	—		$	(11,727	)	$	(4,165	)	$	(18,075	)	$	(4,409	)	$	(41,275	)
Provision:
Current period		(22,284	)		(24,373	)		(13,132	)		(23,313	)		(66,653	)		(26,072	)		(175,827	)
Prior periods		—			—			(2,721	)		—			(592	)		56			(3,257	)
Total		(22,284	)		(24,373	)		(15,853	)		(23,313	)		(67,245	)		(26,016	)		(179,084	)
Actual:
Current period**		20,367			21,645			(1,572	)		18,633			33,199			19,506			111,778
Prior periods		2,899			—			6,554			4,150			18,667			4,353			36,623
Total		23,266			21,645			4,982			22,783			51,866			23,859			148,401
Balance at December 31, 2005	$	(1,917	)	$	(2,728	)	$	(22,598	)	$	(4,695	)	$	(33,454	)	$	(6,566	)	$	(71,958	)

*

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

**

Includes beginning reserve balances related to TRISENOX, which was acquired in the third quarter of 2005, of $0.1 million for prompt payment discounts and $1.6 million for returns.

Inventories—Our inventories are valued at the lower of cost or market, and include the cost of raw materials, labor, overhead and shipping and handling costs. Cost is computed on domestic inventories using the last-in, first-out ("LIFO") method. For the majority of our foreign inventories, the first-in, first-out ("FIFO") method is utilized. The majority of our inventories are subject to expiration dating. We regularly evaluate the carrying value of our inventories and when, in our opinion, factors indicate that impairment has occurred, we establish a reserve against the inventories' carrying value. Our determination that a valuation reserve might be required, in addition to the quantification of such reserve, requires us to utilize significant judgment. We base our analysis, in part, on the level of inventories on hand in relation to our estimated forecast of product demand, production requirements for forecasted product demand and the expiration dates of inventories. Although we make every effort to ensure the accuracy of forecasts of future product demand, any significant unanticipated decreases in demand could have a material impact on the carrying value of our inventories and our reported operating results. To date, inventory adjustments have not been material.

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        We capitalize inventory costs associated with marketed products and certain products prior to regulatory approval and product launch, based on management's judgment of probable future commercial use and net realizable value. We could be required to expense previously capitalized costs related to pre-approval or pre-launch inventory upon a change in such judgment, due to a denial or delay of approval by regulatory bodies, a delay in commercialization, or other potential factors. We had $51.1 million and $21.9 million of capitalized inventory costs for pre-launch products for the years ended December 31, 2005 and 2004, respectively.

        We have committed to make future minimum payments to third parties for certain raw material inventories. The minimum purchase commitments total $83.3 million as of December 31, 2005, the majority of which relate to modafinil and armodafinil. We expect to fully utilize these contracts.

Valuation of Property and Equipment, Intangible Assets, Goodwill and Investments—Our property and equipment have been recorded at cost and are being depreciated on a straight-line basis over the estimated useful life of those assets.

        We regularly assess our property and equipment, intangible assets, goodwill and other long lived assets to determine whether any impairment in these assets may exist and, if so, the extent of such impairment. To do this, in the case of goodwill we estimate the fair value of each of our reporting units and compare it to the book value of their net assets. In the case of intangibles and other long lived assets, we assess whether triggering events have occurred and if so, we compare the estimated cash flows of the related asset group and compare it to the book value of the asset group. Calculating fair value as well as future cash flows requires that we make a number of critical legal, economic, market and business assumptions that reflect our best estimates as of the testing date. We believe the methods we use to determine these underlying assumptions and estimates are reasonable and reflective of common practice. Notwithstanding this, our assumptions and estimates may differ significantly from actual results, or circumstances could change that would cause us to conclude that an impairment now exists or that we previously understated the extent of impairment. For additional information regarding our significant accounting policies with respect to goodwill, intangibles and other long-lived assets, see Note 1 of our Consolidated Financial Statements included in Part II, Item 8 of this Annual Report on Form 10-K.

Income taxes—We provide for income taxes in accordance with SFAS No. 109, "Accounting for Income Taxes," which requires the recognition of deferred tax assets and liabilities for the expected tax consequences of temporary differences between the tax and financial reporting bases of assets and liabilities.

        Prior to 2002, we had a history of losses from our operations, which generated significant international, federal and state net operating loss carryforwards. We record a valuation allowance against deferred tax assets if we believe that we are not likely to realize future tax benefits. Based on our profitability for the year ended December 31, 2002 and projected future results, in the fourth quarter of 2002, we concluded that it was likely that we would be able to realize a significant portion of the deferred tax assets, and therefore, we reversed a significant portion of the valuation allowance. As a result, beginning in 2003, we began providing for income taxes at a rate equal to our estimated annual combined federal, state and foreign statutory effective rates. Subsequent adjustments to our estimates of our ability to recover the deferred tax assets or other changes in circumstances or estimates could cause our provision for income taxes to vary from period to period, as it has for the current year ended December 31, 2005.

        Based on our profitability for the year ended December 31, 2005, projected future results, and resolution of several generic challenges, during the fourth quarter of 2005 we concluded that it was likely that a significant portion of the deferred tax assets would be realized. Therefore, we again reversed a significant portion of the valuation allowance. At the end of 2005, we retained a valuation allowance of $76.8 million, against a total deferred tax asset balance of $522.7 million, composed

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entirely of state and foreign net operating losses, and state tax credits. We will continue to review and analyze the likelihood of realizing tax benefits related to deferred tax assets as there is more certainty surrounding our future levels of profitability related to specific company operations and the related taxing jurisdictions.

RECENT ACCOUNTING PRONOUNCEMENTS

        In November 2004, the Financial Accounting Standards Board ("FASB") issued SFAS No. 151, "Inventory Costs", which requires abnormal amounts of idle capacity and spoilage costs to be excluded from the cost of inventory and expensed when incurred. This Statement is effective for fiscal years beginning after June 15, 2005. We believe the adoption of this statement, effective January 1, 2006, will not have a significant impact on our 2006 consolidated financial statements.

        In December 2004, the FASB issued SFAS No. 123(R) (revised 2004) "Share-Based Payment." SFAS No. 123(R) requires employee stock-based compensation to be measured based on the grant-date fair value of the awards and the cost to be recognized over the period during which an employee is required to provide service in exchange for the award. The Statement eliminates the alternative use of Accounting Principles Board ("APB") No. 25's intrinsic value method of accounting for awards, which is the Company's accounting policy for stock options. See Note 1 to the Consolidated Financial Statements for the pro forma impact of compensation expense from stock options on net earnings and earnings per share. SFAS No. 123(R) is effective as of January 1, 2006. We will adopt the provisions of SFAS No. 123(R) on a modified, prospective basis. We expect the impact of adoption of this statement in 2006 to be approximately $20.0 million, net of tax, assuming a tax rate of 36.7 percent and other key assumptions remain constant since adoption and that any stock option grants that may be made during 2006 are excluded.

        In March 2005, the FASB issued final guidance that clarifies how companies should account for "conditional" asset retirement obligations. FASB Interpretation Accounting for Conditional Asset Retirement Obligations (FIN 47), deals with obligations to perform asset retirement activities in which the timing and (or) method of settlement are conditional on a future event (e.g., legal requirements surrounding asbestos handling and disposal that are triggered by demolishing or renovating a facility). This guidance requires companies to recognize liabilities for these obligations. We have adopted FIN 47 at December 31, 2005. This interpretation did not have a material effect on the financial position, liquidity or results of operations.

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ITEM 7A.    QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

        We are exposed to foreign currency exchange risk related to our operations in European subsidiaries that have transactions, assets, and liabilities denominated in foreign currencies that are translated into U.S. dollars for consolidated financial reporting purposes. Historically, we have not hedged any of these foreign currency exchange risks. For the year ended December 31, 2005, an average 10% weakening of the U.S. dollar relative to the currencies in which our European subsidiaries operate would have resulted in an increase of $17.8 million in reported total revenues and a corresponding increase in reported expenses. This sensitivity analysis of the effects of changes in foreign currency exchange rates does not assume any changes in the level of operations of our European subsidiaries.

        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.

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ITEM 8.    FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

REPORT OF MANAGEMENT

Management's Report on Financial Statements

        Our management is responsible for the preparation, integrity and fair presentation of information in our consolidated financial statements, including estimates and judgments. The consolidated financial statements presented in this Annual Report on Form 10-K have been prepared in accordance with accounting principles generally accepted in the United States of America. Our management believes the consolidated financial statements and other financial information included in this Annual Report on Form 10-K fairly present, in all material respects, our financial condition, results of operations and cash flows as of and for the periods presented in this Annual Report on Form 10-K. The consolidated financial statements have been audited by PricewaterhouseCoopers LLP, an independent registered public accounting firm, as stated in their report, which is included herein.

Management's Report on Internal Control Over Financial Reporting

        Our management is responsible for establishing and maintaining adequate internal control over financial reporting. Our internal control over financial reporting is designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with accounting principles generally accepted in the United States of America.

        Our internal control over financial reporting includes those policies and procedures that:

•

pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect our transactions and dispositions of our assets;



•

provide reasonable assurance that our transactions are recorded as necessary to permit preparation of our financial statements in accordance with accounting principles generally accepted in the United States of America, and that our receipts and expenditures are being made only in accordance with authorization of our management and our directors; and



•

provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of our assets that could have a material effect on the consolidated financial statements.

        Because of its inherent limitations, internal control over financial reporting can provide only reasonable assurance and may not prevent or detect misstatements. Also, projections of any evaluation of the effectiveness of such controls in future periods are subject to the risk that the controls may become inadequate because of changes in conditions or that the degree of compliance with the policies and procedures may deteriorate.

        Our management conducted an assessment of the effectiveness of internal control over financial reporting based on the framework in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based on this assessment, our management concluded that, as of December 31, 2005, our internal controls over financial reporting were effective to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with accounting principles generally accepted in the United States of America. As permitted by SEC rules and regulations, our management has excluded Zeneus Holdings Limited and its wholly-owned subsidiaries ("Zeneus") from its assessment of internal control over financial reporting as of December 31, 2005 because it was acquired in 2005. Total assets and total revenues of Zeneus, our wholly-owned subsidiary, were $414.4 million and $1.4 million, which represented 14.7% and 0.1%, respectively, of the related consolidated financial statement amounts as of and for the year ended December 31, 2005. Refer to Note 2 of our Consolidated Financial Statements included in Part II, Item 8 of this Annual Report on Form 10-K for more information about the Zeneus acquisition.

        Our management's assessment of the effectiveness of our internal control over financial reporting has been audited by PricewaterhouseCoopers LLP, an independent registered public accounting firm, as stated in their report which is included herein.

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REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

To the Board of Directors and Shareholders of Cephalon, Inc.:

        We have completed integrated audits of Cephalon, Inc.'s 2005 and 2004 consolidated financial statements and of its internal control over financial reporting as of December 31, 2005 and an audit of its 2003 consolidated financial statements in accordance with the standards of the Public Company Accounting Oversight Board (United States). Our opinions, based on our audits, are presented below.

Consolidated financial statements and financial statement schedule

        In our opinion, the consolidated financial statements listed in the index appearing under Item 15(a)(1) on page 123, present fairly, in all material respects, the financial position of Cephalon, Inc. and its subsidiaries at December 31, 2005 and 2004, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2005 in conformity with accounting principles generally accepted in the United States of America. In addition, in our opinion, the financial statement schedule listed in the index appearing under Item 15(a)(2) on page 123 presents fairly, in all material respects, the information set forth therein when read in conjunction with the related consolidated financial statements. These financial statements and the financial statement schedule are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements and the financial statement schedule based on our audits. We conducted our audits of these statements in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit of financial statements includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

Internal control over financial reporting

        Also, in our opinion, management's assessment, included in "Management's Report on Internal Control Over Financial Reporting" appearing under Item 8, that the Company maintained effective internal control over financial reporting as of December 31, 2005 based on criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO), is fairly stated, in all material respects, based on those criteria. Furthermore, in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2005, based on criteria established in Internal Control—Integrated Framework issued by the COSO. The Company's management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting. Our responsibility is to express opinions on management's assessment and on the effectiveness of the Company's internal control over financial reporting based on our audit. We conducted our audit of internal control over financial reporting in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. An audit of internal control over financial reporting includes obtaining an understanding of internal control over financial reporting, evaluating management's assessment, testing and evaluating the design and operating effectiveness of internal control, and performing such other procedures as we consider necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinions.

        A company's internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for

75

external purposes in accordance with generally accepted accounting principles. A company's internal control over financial reporting includes those policies and procedures that (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company's assets that could have a material effect on the financial statements.

        Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

        As described in "Management's Report on Internal Control Over Financial Reporting", management has excluded Zeneus Holdings Limited and its wholly-owned subsidiaries (Zeneus) from its assessment of internal control over financial reporting as of December 31, 2005 because it was acquired by the Company in a purchase business combination during 2005. We have also excluded Zeneus from our audit of internal control over financial reporting. Zeneus is a wholly-owned subsidiary whose total assets and total revenues were $414.4 million and $1.4 million, which represent 14.7% and 0.1%, respectively, of the related consolidated financial statement amounts as of and for the year ended December 31, 2005.

/s/ PricewaterhouseCoopers LLP

Philadelphia, PA
March 10, 2006

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CEPHALON, INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

			December 31, 2005			December 31, 2004
			(In thousands, except share data)
ASSETS
CURRENT ASSETS:
	Cash and cash equivalents		$	205,060		$	574,244
	Investments			279,030			217,432
	Receivables, net			199,086			208,225
	Inventory, net			137,886			86,629
	Deferred tax assets, net			187,436			38,574
	Other current assets			40,339			39,915
		Total current assets		1,048,837			1,165,019
PROPERTY AND EQUIPMENT, net				323,830			244,834
GOODWILL				471,051			372,534
INTANGIBLE ASSETS, net				742,874			449,402
DEBT ISSUANCE COSTS, net				13,172			25,401
DEFERRED TAX ASSETS, net				200,629			117,183
OTHER ASSETS				18,813			22,549
			$	2,819,206		$	2,396,922
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
	Current portion of long-term debt		$	933,160		$	5,114
	Accounts payable			53,699			52,488
	Accrued expenses			291,744			170,436
		Total current liabilities		1,278,603			228,038
LONG-TERM DEBT				763,097			1,284,410
DEFERRED TAX LIABILITIES, net				110,703			39,119
OTHER LIABILITIES				54,632			15,311
		Total liabilities		2,207,035			1,566,878
COMMITMENTS AND CONTINGENCIES (Note 12)				—			—
STOCKHOLDERS' EQUITY:
	Preferred stock, $.01 par value, 5,000,000 shares authorized, 2,500,000 shares issued, and none outstanding			—			—
	Common stock, $.01 par value, 200,000,000 shares authorized, 58,445,405 and 57,973,050 shares issued, and 58,072,562 and 57,640,266 shares outstanding			584			580
	Additional paid-in capital			1,166,166			1,172,499
	Treasury stock, 372,843 and 332,784 shares outstanding, at cost			(17,125	)		(14,860	)
	Accumulated deficit			(570,072	)		(395,118	)
	Accumulated other comprehensive income			32,618			66,943
		Total stockholders' equity		612,171			830,044
			$	2,819,206		$	2,396,922

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

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CEPHALON, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS

		Year Ended December 31,
		2005			2004			2003
		(In thousands, except per share data)
REVENUES:
	Sales	$	1,156,518		$	980,375		$	685,250
	Other revenues		55,374			35,050			29,557
			1,211,892			1,015,425			714,807
COSTS AND EXPENSES:
	Cost of sales		164,223			119,973			92,375
	Research and development		354,826			273,972			168,222
	Selling, general and administrative		443,861			339,477			254,088
	Depreciation and amortization		84,305			52,798			44,073
	Impairment charges		20,820			30,071			—
	Acquired in-process research and development		366,815			185,700			—
			1,434,850			1,001,991			558,758
INCOME (LOSS) FROM OPERATIONS			(222,958	)		13,434			156,049
OTHER INCOME AND (EXPENSE):
	Interest income		26,171			16,486			11,298
	Interest expense		(25,235	)		(22,186	)		(28,905	)
	Debt exchange expense		—			(28,230	)		—
	Write-off of deferred debt issuance costs		(27,109	)		—			—
	Gain (charge) on early extinguishment of debt		2,085			(2,313	)		(9,816	)
	Other income (expense), net		1,928			(5,375	)		1,688
			(22,160	)		(41,618	)		(25,735	)
INCOME (LOSS) BEFORE INCOME TAXES			(245,118	)		(28,184	)		130,314
INCOME TAX BENEFIT (EXPENSE)			70,164			(45,629	)		(46,456	)
NET INCOME (LOSS)		$	(174,954	)	$	(73,813	)	$	83,858
BASIC INCOME (LOSS) PER COMMON SHARE		$	(3.01	)	$	(1.31	)	$	1.49
DILUTED INCOME (LOSS) PER COMMON SHARE		$	(3.01	)	$	(1.31	)	$	1.42
WEIGHTED AVERAGE NUMBER OF COMMON SHARES OUTSTANDING			58,051			56,489			55,560
WEIGHTED AVERAGE NUMBER OF COMMON SHARES OUTSTANDING-ASSUMING DILUTION			58,051			56,489			64,076

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

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CEPHALON, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY

								Common Stock						Treasury Stock							Accumulated Other Comprehensive Income
		Comprehensive Income (Loss)									Additional Paid-in Capital							Accumulated Deficit
					Total			Shares	Amount					Shares	Amount
		(In thousands, except share data)
BALANCE, JANUARY 1, 2003					$	642,585		55,425,841	$	554	$	1,034,137		272,857	$	(11,989	)	$	(405,163	)	$	25,046
	Net income	$	83,858			83,858													83,858
	Foreign currency translation gain		28,995
	Unrealized investment losses		(1,291	)
	Other comprehensive gain		27,704			27,704																27,704
	Comprehensive income	$	111,562
	Sale of warrants associated with convertible subordinated notes					178,315						178,315
	Purchase of convertible note hedge associated with convertible subordinated notes					(258,584	)					(258,584	)
	Tax benefit from the purchase of convertible note hedge					90,500						90,500
	Stock options exercised					4,528		299,056		3		4,525
	Tax benefit from the exercise of stock options					944						944
	Restricted stock award plan					1,394		99,025		1		1,393
	Employer contributions to employee benefit plan					829		18,588				829
	Treasury stock acquired					(1,703	)							35,971		(1,703	)
BALANCE, DECEMBER 31, 2003						770,370		55,842,510		558		1,052,059		308,828		(13,692	)		(321,305	)		52,750
	Net loss	$	(73,813	)		(73,813	)												(73,813	)
	Foreign currency translation gain		16,071
	Unrealized investment losses		(1,878	)
	Other comprehensive gain		14,193			14,193																14,193
	Comprehensive loss	$	(59,620	)
	Issuance of common stock upon conversion of convertible notes					105,122		1,518,169		15		105,107
	Tax effect upon conversion of convertible notes					(10,100	)					(10,100	)
	Stock options exercised					12,051		535,446		6		12,045
	Tax benefit from the exercise of stock options					8,017						8,017
	Restricted stock award plan					5,372		76,925		1		5,371
	Treasury stock acquired					(1,168	)							23,956		(1,168	)
BALANCE, DECEMBER 31, 2004						830,044		57,973,050		580		1,172,499		332,784		(14,860	)		(395,118	)		66,943
	Net loss	$	(174,954	)		(174,954	)												(174,954	)
	Foreign currency translation loss		(33,317	)
	Unrealized investment losses		(1,008	)
	Other comprehensive loss		(34,325	)		(34,325	)															(34,325	)
	Comprehensive loss	$	(209,279	)
	Sale of warrants associated with convertible subordinated notes					217,071						217,071
	Purchase of convertible note hedge associated with convertible subordinated notes					(382,261	)					(382,261	)
	Tax benefit from the purchase of convertible note hedge					133,791						133,791
	Stock options exercised					11,460		346,730		3		11,457
	Tax benefit from the exercise of stock options, net of adjustment					2,826						2,826
	Restricted stock award plan					10,784		125,625		1		10,783
	Treasury stock acquired					(2,265	)							40,059		(2,265	)
BALANCE, DECEMBER 31, 2005					$	612,171		58,445,405	$	584	$	1,166,166		372,843	$	(17,125	)	$	(570,072	)	$	32,618

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

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CEPHALON, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

				Year Ended December 31,
				2005			2004			2003
				(In thousands)
CASH FLOWS FROM OPERATING ACTIVITIES:
	Net (loss) income			$	(174,954	)	$	(73,813	)	$	83,858
	Adjustments to reconcile net (loss) income to net cash provided by operating activities:
		Deferred income tax (benefit) expense			(31,389	)		40,081			32,437
		Tax benefit from equity compensation			5,826			8,017			944
		Debt exchange expense			—			28,230			—
		Tax effect on conversion of convertible notes			—			(10,100	)		—
		Depreciation and amortization			89,967			59,016			45,135
		Amortization of debt issuance costs			34,410			8,275			7,602
		Stock-based compensation expense			10,784			5,372			2,224
		Non-cash (gain) charge on early extinguishment of debt			(4,549	)		2,313			3,615
		Pension curtailment			—			(4,214	)		—
		Loss on disposals of property and equipment			1,107			1,423			—
		Impairment charges			20,820			30,071			—
		Acquired in-process research and development			201,815			185,700			—
		Changes in operating assets and liabilities, net of effect from acquisitions:
			Receivables		35,070			(105,523	)		4,691
			Inventory		(44,167	)		(16,699	)		(1,691	)
			Other assets		(36,528	)		(27,042	)		7,741
			Accounts payable, accrued expenses and deferred revenues		94,523			47,864			17,477
			Other liabilities		(17,004	)		(367	)		(3,792	)
			Net cash provided by operating activities		185,731			178,604			200,241
CASH FLOWS FROM INVESTING ACTIVITIES:
	Purchases of property and equipment				(118,050	)		(50,244	)		(40,453	)
	Investments in non-marketable securities				—			—			(32,975	)
	Acquisition of CIMA LABS, net of cash acquired				—			(482,521	)		—
	Acquisition of Salmedix, net of cash acquired				(130,733	)		—			—
	Acquisition of TRISENOX				(69,722	)		—			—
	Acquisition of Zeneus, net of cash acquired				(365,786	)		—			—
	Acquisition of intangible assets				(33,459	)		(45,771	)		—
	Sales and maturities of investments				149,072			90,973			143,815
	Purchases of investments				(211,802	)		(197,651	)		(87,979	)
		Net cash used for investing activities			(780,480	)		(685,214	)		(17,592	)
CASH FLOWS FROM FINANCING ACTIVITIES:
	Proceeds from exercises of common stock options				11,460			12,051			4,528
	Acquisition of treasury stock				(2,265	)		(1,168	)		(1,703	)
	Payments on and retirements of long-term debt				(504,113	)		(51,905	)		(211,714	)
	Net proceeds from issuance of convertible subordinated notes				891,949			—			727,085
	Proceeds from sale of warrants				217,071			—			178,315
	Purchase of convertible note hedge				(382,261	)		—			(258,584	)
		Net cash provided by (used for) financing activities			231,841			(41,022	)		437,927
EFFECT OF EXCHANGE RATE CHANGES ON CASH AND CASH EQUIVALENTS					(6,276	)		6,177			9,026
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS					(369,184	)		(541,455	)		629,602
CASH AND CASH EQUIVALENTS, BEGINNING OF YEAR					574,244			1,115,699			486,097
CASH AND CASH EQUIVALENTS, END OF YEAR				$	205,060		$	574,244		$	1,115,699
Supplemental disclosures of cash flow information:
	Cash payments for interest, net of capitalized interest			$	16,595		$	16,588		$	25,947
	Cash payments for income taxes				15,963			24,182			4,018
Non-cash financing activities:
	Capital lease additions				2,303			2,337			830
	Tax benefit from the purchase of convertible note hedge				133,791			—			90,500
	Conversion of convertible notes into common stock				—			78,250			—

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

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CEPHALON, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(In thousands, except per share data)

1.    NATURE OF BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Business

        Cephalon is an international biopharmaceutical company dedicated to the discovery, development and marketing of innovative products in four core therapeutic areas: central nervous system ("CNS") disorders, pain, cancer and addiction. In addition to conducting an active research and development program, we market four products in the United States and numerous products in various countries throughout Europe.

Use of Estimates

        The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires us to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues, and expenses, and related disclosure of assets and liabilities. Actual results may differ from those estimates.

Principles of Consolidation

        The consolidated financial statements include the results of our operations and our wholly-owned subsidiaries. All significant intercompany accounts and transactions have been eliminated. We completed the acquisitions of issued share capital of Zeneus Holdings Limited and its wholly-owned subsidiaries ("Zeneus") on December 22, 2005, substantially all assets related to the TRISENOX injection business from Cell Therapeutics, Inc. ("CTI") and CTI Technologies, Inc., a wholly-owned subsidiary of CTI on July 18, 2005, outstanding capital stock of Salmedix, Inc. on June 14, 2005 and the outstanding shares of capital stock of CIMA LABS INC. ("CIMA LABS") on August 12, 2004. These acquisitions have been accounted for either as business combinations or asset purchases.

Foreign Currency

        For foreign operating entities with currencies other than the U.S. Dollar, the local currency is the functional currency. We translate asset and liability balances at exchange rates in effect at the end of the period and income and expense transactions at the average exchange rates in effect during the period. Resulting translation adjustments are reported as a separate component of accumulated other comprehensive income included in stockholders' equity. Gains and losses from foreign currency transactions are included in the consolidated statements of operations.

        Statement of Financial Accounting Standards ("SFAS") No. 95, "Statement of Cash Flows" requires that the effect of exchange rate changes on cash held in foreign currencies be reported as a separate item in the reconciliation of beginning and ending cash and cash equivalents. All other foreign currency cash flows are reported in the applicable line of the consolidated statement of cash flows using an approximation of the exchange rate in effect at the time of the cash flows.

Cash Equivalents and Investments

        Cash equivalents include investments in liquid securities with original maturities of three months or less from the date of purchase. In accordance with SFAS No. 115, "Accounting for Certain Investments in Debt and Equity Securities," we consider our investments to be "available for sale." We classify these investments as short-term and carry them at fair market value. Unrealized gains and losses have been recorded as a separate component of accumulated other comprehensive income included in

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stockholders' equity. All realized gains and losses on our available for sale securities are recognized in results of operations.

Major U.S. Customers and Concentration of Credit Risk

        Our three largest products in terms of product sales, PROVIGIL® (modafinil) Tablets [C-IV], ACTIQ® (oral transmucosal fentanyl citrate) [C-II] and GABITRIL® (tiagabine hydrochloride), comprised approximately 86% of our worldwide net sales. Approximately 94% of PROVIGIL, ACTIQ and GABITRIL sales for the year ended December 31, 2005 were in the U.S. market. In the United States, we sell our products primarily to a limited number of pharmaceutical wholesalers without requiring collateral. We periodically assess the financial strength of these customers and establish allowances for anticipated losses, if necessary.

		% of total trade accounts receivable						% of worldwide net product sales
		For the period ended December 31,						For the year ended December 31,
		2005		2004		2003		2005		2004		2003
Major U.S. customers:
	AmerisourceBergen Corporation	10	%	14	%	19	%	19	%	20	%	22	%
	Cardinal Health, Inc.	33		31		23		37		36		33
	McKesson Corporation	12		35		28		30		31		27
Total		55	%	80	%	70	%	86	%	87	%	82	%

        At December 31, 2005, trade accounts receivable of our major U.S. customers as a percentage of total trade accounts receivable of 55% decreased as compared to 80% at December 31, 2004. This decrease is primarily attributable to growth of our European business. For a summary of accounts receivable, see Note 4 herein.

Inventory

        Inventory is stated at the lower of cost or market value. Effective January 1, 2002, we began using the last-in, first-out ("LIFO") method for our domestic inventories. We use the first-in, first-out ("FIFO") method for the majority of our foreign inventories. See Note 5 herein.

        We capitalize inventory costs associated with marketed products and certain products prior to regulatory approval and product launch, based on management's judgment of probable future commercial use and net realizable value. We could be required to expense previously capitalized costs related to pre-approval or pre-launch inventory upon a change in such judgment, due to a denial or delay of approval by regulatory bodies, a delay in commercialization, or other potential factors.

Property and Equipment

        Property and equipment are recorded at cost and depreciated using the straight-line method over the estimated useful lives of the assets, which range from three to 40 years. Property and equipment under capital leases are depreciated or amortized over the shorter of the lease term or the expected

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useful life of the assets. Expenditures for maintenance and repairs are charged to expense as incurred, while major renewals and betterments are capitalized.

        We capitalize interest in connection with the construction of plant and equipment.

Fair Value of Financial Instruments

        The carrying values of cash, cash equivalents, short-term investments, accounts receivable, accounts payable and accrued expenses approximate the respective fair values. The market value of our 2.0% convertible senior subordinated notes was $1.4 billion as compared to a carrying value of $920.0 million, the market value of our 2.5% convertible subordinated notes approximated the carrying value of $10.0 million, and the market value of our Zero Coupon convertible subordinated notes was $881.3 million as compared to a carrying value of $750.4 million, at December 31, 2005, based on quoted market values. The majority of our other debt instruments that were outstanding as of December 31, 2005 do not have readily ascertainable market values; however, management believes that the carrying values approximate the respective fair values.

Goodwill, Intangible Assets and Other Long-Lived Assets

        Goodwill represents the excess of purchase price over net assets acquired. In accordance with SFAS No. 142, "Goodwill and Other Intangible Assets," ("SFAS No. 142") goodwill is not amortized; rather, it is subject to a periodic assessment for impairment by applying a fair-value-based test. Under SFAS No. 142 at July 1, 2005, we allocated goodwill to each of our reporting units based on their relative fair value, with $281.6 million of goodwill allocated to our United States segment and $87.9 million allocated to our Europe segment. We completed our annual test of impairment of goodwill in each segment at July 1, 2005 and concluded that there was no impairment.

        In accordance with SFAS No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets," we review amortizable assets for impairment on a quarterly basis or whenever changes in circumstances indicate the carrying value of the asset may not be recoverable. If impairment is indicated, we measure the amount of such impairment by comparing the carrying value of the assets to the present value of the expected future cash flows associated with the use of the asset.

Revenue Recognition

        In the United States, we sell our products to pharmaceutical wholesalers, the largest three of which account for 86% of our worldwide net sales for the year ended December 31, 2005. 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 correlate to the number of prescriptions written for our products as reported by IMS Health Incorporated. We believe that speculative buying of product, particularly in anticipation of possible price increases, has been the historic practice of many pharmaceutical wholesalers. In past years, we attempted to minimize these fluctuations both by providing, from time to time, discounts to our customers to stock normal amounts of inventory (which we had historically defined as approximately one month's supply at our current sales level) and by canceling orders if we believe a particular customer is speculatively buying inventory in anticipation of possible price increases.

83

        Over the past two years, our wholesaler customers, as well as others in the industry, began modifying their business models from arrangements where they derive profits from the management of various discounts and rebates, to arrangements where they charge a fee for their services. In connection with this new wholesaler business model, we finalized wholesaler service agreements in the third quarter of 2005 with our major wholesaler customers. These agreements obligate the wholesalers to provide us with periodic retail demand 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 limits based on product demand.

        As of December 31, 2005, we received information from our three largest U.S. wholesaler customers about the levels of inventory they held for our products. Based on this information, which we have not independently verified, we believe that total inventory held at these wholesalers is approximately 2 to 3 weeks supply at our current sales levels. Sales recorded for the year ended December 31, 2005 were generally representative of underlying demand for the products.

        Product sales are recognized upon the transfer of ownership and risk of loss for the product to the customer. In the United States, we sell all commercial products F.O.B. shipping point. Transfer of ownership and risk of loss for the product pass to the customer at the point that the product is picked up by a common carrier for shipment to the customer. In Europe, product sales are recognized predominantly upon customer receipt of the product except in certain contractual arrangements where different terms may be specified. We record product sales net of estimated reserves for contractual allowances, discounts and returns. Contractual allowances result from sales under contracts with managed care organizations and government agencies.

        Other revenue, which includes revenues from collaborative agreements, consists primarily of up-front fees, ongoing research and development funding, milestone payments and payments under co-promotional or managed services agreements. Non-refundable up-front fees are deferred and amortized to revenue over the related performance period. We estimate our performance period based on the specific terms of each collaborative agreement. We adjust the performance periods, if appropriate, based upon available facts and circumstances. We recognize periodic payments over the period that we perform the related activities under the terms of the agreements. Revenue resulting from the achievement of milestone events stipulated in the agreements is recognized when the milestone is achieved. Milestones are based upon the occurrence of a substantive element specified in the contract or as a measure of substantive progress towards completion under the contract.

        Reimbursement rates of research and development activities under collaborative agreements vary according to the terms of the individual agreements. Costs incurred related to collaborative agreements and reflected in our operating expenses approximated $33.6 million, $27.9 million and $46.1 million for the years ended December 31, 2005, 2004, and 2003, respectively.

        Payments under co-promotional or managed services agreements are recognized when the products are sold or the promotional activities are performed. The portion of the payments that represents reimbursement of our expenses is recognized as an offset to those expenses in our statement of income.

Research and Development

        All research and development costs are charged to expense as incurred.

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Acquired In-Process Research and Development

        Purchased in-process research and development ("IPR&D") represents the estimated fair value assigned to research and development projects acquired in a purchase business combination that have not been completed at the date of acquisition and which have no future alternative use. Accordingly, these costs are charged to expense as of the acquisition date.

        The value assigned to purchased in-process technology is determined by estimating the costs to develop the acquired technology into commercially viable products, estimating the resulting net cash flows from the projects, and discounting the net cash flows to their present value. The revenue projections used to value IPR&D were, in some cases, reduced based on the probability of developing a new drug, and considered the relevant market sizes and growth factors, expected trends in technology, and the nature and expected timing of new product introductions by us and our competitors. The resulting net cash flows from such projects are based on management's estimates of cost of sales, operating expenses, and income taxes from such projects. The rates utilized to discount the net cash flows to their present value were based on estimated cost of capital calculations.

        If these projects are not successfully developed, the sales and profitability of the combined company may be adversely affected in future periods. Additionally, the value of other acquired intangible assets may become impaired. We believed that the foregoing assumptions used in the IPR&D analysis were reasonable at the time of the acquisition. No assurance can be given, however, that the underlying assumptions used to estimate expected project sales, development costs or profitability, or the events associated with such projects, will transpire as estimated.

Other Comprehensive Income

        We follow SFAS No. 130, "Reporting Comprehensive Income." This statement requires the classification of items of other comprehensive income by their nature and disclosure of the accumulated balance of other comprehensive income, separately within the equity section of the balance sheet. The balance in accumulated other comprehensive income due to foreign currency translation adjustment gains was $33.6 million and $66.9 million as of December 31, 2005 and 2004, respectively. The balance in accumulated other comprehensive income due to unrealized investment losses was $1.0 million, net of tax, as of December 31, 2005 and negligible as of December 31, 2004.

Stock-based Compensation

        We account for stock option plans and restricted stock award plans in accordance with Accounting Principles Board Opinion ("APB") No. 25, "Accounting for Stock Issued to Employees." Accordingly, no compensation expense has been recognized for stock options since all options granted had an exercise price equal to the market value of the underlying stock on the grant date. Restricted stock awards are expensed. See Note 13 herein. The following table illustrates the effect on pro forma net

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income (loss) and earnings (loss) per share if we had applied the fair value recognition provisions of SFAS 123, "Accounting for Stock-Based Compensation."

		Year ended December 31,
		2005			2004			2003
Net income (loss), as reported		$	(174,954	)	$	(73,813	)	$	83,858
Add: Stock-based employee compensation expense included in reported net income (loss), net of tax			6,826			3,187			896
Deduct: Total stock-based employee compensation expense determined under fair value based method for all awards, net of tax			(30,163	)		(40,035	)		(34,799	)
Pro forma net income (loss)		$	(198,291	)	$	(110,661	)	$	49,955
Earnings (loss) per share:
	Basic income (loss) per share, as reported	$	(3.01	)	$	(1.31	)	$	1.49
	Basic income (loss) per share, pro forma	$	(3.42	)	$	(1.96	)	$	0.89
	Diluted income (loss) per share, as reported	$	(3.01	)	$	(1.31	)	$	1.42
	Diluted income (loss) per share, pro forma	$	(3.42	)	$	(1.96	)	$	0.87

        The fair value of each option grant at the grant date is calculated using the Black-Scholes option-pricing model. The following weighted average assumptions were used for grants in 2005, 2004 and 2003:

	2005		2004		2003
Risk free interest rate	4.41	%	3.87	%	3.44	%
Expected life (years)	6.5		6.5		6.0
Expected volatility	50	%	66	%	67	%
Expected dividend yield	—	%	—	%	—	%

Income Taxes

        We account for income taxes using the liability method under SFAS No. 109, "Accounting for Income Taxes." This method generally provides that deferred tax assets and liabilities be recognized for temporary differences between the financial reporting basis and the tax basis of the assets and liabilities and expected benefits of utilizing net operating loss and tax credit carryforwards. We record a valuation allowance for certain temporary differences for which it is more likely than not that we will not generate future tax benefits. The impact on deferred taxes of changes in tax rates and laws, if any, are applied to the years during which temporary differences are expected to be settled and reflected in the consolidated financial statements in the period of enactment.

Reclassifications

        Certain reclassifications of prior year amounts have been made to conform to the current year presentation. In the December 31, 2004 balance sheet, certain reclassifications and netting of assets and liabilities have been made to conform with the current year presentation including deferred tax accounts.

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CEPHALON, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(In thousands, except per share data)

Recent Accounting Pronouncements

        In November 2004, the Financial Accounting Standards Board ("FASB") issued SFAS No. 151, "Inventory Costs," which requires abnormal amounts of idle capacity and spoilage costs to be excluded from the cost of inventory and expensed when incurred. This Statement is effective for fiscal years beginning after June 15, 2005. We believe the adoption of this statement effective January 1, 2006 will not have a significant impact on our 2006 consolidated financial statements.

        In December 2004, the FASB issued SFAS No. 123(R) (revised 2004) "Share-Based Payment." SFAS No. 123(R) requires employee stock-based compensation to be measured based on the grant-date fair value of the awards and the cost to be recognized over the period during which an employee is required to provide service in exchange for the award. The Statement eliminates the alternative use of APB No. 25's intrinsic value method of accounting for awards, which is our accounting policy for stock options. See Note 1 herein for the pro forma impact of compensation expense from stock options on net earnings and earnings per share. SFAS No. 123(R) is effective as of January 1, 2006. We will adopt the provisions of SFAS No. 123(R) on a modified, prospective basis. We expect the impact of adoption of this statement in 2006 to be approximately $20.0 million, net of tax, assuming a tax rate of 36.7 percent and other key assumptions remain constant since adoption and that any stock option grants that may be made during 2006 are excluded.

        In March 2005, the FASB issued final guidance that clarifies how companies should account for "conditional" asset retirement obligations. FASB Interpretation Accounting for Conditional Asset Retirement Obligations ("FIN 47"), deals with obligations to perform asset retirement activities in which the timing and (or) method of settlement are conditional on a future event (e.g., legal requirements surrounding asbestos handling and disposal that are triggered by demolishing or renovating a facility). This guidance requires companies to recognize liabilities for these obligations. We have adopted FIN 47 at December 31, 2005. This interpretation did not have a material effect on our financial position, liquidity or results of operations.

2.    ACQUISITIONS

CIMA LABS INC.

        On August 12, 2004, we completed our acquisition of CIMA LABS. Under the Agreement and Plan of Merger dated November 3, 2003, we acquired each outstanding share of CIMA LABS common stock for $34.00 per share in cash. The total cash paid to CIMA LABS stockholders in the transaction was approximately $482.5 million, net of CIMA LABS' existing cash on hand, or $409.4 million, net of its cash, cash equivalents and investments. As a result of the acquisition, we obtained the rights to CIMA LABS' fentanyl effervescent buccal tablets ("FEBT") product candidate, for which we recently filed a New Drug Application ("NDA") with the U.S. Food and Drug Administration ("FDA") for the treatment of breakthrough cancer pain in opioid-tolerant patients. Fentanyl effervescent buccal tablets utilize an enhanced absorption transmucosal drug delivery technology that we believe may facilitate the rapid onset of pain relief in such patients. We are targeting approval of this product by the FDA in late 2006.

        The total purchase price of $514.1 million consists of $500.1 million for all outstanding shares of CIMA LABS at $34.00 per share and $14.0 million in direct transaction costs. The acquisition was funded from Cephalon's existing cash and short-term investments. In connection with the acquisition,

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CIMA LABS used $18.8 million of their own funds to purchase all outstanding employee stock options, whether or not vested or exercisable, for an amount equal to $34.00 less the exercise price for such option.

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

			At August 12, 2004
		Cash and cash equivalents	$	31,604
		Available-for-sale investments		73,169
		Receivables		8,821
		Inventory		6,224
		Deferred tax asset, net		20,985
		Other current assets		555
		Property, plant and equipment		82,474
		Intangible assets		113,100
		Acquired in-process research and development		185,700
		Goodwill		68,843
	Total assets acquired			591,475
		Current liabilities		(32,783	)
		Deferred tax liability		(44,567	)
	Total liabilities assumed			(77,350	)
Net assets acquired			$	514,125

        Of the $113.1 million of acquired intangible assets, $70.0 million was assigned to the DuraSolv® technology with an estimated useful life of 14 years, $32.7 million was assigned to the OraSolv® technology with a weighted average estimated useful life of approximately 6 years, and $10.4 million was assigned to the developed OraVescent® technology with an estimated useful life of 15 years. During the fourth quarter of 2005, goodwill was reduced by $9.0 million as a result of a reassessment of the realizability of certain deferred tax assets.

        Our purchase price allocation was finalized during 2005. We allocated $185.7 million of the purchase price to IPR&D projects. At the acquisition date, CIMA LABS' ongoing research and development initiatives were primarily involved with the development and commencement of Phase 3 clinical trials of FEBT (at a total cost of approximately $5.6 million), and several other minor ongoing research and development projects. As of the year ended December 31, 2005, we spent an additional $17.3 million on the FEBT project and do not expect to incur significant additional charges to complete this project. The estimated revenues for the in-process projects, including FEBT, are expected to be recognized from 2006 through 2019. A discount rate of 28 percent was used to value the project. We believe that this discount rate was commensurate with the project stage of development and the uncertainties in the economic estimates described above. At the date of acquisition, the development of these projects had not yet reached technological feasibility, and the research and development in

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progress had no alternative future uses. Accordingly, these costs in the amount of $185.7 million were charged to expense in the third quarter of 2004.

        The results of operations for CIMA LABS have been included in our consolidated statements since the acquisition date of August 12, 2004.

SALMEDIX, INC.

        On June 14, 2005, we completed our acquisition of Salmedix, Inc. Under the Agreement and Plan of Merger dated May 12, 2005, we acquired all of the outstanding capital stock of Salmedix for $160.9 million in cash and future payments totaling up to $40 million upon achievement of certain regulatory milestones. The acquisition was funded from our existing cash on hand and was accounted for as an asset acquisition, as Salmedix is a development stage company. As a result of the acquisition, we obtained the rights to market TREANDA™ (bendamustine hydrochloride) for which we are enrolling patients in Phase 3 clinical trials in the United States and Canada for the treatment of indolent (slowly progressing) non-Hodgkin's lymphoma ("NHL"), a type of hematologic malignancy. Of the purchase price, $30.8 million has been allocated to the fair value of the tangible net assets and liabilities as of the acquisition date, with the remaining purchase price of $130.1 million allocated to IPR&D relating primarily to TREANDA. Upon acquisition, we recognized a net deferred tax asset of $4.3 million relating to the U.S. federal and state net operating losses and tax credits acquired from Salmedix. In the fourth quarter of 2005, we reversed a portion of the previously recorded valuation allowance as we believe it is more likely than not that the related deferred tax assets will be recovered. The results of operations for Salmedix have been included in our consolidated financial statements as of the acquisition date.

VIVITROL LICENSE AND COLLABORATION

        In June 2005, we entered into a license and collaboration agreement with Alkermes, Inc. to develop and commercialize VIVITROL™ (naltrexone for extended-release injectable suspension) in the United States. Concurrent with the execution of this agreement, we entered into a supply agreement under which Alkermes will provide to us finished commercial supplies of VIVITROL. VIVITROL is an investigational drug in development by Alkermes for the treatment of alcohol dependence.

        Alkermes submitted an NDA for VIVITROL to the FDA on March 31, 2005 and on December 28, 2005, we announced that the FDA had issued an approvable letter for VIVITROL. We made an initial payment of $160 million cash to Alkermes upon execution of the agreement, all of which has been recorded as an IPR&D charge as the product has not yet received FDA approval. In the fourth quarter of 2005, we reversed the previously recorded valuation allowance on the majority of the potential tax benefit related to the acquired product rights as we believe it will now be realized. We also have agreed to make an additional cash payment of $110 million to Alkermes if VIVITROL is approved by the FDA. Alkermes also could receive up to an additional $220 million in milestone payments from us upon attainment of certain agreed-upon sales levels of VIVITROL.

        Cephalon and Alkermes have formed a joint steering committee that will share responsibility for the commercialization, development and supply strategy for VIVITROL. We will have primary responsibility for the commercialization of VIVITROL, while Alkermes will be responsible for

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obtaining marketing approval and manufacturing the product. Until the later of December 31, 2007 or 18 months following FDA approval of the product, Alkermes is responsible for any cumulative losses up to $120 million and we are responsible for any cumulative losses in excess of $120 million. Pre-tax profit, as adjusted for certain items, and losses incurred after the later of December 31, 2007 or 18 months following FDA approval will be split equally between the parties. We will recognize all product sales following commercial launch.

TRISENOX

        On July 18, 2005, we completed the acquisition of substantially all assets related to the TRISENOX® (arsenic trioxide) injection business from CTI and CTI Technologies, Inc., a wholly-owned subsidiary of CTI, for $69.7 million in cash, funded from our existing cash on hand. The acquisition agreement provides for contingent future cash payments to CTI, totaling up to $100.0 million, upon the achievement of certain label expansion and sales milestones. TRISENOX is indicated as a single agent for the treatment of patients with relapsed or refractory acute promyelocytic leukemia ("APL"), a life-threatening hematologic cancer. The results of operations of TRISENOX have been included in the consolidated statements of operations since the acquisition date.

        The acquisition of the assets related to the TRISENOX business has been accounted for as a business combination. At the date of acquisition, the fair value of assets and liabilities acquired equaled $114.0 million, consisting of $0.7 million of net working capital, $113.0 million of intangible assets, $0.5 million of acquired IPR&D (which was expensed in the third quarter of 2005), net deferred tax assets of $15.6 million and deferred tax liabilities of $15.8 million. We finalized our purchase price allocation during the fourth quarter of 2005.

        The fair value of acquired net assets exceeded the cost by $42.4 million. Because the acquisition agreement provides for contingent consideration up to $100 million, the $42.4 million excess of fair value of acquired net assets over cost has been recognized as a liability at the date of acquisition in accordance with SFAS 141. When the contingencies are resolved, any contingent consideration amounts paid will reduce this liability. Any excess of the contingent payments over this liability will be recognized as an additional cost of the TRISENOX acquisition. Any excess of this liability over the contingent payments will reduce the recognized value of the acquired net assets on a pro rata basis.

        All of the intangible assets acquired relate to the developed TRISENOX technology with estimated useful lives between eight and 13 years.

ZENEUS HOLDINGS LIMITED

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

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

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

			At December 22, 2005
		Cash and cash equivalents	$	19,792
		Receivables		29,577
		Inventory		12,085
		Other current assets		1,238
		Property, plant and equipment		1,319
		Intangible assets		236,300
		Acquired in-process research and development		71,200
		Goodwill		114,581
	Total assets acquired			486,092
		Other liabilities		(29,624	)
		Deferred tax liability		(70,890	)
	Total liabilities assumed			(100,514	)
Net assets acquired			$	385,578

        Of the $236.3 million of acquired intangible assets, $182.5 million was assigned to the Myocet-related technology with an estimated useful life of 20 years, $26.1 million was assigned to Abelcet-related technology with an estimated useful life of approximately 20 years, $8.6 million was assigned to the Targretin technology with an estimated useful life of 9 years and $19.1 was assigned to non core products with an average estimated useful life of 20 years. All of the $114.6 million of goodwill was assigned to our Europe segment and none of this goodwill is expected to be deductible for income tax purposes.

        We allocated $71.2 million of the purchase price to an IPR&D project related to Myocet for use in the U.S. market. Myocet has not been approved by the FDA in the U.S., thus the estimated value of $71.2 million relating to the U.S. Myocet technology is considered IPR&D. At the acquisition date, Zeneus had several early stage projects that were not assigned any value based on Management's view of the likelihood of positive outcomes. The estimated revenue for the in-process project is expected to be recognized from 2008 through 2025. A discount rate of 16 percent was used to value the project. We believe that this discount rate was commensurate with the project stage of development and the uncertainties in the economic estimates described above. See Note 1 herein for a description of our policy as it relates to IPR&D.

        At the date of acquisition, the project had not yet reached commercialization and the development in progress had no alternative future uses. Accordingly, these costs in the amount of $71.2 million were

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charged to expense in the fourth quarter of 2005. Our remaining costs to complete this project are expected to be minimal.

        The purchase price allocation is still being finalized. We expect to finalize the allocation by the end of the second quarter of 2006.

UNAUDITED PRO FORMA INFORMATION

        The following unaudited pro forma information shows the results of our operations for the years ended December 31, 2005, 2004 and 2003 as though the acquisitions of CIMA LABS, included in 2004 and 2003, and Zeneus, included in 2005 and 2004, had occurred as of the beginning of the periods presented:

		For the year ended December 31,
		2005			2004			2003
	Total revenues	$	1,305,404		$	1,124,920		$	790,883
	Net income (loss)	$	(195,601	)	$	(103,927	)	$	71,442
Basic and diluted net income (loss) per common share:
	Basic income (loss) per common share	$	(3.37	)	$	(1.84	)	$	1.27
	Diluted income (loss) per common share	$	(3.37	)	$	(1.84	)	$	1.23

        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.

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3.    CASH, CASH EQUIVALENTS AND INVESTMENTS

        At December 31, cash, cash equivalents and investments consisted of the following:

		2005		2004
Cash and cash equivalents:
	Demand deposits	$	116,931	$	80,910
	Repurchase agreements		44,660		196,215
	Commercial paper		31,489		244,496
	Asset-backed securities		11,980		34,973
	Bonds		—		17,650
			205,060		574,244
Short-term investments (at market value):
	U.S. government agency obligations		84,469		107,803
	Asset-backed securities		48,158		37,023
	Bonds		127,602		61,738
	Non-U.S. corporate obligations		—		4,063
	Commercial paper		18,801		6,805
			279,030		217,432
		$	484,090	$	791,676

        The contractual maturities of our investments in cash, cash equivalents, and investments at December 31, 2005 are as follows:

Less than one year	$	456,132
Greater than one year but less than two years		24,055
Greater than two years		3,903
	$	484,090

4.    RECEIVABLES, NET

        At December 31, receivables consisted of the following:

	2005			2004
Trade receivables	$	177,897		$	187,375
Receivables from collaborations		4,877			14,099
Other receivables		21,934			10,466
		204,708			211,940
Less reserve for sales discounts and allowances		(5,622	)		(3,715	)
	$	199,086		$	208,225

        Trade receivables are recorded at the invoiced amount and do not bear interest. Our allowance for doubtful accounts is our best estimate of probable credit losses in our existing accounts receivable. We

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determine the allowance based on a percentage of trade receivables past due, specific customer issues, and a reserve related to our specific historical write-off experience and general industry experience. We review and adjust our allowance for doubtful accounts quarterly. Receivable balances or specific customer issues are written off against the allowance when we feel that it is probable that the receivable amount will not be recovered. Certain European receivable balances with government operated hospitals are over 90 days past due but we believe are collectible and are therefore, not reserved. In the past, our historical write-off experience has not been significant. We do not have any off-balance sheet credit exposure related to our customers.

5.    INVENTORY, NET

        At December 31, inventory consisted of the following:

	2005		2004
Raw material	$	67,164	$	31,511
Work-in-process		28,430		4,286
Finished goods		42,292		50,832
	$	137,886	$	86,629

        Our domestic inventories and certain of our foreign inventories are valued using the last-in, first-out ("LIFO") method. The excess of current or replacement cost over LIFO inventory value was $2.0 million at December 31, 2005 and the excess of LIFO inventory value over current or replacement cost was $0.3 million at December 31, 2004.

        The majority of our foreign inventories are valued using the first-in, first-out ("FIFO") method. Inventories valued using the FIFO method were $46.0 million and $31.8 million at December 31, 2005 and 2004, respectively.

        We capitalize inventory costs associated with marketed products and certain products prior to regulatory approval and product launch, based on management's judgment of probable future commercial use and net realizable value. We could be required to expense previously capitalized costs related to pre-approval or pre-launch inventory upon a change in such judgment, due to a denial or delay of approval by regulatory bodies, a delay in commercialization, or other potential factors. We had $51.1 million and $21.9 million of capitalized inventory costs for pre-launch products for the years ended December 31, 2005 and 2004, respectively.

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6.    PROPERTY AND EQUIPMENT, NET

        At December 31, property and equipment consisted of the following:

	Estimated Useful Lives	2005			2004
Land and improvements	—	$	9,019		$	9,425
Buildings and improvements	3-40 years		162,808			129,753
Laboratory, machinery and other equipment	3-15 years		145,916			120,375
Construction in progress	—		97,527			62,638
			415,270			322,191
Less accumulated depreciation and amortization			(91,440	)		(77,357	)
		$	323,830		$	244,834

        Depreciation and amortization expense related to property and equipment, excluding depreciation related to assets used in the production of inventory, was $26.7 million, $15.0 million and $11.0 million for the years ended December 31, 2005, 2004 and 2003, respectively. We had $14.9 million of capitalized software costs included in construction in progress at December 31, 2005.

7.    INTANGIBLE ASSETS, NET AND OTHER ASSETS

        Other intangible assets consisted of the following:

		December 31, 2005						December 31, 2004
	Estimated Useful Lives	Gross Carrying Amount		Accumulated Amortization		Net Carrying Amount		Gross Carrying Amount		Accumulated Amortization		Net Carrying Amount
Developed technology acquired from Group Lafon	10-15 years	$	132,000	$	39,467	$	92,533	$	132,000	$	29,600	$	102,400
Trademarks/tradenames acquired from Group Lafon	15 years		16,000		4,267		11,733		16,000		3,200		12,800
GABITRIL product rights	9-15 years		115,371		38,053		77,318		119,352		29,859		89,493
Novartis CNS product rights	10 years		—		—		—		41,641		16,656		24,985
ACTIQ marketing rights	10 years		75,465		31,359		44,106		75,465		23,707		51,758
Modafinil marketing rights	10 years		8,937		2,896		6,041		10,288		2,314		7,974
DuraSolv® technology	14 years		70,000		6,696		63,304		70,000		1,826		68,174
OraSolv® technology	6 years		32,700		7,210		25,490		32,700		1,966		30,734
ORAVESCENT® technology	15 years		10,400		930		9,470		10,400		254		10,146
NAXY® and MONO-NAXY® product rights	5 years		38,503		7,780		30,723		44,343		176		44,167
TRISENOX product rights	8-13 years		112,942		4,494		108,448		—		—		—
Trademarks/tradenames acquired from Zeneus	9-20 years		236,300		—		236,300		—		—		—
Other product rights	5-14 years		50,125		12,717		37,408		22,283		15,512		6,771
		$	898,743	$	155,869	$	742,874	$	574,472	$	125,070	$	449,402

        Other intangible assets are amortized over their estimated useful economic life using the straight line method. Amortization expense was $57.7 million, $37.8 million and $33.1 million for the years ended December 31, 2005, 2004 and 2003, respectively. Estimated amortization expense of intangible assets for each of the next five years is approximately $74.1 million in 2006, $72.8 million in 2007 and 2008, $72.6 million in 2009 and $62.7 million in 2010.

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Impairment Charges

        As a result of the negotiations with Novartis in the fourth quarter of 2005 and the termination of the PROVIGIL distribution agreement in the United Kingdom in March 2006, we determined that the carrying value of our investment in Novartis CNS product rights was fully impaired and we recorded an impairment charge of $20.8 million in our fourth quarter of 2005 results of operations.

        In January 2003, we purchased from MDS Proteomics Inc. ("MDSP"), a privately-held Canadian company and a subsidiary of MDS Inc., a $30.0 million convertible note due 2010 and entered into a five-year research agreement focused on accelerating the clinical development of our pipeline of small chemical compounds. In 2004, MDSP decided to change its business model to focus upon the provision of services to the pharmaceutical and biotechnology industries.

        On July 29, 2004, MDSP completed its reorganization under Canada's Companies Creditors' Arrangement Act and changed its name to Protana Inc. As part of the reorganization, we agreed to terminate our research agreement with Protana and cancelled the $30.0 million convertible note we held in return for shares of Class A Preferred Stock and Common Stock of Protana. In light of the restructuring of Protana and the uncertain business prospects for the company, we determined that the carrying value of our investment was fully impaired and we recorded an impairment charge of $30.1 million, which included transaction costs, in our second quarter of 2004 results of operations.

8.    ACCRUED EXPENSES

        At December 31, accrued expenses consisted of the following:

	2005		2004
Accrued compensation and benefits	$	37,707	$	27,692
Accrued income taxes		15,898		15,263
Accrued clinical trial fees		19,499		16,494
Accrued research and development		15,794		9,881
Accrued sales and marketing costs		22,655		18,065
Accrued contractual sales allowances		44,738		26,649
Accrued product sales returns allowances		22,598		11,727
Accrued product related costs		47,787		10,939
Other accrued expenses		65,068		33,726
	$	291,744	$	170,436

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CEPHALON, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(In thousands, except per share data)

9.    LONG-TERM DEBT

        At December 31, long-term debt consisted of the following:

	2005			2004
2.0% convertible senior subordinated notes due June 1, 2015	$	920,000		$	—
2.5% convertible subordinated notes due December 2006		10,007			521,750
Change in fair value of hedged portion of 2.5% convertible notes		—			(1,772	)
Zero Coupon convertible subordinated notes first putable June 2008 (Old)		313			303
Zero Coupon convertible subordinated notes first putable June 2010 (Old)		99			102
Zero Coupon convertible subordinated notes first putable June 2008 (New)		374,958			374,697
Zero Coupon convertible subordinated notes first putable June 2010 (New)		375,070			374,898
Mortgage and building improvement loans		8,975			9,721
Capital lease obligations		3,658			3,270
Other		3,177			6,555
Total debt		1,696,257			1,289,524
Less current portion		(933,160	)		(5,114	)
Total long-term debt	$	763,097		$	1,284,410

        Aggregate maturities of long-term debt are as follows:

2006	$	933,160
2007		3,275
2008		378,247
2009		2,318
2010		376,567
2011 and thereafter		2,690
	$	1,696,257

        During the fourth quarter of 2005, our 2.0% convertible senior subordinated notes due June 1, 2015 (the "2.0% Notes") became convertible. As a result, the 2.0% Notes have been classified as a current liability on our balance sheet and the related deferred debt issuance costs of $27.1 million have been written off as of December 31, 2005. In January 2006, our 2008 and 2010 Zero Coupon Notes became convertible and the related deferred debt issuance costs of $13.1 million will be written off during the quarter ended March 31, 2006. As of the filing date of this report, our 2.0% Notes and Zero Coupon Notes are considered to be current liabilities and will be presented in current portion of long-term debt in our March 31, 2006 consolidated balance sheet unless our stock price decreases to a level where these notes are no longer convertible.

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

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2.0% Convertible Senior Subordinated Notes

        In June and July 2005, we issued through a public offering $920 million of 2.0% Notes. Interest on the 2.0% Notes is payable semi-annually in arrears on June 1 and December 1 of each year, commencing December 1, 2005.

        The 2.0% Notes are subordinated to our existing and future senior indebtedness and senior to our existing and future subordinated indebtedness. The 2.0% Notes are convertible prior to maturity, subject to certain conditions described below, into cash and shares of our common stock at an initial conversion price of $46.70 per share, subject to adjustment (equivalent to a conversion rate of approximately 21.4133 shares per $1,000 principal amount of 2.0% Notes).

        The 2.0% Notes also contain a restricted convertibility feature that does not affect the conversion price of the 2.0% Notes but, instead, places restrictions on a holder's ability to convert their 2.0% Notes into shares of our common stock (the "conversion shares"). A holder may convert the 2.0% Notes prior to December 1, 2014 only if one or more of the following conditions are satisfied:

•

if, on the trading day prior to the date of surrender, the closing sale price of our common stock is more than 120% of the applicable conversion price per share (the "conversion price premium");



•

if the average of the trading prices of the 2.0% Notes for any five consecutive trading day period is less than 100% of the average of the conversion values of the 2.0% Notes during that period; or



•

if we make certain significant distributions to our holders of common stock; we enter into specified corporate transactions; or our common stock ceases to be approved for listing on the Nasdaq National Market and is not listed for trading on a U.S. national securities exchange or any similar U.S. system of automated securities price dissemination.

        Holders also may surrender their 2.0% Notes for conversion anytime after December 1, 2014 and on or prior to the close of business on the business day immediately preceding the maturity date, regardless if any of the foregoing conditions have been satisfied. Upon the satisfaction of any of the foregoing conditions as of the last day of the reporting period, or during the twelve months prior to December 1, 2014, we would classify the then-aggregate principal balance of the 2.0% Notes as a current liability on our balance sheet and would write off to expense all remaining unamortized debt issuance charges.

        Each $1,000 principal amount of the 2.0% Notes is convertible into cash and shares of our common stock, if any, based on an amount (the "Daily Conversion Value"), calculated for each of the twenty trading days immediately following the conversion date (the "Conversion Period"). The Daily Conversion Value for each trading day during the Conversion Period for each $1,000 aggregate principal amount of the 2.0% Notes is equal to one-twentieth of the product of the then applicable conversion rate multiplied by the volume weighted average price of our common stock on that day.

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        For each $1,000 aggregate principal amount of the 2.0% Notes surrendered for conversion, we will deliver the aggregate of the following for each trading day during the Conversion Period:

(1)

if the Daily Conversion Value for each trading day for each $1,000 aggregate principal amount of the 2.0% Notes exceeds $50.00, (a) a cash payment of $50.00 and (b) the remaining Daily Conversion Value in shares of our common stock; or



(2)

if the Daily Conversion Value for each trading day for each $1,000 aggregate principal amount of the 2.0% Notes is less than or equal to $50.00, a cash payment equal to the Daily Conversion Value.

        If the 2.0% Notes are converted in connection with certain fundamental changes that occur prior to June 2015, we may be obligated to pay an additional (or "make whole") premium with respect to the 2.0% Notes so converted.

Convertible Note Hedge and Warrant Agreements

        Concurrent with the sale of the 2.0% Notes, we purchased Convertible Note Hedges from Deutsche Bank AG ("DB") at a cost of $382.3 million. We also sold to DB warrants to purchase an aggregate of 19,700,214 shares of our common stock and received net proceeds from the sale of these warrants of $217.1 million. Taken together, the Convertible Note Hedge and warrant agreements have the effect of increasing the effective conversion price of the 2.0% Notes from our perspective to $67.92 per share. At our option, the warrants may be settled in either net cash or net shares. The Convertible Note Hedge must be settled using net shares. Under the Convertible Note Hedge, DB will deliver to us the aggregate number of shares we are required to deliver to a holder of 2.0% Notes that presents such notes for conversion. If the market price per share of our common stock is above $67.92 per share, we will be required to deliver either shares of our common stock or cash to DB representing the value of the warrants in excess of the strike price of the warrants. In accordance with Emerging Issues Task Force Issue No. 00-19, "Accounting for Derivative Financial Instruments Indexed to, and Potentially Settled In, a Company's Own Stock" ("EITF No. 00-19") and SFAS No. 150, "Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity," we recorded the Convertible Note Hedges and warrants in additional paid in capital, and will not recognize subsequent changes in fair value. We also recognized a deferred tax asset of $133.8 million for the effect of the future tax benefits related to the Convertible Note Hedge.

        The warrants have a strike price of $67.92. The warrants are exercisable only on the respective expiration dates (European style). We issued and sold the warrants to DB in a transaction exempt from the registration requirements of the Securities Act of 1933, as amended, because the offer and sale did not involve a public offering. There were no underwriting commissions or discounts in connection with the sale of the warrants.

2.5% Convertible Subordinated Notes

        In December 2001, we completed a private placement of $600.0 million of 2.5% convertible subordinated notes due December 2006 (the "2.5% Notes"). Debt issuance costs of $21.3 million were originally capitalized in other assets. $7.6 million of debt issuance costs were written off in conjunction with the debt exchange and the cash tender offer described below. $0.1 million of debt issuance costs

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remain at December 31, 2005. Interest on the notes is payable each June 15 and December 15, beginning June 15, 2002. The notes are convertible into our common stock at a conversion price of $81.00 per share, subject to adjustment in certain circumstances. The notes became redeemable at our option on and after December 20, 2004.

        In July 2004, a holder of the 2.5% Notes approached us, and we agreed, to exchange $78.3 million of these outstanding notes for 1,518,169 shares of our common stock. We recognized debt exchange expense of $28.2 million in the third quarter of 2004 relating to these early exchanges in accordance with SFAS No. 84, "Induced Conversion of Convertible Debt." We also recognized the tax effect of this exchange of $10.1 million as a reduction of additional paid-in capital in our statement of stockholders' equity and as a tax benefit in our statement of operations for the year ended December 31, 2004.

        In July 2005, we completed a cash tender offer for our outstanding 2.5% Notes. As a result of the tender, we purchased approximately $512 million of the 2.5% Notes at a price of $975 for each $1,000 of principal amount of 2.5% Notes tendered, plus accrued and unpaid interest to the date of payment of $1.94 for each $1,000 of principal amount of 2.5% Notes tendered. After completion of the tender offer, there remains outstanding approximately $10 million of the 2.5% Notes. In July 2005, we also terminated the interest rate swap agreement associated with $200 million notional amount of the 2.5% Notes.

        In the third quarter of 2005, we recognized a net gain of $2.1 million consisting of a gain on extinguishment of the 2.5% Notes of $7.4 million and a loss on the termination of the interest rate swap of $5.3 million.

Zero Coupon Convertible Subordinated Notes

        In June 2003, we issued and sold in a private placement $750.0 million of Zero Coupon Convertible Notes. The interest rate on the notes is zero and the notes do not accrete interest. The notes were issued in two tranches: $375.0 million of Zero Coupon Convertible Subordinated Notes Due 2033, First Putable June 15, 2008 (the "Old 2008 Notes") and $375.0 million of Zero Coupon Convertible Subordinated Notes Due 2033, First Putable June 15, 2010 (the "Old 2010 Notes" and, together with the Old 2008 Notes, the "Old Notes").

        In November 2004, we commenced an offer to exchange our Zero Coupon Convertible Subordinated Notes Due 2033, First Putable June 15, 2008 (the "New 2008 Notes"), and our Zero Coupon Convertible Subordinated Notes Due 2033, First Putable June 15, 2010 (the "New 2010 Notes" and, together with the New 2008 Notes, the "New Notes"), for any and all of our outstanding Old 2008 Notes and Old 2010 Notes. Upon expiration of the exchange offer, we issued $374.7 million principal amount at maturity of New 2008 Notes in exchange for a like principal amount at maturity of our outstanding Old 2008 Notes and $374.9 million principal amount at maturity of New 2010 Notes in exchange for a like principal amount at maturity of our outstanding Old 2010 Notes. There remains outstanding $0.3 million and $0.1 million of the Old 2008 and Old 2010 Notes, respectively, as of December 31, 2005.

        The New Notes were issued solely to our existing security holders pursuant to our offer to exchange, which was made in reliance upon the exemption from the registration requirement of the

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Securities Act afforded by Section 3(a)(9) thereof. We did not pay or give, directly or indirectly, any commission or other remuneration for solicitation of the exchange of the Old Notes for the New Notes.

        The New Notes contain the following terms:

•

the New 2008 Notes are first putable on June 15, 2008 at a price of 100.25% of the face amount of the New 2008 Notes. The holders of the New 2008 Notes may also require us to repurchase all or a portion of the New 2008 Notes for cash on June 15, 2013, June 15, 2018, June 15, 2023 and June 15, 2028, in each case at a price equal to the face amount of the New 2008 Notes. The New 2008 Notes are convertible prior to maturity, subject to certain conditions described below, into cash and shares of our common stock at a conversion price of $59.50 per share (an equivalent conversion rate of approximately 16.8067 shares per $1,000 principal amount of notes). We may redeem any outstanding New 2008 Notes for cash on June 15, 2008 at a price equal to 100.25% of the principal amount of such notes redeemed and after June 15, 2008 at a price equal to 100% of the principal amount of such notes redeemed; and



•

the New 2010 Notes are first putable for cash on June 15, 2010 at a price of 100.25% of the face amount of the New 2010 Notes. The holders of the New 2010 Notes may also require us to repurchase all or a portion of the New 2010 Notes for cash on June 15, 2015, June 15, 2020, June 15, 2025 and June 15, 2030, in each case at a price equal to the face amount of the New 2010 Notes. The New 2010 Notes are convertible prior to maturity, subject to certain conditions described below, into cash and shares of our common stock at a conversion price of $56.50 per share (an equivalent conversion rate of approximately 17.6991 shares per $1,000 principal amount of notes). We may redeem any outstanding New 2010 Notes for cash on June 15, 2010 at a price equal to 100.25% of the principal amount of such notes redeemed and after June 15, 2010 at a price equal to 100% of the principal amount of such notes redeemed.

        The New Notes also contain restricted convertibility terms that do not affect the conversion price of the notes, but instead place restrictions on a holder's ability to convert their notes into a combination of cash and shares of our common stock, as described below. A holder may convert the New Notes only if one or more of the following conditions are satisfied:

•

if, on the trading day prior to the date of surrender, the closing sale price of our common stock is more than 120% of the applicable conversion price per share;



•

if we have called the New Notes for redemption;



•

if the average of the trading prices of the applicable New Notes for a specified period is less than 100% of the average of the conversion values of the New Notes during that period; provided, however, that no New Notes may be converted based on the satisfaction of this condition during the six-month period immediately preceding each specified date on which the holders may require us to repurchase their notes (for example, with respect to the June 15, 2008 put date for the New 2008 Notes, the New 2008 Notes may not be converted from December 15, 2007 to June 15, 2008); or



•

if we make certain significant distributions to holders of its common stock, if we enter into specified corporate transactions or if our common stock is neither listed for trading on a U.S.

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national securities exchange or any similar U.S. system of automated securities price dissemination (a "Fundamental Change").

        Upon the satisfaction of any one of these conditions, we would classify the then-aggregate outstanding principal balance of New Notes as a current liability on our balance sheet.

        Each $1,000 principal amount of New Notes is convertible into cash and shares of our common stock, if any, based on an amount (the "Daily Conversion Value"), calculated for each of the ten trading days immediately following the conversion date (the "Conversion Period"). The Daily Conversion Value for each trading day during the Conversion Period for each $1,000 aggregate principal amount of New Notes is equal to one-tenth of the product of the then applicable conversion rate multiplied by the volume weighted average price of our common stock on that day.

        For each $1,000 aggregate principal amount of New Notes surrendered for conversion, we will deliver the aggregate of the following for each trading day during the Conversion Period:

        (1)   if the Daily Conversion Value for each trading day for each $1,000 aggregate principal amount of New Notes exceeds $100.00, (a) a cash payment of $100.00 and (b) the remaining Daily Conversion Value in shares of our common stock; or

        (2)   if the Daily Conversion Value for each trading day for each $1,000 aggregate principal amount of New Notes is less than or equal to $100.00, a cash payment equal to the Daily Conversion Value.

        If the New Notes are converted in connection with a Fundamental Change that occurs prior to June 15, 2008, we may also be obligated to pay an additional premium with respect to the New Notes so converted.

Convertible Note Hedge

        Concurrent with the private placement of the Old Notes, we purchased a Convertible Note Hedge from Credit Suisse First Boston International ("CSFBI") at a cost of $258.6 million. We also sold to CSFBI warrants to purchase an aggregate of 12,939,689 shares of our common stock and received net proceeds from the sale of $178.3 million. In connection with our exchange of Old Notes for New Notes, we amended the Convertible Note Hedge to reflect the mandatory net share settlement feature of the New Notes. Taken together, the Convertible Note Hedge and warrants have the effect of increasing the effective conversion price of the New Notes from our perspective to $72.08, a 50% premium to the last reported NASDAQ composite bid for our common stock on the day preceding the date of the original agreements. At our option, the warrants may be settled in either net cash or net shares; the Convertible Note Hedge must be settled using net shares. Under the Convertible Note Hedge, CSFBI will deliver to us the aggregate number of shares we are required to deliver to a holder of New Notes that presents such New Notes for conversion, provided, however, that if the market price per share of our common stock is above $72.08, we will be required to deliver either shares of our common stock or cash to CSFBI representing the value of the warrants in excess of the strike price of the warrants. In accordance with Emerging Issues Task Force Issue No. 00-19, "Accounting for Derivative Financial Instruments Indexed to, and Potentially Settled In, a Company's Own Stock" and SFAS No. 150, "Accounting for Certain Financial Instruments with Characteristics of both Liabilities

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and Equity," we recorded the Convertible Note Hedge and warrants in additional paid in capital as of June 30, 2003, and do not recognize subsequent changes in fair value. We also recognized a deferred tax asset of $90.5 million in the second quarter of 2003 for the effect of the future tax benefits related to the Convertible Note Hedge.

        The warrants have a strike price of $72.08. Of the total warrants sold, 6,302,521 warrants expire on June 15, 2008, with the remaining 6,637,168 warrants expiring on June 15, 2010. The warrants are exercisable only on the respective expiration dates (European style) or upon the conversion of the notes, if earlier.

Gain (Charge) on Early Extinguishment of Debt

        For the year ended December 31, 2005, $2.1 million was recognized in our financial statements as a gain on early extinguishment of debt as follows:

	Principal Amount		Discount		Write-off of unamortized debt issuance costs			Professional Fees			Loss on termination of interest rate swap			Total gain on early extinguishment of debt
2.5% convertible subordinated notes repurchased in July 2005	$	512,000	$	12,794	$	(5,326	)	$	(65	)	$	(5,318	)	$	2,085

        For the year ended December 31, 2004, $2.3 million was recognized in our financial statements as a (charge) on early extinguishment of debt as follows:

	Principal Amount		Premium			Write-off of unamortized debt issuance costs			Total (charge) on early extinguishment of debt
3.875% convertible subordinated notes repurchased in March 2004	$	10,000	$	(950	)	$	(11	)	$	(961	)
3.875% convertible subordinated notes repurchased in August 2004		33,000		(1,320	)		(32	)		(1,352	)
Total for 2004	$	43,000	$	(2,270	)	$	(43	)	$	(2,313	)

        For the year ended December 31, 2003, $9.8 million was recognized in our financial statements as a (charge) on early extinguishment of debt as follows:

	Principal Amount		Premium			Write-off of unamortized debt issuance costs			Total (charge) on early extinguishment of debt
5.25% Notes redeemed in July 2003	$	174,000	$	(5,481	)	$	(3,598	)	$	(9,079	)
3.875% Notes purchased in July 2003		12,000		(720	)		(17	)		(737	)
Total for 2003	$	186,000	$	(6,201	)	$	(3,615	)	$	(9,816	)

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Mortgage and Building Improvement Loans

        In March 1995, we purchased the buildings housing our administrative offices and research facilities in West Chester, Pennsylvania for $11.0 million. We financed the purchase through the assumption of an existing $6.9 million first mortgage and from $11.6 million in state funding provided by the Commonwealth of Pennsylvania. The first mortgage has a 15-year term with an annual interest rate of 9.625%. The state funding has a 15-year term with an annual interest rate of 2%. The loans require annual aggregate principal and interest payments of $1.8 million. The loans are secured by the buildings and by all our equipment located in Pennsylvania that is otherwise unsecured.

        In November 2002, the Pennsylvania Industrial Development Board ("PIDA") authorized the write-off of the outstanding principal balance of $5.3 million due on a loan granted by PIDA in 1995, contingent upon the commencement of construction of a new headquarters facility in the Commonwealth of Pennsylvania no later than June 30, 2004 and our creation of a specified number of new jobs in the Commonwealth. At its meeting held June 8, 2004, the PIDA Board approved the extension of the construction deadline until December 31, 2005, subject to the requirement that, effective July 1, 2004, we must commence payment of interest only on the original loan. In January 2006, the PIDA board voted to extend the deadline to December 31, 2007 for the job creation obligations, and eliminated the requirement to commence construction of a new headquarters facility by December 31, 2005. If the PIDA Board determines not to grant an extension to the December 31, 2007 job-creation deadline or we do not meet these job-creation obligations, we will be required to resume payment of principal on the original loan in addition to the payment of interest.

10.    EARNINGS PER SHARE ("EPS")

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

        The 2.0% Notes and New Zero Coupon Notes each are considered to be instrument C securities as defined by EITF 90-19, "Convertible Bonds with Issuer Option to Settle for Cash upon Conversion"; therefore, these notes are included in the dilutive earnings per share calculation using the treasury stock method. Under the treasury stock method, we must calculate the number of shares issuable under the terms of these notes based on the average market price of the stock during the period, and include that number in the total diluted shares figure for the period. Since the average share price of our stock during the fourth quarter of 2005 exceeded the conversion price of $46.70 for the 2.0% Notes, the impact of these notes during the period was an additional 1.4 million of incremental shares included to calculate diluted EPS. Since the average share price of our stock during the fourth quarter of 2005 did not exceed the conversion prices of $56.50 and $59.50 for the New Zero Coupon Notes, there was no

104

impact of these notes on diluted shares or diluted EPS during the period. Since the average share price of our stock during the year ended December 31, 2005 did not exceed the conversion prices of $46.70 for the 2.0% Notes and $56.50 and $59.50 for the New Zero Coupon Notes and there was a net loss for the year ended December 31, 2005, there was no impact of these notes on diluted shares or diluted EPS during the period.

        We have entered into Convertible Note Hedge and warrant agreements that, in combination, have the economic effect of reducing the dilutive impact of the 2.0% Notes and the New Zero Coupon Notes by increasing the effective conversion price for these notes, from our perspective, to $67.92 and $72.08, respectively. SFAS No. 128, however, requires us to analyze separately the impact of the Convertible Note Hedge and warrant agreements on diluted EPS. As a result, the purchases of the Convertible Note Hedges are excluded because their impact will always be anti-dilutive. SFAS No. 128 further requires that the impact of the sale of the warrants be computed using the treasury stock method. For example, using the treasury stock method, if the average price of our stock during the period ended December 31, 2005 had been $75.00, $85.00 or $95.00, the shares from the warrants to be included in diluted EPS would have been 2.4 million, 5.9 million and 8.7 million shares, respectively. The total number of shares that could potentially be included under the warrants is 32.6 million. Since the average share price of our stock during the fourth quarter of 2005 and the year ended December 31, 2005 since issuance did not exceed the effected conversion prices of either the 2.0% Notes or new Zero Coupon Notes and there was a net loss for the year ended December 31, 2005, there was no impact of the warrants on diluted shares or diluted EPS during the period.

        As of the filing date of this report, if our stock price continues to exceed the 2.0% Notes and New Zero Coupon Notes effective conversion prices at March 31, 2006, the impact of the convertible notes and warrants will be included in the fully diluted EPS calculation.

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

		Year ended December 31,
		2005			2004			2003
Basic income (loss) per common share computation:
	Numerator:
Net income (loss) used for basic income (loss) per common share		$	(174,954	)	$	(73,813	)	$	82,820
Net income used for basic income per participating security			—			—			1,038
	Total net income (loss)	$	(174,954	)	$	(73,813	)	$	83,858
	Denominator:
Weighted average shares used for basic income (loss) per common share			58,051			56,489			55,560
Weighted average shares of participating securities			—			316			696
	Basic income (loss) per common share	$	(3.01	)	$	(1.31	)	$	1.49
Diluted income (loss) per common share computation:
	Numerator:
Net income (loss) used for basic income (loss) per common share			(174,954	)		(73,813	)		82,820
Interest on convertible notes (net of tax) per common share			—			—			8,361
Net income (loss) used for diluted income (loss) per common share		$	(174,954	)	$	(73,813	)	$	91,181
	Denominator:
Weighted average shares used for basic income (loss) per common share			58,051			56,489			55,560
Effect of dilutive securities:
Convertible subordinated notes			—			—			7,411
Employee stock options and restricted stock awards			—			—			1,105
Weighted average shares used for diluted income (loss) per common share			58,051			56,489			64,076
	Diluted income (loss) per common share	$	(3.01	)	$	(1.31	)	$	1.42

        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:

		Year ended December 31,
		2005	2004	2003
Weighted average shares excluded:
	Employee stock options	8,827	4,041	5,793
	Convertible subordinated notes including Old Notes	3,454	7,284	9,148
		12,281	11,325	14,941

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11.    PENSIONS AND OTHER POSTRETIREMENT BENEFITS

        At Cephalon France, we have a defined benefit pension plan for current employees and a postretirement benefit plan for employees who retired prior to 2003. These plans are noncontributory and are not funded; benefit payments are funded from operations.

        We account for these plans using actuarial models required by SFAS No. 87, "Employers' Accounting for Pensions", and SFAS No. 106, "Employers' Accounting for Postretirement Benefits Other Than Pensions". A summary of our change in benefit obligation as of the end of the last three fiscal years, and the components of net periodic benefit costs for each of the last three fiscal years, is as follows:

		Pension Benefits									Other Benefits
		2005			2004			2003			2005			2004			2003
Change in benefit obligation:
	Benefit obligation at beginning of year	$	7,421		$	6,627		$	5,559		$	1,839		$	6,000		$	4,713
	Service cost		515			486			376			34			33			376
	Interest cost		321			351			290			56			89			257
	Actuarial gain		(264	)		(277	)		—			(6	)		(41	)		(6	)
	Amortization of prior improvements		—			—			—			(25	)		—			(259	)
	Recognized (gain) loss due to plan curtailment		—			—			—			—			(4,214	)		—
	Benefits paid		(68	)		(359	)		(695	)		(99	)		(113	)		(65	)
	Foreign currency translation		(714	)		593			1,097			(239	)		85			984
	Benefit obligation at end of year	$	7,211		$	7,421		$	6,627		$	1,560		$	1,839		$	6,000

		Pension Benefits								Other Benefits
		2005			2004			2003		2005			2004			2003
Components of net periodic benefit cost:
	Service cost	$	515		$	486		$	376	$	34		$	33		$	376
	Interest cost		321			351			290		56			89			257
	Amortization of prior improvements		—			—			—		(25	)		—			(259	)
	Recognized (gain) loss due to plan curtailment		—			—			—		—			(4,214	)		—
	Recognized actuarial (gain) loss		(264	)		(277	)		—		(6	)		(41	)		(6	)
	Net periodic benefit cost	$	572		$	560		$	666	$	59		$	(4,133	)	$	(368	)

        In the first quarter of 2004, we cancelled postretirement health care benefits at Cephalon France for employees not yet retired. This resulted in a gain of $4.2 million, which has been recognized as an offset to net periodic benefits costs for the year ended December 31, 2004.

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        The following table presents the significant assumptions used in the above calculations:

	Pension Benefits						Other Benefits
	2005		2004		2003		2005		2004		2003
Discount rate	4.0	%	4.5	%	5.0	%	4.0	%	4.5	%	5.0	%
Rate of compensation increase	3.0	%	3.0	%	3.0	%	3.0	%	3.0	%	3.0	%
Rate of health care cost increase	—	%	—	%	—	%	2.0	%	2.0	%	4.0	%

        Contributions made by Cephalon France for postretirement health care benefits have been frozen at 2004 levels for all future periods. Participants are required to pay for any changes to the cost of this plan. Therefore, the disclosure of the effects of a 1% change in the assumed health care cost trend is not applicable as it would not impact our costs.

        The accumulated benefit obligation for the defined benefit pension plan was $4.6 million, $5.2 million and $4.7 million at December 31, 2005, 2004 and 2003, respectively.

        The following benefits payments, which reflect expected future service, as appropriate, are expected to be paid as follows:

Year	Pension Benefits		Other Benefits
2006	$	175	$	112
2007		82		133
2008		152		128
2009		242		150
2010		754		127
2011-2015		9,550		766

12.    COMMITMENTS AND CONTINGENCIES

Leases

        We lease certain of our offices and automobiles under operating leases in the United States and Europe that expire at various times through 2019. Lease expense under all operating leases totaled $16.0 million, $12.4 million and $6.9 million in 2005, 2004, and 2003, respectively. Estimated lease expense for each of the next five years is as follows:

2006	$	12,364
2007		7,970
2008		5,698
2009		3,778
2010		2,520
2011 and thereafter		10,710
	$	43,040

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Cephalon Clinical Partners, L.P.

        In August 1992, we exclusively licensed our rights to MYOTROPHIN for human therapeutic use within the United States, Canada and Europe to Cephalon Clinical Partners, L.P. ("CCP"). Development and clinical testing of MYOTROPHIN is performed on behalf of CCP under a research and development agreement with CCP.

        CCP has granted us an exclusive license to manufacture and market MYOTROPHIN for human therapeutic use within the United States, Canada and Europe in return for royalty payments equal to a percentage of product sales and a milestone payment of approximately $16.0 million that will be made if MYOTROPHIN receives regulatory approval.

        We have a contractual option, but not an obligation, to purchase all of the limited partnership interests of CCP, which is exercisable upon the occurrence of certain events following the first commercial sale of MYOTROPHIN. If, and only if, we decide to exercise this purchase option, we would make an advance payment of approximately $40.3 million in cash or, at our election, approximately $42.4 million in shares of common stock or a combination thereof. Should we discontinue development of MYOTROPHIN, or if we do not exercise this purchase option, our license will terminate and all rights to manufacture or market MYOTROPHIN in the United States, Canada and Europe will revert to CCP, which may then commercialize MYOTROPHIN itself or license or assign its rights to a third party. In that event, we would not receive any benefits from such commercialization, license or assignment of rights.

Legal Proceedings

        In March 2003, we filed a patent infringement lawsuit in the U.S. District Court in New Jersey against four companies—Teva Pharmaceuticals USA, Inc., Mylan Pharmaceuticals, Inc., Ranbaxy Laboratories Limited and Barr Laboratories, Inc.—based upon the ANDAs 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 October 6, 2014 (subject to a six-month extension to April 6, 2015 upon acceptance by the FDA of the pediatric study data submitted by us on December 21, 2005). We believe that these four companies were the first to file ANDAs with Paragraph IV certifications and thus are eligible for the 180-day exclusivity provided by the provisions of the Federal Food, Drug and Cosmetic Act.

        In late 2005 and early 2006, we announced that we had entered into settlement agreements with each of these four defendants. As part of these separate settlements, we agreed to grant to each of Teva, Mylan, Ranbaxy and Barr a non-exclusive royalty-bearing right to market and sell a generic version of PROVIGIL in the United States. These licenses will become effective in October 2011, unless we obtain a pediatric extension for PROVIGIL, which would permit entry by these firms in April 2012. An earlier entry may occur based upon the entry of another generic version of PROVIGIL. Each of these settlements has been filed with both the FTC and the Antitrust Division of the DOJ as required by the Medicare Modernization Act. The FTC has requested from us, and we have provided, certain information in connection with its review of the settlements. The FTC, the DOJ, or a private party could challenge in an administrative or judicial proceeding any or all of the settlements if they

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believe that the agreements violate the antitrust laws. If the settlements are challenged, there is no assurance that we could successfully defend against such challenge and, in that case, we could be subject to, among other things, damages, fines and possible invalidation of the settlement agreements.

        The impact on 2005 consolidated statements of operations was a $10.6 million selling, general and administrative charge for agreements executed with Teva and Ranbaxy. We received licenses to certain modafinil-related intellectual property developed by each party and in exchange for these licenses, we agreed to make payments to Barr, Ranbaxy and Teva collectively totaling up to $136.0 million over the next several years, 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 will purchase an annual minimum amount of modafinil over a six year period beginning in 2006, with the aggregate payments over that period totaling approximately $82.6 million.

        In early 2005, we also filed a patent infringement lawsuit in the U.S. District Court in New Jersey against Carlsbad Technology, Inc. based upon the Paragraph IV ANDA filed related to modafinil that Carlsbad filed with the FDA. Carlsbad has asserted counterclaims for non-infringement of the '516 Patent and invalidity of the '516 Patent. Carlsbad also has asserted a counterclaim for non-infringement of our U.S. Patent No. 4,927,855 (which we have not asserted against Carlsbad). We have moved to dismiss all of Carlsbad's counterclaims; Carlsbad has opposed the motion, and a decision is pending. Discovery in this action has only recently commenced. This ongoing litigation with Carlsbad is unaffected by each of the settlement agreements we have signed with Teva, Mylan, Ranbaxy and Barr.

        In late November 2005, we received notice that Caraco Pharmaceutical Laboratories, Ltd. also filed a Paragraph IV ANDA with the FDA seeking to market a generic form of PROVIGIL. We have not filed a patent infringement lawsuit against Caraco to date.

        In February 2006, we also announced that we had agreed to settle with Barr our pending patent infringement dispute in the United States related to Barr's ANDA filed with the FDA seeking to sell a generic version of ACTIQ. Under the settlement, we will grant Barr an exclusive royalty bearing right to market and sell a generic version of ACTIQ in the United States, effective on December 6, 2006. Barr will pay specified royalties on net profits of a generic ACTIQ product for the period December 6, 2006 through February 3, 2007, subject to certain limitations. The patents covering the current formulation of the product are set to expire as early as September 2006. If we are successful in our efforts to complete a clinical study of ACTIQ in pediatric patients prior to September 2006, the FDA could grant us six months of exclusivity beyond the September 2006 patent expiration. Under the license and supply agreement we entered into with Barr in July 2004, we could face generic competition from Barr prior to December 6, 2006 if we receive FDA approval of FEBT before this date or if we are unable to complete the ongoing pediatric studies with ACTIQ prior to September 2006. The settlement with Barr related to ACTIQ has been filed with both the FTC and the Antitrust Division of the DOJ as required by the Medicare Modernization Act. The FTC has requested from us, and we have provided, certain information in connection with its review of this settlement. The FTC, the DOJ, or a private party could challenge in an administrative or judicial proceeding the settlement with Barr if they believe that the agreement violates the antitrust laws. If the settlement is challenged, there is no assurance that we could successfully defend against such challenge and, in that

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case, we could be subject to, among other things, damages, fines and possible invalidation of the settlement agreement.

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

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

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 nor reasonably estimable, we have not recorded a liability on our balance sheet for any such contingencies. As of December 31, 2005, the potential milestone and other contingency payments due under current contractual agreements are approximately $681.5 million.

        We have committed to make future minimum payments to third parties for certain raw material inventories. The minimum purchase commitments total $83.3 million as of December 31, 2005, the majority of which relate to modafinil and armodafinil.

13.    STOCKHOLDERS' EQUITY

Equity Compensation Plans

        We have established equity compensation plans for our employees, directors and certain other individuals. All grants and terms are authorized by the Stock Option and Compensation Committee of our Board of Directors. We may grant non-qualified stock options under the Cephalon, Inc. 2004 Equity Compensation Plan and the Cephalon, Inc. 2000 Equity Compensation Plan, and also may grant incentive stock options and restricted stock awards under the 2004 Plan. Options and restricted stock

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awards generally become exercisable or vest ratably over four years from the grant date, and options must be exercised within ten years of the grant date. There are currently 9.7 million and 4.3 million shares authorized for issuance under the 2004 Plan and the 2000 Plan, respectively. At December 31, 2005, the shares available for future stock option grants and restricted stock grants were 360,244 and 12,409, respectively.

Stock Options

        The following tables summarize the aggregate option activity under the plans for the years ended December 31:

		2005				2004				2003
		Shares		Weighted Average Exercise Price		Shares		Weighted Average Exercise Price		Shares		Weighted Average Exercise Price
Outstanding, January 1,		9,664,084		$	50.34	9,881,100		$	49.04	7,576,941		$	48.52
	Granted	1,022,100			50.24	768,950			49.43	2,882,400			47.75
	Exercised	(346,730	)		32.89	(535,446	)		22.51	(299,056	)		16.01
	Cancelled	(383,550	)		53.05	(450,520	)		53.29	(279,185	)		56.54
Outstanding, December 31,		9,955,904			50.84	9,664,084			50.34	9,881,100			49.04
Exercisable at end of year		6,733,471		$	51.49	5,485,360		$	49.56	4,071,207		$	43.68
Weighted average fair value of options granted during the year				$	27.52			$	31.81			$	29.55

	Options Outstanding				Options Exercisable
Range of Exercise Price	Shares	Weighted Average Remaining Contractual Life (years)	Weighted Average Exercise Price		Shares	Weighted Average Exercise Price
$6.00-$14.99	388,133	2.5	$	9.43	388,133	$	9.43
$15.00-$29.99	391,763	3.4		24.60	391,763		24.60
$30.00-$50.99	3,339,974	7.8		47.45	1,582,487		47.10
$51.00-$59.99	4,115,359	6.6		51.75	2,666,063		51.95
$60.00-$71.96	1,720,675	5.9		70.50	1,705,025		70.55
	9,955,904	6.9		50.84	6,733,471		51.49

        During 2005, 2004, and 2003, we received net proceeds of $11.5 million, $12.1 million and $4.5 million, respectively, from the exercise of stock options.

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Restricted Stock

        The following table summarizes restricted stock award activity for the years ended December 31:

		2005			2004			2003
Outstanding, January 1,			455,650			223,175			133,275
	Granted		298,500			309,400			195,000
	Vested		(125,625	)		(76,925	)		(99,775	)
	Canceled		(3,950	)		—			(5,325	)
Outstanding, December 31,			624,575			455,650			223,175
Compensation expense recognized		$	10,784		$	5,372		$	1,394

Qualified Savings and Investment Plan

        We have a profit sharing plan pursuant to section 401(k) of the Internal Revenue Code whereby eligible employees may contribute up to 20% of their annual salary to the plan, subject to statutory maximums. For the periods 2002 through June 30, 2003, our contribution was 100% of the first 6% of employee salaries at a ratio of 50% cash and 50% Cephalon stock. Effective July 1, 2003, our matching contribution is made solely in cash on 100% on the first 6% of employee salaries. We contributed $8.8 million, $6.3 million and $4.1 million, in either cash or a combination of cash and common stock to the plan for the years 2005, 2004, and 2003, respectively.

Pro forma Aggregate Conversions or Exercises

        At December 31, 2005, the conversion or exercise of all outstanding options and restricted stock awards would increase the outstanding number of shares of common stock by approximately 10,580,479 shares, or 18%. The conversion of our convertible subordinated notes and warrants into shares of Cephalon common stock in accordance with their terms is dependent upon actual stock price at the time of conversion.

Preferred Share Purchase Rights

        In November 1993, our Board of Directors declared a dividend distribution of one right for each outstanding share of common stock. In addition, a right attaches to and trades with each new issue of our common stock. Each right entitles each registered holder, upon the occurrence of certain events, to purchase from us a unit consisting of one one-hundredth of a share of our Series A Junior Participating Preferred Stock, or a combination of securities and assets of equivalent value, at a purchase price of $200.00 per unit, subject to adjustment.

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14.    INCOME TAXES

        The components of total income (loss) from operations before income taxes were:

	2005			2004			2003
United States	$	(163,175	)	$	(28,213	)	$	134,194
Foreign		(81,943	)		29			(3,880	)
Total	$	(245,118	)	$	(28,184	)	$	130,314

        The components of the provision (benefit) for income taxes are as follows:

		2005			2004			2003
Current taxes:
	United States	$	5,435		$	4,074		$	2,170
	Foreign		3,685			4,675			7,379
	State		(1,943	)		3,883			3,526
			7,177			12,632			13,075
Deferred taxes:
	United States		(23,287	)		48,021			36,887
	Foreign		(9,096	)		(6,681	)		(3,913	)
	State		994			(1,259	)		—
			(31,389	)		40,081			32,974
Change in valuation allowance			(45,952	)		(7,084	)		407
			(77,341	)		32,997			33,381
Total		$	(70,164	)	$	45,629		$	46,456

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        A reconciliation of the United States Federal statutory rate to our effective tax rate is as follows:

	2005		2004		2003
U.S. Federal statutory rate—expense (benefit)	(35.0	)%	(35.0	)%	35.0	%
In-process research and development	18.6		230.6		—
Meals and entertainment	0.6		5.8		0.6
Executive compensation	0.7		3.8		1.3
Other deductible expenses	(0.3	)	(6.1	)	(0.5	)
Revision of prior years' estimates	0.7		6.4		0.5
State income taxes, net of U.S. federal tax benefit	(0.7	)	6.1		1.8
Tax rate differential & permanent items on foreign income	9.5		1.8		(4.5	)
Change in valuation allowance	(18.8	)	(25.1	)	0.3
Research and development	(4.5	)	(42.2	)	—
Alternative minimum tax	—		13.5		—
Other	0.6		2.3		1.2
Consolidated effective tax rate	(28.6	)%	161.9	%	35.7	%

        The tax benefits associated with employee exercises of non-qualified stock options and disqualifying dispositions of stock acquired with incentive stock options reduce taxes payable or increase the deferred tax asset until we begin paying U.S. federal tax. Tax benefits of $2.6 million and $8.0 million associated with the exercise of employee stock options were recorded to additional paid-in capital in 2005 and 2004, respectively.

        Our foreign subsidiaries have no unremitted earnings at December 31, 2005.

        Deferred income taxes reflect the tax effects of temporary differences between the bases of assets and liabilities recognized for financial reporting purposes and tax purposes, and net operating loss and

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tax credit carryforwards. Significant components of net deferred tax assets and deferred tax liabilities as of December 31 are as follows:

		2005			2004			2003
Deferred tax assets:
Net operating loss carryforwards		$	104,873		$	54,597		$	93,884
	Original issue discount		186,536			74,546			84,315
	Capitalized research and development expenditures		24,085			31,711			42,563
	Unrealized profit in inventory		17,837			25,950			8,714
	Research and development tax credits		50,458			37,110			21,358
	Acquired product rights and intangible assets		66,802			8,173			8,495
	Reserves and accrued expenses		23,594			8,285			3,915
	Alternative minimum tax credit carryforwards		6,978			5,524			1,693
	Deferred revenue		179			943			757
	Deferred compensation		2,524			—			—
	Deferred charges on convertible debentures		9,678			—			—
	Accounts receivable discounts and allowance		24,932			13,794			5,238
	Other, net		4,425			—			4,221
	Total deferred tax assets		522,901			260,633			275,153
	Valuation allowance		(76,840	)		(49,895	)		(48,675	)
	Net deferred tax assets	$	446,061		$	210,738		$	226,478
Deferred tax liabilities:
	Acquired intangible assets from Group Lafon acquisition	$	38,068		$	46,094		$	44,916
	Acquired intangible assets from CIMA LABS acquisition		36,063			40,895			—
	Acquired intangible assets from CTI acquisition		18,164			—			—
	Acquired intangible assets from Zeneus acquisition		70,890			—			—
	Deferred compensation		—			2,283			—
	Fixed assets		4,930			4,032			—
	Other		584			796			749
	Total deferred tax liabilities	$	168,699		$	94,100		$	45,665
Net deferred tax assets		$	277,362		$	116,638		$	180,813

        In accordance with SFAS No. 109, the above overall net deferred tax assets for 2005 and 2004 are presented in the Consolidated Balance Sheet as: Current deferred tax assets, net; Non-current deferred tax assets, net; and Long-term deferred tax liabilities, net.

        At December 31, 2005, we had gross operating loss carryforwards for U.S. federal income tax purposes of approximately $87.4 million and apportioned state gross operating losses of approximately

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$450.0 million that expire in varying years starting in 2006. We also have foreign gross operating losses of approximately $122 million, of which $31.9 million may be carried forward 5 years, $1.8 million may be carried forward 15 years and $88.3 million may be carried forward with indefinite expiration dates. The net operating loss carryforwards differ from the accumulated deficit principally due to differences in the recognition of certain research and development expenses for financial and federal income tax reporting and net operating loss carryforwards acquired in business combinations. Federal research tax credits of $42.9 million are available to offset future tax liabilities and expire starting in 2006. The amount of U.S. federal net operating loss carryforwards that can be utilized in any one period will be limited by federal income tax regulations since a change in ownership as defined in Section 382 of the Internal Revenue Code occurred in the prior years. We do not believe that such limitation will have a material adverse impact on the utilization of the net operating loss carryforwards, but we do believe it will affect utilization of tax credit carryforwards.

        In the fourth quarter of 2005, we determined that all of our domestic federal net operating loss carryforwards, portions of foreign operating loss carryforwards, domestic tax credits and certain other deferred tax assets were more likely than not to be recovered. The remaining valuation allowance of $76.8 million at December 31, 2005 consists of certain state tax credits, existing and acquired foreign and state operating loss carryforwards that we believe are not likely to be recovered.

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CEPHALON, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(In thousands, except per share data)

15.    SELECTED CONSOLIDATED QUARTERLY FINANCIAL DATA (UNAUDITED)

		2005 Quarter Ended
		December 31,		September 30,		June 30,			March 31,
Statement of Operations Data:
	Net sales	$	322,930	$	294,371	$	272,608		$	266,609
	Gross profit		272,800		256,742		237,258			225,495
	Net income (loss)	$	18,073	$	29,343	$	(249,032	)	$	26,662
	Basic (loss) income per common share	$	0.31	$	0.51	$	(4.29	)	$	0.46
	Weighted average number of common shares outstanding		58,099		58,064		58,046			57,994
	Diluted income per common share	$	0.30	$	0.50	$	(4.29	)	$	0.44
	Weighted average number of common shares outstanding-assuming dilution		60,351		59,398		58,046			65,065

		2004 Quarter Ended
		December 31,		September 30,			June 30,			March 31,
Statement of Operations Data:
	Net sales	$	281,400	$	253,594		$	234,990		$	210,391
	Gross profit		251,026		219,812			205,150			184,414
	Net income (loss) applicable to common shares	$	78,105	$	(165,246	)	$	(8,383	)	$	21,711
	Basic (loss) income per common share	$	1.35	$	(2.94	)	$	(0.15	)	$	0.38
	Weighted average number of shares outstanding		57,754		56,178			56,110			55,905
	Diluted income per common share	$	1.23	$	(2.94	)	$	(0.15	)	$	0.36
	Weighted average number of shares outstanding-assuming dilution		64,889		56,178			56,110			65,006

16.    SEGMENT AND SUBSIDIARY INFORMATION

        Due to changes in our internal management and reporting structure in the second quarter of 2005, our chief operating decision maker now evaluates performance and makes decisions based on two segments, United States and Europe. As a result of this change, we have revised our segment reporting to include inter-segment sales and pre-tax income for these two segments as required by SFAS No. 131 "Disclosure about Segments of an Enterprise and Related Information" ("SFAS No. 131"). Prior to the second quarter of 2005, we disclosed financial information for the United States and Europe in order to satisfy the geographical requirements of SFAS No. 131 but did not present inter-segment sales and pre-tax income for these two segments.

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        Revenue and pre-tax income (loss) for the years ended December 31, 2005, 2004 and 2003, and long-lived assets as of December 31, 2005 and December 31, 2004 are provided below:

        Revenues for the years ended December 31:

			2005
			United States			Europe			Total
	PROVIGIL sales		$	475,557		$	37,248		$	512,805
	ACTIQ sales			394,676			17,102			411,778
	GABITRIL sales			66,517			5,741			72,258
	Other sales			49,695			109,982			159,677
	Other revenues			47,587			7,787			55,374
		Total External Revenues		1,034,032			177,860			1,211,892
Inter-Segment Sales				12,372			85,705			98,077
Elimination of Inter-Segment Sales				(12,372	)		(85,705	)		(98,077	)
Total Revenues			$	1,034,032		$	177,860		$	1,211,892

			2004
			United States			Europe			Total
	PROVIGIL sales		$	406,238		$	33,429		$	439,667
	ACTIQ sales			337,072			7,925			344,997
	GABITRIL sales			87,349			6,815			94,164
	Other sales			13,270			88,277			101,547
	Other revenues			28,749			6,301			35,050
		Total External Revenues		872,678			142,747			1,015,425
Inter-Segment Sales				13,623			44,097			57,720
Elimination of Inter-Segment Sales				(13,623	)		(44,097	)		(57,720	)
Total Revenues			$	872,678		$	142,747		$	1,015,425

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			2003
			United States			Europe			Total
	PROVIGIL sales		$	264,324		$	26,141		$	290,465
	ACTIQ sales			234,111			3,356			237,467
	GABITRIL sales			57,774			5,925			63,699
	Other sales			—			93,619			93,619
	Other revenues			20,118			9,439			29,557
		Total External Revenues		576,327			138,480			714,807
Inter-Segment Sales				4,121			53,072			57,193
Elimination of Inter-Segment Sales				(4,121	)		(53,072	)		(57,193	)
Total Revenues			$	576,327		$	138,480		$	714,807

		December 31, 2005			December 31, 2004			December 31, 2003
Pre-tax income (loss):
	United States	$	(163,175	)	$	(28,213	)	$	134,194
	Europe		(81,943	)		29			(3,880	)
	Total	$	(245,118	)	$	(28,184	)	$	130,314

		December 31, 2005		December 31, 2004
Long-lived assets:
	United States	$	1,084,619	$	657,327
	Europe		685,750		574,576
	Total	$	1,770,369	$	1,231,903

        We performed our annual test of impairment of goodwill as of July 1, 2005. Under SFAS No. 142, as a result of our reorganization of our internal management and reporting structure, we allocated goodwill to each of our reporting units based on their relative fair value. Accordingly, $281.6 million of goodwill was allocated to our United States segment and $87.9 million was allocated to our Europe segment. Following the completion of this allocation, we completed our annual test of impairment of goodwill and concluded that there was no impairment.

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ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE

        None.

ITEM 9A. CONTROLS AND PROCEDURES

(a) Evaluation of Disclosure Controls and Procedures

        Our management, with the participation of our Chief Executive Officer and Chief Financial Officer, evaluated the effectiveness of our disclosure controls and procedures as of the end of the period covered by this Annual Report on Form 10-K. Based on that evaluation, the Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures as of the end of the period covered by this Annual Report on Form 10-K 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) Management's Annual Report on Internal Control over Financial Reporting

        Management's Report on Internal Control over Financial Reporting is included in Part II, Item 8 of this Annual Report on Form 10-K and incorporated into this Item 9A by reference.

(c) Attestation Report of the Registered Public Accounting Firm

        Management's assessment of the effectiveness of internal control over financial reporting as of December 31, 2005 has been audited by PricewaterhouseCoopers LLP, an independent registered public accounting firm, as stated in their report included in Part II, Item 8 of this Annual Report on Form 10-K and incorporated into this Item 9A by reference.

(d) 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.

ITEM 9B. OTHER INFORMATION

        Not applicable.

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PART III

ITEM 10.    DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT

Directors

        The information required by Item 10 is incorporated herein by reference to the information contained under the caption "Proposal 1—Election of Directors" in our definitive proxy statement related to the 2006 annual meeting of stockholders.

Executive Officers

        The information concerning our executive officers required by this Item 10 is provided under the caption "Executive Officers of the Registrant" in Part I hereof.

Section 16(a) Beneficial Ownership Reporting Compliance

        The information concerning Section 16(a) Beneficial Ownership Reporting Compliance by our directors and executive officers is incorporated by reference to the information contained under the caption "Section 16(a) Beneficial Ownership Reporting Compliance" in our definitive proxy statement related to the 2006 annual meeting of stockholders.

Code of Ethics

        The information concerning our Code of Ethics is incorporated by reference to the information contained under the caption "Governance of the Company—Does the Company have a 'Code of Ethics'?" in our definitive proxy statement related to the 2006 annual meeting of stockholders.

ITEM 11.    EXECUTIVE COMPENSATION

        The information required by this Item 11 is incorporated by reference to the information contained in our definitive proxy statement for the 2006 annual meeting of stockholders.

ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS

        The information required by Item 12 is incorporated by reference to the information contained in our definitive proxy statement for the 2006 annual meeting of stockholders.

ITEM 13.    CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

        The information required by Item 13 is incorporated by reference to the information contained in our definitive proxy statement for the 2006 annual meeting of stockholders.

ITEM 14.    PRINCIPAL ACCOUNTING FEES AND SERVICES

        The information required by Item 14 is incorporated by reference to the information contained in our definitive proxy statement for the 2006 annual meeting of stockholders.

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PART IV

ITEM 15. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES

(a) DOCUMENTS FILED AS PART OF THIS REPORT

        The following is a list of our consolidated financial statements and our subsidiaries and supplementary data included in this Annual Report on Form 10-K under Item 8 of Part II hereof:

1.    FINANCIAL STATEMENTS AND SUPPLEMENTAL DATA
	Report of Management.
	Report of Independent Registered Public Accounting Firm.
	Consolidated Balance Sheets as of December 31, 2005 and 2004.
	Consolidated Statements of Operations for the years ended December 31, 2005, 2004 and 2003.
	Consolidated Statements of Stockholders' Equity for the years ended December 31, 2005, 2004 and 2003.
	Consolidated Statements of Cash Flows for the years ended December 31, 2005, 2004 and 2003.
	Notes to Consolidated Financial Statements.
2.    FINANCIAL STATEMENT SCHEDULES
	Schedule II—Valuation and Qualifying Accounts.

        Schedules, other than those listed above, are omitted because they are not applicable or are not required, or because the required information is included in the consolidated financial statements or notes thereto.

(b) EXHIBITS

        The following is a list of exhibits filed as part of this annual report on Form 10-K. Where so indicated by footnote, exhibits that were previously filed are incorporated by reference. For exhibits incorporated by reference, the location of the exhibit in the previous filing is indicated.

Exhibit No.	Description
2.1	Agreement and Plan of Merger by and among Cephalon, Inc., Cepsal Acquisition Corp., Salmedix, Inc., David S. Kabakoff, Arnold L. Oronsky, and Paul Klingenstein dated May 12, 2005., filed as Exhibit 2.1 to the Company's Quarterly Report on Form 10-Q for the period ended June 30, 2005.
2.2	Share Purchase Agreement dated as of December 5, 2005 between Cephalon, Inc., Cephalon International Holdings, Inc. and certain shareholders of Zeneus Holdings Limited, filed as Exhibit 2.1 to the Company's Current Report on Form 8-K filed December 22, 2005.
3.1(a)	Restated Certificate of Incorporation, as amended, filed as Exhibit 3.1 to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1996.
3.1(b)	Certificate of Amendment of Restated Certificate of Incorporation, filed as Exhibit 3.1 to the Company's Quarterly Report on Form 10-Q for the period ending June 30, 2002.
3.2	Bylaws of the Registrant, as amended and restated, filed as Exhibit 3.2 to the Company's Current Report on Form 8-K filed October 21, 2005.

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4.1	Specimen copy of stock certificate for shares of Common Stock of the Registrant, filed as Exhibit 4.1 to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1993.
4.2(a)	Amended and Restated Rights Agreement, dated as of January 1, 1999 between Cephalon, Inc. and StockTrans, Inc. as Rights Agent, filed as Exhibit 1 to the Company's Form 8-A/A (12G) filed January 20, 1999.
4.2(b)	First Amendment to Amended and Restated Rights Agreement, dated July 31, 2000 between Cephalon, Inc. and StockTrans, Inc. as Rights Agent, filed as Exhibit 1 to the Company's Form 8-A/12G filed on August 2, 2000.
4.2(c)	Second Amendment to Amended and Restated Rights Agreement, dated October 27, 2003 between Cephalon, Inc. and StockTrans, Inc. as Rights Agent, filed as Exhibit 1 to the Company's Form 8-A/12G on October 27, 2003.
4.3(a)	Form of Series A Warrant to purchasers of Units including a limited partnership interest in Cephalon Clinical Partners, L.P., filed as Exhibit 10.4 to the Company's Registration Statement on Form S-3 (Registration No. 333-56816) filed on January 7, 1993.
4.3(b)	Form of Series B Warrant to purchasers of Units including a limited partnership interest in Cephalon Clinical Partners, L.P., filed as Exhibit 10.5 to the Company's Registration Statement on Form S-3 (Registration No. 333-56816) filed on January 7, 1993.
4.4(a)	Indenture dated as of June 11, 2003 between the Registrant and U.S. Bank National Association, filed as Exhibit 4.1 to the Company's Quarterly Report on Form 10-Q for the period ended June 30, 2003.
4.4(b)	Registration Rights Agreement, dated as of June 11, 2003, between Cephalon, Inc. and Credit Suisse First Boston LLC, CIBC World Markets Corp., J.P. Morgan Securities Inc., Morgan Stanley & Co. Incorporated, SG Cowen Securities Corporation, ABN AMRO Rothschild LLC, Citigroup Global Markets Inc. and Lehman Brothers Inc., as Initial Purchasers, filed as Exhibit 10.4 to the Company's Quarterly Report on Form 10-Q for the period ended June 30, 2003.
4.5(a)	Indenture dated as of December 20, 2004 between the Registrant and U.S. Bank National Association, filed as Exhibit 4.l to the Company's Current Report on Form 8-K dated December 21, 2004.
4.5(b)	Registration Rights Agreement, dated as of December 20, 2004, between Cephalon, Inc. and U.S. Bank, National Association, filed as Exhibit 4.2 to the Company's Current Report on Form 8-K dated December 21, 2004.
4.6(a)	Indenture, dated June 7, 2005, between Cephalon, Inc. and U.S. Bank, National Association, as trustee, previously filed as Exhibit 4.1 to the Company's Current Report on Form 8-K dated June 8, 2005.
4.6(b)	Form of 2.00% convertible senior subordinated notes due 2015, previously filed as Exhibit 4.2 to the Company's Current Report on Form 8-K dated June 8, 2005.
†10.1(a)	Executive Severance Agreement between Frank Baldino, Jr. and Cephalon, Inc. dated July 25, 2002, filed as Exhibit 10.1 to the Company's Quarterly Report on Form 10-Q for the period ending June 30, 2002.
†10.1(b)	Form of Executive Severance Agreement between Certain Executives and Cephalon, Inc. dated July 25, 2002, filed as Exhibit 10.2 to the Company's Quarterly Report on Form 10-Q for the period ending June 30, 2002.

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†10.2	Cephalon, Inc. 2005 Management Incentive Compensation Plan, filed as Exhibit 10.1 to the Company's Current Report on Form 8-K dated February 3, 2005.
†10.3(a)	Cephalon, Inc. Amended and Restated 1987 Stock Option Plan, filed as Exhibit 10.7 to the Transition Report on Form 10-K for transition period January 1, 1991 to December 31, 1991, as amended by Amendment No. 1 filed on September 4, 1992.
†10.3(b)	Cephalon, Inc. 2000 Equity Compensation Plan for Employees and Key Advisors, as amended and restated, effective as of May 15, 2002, filed as Exhibit 99.1 to the Company's Registration Statement on Form S-8 (Registration No. 333-106115) filed on June 13, 2003.
†10.3(c)	Cephalon, Inc. 2000 Equity Compensation Plan—Form of Employee Non-Qualified Stock Option, filed as Exhibit 10.3(a) to the Company's Quarterly Report on Form 10-Q for the period ended September 30, 2004.
†10.3(d)	Cephalon, Inc. 2000 Equity Compensation Plan—Form of Nonqualified Stock Option Agreement for Employees (For Grants Made On or After October 17, 2005), filed as Exhibit 10.3 to the Company's Current Report on Form 8-K filed on October 21, 2005.
†10.3(e)	Cephalon, Inc. 1995 Equity Compensation Plan, as amended and restated, effective as of May 15, 2002, filed as Exhibit 99.1 to the Company's Registration Statement on Form S-8 (Registration No. 333-106112) filed on June 13, 2003.
†10.3(f)	Amendment No. 2004-1 to the Cephalon, Inc. 1995 Equity Compensation Plan, effective as of May 13, 2004, filed as Exhibit 99.1 to the Company's Registration Statement on Form S-8 (Registration No. 333-118611) filed on August 27, 2004.
†10.3(g)	Cephalon, Inc. 2004 Equity Compensation Plan—Employee Restricted Stock Grant Term Sheet, filed as Exhibit 99.1 to the Company's Current Report on Form 8-K dated December 16, 2004.
†10.3(h)	Cephalon, Inc. 2004 Equity Compensation Plan—Form of Non-Employee Director Non-Qualified Stock Option, filed as Exhibit 10.3(c) to the Company's Quarterly Report on Form 10-Q for the period ended September 30, 2004.
†10.3(i)	Cephalon, Inc. 2004 Equity Compensation Plan—Form of Employee Non-Qualified Stock Option, filed as Exhibit 10.3(d) to the Company's Quarterly Report on Form 10-Q for the period ended September 30, 2004.
†10.3(j)	Cephalon, Inc. 2004 Equity Compensation Plan—Form of Employee Incentive Stock Option, filed as Exhibit 10.3(e) to the Company's Quarterly Report on Form 10-Q for the period ended September 30, 2004.
†10.3(k)	Cephalon, Inc. 2004 Equity Compensation Plan—Form of Incentive Stock Option Agreement for Employees (For Grants Made On or After October 17, 2005), filed as Exhibit 10.1 to the Company's Current Report on Form 8-K filed on October 21, 2005.
†10.3(l)	Cephalon, Inc. 2004 Equity Compensation Plan—Form of Nonqualified Stock Option Agreement for Employees (For Grants Made On or After October 17, 2005), filed as Exhibit 10.2 to the Company's Current Report on Form 8-K filed on October 21, 2005.
†10.3(m)	Cephalon, Inc. 2004 Equity Compensation Plan—Form of Nonqualified Stock Option Agreement for Non-Employee Directors (For Grants Made On or After October 17, 2005) (Initial Grants Upon Joining Board), filed as Exhibit 10.4 to the Company's Current Report on Form 8-K filed on October 21, 2005.

125

†10.3(n)	Cephalon, Inc. 2004 Equity Compensation Plan—Form of Nonqualified Stock Option Agreement for Non-Employee Directors (For Grants Made On or After October 17, 2005) (Annual Grants to Non-Employee Directors) filed as Exhibit 10.5 to the Company's Current Report on Form 8-K filed on October 21, 2005.
†10.3(o)	Cephalon, Inc. Amended and Restated Non-Qualified Deferred Compensation Plan, filed as Exhibit 10.1 to the Company's Current Report on Form 8-K filed on December 7, 2005.
†10.4(a)	Summary of Agreement for Payment of Services between Cephalon, Inc. and its Board of Directors, as approved May 13, 2004, filed as Exhibit 10.4 to the Company's Annual Report on Form 10-K for the year ended December 31, 2004.
†10.4(b)	Summary of Agreement for Payment of Services between Cephalon, Inc. and its Board of Directors, as approved May 18, 2005, filed as Exhibit 10.2 to the Company's Quarterly Report on Form 10-Q for the period ended June 30, 2005.
10.5(a)	License Agreement, dated May 15, 1992 between Cephalon, Inc. and Kyowa Hakko Kogyo Co., Ltd., filed as Exhibit 10.6 to the Transition Report on Form 10-K for transition period January 1, 1991 to December 31, 1991, as amended by Amendment No. 1 filed on September 4, 1992 on Form 8.
10.5(b)	Letter agreement, dated March 6, 1995 amending the License Agreement between Cephalon, Inc. and Kyowa Hakko Kogyo Co., Ltd., filed as Exhibit 10.4(b) to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1994.
10.5(c)	Letter agreement, dated May 11, 1999 amending the License Agreement between Cephalon, Inc. and Kyowa Hakko Kogyo Co., Ltd., filed as Exhibit 10.4(c) to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1999. (1)
10.6	Supply, Distribution and License Agreement, dated as of July 27, 1993 between Kyowa Hakko Kogyo Co., Ltd. and Cephalon, Inc., filed as Exhibit 10.3 to the Company's Registration Statement on Form S-3 (Registration No. 33-73896) filed on January 10, 1994. (1)
10.7(a)	Distribution, License and Supply Agreement, dated December 7, 1999, between Anesta Corp. and Elan Pharma International Limited, filed as Exhibit 10.18 to Anesta Corp.'s Annual Report on Form 10-K for the fiscal year ended December 31, 1999. (1)
10.7(b)	Intellectual Property Sale, Amendment and Termination Agreement dated October 2, 2002, amending the Distribution, License and Supply Agreement, dated as of December 7, 1999, and as amended from time to time thereafter, by and between Anesta Corp. and Elan Pharma International Limited, filed as Exhibit 10.1 to the Company's Quarterly Report on Form 10-Q for the period ending September 30, 2002.
10.7(c)	Termination and Asset Sale and Purchase Agreement, dated March 13, 2000 between Abbott Laboratories, Inc. and Anesta Corp., filed as Exhibit 10.19 to Anesta Corp.'s Quarterly Report on Form 10-Q for the period ending March 31, 2000. (1)
10.7(d)	Technology License Agreement, dated September 16, 1985, as amended through December 3, 1993 between Anesta Corp. and the University of Utah Research Foundation, filed as Exhibit 10.6 to Anesta Corp.'s Registration Statement on Form S-1 (File No. 33-72608) filed May 31, 1996. (1)
10.8(a)	GABITRIL Product Agreement, dated October 31, 2000 between Cephalon, Inc. and Abbott Laboratories, filed as Exhibit 10.13(b) to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 2000. (1)

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10.8(b)	Toll Manufacturing and Packaging Agreement, dated October 31, 2000 between Cephalon, Inc. and Abbott Laboratories, filed as Exhibit 10.13(c) to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 2000. (1)
10.8(c)	First Amendment to Toll Manufacturing and Packaging Agreement by and between Abbott Laboratories and Cephalon, Inc. dated October 1, 2004, filed as Exhibit 10.8(c) to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 2004. (1)
10.9(a)	License and Supply Agreement dated July 7, 2004 between Barr Laboratories, Inc. and Cephalon, Inc., filed as Exhibit 10.1 to the Company's Quarterly Report on Form 10-Q for the period ended September 30, 2004 (1)
10.9(b)	Amendment No. 1 to the License and Supply Agreement between Barr Laboratories, Inc. and Cephalon, Inc. dated July 9, 2004, filed as Exhibit 10.2 to the Company's Quarterly Report on Form 10-Q for the period ended September 30, 2004.
10.10	Decision and Order of the Federal Trade Commission in the matter of Cephalon, Inc. and CIMA LABS INC. dated August 9, 2004, filed as Exhibit 10.1(c) to the Company's Quarterly Report on Form 10-Q for the period ended September 30, 2004.
10.11	Sale and Purchase Agreement dated as of December 8, 2004 by and between Sanofi-Synthelabo France and Cephalon France, previously filed as Exhibit 10.19 to the Company's Annual Report on Form 10-K for the year ended December 31, 2004. (1)
10.12	Acquisition Agreement by and among Cell Therapeutics, Inc., CTI Technologies, Inc. and Cephalon, Inc. dated June 10, 2005, incorporated by reference from Exhibit 10.1 to Cell Therapeutics' Current Report on Form 8-K filed June 14, 2005.
10.13(a)	License and Collaboration Agreement between Alkermes, Inc. and Cephalon, Inc. dated as of June 23, 2005, filed as Exhibit 10.5(a) to the Company's Quarterly Report on Form 10-Q for the period ended June 30, 2005. (1)
10.13(b)	Supply Agreement between Alkermes, Inc. and Cephalon, Inc. dated as of June 23, 2005, filed as Exhibit 10.5(b) to the Company's Quarterly Report on Form 10-Q for the period ended June 30, 2005. (1)
10.14	Co-Promotion Agreement by and between Cephalon, Inc. and McNeil Consumer & Specialty Pharmaceuticals, a division of McNeil-PPC, Inc., dated August 31, 2005, filed as Exhibit 10.1 to the Company's Quarterly Report on Form 10-Q for the period ended September 30, 2005. (1)
10.15(a)	Office Lease between The Multi-Employer Property Trust and Cephalon, Inc. dated January 14, 2004, previously filed as Exhibit 10.20(a) to the Company's Annual Report on Form 10-K for the year ended December 31, 2004. (1)
10.15(b)	Consent to Sublease between The Multi-Employer Property Trust, Systems & Computer Technology Corporation and Cephalon, Inc. dated April 2, 2004, previously filed as Exhibit 10.20(b) to the Company's Annual Report on Form 10-K for the year ended December 31, 2004. (1)
10.16(a)	Wiley Post Plaza Lease, dated December 7, 1994 between Anesta Corp. and Asset Management Services, filed as Exhibit 10.13 to Anesta Corp.'s Annual Report on Form 10-K (File No. 0-23160) for the fiscal year ended December 31, 1994.
10.16(b)	Amendment No. 1 to Wiley Post Plaza Lease between Anesta Corp. and Asset Management Services dated October 26, 1996, filed as Exhibit 10.11(b) to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 2003.

127

10.16(c)	Amendment No. 2 to Wiley Post Plaza Lease between Anesta Corp. and Asset Management Services dated January 7, 1997, filed as Exhibit 10.11(c) to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 2003.
10.16(d)	Amendment No. 3 to Wiley Post Plaza Lease between Anesta Corp. and Asset Management Services dated September 30, 1998, filed as Exhibit 10.11(d) to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 2003.
10.16(e)	Amendment No. 4 to Wiley Post Plaza Lease between Anesta Corp. and Asset Management Services dated February 29, 2000, filed as Exhibit 10.11(e) to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 2003.
10.16(f)	Amendment No. 5 to Wiley Post Plaza Lease between Anesta Corp. and Asset Management Services dated July 20, 2001, filed as Exhibit 10.11(f) to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 2003.
10.16(g)	Amendment No. 6 to Wiley Post Plaza Lease between Anesta Corp. and Asset Management Services dated July 20, 2001, filed as Exhibit 10.11(g) to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 2003.
10.16(h)	Amendment No. 7 to Wiley Post Plaza Lease between Anesta Corp. and Asset Management Services dated July 20, 2001, filed as Exhibit 10.11(h) to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 2003.
10.16(i)	Amendment No. 8 to Wiley Post Plaza Lease between Anesta Corp. and Asset Management Services dated October 14, 2002, filed as Exhibit 10.11(i) to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 2003.
10.16(j)	Amendment No. 9 to Wiley Post Plaza Lease between Anesta Corp. and Asset Management Services dated May 15, 2003, filed as Exhibit 10.11(j) to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 2003. (1)
10.16(k)	Amendment No. 10 to Wiley Post Plaza Lease between Anesta Corp. and Wiley Post Plaza, L.C. dated June 24, 2004, filed as Exhibit 10.2 to the Company's Quarterly Report on Form 10-Q for the period ended June 30, 2004. (1)
10.17(a)	Amended and Restated Agreement of Limited Partnership, dated as of June 22, 1992 by and among Cephalon Development Corporation, as general partner, and each of the limited partners of Cephalon Clinical Partners, L.P., filed as Exhibit 10.1 to the Company's Registration Statement on Form S-3 (Registration No. 33-56816) on January 7, 1993.
10.17(b)	Amended and Restated Product Development Agreement, dated as of August 11, 1992 between Cephalon, Inc. and Cephalon Clinical Partners, L.P., filed as Exhibit 10.2 to the Company's Registration Statement on Form S-3 (Registration No. 33-56816) filed on January 7, 1993.
10.17(c)	Purchase Agreement, dated as of August 11, 1992 by and between Cephalon, Inc. and each of the limited partners of Cephalon Clinical Partners, L.P., filed as Exhibit 10.3 to the Company's Registration Statement on Form S-3 (Registration No. 33-56816) filed on January 7, 1993.
10.17(d)	Pledge Agreement, dated as of August 11, 1992 by and between Cephalon, Inc. and Cephalon Clinical Partners, L.P., filed as Exhibit 10.8 to the Company's Registration Statement on Form S-3 (Registration No. 33-56816) filed on January 7, 1993.

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10.17(e)	Promissory Note, dated as of August 11, 1992 issued by Cephalon Clinical Partners, L.P. to Cephalon, Inc., filed as Exhibit 10.9 to the Company's Registration Statement on Form S-3 (Registration No. 33-56816) filed on January 7, 1993.
10.17(f)	Form of Promissory Note, issued by each of the limited partners of Cephalon Clinical partners, L.P. to Cephalon Clinical Partners, L.P., filed as Exhibit 10.10 to the Company's Registration Statement on Form S-3 (Registration No. 33-56816) filed on January 7, 1993.
10.18(a)	ISDA Master Agreement dated January 22, 2003, between Credit Suisse First Boston International and Cephalon, Inc., including Schedule to the Master Agreement dated as of January 22, 2003, filed as Exhibit 10.1 to the Company's Quarterly Report on Form 10-Q for the period ended March 31, 2003.
10.18(b)	ISDA Credit Support Annex to the Schedule to the ISDA Master Agreement dated as of January 22, 2003 between Credit Suisse First Boston International and Cephalon, Inc., including the Elections and Variables to the ISDA Credit Support Annex dated as of January 22, 2003, filed as Exhibit 10.2 to the Company's Quarterly Report on Form 10-Q for the period ended March 31, 2003.
10.18(c)	Letter Agreement Confirmation dated January 22, 2003, between Credit Suisse First Boston International and Cephalon, Inc, filed as Exhibit 10.3 to the Company's Quarterly Report on Form 10-Q for the period ended March 31, 2003.
10.18(d)	Termination of Letter Agreement dated July 22, 2005, between Credit Suisse First Boston International and Cephalon, Inc., filed as Exhibit 10.2 to the Company's Quarterly Report on Form 10-Q for the period ended September 30, 2005.
10.19(a)	Five Year Warrant, dated June 6, 2003, between the Company and Credit Suisse First Boston International filed as Exhibit 99.d(3) to the Company's Schedule TO-I dated November 16, 2004.
10.19(b)	Seven Year Warrant, dated June 6, 2003, between the Company and Credit Suisse First Boston International filed as Exhibit 99.d(4) to the Company's Schedule TO-I dated November 16, 2004.
10.19(c)	Five Year Convertible Note Hedge, dated December 3, 2004, between the Company and Credit Suisse First Boston International, filed as Exhibit 99.d(5) to the Company's Schedule TO-I/A dated December 14, 2004.
10.19(d)	Seven Year Convertible Note Hedge, dated December 3, 2004, between the Company and Credit Suisse First Boston International, filed as Exhibit 99.d(6) to the Company's Schedule TO-I/A dated December 14, 2004.
10.20(a)	Convertible Note Hedge Confirmation, dated as of June 2, 2005, between the Company and Deutsche Bank AG, filed as Exhibit 10.1 to the Company's Current Report on Form 8-K filed June 8, 2005.
10.20(b)	Warrant Confirmation, dated as of June 2, 2005, between the Company and Deutsche Bank AG, filed as Exhibit 10.2 to the Company's Current Report on Form 8-K filed June 8, 2005.
10.20(c)	Amendment to Hedge Confirmation dated as of June 2, 2005 by and among the Company, Deutsche Bank AG, New York and Deutsche Bank AG, London, filed as Exhibit 10.1 to the Company's Current Report on Form 8-K filed July 7, 2005.
10.20(d)	Hedge Confirmation dated as of June 28, 2005 by and among the Company, Deutsche Bank AG, New York and Deutsche Bank AG, London, filed as Exhibit 10.2 to the Company's Current Report on Form 8-K filed July 7, 2005.

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10.20(e)	Amendment to Warrant Confirmation dated as of June 2, 2005 by and among the Company, Deutsche Bank AG, New York and Deutsche Bank AG, London, filed as Exhibit 10.3 to the Company's Current Report on Form 8-K filed July 7, 2005.
*10.21	Agreement dated as of December 8, 2005 by and between Cephalon, Inc., Teva Pharmaceutical Industries Ltd., and Teva Pharmaceuticals USA, Inc. (2)
*10.22	Settlement Agreement dated as of December 22, 2005 by and between Cephalon, Inc. and Ranbaxy Laboratories Limited. (2)
*12.1	Statement Regarding Computation of Ratios
*21	List of Subsidiaries
*23.1	Consent of PricewaterhouseCoopers LLP.
*31.1	Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
*31.2	Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
*32.1	Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
*32.2	Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

*

Filed herewith.

†

Compensation plans and arrangements for executives and others.

(1)

Portions of the Exhibit have been omitted and have been filed separately pursuant to an application for confidential treatment granted by the Securities and Exchange Commission.

(2)

Portions of the Exhibit have been omitted and have been filed separately pursuant to an application for confidential treatment filed with the Securities and Exchange Commission pursuant to Rule 24b-2 under the Securities Exchange Act of 1934, as amended.

PROVIGIL, ACTIQ, GABITRIL, SPARLON, NUVIGIL, TREANDA, TRISENOX, DURASOLV, ORASOLV, ORAVESCENT, SPASFON LYOC, PARALYOC, PROXALYOC, LOPERAMIDE LYOC, SPASFON, FONZYLANE, MYOCET, ABELCET, TARGRETIN and MYOTROPHIN are trademarks or registered trademarks of Cephalon, Inc. or its subsidiaries. All other brands and names used herein are trademarks of their respective owners.

130

CEPHALON, INC. AND SUBSIDIARIES

SCHEDULE II—VALUATION AND QUALIFYING ACCOUNTS

(In thousands)

Year Ended December 31,		Balance at Beginning of the Year		Additions (Deductions)(1)			Other Additions (Deductions)(2)			Balance at End of the Year
Reserve for sales discounts, returns and allowances:
	2005	$	15,443	$	62,525		$	(49,747	)	$	28,221
	2004	$	8,774	$	29,958		$	(23,290	)	$	15,443
	2003	$	5,101	$	19,417		$	(15,744	)	$	8,774
Reserve for inventories:
	2005	$	1,566	$	3,069		$	(402	)	$	4,233
	2004	$	3,233	$	(1,758	)	$	91		$	1,566
	2003	$	3,797	$	615		$	(1,179	)	$	3,233

(1)

Amounts represent charges and reductions to expenses and revenue.

(2)

Amounts represent utilization and adjustments of balance sheet reserve accounts.

131

SIGNATURES

        Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

Date: March 13, 2006
	CEPHALON, INC.
	By:	/s/  FRANK BALDINO, JR. Frank Baldino, Jr., Ph.D. Chairman and Chief Executive Officer

        Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated.

Signature	Title	Date
/s/  FRANK BALDINO, JR. Frank Baldino, Jr., Ph.D.	Chairman and Chief Executive Officer (Principal executive officer)	March 13, 2006
/s/  J. KEVIN BUCHI J. Kevin Buchi	Executive Vice President and Chief Financial Officer (Principal financial and accounting officer)	March 13, 2006
/s/  WILLIAM P. EGAN William P. Egan	Director	March 13, 2006
/s/  MARTYN D. GREENACRE Martyn D. Greenacre	Director	March 13, 2006
/s/  VAUGHN M. KAILIAN Vaughn M. Kailian	Director	March 13, 2006
/s/  CHARLES A. SANDERS Charles A. Sanders, M.D.	Director	March 13, 2006
/s/  GAIL R. WILENSKY Gail R. Wilensky, Ph.D.	Director	March 13, 2006
/s/  DENNIS L. WINGER Dennis L. Winger	Director	March 13, 2006
/s/  HORST WITZEL Horst Witzel, Dr.-Ing.	Director	March 13, 2006

132

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TABLE OF CONTENTS
CAUTIONARY NOTE REGARDING FORWARD-LOOKING STATEMENTS
PART I

ITEM 1. BUSINESS

ITEM 1A. RISK FACTORS
ITEM 1B. UNRESOLVED STAFF COMMENTS
ITEM 2. PROPERTIES
ITEM 3. LEGAL PROCEEDINGS
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

PART II

ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES

Equity Compensation Plan Information

ITEM 6. SELECTED FINANCIAL DATA

ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

REPORT OF MANAGEMENT
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
CEPHALON, INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS
CEPHALON, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS
CEPHALON, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS
CEPHALON, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (In thousands, except per share data)
CEPHALON, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (In thousands, except per share data)
CEPHALON, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (In thousands, except per share data)
CEPHALON, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (In thousands, except per share data)

ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
ITEM 9A. CONTROLS AND PROCEDURES
ITEM 9B. OTHER INFORMATION

PART III

ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
ITEM 11. EXECUTIVE COMPENSATION
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
ITEM 14. PRINCIPAL ACCOUNTING FEES AND SERVICES

PART IV

ITEM 15. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES

CEPHALON, INC. AND SUBSIDIARIES SCHEDULE II—VALUATION AND QUALIFYING ACCOUNTS (In thousands)
SIGNATURES

EX-10.21

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Exhibit 10.21

AGREEMENT

        THIS AGREEMENT ("Agreement") is entered into this 8th day of December, 2005, and is effective as of December 4, 2005 ("Effective Date"), by and between CEPHALON, INC., a Delaware corporation, with its principal place of business at 41 Moores Road, Frazer, Pennsylvania 19355 (together with its Affiliates, referred to hereinafter as "Cephalon"), on the one hand, and Teva Pharmaceutical Industries Ltd., an Israeli corporation, with its principal place of business located at 5 Basel St., Petah Tikva, Israel (hereinafter "Teva Israel"), and Teva Pharmaceuticals USA, Inc., a Delaware corporation, with its principal place of business located at 1090 Horsham Road, P.O. Box 1090, North Wales, Pennsylvania 19454 (hereinafter "Teva USA") (Teva Israel and Teva USA, each together with its and their Affiliates, shall be collectively referred to hereinafter from time to time as "Teva").

        WHEREAS, Cephalon is the owner by assignment of all right and title in U.S. Reissue Patent No. RE37,516 ("the RE “516 Patent"), issued by the United States Patent and Trademark Office on January 15, 2002 and expiring on October 6, 2014.

        WHEREAS PROVIGIL® (modafinil), which Cephalon represents is covered by claims of the RE “516 Patent, is the commercial formulation of modafinil developed, manufactured and sold by Cephalon pursuant to FDA approval of Cephalon's NDA 20-717.

        WHEREAS by letter dated February 25, 2003, Teva notified Cephalon that Teva had submitted ANDA No. 76-596 to the FDA under Section 505(j) of the Federal Food, Drug and Cosmetic Act (21 U.S.C. § 355(j)), seeking approval to engage in the commercial manufacture, use, and sale of tablets containing 100 mg and 200 mg of modafinil, a generic version of PROVIGIL® modafinil tablets, before the expiration date of the RE “516 Patent.

**Portions of the Exhibit have been omitted and have been filed separately purusant to an application for confidential treatment filed with the Securities and Exchange Commission pursuant to Rule 24b-2 under the Securities Exchange Act of 1934, as amended.

        WHEREAS Cephalon timely filed suit against Teva and three other companies that had also filed Paragraph IV ANDAs concerning PROVIGIL® modafinil in an action captioned Cephalon, Inc. v. Mylan Pharmaceuticals Inc., et al., Civil Action No. 03-CV-1394 (JCL), in the United States District Court for the District of New Jersey, seeking, among other things, a declaration that Teva's making, using, offering to sell, selling, or importing Teva ANDA Modafinil tablets would infringe the RE “516 Patent, an order providing that the effective date of any approval of Teva's ANDA No. 76-596 shall be a date which is not earlier than the date of the expiration of the RE “516 Patent; and an order permanently enjoining Teva from making, using, offering to sell, selling, or importing tablets as described in Teva's ANDA No. 76-596 until after the date of the expiration of the RE “516 Patent.

        WHEREAS, Teva answered Cephalon's complaint by denying infringement, and by asserting affirmative defenses that the RE “516 patent is either not infringed, invalid and/or unenforceable.

        WHEREAS, Cephalon and Teva have taken discovery, but no partial or final judgment has been entered as to any issue in dispute.

        WHEREAS, Cephalon, Cephalon (UK) Limited, Teva UK Limited and Tenlec Pharma Limited are parties to a lawsuit in the United Kingdom High Court of Justice, Chancery Division, HC 05 CO 1802 (the "UK Action").

        WHEREAS, Cephalon is the owner of European Patents (UK) Nos. 0 731 698 and 0 966 962 for "Modafinil having defined particle size'," (the "UK Patents"), which are the subject of the UK Action.

        WHEREAS, the parties respectively possess other relevant intellectual property rights

**Portions of the Exhibit have been omitted and have been filed separately purusant to an application for confidential treatment filed with the Securities and Exchange Commission pursuant to Rule 24b-2 under the Securities Exchange Act of 1934, as amended.

2

related to modafinil in the United States, Europe or elsewhere that are or may be the subject of further as yet unfiled disputes between the parties related to matters at issue in the respective litigations in the United States and/or United Kingdom, or with respect to which the parties may have interest in reaching suitable commercial arrangements so as to avoid the necessity of future litigation.

        WHEREAS, to avoid the time and expense of further litigation, and in compromise of the disputed claims set forth above, the parties now desire to resolve their disputes on a worldwide basis, including, but not limited to, with respect to the litigation matters pending in the United States and the United Kingdom, by settlement and to enter into such licensing or other commercial arrangements as shall fairly effect an amicable resolution of such unfiled disputes to avoid the time and expense of future potential litigation.

        WHEREAS, Cephalon desires to license from Teva Israel, and Teva Israel is willing to license to Cephalon on the terms and conditions set forth herein, worldwide intellectual property rights owned by Teva that relate to the compound modafinil [**].

        WHEREAS, in addition to the above-described arrangements,

(a)

the parties desire to provide for the supply by Teva Israel and the purchase by Cephalon of the active pharmaceutical ingredient ("API") modafinil; and



(b)

Teva desires to obtain and Cephalon desires to grant Teva a license to use certain clinical and safety data obtained from studies of [**].

        NOW, THEREFORE, in consideration of the foregoing premises and the mutual representations, covenants and conditions herein set forth, the receipt and sufficiency of which consideration are hereby acknowledged, the parties agree as follows:

**Portions of the Exhibit have been omitted and have been filed separately purusant to an application for confidential treatment filed with the Securities and Exchange Commission pursuant to Rule 24b-2 under the Securities Exchange Act of 1934, as amended.

3

1.     DEFINITIONS

        1.1 "Action" shall mean Cephalon, Inc. v. Mylan Pharmaceuticals Inc., et al., Civil Action No. 03-CV-1394 (JCL), pending in the United States District Court for the District of New Jersey.

        1.2 "Affiliate" shall mean any corporation, partnership, joint venture or firm which controls, is controlled by or under common control with a specified person or entity. For purposes of this definition, "control" shall be presumed to exist if one of the following conditions is met: (a) in the case of corporate entities, direct or indirect ownership of at least fifty percent (50%) of the stock or shares having the right to vote for the election of directors and (b) in the case of non-corporate entities, direct or indirect ownership of at least fifty percent (50%) of the equity interest with the power to direct the management and policy decisions of such non-corporate entities. For purposes of this Agreement, Tenlec Pharma Limited shall be considered an Affiliate of Teva.

        1.3 "Cephalon Modafinil Product" shall mean [**].

        1.4 "Teva Generic Modafinil Product" shall mean any Subject Modafinil Product marketed and sold by Teva pursuant to the terms of this Agreement or the same or similar finished pharmaceutical product that contains modafinil as the active ingredient marketed and sold by Teva in a jurisdiction other than the United States.

        1.5 "Teva USA" shall mean the corporation so designated in the preamble and shall also include its predecessors, successors, assigns, subsidiaries, divisions, and groups.

**Portions of the Exhibit have been omitted and have been filed separately purusant to an application for confidential treatment filed with the Securities and Exchange Commission pursuant to Rule 24b-2 under the Securities Exchange Act of 1934, as amended.

4

        1.6 "Teva Israel" shall mean the corporation so designated in the preamble and shall also include its predecessors, successors, assigns, subsidiaries, divisions, and groups.

        1.7 "Teva ANDA Modafinil Product" shall mean [**].

        1.8 "Teva Modafinil ANDA" shall mean ANDA No. 76-596.

        1.9 "Cephalon" shall mean the corporation so designated in the preamble and shall also include its predecessors, successors, assigns, subsidiaries, divisions, and groups.

        1.10 "Date Certain" shall mean the later of: (a) October 6, 2011 (three years prior to the expiration of the Patent In Suit); or (b) in the event that Cephalon obtains a pediatric extension on the Patent in Suit, April 6, 2012 (which is three years prior to the expiration of the pediatric extension, if obtained).

        1.11 "Generic Modafinil Product" shall mean any Subject Modafinil Product that is not marketed under the mark PROVIGIL®.

        1.12 "Listed Patents" shall mean [**].

        1.13 "Modafinil Litigation" shall mean (a) Cephalon, Inc. v. Mylan Pharmaceuticals Inc., et al., Civil Action No. 03-CV-1394 (JCL), pending in the United States District Court for the District of New Jersey; (b) Cephalon, Inc. v. Carlsbad Tech., Inc., Civil Action No. 05-CV-1089 (JCL), pending in the United States District Court for the District of New Jersey; and (c) any action filed under Title 35, United States Code, 35 U.S.C. §§ 271 and 281 against any Modafinil Paragraph IV ANDA Filing Entity.

**Portions of the Exhibit have been omitted and have been filed separately purusant to an application for confidential treatment filed with the Securities and Exchange Commission pursuant to Rule 24b-2 under the Securities Exchange Act of 1934, as amended.

5

        1.14 "Modafinil Paragraph IV ANDA Filing Entity" shall mean any entity that has notified or subsequently notifies Cephalon that it has filed an ANDA with a Paragraph IV certification concerning a product containing modafinil as an active ingredient for which PROVIGIL® (or any modafinil drug product that is the subject of Cephalon's NDA 20-717) is the reference listed drug.

        1.15 "Net Profits" shall mean the gross receipts derived in arms-length transactions from the sale of Teva Generic Modafinil Product in the United States, or applicable other markets by Teva (or by its Affiliates or sublicensees), to independent third parties in the United States or applicable other markets, less the sum of the following items:

(a)

Import, export, excise and sales taxes and custom duties paid or allowed by the selling party and any other governmental charges imposed upon the production, importation, use or sale of Teva Generic Modafinil Product by Teva and/or its Affiliates;



(b)

Credit for returns, refunds, rebates and allowances, or trades to customers for returned or recalled Teva Generic Modafinil Product;



(c)

Trade, quantity and cash discounts actually allowed;



(d)

Transportation, freight and insurance allowances;



(e)

Rebates actually granted to wholesalers or other customers, administrative fees in lieu of rebates paid to managed care and other similar institutions, chargebacks and retroactive price adjustments, including Shelf Stock Adjustments, and any other similar allowances which effectively reduce the net selling price; and

**Portions of the Exhibit have been omitted and have been filed separately purusant to an application for confidential treatment filed with the Securities and Exchange Commission pursuant to Rule 24b-2 under the Securities Exchange Act of 1934, as amended.

6

(f)

The purchase price paid to Cephalon for Teva Generic Modafinil Product pursuant to any applicable Cephalon/Teva License and Supply Agreement, or Teva's costs of making Teva Generic Modafinil Product.

        Gross and Net Profits shall be calculated according to US GAAP. Sales or transfers between or among a party to this Agreement and its Affiliates or sublicensees shall be excluded from the computation of Net Profits except where such Affiliates or sublicensees are end users, but Net Profits shall include the subsequent final sales to third parties by such Affiliates or sublicensees.

        Where (i) Teva Generic Modafinil Product is sold as one of a number of items without a separate price; or (ii) the consideration for the Teva Generic Modafinil Product shall include any non-cash element; or (iii) the Teva Generic Modafinil Product shall be transferred in any manner other than an invoiced sale, the gross sales applicable to any such transaction shall be deemed to be the selling party's average gross sales for the applicable quantity of Teva Generic Modafinil Product during the calendar quarter. If there are no independent gross sales of Teva Generic Modafinil Product in the United States or applicable other markets at that time, then Teva and Cephalon shall appoint a mutually acceptable third party (that is not an Affiliate of either Teva or Cephalon) to determine in good faith an estimate of the gross sales applicable to any such transactions based on a consideration of all relevant market factors, taking into account practices and policies customary in the industry.

        1.16 "Net Sales" shall mean the gross receipts derived in arms-length transactions from the sale of Cephalon

**Portions of the Exhibit have been omitted and have been filed separately purusant to an application for confidential treatment filed with the Securities and Exchange Commission pursuant to Rule 24b-2 under the Securities Exchange Act of 1934, as amended.

7

Modafinil Product in the United States or other applicable markets by Cephalon (or by its Affiliates, distributors and resellers) (but excluding any sales of Cephalon Modafinil Product sold by Cephalon to Teva in the United Kingdom pursuant to the terms of the United Kingdom supply and distribution agreement to be entered into by the parties as contemplated in Section 2.6, or pursuant to the terms of any analogous agreements between the parties for other EU countries as contemplated by that Section) to independent third parties in the United States or other applicable markets, less the sum of the following items:

(a)

Import, export, excise and sales taxes and custom duties paid or allowed by the selling party and any other governmental charges imposed upon the production, importation, use or sale of Cephalon Modafinil Product;



(b)

Credit for returns, refunds, rebates and allowances, or trades to customers for returned or recalled Cephalon Modafinil Product;



(c)

Trade, quantity and cash discounts actually allowed;



(d)

Transportation, freight and insurance allowances; and



(e)

Rebates actually granted to wholesalers or other customers, administrative fees in lieu of rebates paid to managed care and other similar institutions, chargebacks and retroactive price adjustments and any other similar allowances which effectively reduce the net selling price.

        Gross and Net Sales shall be calculated according to US GAAP. Sales or transfers between or among a party to this Agreement and its Affiliates or sublicensees shall be excluded from the computation of Net Sales except where such Affiliates or sublicensees are end users, but Net Sales shall include the subsequent final sales to third parties by such Affiliates or sublicensees.

**Portions of the Exhibit have been omitted and have been filed separately purusant to an application for confidential treatment filed with the Securities and Exchange Commission pursuant to Rule 24b-2 under the Securities Exchange Act of 1934, as amended.

8

        Where (i) Cephalon Modafinil Product is sold as one of a number of items without a separate price; or (ii) the consideration for the Cephalon Modafinil Product shall include any non-cash element; or (iii) the Cephalon Modafinil Product shall be transferred in any manner other than an invoiced sale, the gross sales applicable to any such transaction shall be deemed to be the selling party's average gross sales for the applicable quantity of Cephalon Modafinil Product during the calendar quarter. If there are no independent gross sales of Cephalon Modafinil Product in the United States at that time, then Teva and Cephalon shall appoint a mutually acceptable third party (that is not an Affiliate of either Teva or Cephalon) to determine in good faith and estimate of the gross sales applicable to any such transactions based on a consideration of all relevant market factors, taking into account practices and policies customary in the industry.

        1.17 "Other Modafinil Paragraph IV ANDA Filing Entity" shall mean any Modafinil Paragraph IV ANDA Filing Entity besides Teva or Cephalon or its and their Affiliates.

        1.18 "Patent In Suit" shall mean the RE “516 Patent.

**Portions of the Exhibit have been omitted and have been filed separately purusant to an application for confidential treatment filed with the Securities and Exchange Commission pursuant to Rule 24b-2 under the Securities Exchange Act of 1934, as amended.

9

        1.19 "Subject Modafinil Product" shall mean [**].

        1.20 "Intellectual Property Rights" means all patents (including, without limitation, all reissues, extensions, substitutions, confirmations, re-registrations, re-examinations, invalidations, supplementary protection certificates and patents of addition) and patent applications (including, without limitation, all provisional applications, continuations, continuations-in-part and divisions), copyrights, data rights, trade secret rights, and know-how owned by Teva on or after the Effective Date that claim or otherwise cover any aspect of the compound modafinil, including, without limitation, [**], including without limitation those set forth in Annex 1.20 of this Agreement.

2.     OBLIGATIONS OF THE PARTIES

        2.1 Teva and Cephalon Warranties Regarding the Action.

        The parties agree that this Agreement includes a settlement which is a compromise of disputed claims and that acceptance of the consideration herein is not to be construed as an admission by either party as to the underlying merits of the Action. However, as an express inducement to Cephalon to enter into this settlement, in consideration of the terms hereof, Teva hereby warrants, represents and agrees that Teva, on behalf of itself and its Affiliates, will not make, use, offer to sell, or sell or actively induce or assist any other entity to make, use, offer to sell, or sell Subject Modafinil Product within the United States, or to import or cause to be imported any Subject Modafinil Product into the United States, except as otherwise permitted under, and according to the terms of, the license granted by Cephalon in this Agreement. The parties agree that [**].

**Portions of the Exhibit have been omitted and have been filed separately purusant to an application for confidential treatment filed with the Securities and Exchange Commission pursuant to Rule 24b-2 under the Securities Exchange Act of 1934, as amended.

10

        2.2 License to Cephalon.

(a)

Teva Israel hereby grants to Cephalon a non-exclusive, worldwide license to all Intellectual Property Rights solely for the manufacture, development, formulation, use, sale, offer for sale, and importation of finished pharmaceutical products that contain the compound modafinil, including, without limitation, [**]. Further, as an express inducement to Teva to enter into this Agreement, in consideration of the terms hereof, Cephalon hereby warrants, represents and agrees that Cephalon, on behalf of itself and its Affiliates, will not challenge or otherwise dispute any issued patents included in the Intellectual Property Rights on a worldwide basis.



(b)

In consideration of the license set forth in Section 2.2 (a) above, Cephalon shall make royalty payments to Teva Israel as follows, commencing as of the Effective Date:



(i)

within [**]: a lump sum royalty payment of [**] for the Intellectual Property Rights licensed hereunder;



(ii)

upon the achievement of worldwide sales by Cephalon and its Affiliates of [**] as determined based upon IMS data, a lump sum payment of [**];



(iii)

upon the achievement of worldwide sales by Cephalon and its Affiliates of [**] as determined based upon IMS data, a lump sum payment of [**];



(iv)

on the date of [**], a lump sum payment [**]; and



(v)

From January 1, 2006 and until the earlier of:

**Portions of the Exhibit have been omitted and have been filed separately purusant to an application for confidential treatment filed with the Securities and Exchange Commission pursuant to Rule 24b-2 under the Securities Exchange Act of 1934, as amended.

11

(a)

the last to expire of any issued patents in the Intellectual Property Rights containing a valid and enforceable claim (the Intellectual Property Rights will be deemed valid and enforceable unless determined otherwise by a final nonappealable decision of a court of competent jurisdiction); or



(b)

such time as the cumulative sum of all royalties paid by Cephalon under this Section 2.2 (b) (i) through(iv) above & this Section 2.2 (b) (v), as demonstrated by its accounting records maintained in accordance with GAAP, shall have reached a total of [**] ("Royalty Cap");

        Cephalon shall pay to Teva a royalty in the amount of [**]. For the removal of doubt, both this [**] royalty payment and the lump sum payments set forth in Section 2.2 (b) (i) through (iv) shall apply against the Royalty Cap.

(c)

It is understood and agreed that upon the earlier of (i) the last to expire of any issued patents in the Intellectual Property Rights containing a valid and enforceable claim (the Intellectual Property Rights will be deemed valid and enforceable unless determined otherwise by a final nonappealable decision of a court of competent jurisdiction) or (ii) the date as of which Cephalon royalty payments have reached the Royalty Cap, Cephalon's royalty obligation shall cease and Cephalon shall thereupon have a fully-paid up non-exclusive, worldwide license to all such Intellectual Property Rights owned by Teva.



(d)

Cephalon agrees to use commercially reasonable efforts to sell the Cephalon Modafinil Product.

**Portions of the Exhibit have been omitted and have been filed separately purusant to an application for confidential treatment filed with the Securities and Exchange Commission pursuant to Rule 24b-2 under the Securities Exchange Act of 1934, as amended.

12

        2.3 License to Teva of the Right to Use of [**]

        In consideration of the payment by Teva Israel to Cephalon of the amount of [**], Cephalon hereby grants to Teva the right to use certain clinical and safety data [**], including the categories of information and data set forth on Annex 2.3.1 hereto, agrees to cooperate promptly in good faith with the reasonable requests of Teva for assistance in identifying and providing such further information related thereto as may be in Cephalon's possession and control as Teva shall reasonably and in good faith request from time to time, and hereby consents to the use of such data by Teva solely for purposes of supporting [**]. The above-mentioned [**] payment shall be made by Teva Israel to Cephalon within [**].

        Cephalon represents that it has or is or will be authorized by all necessary authority to permit Teva the right to use the information for the above purposes. Cephalon agrees to cooperate in good faith to [**].

        2.4 Modafinil API Supply Agreement

        Cephalon and Teva Israel shall enter into a supply agreement, by which Teva Israel shall supply, and Cephalon shall purchase in the United States the following annual volumes of modafinil API per Cephalon specifications at the below prices and upon such other reasonable and customary terms in the industry as the parties shall negotiate in good faith, it being understood that Teva Israel shall use its commercially reasonable efforts to work continuously in good faith to reduce associated costs and increase efficiencies while consistently meeting specifications, and to reflect all such cost reductions and efficiencies through appropriate

**Portions of the Exhibit have been omitted and have been filed separately purusant to an application for confidential treatment filed with the Securities and Exchange Commission pursuant to Rule 24b-2 under the Securities Exchange Act of 1934, as amended.

13

        reductions to the per kilogram price. In addition, the parties agree to cooperate in good faith to work together to help reduce costs.

        Teva Israel warrants and represents that the Year 1 price below in this Section 2.4 reflects [**]. For purposes of this Section, the parties agree that the initial year of this five year supply commitment shall be calendar year [**]. The parties further agree that they shall undertake to work together in good faith promptly following the Effective Date to qualify Teva API material in Cephalon's regulatory filings for modafinil.

        Teva Israel agrees to supply and Cephalon agrees to purchase modafinil API per Cephalon specifications at the below minimum quantities as follows:

        Contract Year

	Minimum Kg Price		Volume	Total Payment
1	[**]	*	[**]	[**]	*
2	[**]	*	[**]	[**]	*
3	[**]	*	[**]	[**]	*
4	[**]	*	[**]	[**]	*
5	[**]	*	[**]	[**]	*

*=subject to Teva's agreement to use commercially reasonable efforts to work continuously in good faith to reduce costs and create efficiencies while consistently meeting specifications and to reflect all such reductions and efficiencies through appropriate reductions to the associated per kilogram price.

**Portions of the Exhibit have been omitted and have been filed separately purusant to an application for confidential treatment filed with the Securities and Exchange Commission pursuant to Rule 24b-2 under the Securities Exchange Act of 1934, as amended.

14

        2.5 Settlement of UK Action and Other Potential Disputes; And Associated Teva Warranties.

(a)

The parties agree that this Agreement includes a settlement which is a compromise of disputed claims and that acceptance of the consideration herein is not to be construed as an admission by either party as to the underlying merits of the UK Action or any other dispute. However, as an express inducement to Cephalon to enter into the settlement of the UK Action, and the settlement of potential litigation and disputes in other countries where Cephalon holds modafinil patent rights, Teva Israel, on behalf of itself and its Affiliates, hereby warrants, represents and agrees that Teva will not itself make, use, offer to sell, or sell or actively induce or assist any other entity to make, use, offer to sell, or sell any finished drug which has modafinil as an active ingredient within the United Kingdom or any other country where Cephalon holds modafinil patent rights (other than in the United States market which is addressed in Section 2.1 above) or to import or cause to be imported any finished drug which has modafinil as an active ingredient into the United Kingdom or any other country where Cephalon holds modafinil patent rights (other than the United States market which is addressed in Section 2.1 above), except as otherwise permitted under, and according to the terms of, the license granted by Cephalon in connection with this Agreement. Subject to Section 3.6 below, the parties agree that [**].



(b)

In full and final settlement of the UK Action (to be dismissed in accordance with Section 4.2 below), Cephalon shall, within [**] of the entry of an appropriate order of the English Court dismissing the UK Action with prejudice, release or otherwise pay to Teva Israel the proceeds of the bond issued to Teva Israel by Cephalon in connection with said

**Portions of the Exhibit have been omitted and have been filed separately purusant to an application for confidential treatment filed with the Securities and Exchange Commission pursuant to Rule 24b-2 under the Securities Exchange Act of 1934, as amended.

15

litigation in the amount of [**], in recognition of the savings inuring to Cephalon in terms of the avoidance of costs, expenditure of time and resources, disruption and burden associated with prosecuting such litigation in the United Kingdom.

(c)

[**], Cephalon shall make a [**] payment to Teva Israel of [**] in recognition of the savings inuring to Cephalon in terms of the avoidance of costs, expenditure of time and resources, disruption and burden associated with prosecuting patent or other litigation in European and other markets outside of the United States or the United Kingdom, wherein Cephalon and Teva have intellectual property rights that are or may in the future be the subject of patent disputes.

        2.6 United Kingdom Supply and Distribution Agreement, and Other Potential Distribution Arrangements.

(a)

Cephalon shall appoint Teva UK Limited (or shall appoint such other subsidiary designated by Teva Israel) as the exclusive distributor in the United Kingdom for all Cephalon Modafinil Product for a period of [**] commencing on or about [**] and shall supply such products to Teva at a price equal to [**]. These terms shall be set forth in an exclusive supply and distribution agreement between Cephalon and the appointed distributor and all terms of said agreement shall be negotiated in good faith by the parties and shall comply with all applicable laws and be substantially similar to those customary in the industry. Cephalon shall provide sufficient quantities of Cephalon Modafinil Product to Teva in advance of the commencement date to allow for timely launch by Teva in the United Kingdom.

**Portions of the Exhibit have been omitted and have been filed separately purusant to an application for confidential treatment filed with the Securities and Exchange Commission pursuant to Rule 24b-2 under the Securities Exchange Act of 1934, as amended.

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(i)

Upon [**], Cephalon shall [**] to Teva Israel, in recognition of the cost and expense involved in Teva's preparation for [**] and in recognition of the license to the Intellectual Property Rights.



(ii)

In the event that Teva intends to enter the United Kingdom with its own generic modafinil product, as permitted hereunder pursuant to Article 3, the parties shall discuss in good faith any appropriate modifications to the exclusive supply and distribution agreement. If the parties are unable to agree upon such appropriate modifications despite such good faith efforts within thirty (30) days, the exclusive supply and distribution agreement shall terminate.



(b)

The parties will also undertake to consider in good faith whether a similar resale and distribution services provider arrangement as discussed above in this Section 2.6 may be feasible in any other countries.

        2.7 Potential Expansion of TREANDA® Supply Agreement

        The parties agree to discuss commercially reasonable terms for expansion of an existing clinical supply and development relationship between Cephalon and Teva's affiliate, Pharmachemie B.V., to include a potential commercial supply agreement for Cephalon requirements for the API contained in the Cephalon cancer drug TREANDA®.

        2.8 Teva Generic Rights. Cephalon shall also grant Teva the generic rights set forth in Section 3 below

**Portions of the Exhibit have been omitted and have been filed separately purusant to an application for confidential treatment filed with the Securities and Exchange Commission pursuant to Rule 24b-2 under the Securities Exchange Act of 1934, as amended.

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3.     TEVA GENERIC RIGHTS

        3.1 Generic Rights. Cephalon grants to Teva the non-exclusive right under the Listed Patents (as applicable) to manufacture, use, market and sell Generic Modafinil Product in the United States and other markets (including provision of modafinil API for Subject Modafinil Product or finished drug which has modafinil as an active ingredient) according to the following terms:

        3.1.1 Teva's generic rights under section 3.1 shall be effective on the Date Certain in the United States, or with respect to any market outside the United States, the earlier of October 6, 2012 or the date which is three calendar years prior to the expiration of the applicable patents and exclusivities in such markets. Teva shall pay Cephalon a royalty equal to [**] sold by Teva and/or its Affiliates in the United States and other markets on or after the effective date of such generic rights until the later of (i) the expiration of all Listed Patents (as applicable) or (ii) the end of any pediatric extension on the Patent in Suit, or with respect to any market outside of the United States, the equivalent later date in such market, subject to any subsequent negotiation concerning an extension of generic rights.

        3.1.2 Notwithstanding Section 3.1.1 above, in the event that Cephalon licenses or permits any other entity to sell any Generic Modafinil Product in the United States or other applicable market prior to the applicable effective date of Teva's generic rights as set forth above in Section 3.1.1, Teva's generic rights under Section 3.1 shall become effective in that market at the same time, i.e., no later than the earliest date on which such other licensed entity begins selling a Generic Modafinil Product in the United States or

**Portions of the Exhibit have been omitted and have been filed separately purusant to an application for confidential treatment filed with the Securities and Exchange Commission pursuant to Rule 24b-2 under the Securities Exchange Act of 1934, as amended.

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other applicable markets. In the event that Teva is permitted to sell Teva Generic Modafinil Product in the United States or other applicable markets prior to the applicable effective date of Teva's generic rights as set forth above in Section 3.1.1, Teva shall pay Cephalon a royalty equal to [**] sold by Teva and/or its Affiliates in the United States and other markets prior to the effective date of Teva's generic rights as set forth above in Section 3.1.1.

        3.1.3 Notwithstanding Section 3.1.1 and subject to Section 3.1.2, in the event that any Other Modafinil Paragraph IV ANDA Filing Entity sells in the United States any Subject Modafinil Product prior to a non-appealable final judgment in any Modafinil Litigation to which such Other Modafinil Paragraph IV ANDA Filing Entity is a party, Teva's non-exclusive generic right shall be effective at the same time, subject to the following restrictions:

        3.1.3.1 Teva shall pay to Cephalon prior to the effective date of Teva's generic rights as set forth above in Section 3.1.1. a royalty equal to [**] made by Teva and/or its Affiliates pursuant to Section 3.1.3, unless and to the extent and during any period that Cephalon has licensed or permitted another entity to sell any Generic Modafinil Product pursuant to Section 3.1.2, in which case the royalty rate from that Section shall apply.

        3.1.3.2 In the event that Cephalon seeks a temporary restraining order or other relief against such Other Modafinil Paragraph IV ANDA Filing Entity to stop such Entity from offering to sell or selling in the United States its Subject Modafinil Products, Teva and/or its Affiliates may continue to market and sell Teva Generic Modafinil Product in

**Portions of the Exhibit have been omitted and have been filed separately purusant to an application for confidential treatment filed with the Securities and Exchange Commission pursuant to Rule 24b-2 under the Securities Exchange Act of 1934, as amended.

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the United States until a court of competent jurisdiction renders a decision on Cephalon's request for a temporary restraining order or other relief, as further described in Sections 3.1.3.3 through 3.1.3.4.

        3.1.3.3 If Cephalon obtains a temporary restraining order or other relief sufficient to stop further offers to sell or sales in the United States of Subject Modafinil Products by all such Other Modafinil Paragraph IV ANDA Filing Entities, and assuming that Cephalon has directed all licensed or permitted entities to cease offering to sell and/or sell Generic Modafinil Product and such licensed or permitted entities have in fact ceased offering to sell and/or selling Generic Modafinil Product,

(a)

Teva's generic rights shall be suspended until the earlier of (i) the date the injunction is lifted, (ii) the date of entry into the market of any licensed or permitted entity selling Generic Modafinil Product, or (iii) the Date Certain, and Teva and/or its Affiliates shall immediately cease offering to sell and/or selling any Teva Generic Modafinil Product until such date, and



(b)

[**].

**Portions of the Exhibit have been omitted and have been filed separately purusant to an application for confidential treatment filed with the Securities and Exchange Commission pursuant to Rule 24b-2 under the Securities Exchange Act of 1934, as amended.

20

        3.1.3.4 If Cephalon requests but does not obtain a temporary restraining order or other relief, Teva may continue to market and sell Teva Generic Modafinil Product in the United States until the resolution of pending Modafinil Litigation. Teva shall continue to pay to Cephalon a royalty equal to [**] as set forth in Sections 3.1.3.1 above, until the Date Certain, at which time, the royalty rate effective in Section 3.1.1 shall apply (or upon the entry of a Cephalon licensee or other permitted entity of Generic Modafinil Product as provided in Section 3.1.2, at which time, the royalty rate effective in Section 3.1.2 shall apply).    

        3.1.3.5 Nothing in this Section or the Agreement shall obligate Cephalon to seek injunctive or other relief to stop such Other Modafinil Paragraph IV ANDA Filing Entity from offering to sell or selling Subject Modafinil Products in the United States.

        3.1.3.6 In the event that Cephalon prevails against all such Other Modafinil Paragraph IV ANDA Filing Entities in Modafinil Litigation, such that offers to sell or sales in the United States of Subject Modafinil Products by all such Other Modafinil Paragraph IV ANDA Filing Entities are admitted by such Other Modafinil Paragraph IV ANDA Filing Entities or held by the court to infringe one or more valid and enforceable claims of the Listed Patents, Teva's generic rights shall be suspended until the Date Certain and Teva and/or its Affiliates shall immediately cease marketing and/or selling Teva Generic Modafinil Product until the Date Certain (or upon the entry of a Cephalon licensee or other permitted entity of Generic Modafinil Product as provided in Section 3.1.2). [**].

**Portions of the Exhibit have been omitted and have been filed separately purusant to an application for confidential treatment filed with the Securities and Exchange Commission pursuant to Rule 24b-2 under the Securities Exchange Act of 1934, as amended.

21

        3.1.3.7 Notwithstanding Section 3.1.1 above, in the event that a final, non-appealable judgment in Modafinil Litigation is entered prior to the Date Certain declaring that one or more Other Modafinil Paragraph IV ANDA Filing Entities may offer to sell or sell Subject Modafinil Products in the United States without infringing any valid, enforceable claim of any Listed Patent on which Cephalon has brought suit, Teva may then market and sell Teva Generic Modafinil Product in the United States. If such final judgment is based on a finding of the invalidity of the Patent in Suit or the Patent in Suit is found to be unenforceable, no royalty will thereafter be due to Cephalon. Otherwise, Teva shall pay a royalty to Cephalon of [**].

        3.2 Cephalon and Teva agree that, [**] of the date of this Agreement, they shall prepare and execute whatever documents are necessary to carry out the terms of Sections 2 and 3 above, which documents shall include, without limitation, the following: (a) License Agreement with respect to those licenses set forth in Article III, (b) Intellectual Property License Agreement, (c) United Kingdom Exclusive Supply and Distribution Agreement, (d) API Supply Agreement. However, subject to applicable laws, the terms and conditions contained herein are binding notwithstanding the failure of the parties to enter into the agreements referenced in this Section 3.2.

        3.3 All sections of Article 3 shall apply mutatis mutantis to territories outside of the United States despite specific reference to the United States, including without limitation the right to enter the market upon entry by another generic set forth in Sections 3.1.2 and 3.1.3.

**Portions of the Exhibit have been omitted and have been filed separately purusant to an application for confidential treatment filed with the Securities and Exchange Commission pursuant to Rule 24b-2 under the Securities Exchange Act of 1934, as amended.

22

        3.4 To the extent that Cephalon shall have reason to anticipate the triggering of Teva's rights under Sections 3.1.2 or 3.1.3 above, it will provide prompt notice thereof to Teva in order to allow Teva adequate time to prepare for launch.

        3.5 Teva shall have the right to commence manufacturing activities in preparation of launch a reasonable period of time prior to agreed upon effective date of license rights granted to Teva hereunder, provided however, that Teva shall not have the right to launch in advance of such effective date, nor to communicate its ability to do so to third parties earlier than [**] prior to the anticipated launch date, without prior written consent of Cephalon.

        3.6 This Agreement shall neither operate nor be construed to prohibit any pre-existing contractual relationships of Teva for supply of API, provided, however, that Teva agrees that it shall not prospectively continue any such current (as of the Effective Date hereof) relationships beyond their current term nor prospectively enter into any new such relationships to the extent same would be reasonably likely to operate to cause Teva to breach its obligations under this Agreement, including Sections 2.1 and/or 2.5 above. In addition, to the extent that Teva is [**], the parties acknowledge that [**].

**Portions of the Exhibit have been omitted and have been filed separately purusant to an application for confidential treatment filed with the Securities and Exchange Commission pursuant to Rule 24b-2 under the Securities Exchange Act of 1934, as amended.

23

        3.7 In order for Teva to exercise the rights under the Listed Patents (as applicable) as contemplated by this Section 3, Cephalon agrees to provide such reasonable assistance and other documentation, including appropriate waivers of exclusivities or evidence of patent licenses, as reasonably necessary for Teva to obtain regulatory approval of Teva ANDA Modafinil Products (or similar non-United States modafinil products).

        3.8 Notwithstanding the terms of this Section 3, Cephalon covenants that it will not sue Teva for infringement under the Listed Patents, or any other patents owned by Cephalon on or after the Effective Date, for any sales by Teva of a generic version of PROVIGIL® (or the same product sold by Cephalon under a different mark in a jurisdiction other than the United States), provided that such sales are not otherwise in breach of this Agreement. Provided, however, in the event that Cephalon changes the mark for the product currently being marketed in the United States as PROVIGIL®, the provisions of this Section 3.8 shall continue to apply to any sales by Teva of a generic version of this same product with this new mark.

4.     DISMISSAL

        4.1 Within five (5) business days following the Effective Date, Cephalon and Teva shall execute and file with the United States District Court for the District of New Jersey a Joint Stipulation for Dismissal With Prejudice, in the form attached hereto as Exhibit A, to be entered by the Court as a final judgment in the litigation, and joint motion for entry thereof. Each party shall bear its own costs with respect to the Settlement of the Action. Teva warrants, represents

**Portions of the Exhibit have been omitted and have been filed separately purusant to an application for confidential treatment filed with the Securities and Exchange Commission pursuant to Rule 24b-2 under the Securities Exchange Act of 1934, as amended.

24

and agrees that it has or will obtain the consent and agreement of any other parties necessary to give effect to this Agreement.

        4.2 As soon as practicable, the parties agree to execute whatever documents are necessary to obtain discontinuance with no rights to reinstate the UK Action and effectuate the terms of this Agreement with respect to the Settlement of the UK Action, including a release of Cephalon and Cephalon (UK) Limited by Teva UK Limited and Tenlec Pharma Limited of any claims or counterclaims which they have or could have asserted in the UK Action. Teva warrants, represents and agrees that it will obtain the consent and agreement of Teva UK Limited and Tenlec Pharma Limited and any other parties necessary to give effect to this Agreement. Each party shall bear its own costs with respect to the Settlement of the UK Action.

        4.3 Cephalon and Teva waive any right to appeal any order previously entered in the Action or the UK Action.

5      MUTUAL RELEASES

        5.1 Teva, on behalf of itself and its subsidiaries, successors, and assigns, including Teva UK Limited, hereby irrevocably releases, acquits, and forever discharges Cephalon and Cephalon (UK) Limited from and against any and all claims, demands, suits, liabilities, actions, causes of action, damages, duties, losses, expenses, costs or obligations of every kind and nature whatsoever, suspected or unsuspected, known or unknown, foreseen or unforeseen, that Teva, its subsidiaries, successors, and assigns, including Teva UK Limited, may now have or at any time may have had up until the date of this Agreement against Cephalon or Cephalon (UK)

**Portions of the Exhibit have been omitted and have been filed separately purusant to an application for confidential treatment filed with the Securities and Exchange Commission pursuant to Rule 24b-2 under the Securities Exchange Act of 1934, as amended.

25

Limited arising under, concerning, or relating to the Action or the UK Action, but specifically excluding a breach by Cephalon of its covenants and obligations under this Agreement (or related agreements referenced in Section 3.2).

        5.2 Cephalon, on behalf of itself and its subsidiaries, successors, and assigns, including Cephalon (UK) Limited hereby irrevocably releases, acquits, and forever discharges Teva and Teva UK Limited from any and all claims, demands, suits, liabilities, actions, causes of action, damages, duties, losses, expenses, costs or obligations of every kind and nature whatsoever, suspected or unsuspected, known or unknown, foreseen or unforeseen, that Cephalon, its subsidiaries, successors, and assigns, including Cephalon (UK) Limited, may now have or at any time may have had up until the date of this Agreement against Teva or Teva UK Limited arising under, concerning, or relating to the Action or the UK Action, but specifically excluding a breach by Teva of its covenants and obligations under this Agreement (or related agreements referenced in Section 3.2).

6      CONFIDENTIALITY

        6.1 Cephalon and Teva shall continue to be bound by and to comply with the terms of the Stipulated Protective Order previously executed in the Action and the terms of the CDA executed between them as of November 29, 2005;

        6.2 Cephalon and Teva agree that the terms of this Agreement shall remain confidential and shall not be disclosed to third parties except subject to a nondisclosure agreement, and pursuant to business discussions relating to asset sales, mergers, or change of control transactions, or upon order of a court of competent jurisdiction or to the extent required

**Portions of the Exhibit have been omitted and have been filed separately purusant to an application for confidential treatment filed with the Securities and Exchange Commission pursuant to Rule 24b-2 under the Securities Exchange Act of 1934, as amended.

26

by law or governmental regulation Cephalon and Teva agree that within 10 days of the execution of this Agreement, they will jointly agree in good faith upon the text of and disseminate an appropriate press release respecting the subject matter of this Agreement, and that they will not otherwise publicize the terms and conditions of this Agreement or make any statements or comments to any news media and/or trade publication, or any third person or entity (except as set forth above) regarding the terms and conditions of this Agreement, except as may be required by law, and then only after having conferred in good faith to obtain the reasonable agreement of the other party. Information otherwise in the public domain is not subject to the provisions of this Section.

7      FILINGS WITH FTC AND DOJ

        7.1 Within ten (10) business days following the date hereof, each party shall file or cause to be filed with the U.S. Federal Trade Commission Bureau of Competition ("FTC") and the Antitrust Division of the U.S. Department of Justice ("DOJ") this Agreement and any notifications required to be filed pursuant to Title XI of the Medicare Prescription Drug Improvement and Modernization Act (Subtitle B—Federal Trade Commission Review) signed into law on December 8, 2003 and any other Applicable Law.

        7.2 The parties shall use all commercially reasonable efforts to coordinate the foregoing filings and any responses thereto, to make such filings promptly and to respond promptly to any requests for additional information made by either of such agencies. Each party reserves the right to communicate with the FTC or DOJ regarding such filings as it believes appropriate. Each party shall keep the other reasonably informed of such communications and

**Portions of the Exhibit have been omitted and have been filed separately purusant to an application for confidential treatment filed with the Securities and Exchange Commission pursuant to Rule 24b-2 under the Securities Exchange Act of 1934, as amended.

27

shall not disclose the Confidential Information of the other without such other party's consent (not to be unreasonably withheld).

        7.3 In the event that either the FTC or DOJ threatens to institute its own judicial or administrative proceeding against either of the parties related to this Agreement, the parties shall promptly meet in good faith to discuss the feasibility of possible modifications to this Agreement.

8      MISCELLANEOUS

        8.1 The terms of this Agreement shall be binding upon and inure to the benefit of the parties hereto, their respective successors, heirs, and assigns.

        8.2 No party shall assign any of its rights or obligations hereunder to any non-Affiliated third party without first obtaining the written consent of the other party hereto, which consent may not be unreasonably withheld.

        8.3 The Agreement shall be interpreted in accordance with and governed by the law of the State of Delaware.

        8.4 Cephalon and Teva agree that the United States District Court for the District of New Jersey shall be the proper and exclusive forum for any action to enforce this Agreement. Each party consents to the personal jurisdiction of that court for such purposes.

        8.5 Notices under this Agreement shall be sent by overnight or first class mail, return receipt or other proof of delivery requested, to the following:

**Portions of the Exhibit have been omitted and have been filed separately purusant to an application for confidential treatment filed with the Securities and Exchange Commission pursuant to Rule 24b-2 under the Securities Exchange Act of 1934, as amended.

28

If to Cephalon:

Legal Department
Cephalon, Inc.
41 Moores Road
Frazer, PA 19355

Attn: John E. Osborn
Sr. Vice President, General Counsel & Secretary
Telephone: (610)-738-6337
Fax: (610)-738-6590

If to Teva:

Legal Department
Teva North America
425 Privet Road, Horsham, PA 19044
Attn: Richard Egosi, Senior Vice President & General Counsel
Telephone: (215) 293-6400
Fax: (215) 293-6499

With copies to:

Teva Pharmaceutical Industries Ltd.
5 Basel Street
PO Box 3190
Petach Tikva 49131, Israel
Attn: Corporate Legal Department—Attention General Counsel
Telephone: 011 972-3-926-7297
Fax: 011 972-3-926-7429

Teva Pharmaceutical Industries Ltd.
5 Basel Street
PO Box 3190
Petach Tikva 49131, Israel
Attn: Vice President, API Division
Telephone:
Fax:

**Portions of the Exhibit have been omitted and have been filed separately purusant to an application for confidential treatment filed with the Securities and Exchange Commission pursuant to Rule 24b-2 under the Securities Exchange Act of 1934, as amended.

29

        8.6 This Agreement may not be modified, amended, supplemented, or repealed except by written agreement executed by duly authorized representatives of the parties.

        8.7 Payments due to Teva under this Agreement shall be made by wire transfer to the following account:

Bank Name:	[**]
Bank Address:	[**]
Bank ABA:	[**]
Beneficiary Account:	[**]
Beneficiary Name:	[**]
Beneficiary Address:	[**]

        8.8 Each party shall have the right, at its own expense, once each fiscal year upon reasonable advance notice, to have a mutually acceptable independent auditor conduct an audit (consistent with US GAAP and applicable laws) of the financial books and accounts of the other party for the purposes of ascertaining the payments due under this Agreement (including, without limitation, calculation of [**], and royalty payments due to Teva under Article 2) as well as the compliance with all financial obligations hereunder.

        8.9 This Agreement represents the entire agreement between Cephalon and Teva with respect to the subject matter of this Agreement and supersedes all prior or contemporaneous agreements, proposals, or understandings, whether written or oral, between Cephalon and Teva with respect to that subject matter.

**Portions of the Exhibit have been omitted and have been filed separately purusant to an application for confidential treatment filed with the Securities and Exchange Commission pursuant to Rule 24b-2 under the Securities Exchange Act of 1934, as amended.

30

        8.10 If one or more provisions of this Agreement are ruled wholly or partly invalid or unenforceable by a court or other government body of competent jurisdiction, then the validity and enforceability of all other provisions of this Agreement shall not in any way be affected or impaired.

        8.11 No waiver of, failure of a party to object to, or failure of a party to take affirmative action with respect to any default, term, or condition of this Agreement, or any breach thereof, shall be deemed to imply or constitute a waiver of any other like default, term, or condition of this Agreement, or subsequent breach thereof.

        8.12 Nothing in this Agreement shall be construed so as to result in a license under, or waiver of, any right of a party, in each case, without an express license or waiver by such party in writing, either hereunder or in a separate writing signed by the parties. For the removal of doubt:

(a)

Nothing in this Agreement shall operate or be construed as granting Teva a license under, or any other rights with respect to, any patents owned by Cephalon other than the Listed Patents; and



(b)

Nothing in this Agreement shall operate or be construed as a waiver by Teva of any right to challenge any patent owned by Cephalon other than the Listed Patents.

**Portions of the Exhibit have been omitted and have been filed separately purusant to an application for confidential treatment filed with the Securities and Exchange Commission pursuant to Rule 24b-2 under the Securities Exchange Act of 1934, as amended.

31

        8.13 Cephalon and Teva have had all desired counsel, legal and otherwise, in entering into this Agreement, and do so in accordance with their own free acts and deeds. This Agreement shall therefore be deemed to have been negotiated and prepared at the joint request, direction, and instruction of each of the parties, at arms length, with the advice and participation of counsel, and will be interpreted in accordance with its terms without favor to either party.

        8.14 Each party represents that it is duly existing; that it has the full power and authority to enter into this Agreement; that there are no other persons or entities whose consent to this Agreement or whose joinder herein is necessary to make fully effective the provisions of this Agreement; that this Agreement does not and will not interfere with any other agreement to which it is a party and that it will not enter into any agreement the execution and/or performance of which would violate or interfere with this Agreement.

        8.15 This Agreement may be signed in counterparts, each of which shall be deemed an original hereof, but all of which together shall constitute one and the same instrument.

**Portions of the Exhibit have been omitted and have been filed separately purusant to an application for confidential treatment filed with the Securities and Exchange Commission pursuant to Rule 24b-2 under the Securities Exchange Act of 1934, as amended.

32

        IN WITNESS WHEREOF, the parties hereto have executed this Agreement effective as of the date first written above.

TEVA PHARMACEUTICALS USA, INC.		CEPHALON, INC.
By:	/s/  RICHARD EGOSI	By:	/s/  FRANK BALDINO, PH.D.
	Printed Name: Richard Egosi		Frank Baldino, Ph.D.
	Title: SVP, General Counsel		Chief Executive Officer
	Date: December 8, 2005		Date: December 8, 2005

TEVA PHARMACEUTICAL INDUSTRIES LTD.
By:	/s/  AHARON YAARI
	Printed Name: Aharon (Arik) Yaari Title: President, Teva API Division Date: December 8, 2005
By:	/s/  RICHARD EGOSI Printed Name: Richard Egosi Title: SVP, General Counsel Date: December 8, 2005

**Portions of the Exhibit have been omitted and have been filed separately purusant to an application for confidential treatment filed with the Securities and Exchange Commission pursuant to Rule 24b-2 under the Securities Exchange Act of 1934, as amended.

33

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AGREEMENT

EX-10.22

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Exhibit 10.22

AGREEMENT

        THIS SETTLEMENT AGREEMENT ("Agreement") is entered into effective this 22nd day of December, 2005 ("Effective Date"), by and between CEPHALON, INC., a corporation organized and existing under the laws of the State of Delaware, with its principal place of business at 41 Moores Road, Frazer, Pennsylvania 19355, and RANBAXY LABORATORIES LIMITED, a corporation existing and operating under the laws of India with principal place of business at Plot 90, Sector 32, Gurgaon 122001 (Haryana), India.

        WHEREAS, Cephalon is the owner by assignment of all right and title in U.S. Reissue Patent No. RE37,516 ("the RE “516 Patent"), issued by the United States Patent and Trademark Office on January 15, 2002 and expiring on October 6, 2014.

        WHEREAS PROVIGIL® (modafinil) is the commercial formulation of modafinil manufactured and sold by Cephalon pursuant to FDA approval of Cephalon's NDA No. 20-717.

        WHEREAS by letter dated March 21, 2003, Ranbaxy notified Cephalon that Ranbaxy had submitted ANDA No. 76-595 to the FDA under Section 505(j) of the Federal Food, Drug and Cosmetic Act (21 U.S.C. § 355(j)), seeking approval to engage in the commercial manufacture, use, and sale of tablets containing 100 mg and 200 mg of modafinil, a generic version of PROVIGIL® (modafinil) tablets, before the expiration date of the RE “516 Patent.

        WHEREAS Cephalon filed suit against Ranbaxy and three other companies that had also filed Paragraph IV ANDAs concerning PROVIGIL® (modafinil) in an action captioned Cephalon, Inc. v. Mylan Pharmaceuticals Inc., et al., Civil Action No. 03-CV-1394 (JCL), in the United States District Court for the District of New Jersey, seeking, among other things, a declaration that Ranbaxy's making, using, offering to sell, selling, or importing Ranbaxy ANDA

**Portions of the Exhibit have been omitted and have been filed separately purusant to an application for confidential treatment filed with the Securities and Exchange Commission pursuant to Rule 24b-2 under the Securities Exchange Act of 1934, as amended.

Modafinil Tablets would infringe the RE “516 Patent, an order providing that the effective date of any approval of Ranbaxy's ANDA No. 76-595 shall be a date which is not earlier than the date of the expiration of the RE “516 Patent; and an order permanently enjoining Ranbaxy from making, using, offering to sell, selling, or importing tablets as described in Ranbaxy's ANDA No. 76-595 until after the date of the expiration of the RE “516 Patent.

        WHEREAS, Ranbaxy answered Cephalon's complaint by denying infringement, by asserting affirmative defenses that the RE “516 patent is invalid and unenforceable, and by filing counterclaims seeking declaratory judgment of noninfringement, invalidity and unenforceability.

        WHEREAS, Cephalon and Ranbaxy have taken discovery, but no partial or final judgment has entered as to any issue in dispute.

        WHEREAS, to avoid the time and expense of further litigation, and in compromise of the disputed claims set forth above, the parties now desire to resolve their disputes by settlement.

        WHEREAS, the parties desire to provide for the supply by Ranbaxy and the purchase by Cephalon of the active pharmaceutical ingredient, modafinil.

        WHEREAS, Cephalon desires to license from Ranbaxy, and Ranbaxy is willing to license to Cephalon on the terms and conditions set forth herein, certain worldwide intellectual property rights owned by Ranbaxy.

        NOW, THEREFORE, in consideration of the foregoing and the mutual covenants and conditions herein set forth, the receipt and sufficiency of which consideration is hereby acknowledged, the parties agree as follows:

**Portions of the Exhibit have been omitted and have been filed separately purusant to an application for confidential treatment filed with the Securities and Exchange Commission pursuant to Rule 24b-2 under the Securities Exchange Act of 1934, as amended.

2

1.     DEFINITIONS

        1.1 "Action" shall mean Cephalon, Inc. v. Mylan Pharmaceuticals Inc., et al., Civil Action No. 03-CV-1394 (JCL), pending in the United States District Court for the District of New Jersey.

        1.2 "Affiliate" shall mean any corporation, partnership, joint venture or firm which controls, is controlled by or under common control with a specified person or entity. For purposes of this definition, "control" shall be presumed to exist if one of the following conditions is met: (a) in the case of corporate entities, direct or indirect ownership of at least fifty percent (50%) of the stock or shares having the right to vote for the election of directors and (b) in the case of non-corporate entities, direct or indirect ownership of at least fifty percent (50%) of the equity interest with the power to direct the management and policy decisions of such non-corporate entities.

        1.3 "API" shall mean the active pharmaceutical ingredient in Subject Modafinil Product, modafinil (it is understood by the parties that where the term "API" is used in this Agreement to refer to a compound or product made by, used by, sold by, or supplied to Cephalon, the term shall mean the active pharmaceutical ingredient modafinil).

        1.4 "Ranbaxy Generic Modafinil" shall mean any Subject Modafinil Product marketed and sold by Ranbaxy pursuant to the terms of this Agreement.

        1.5 "Ranbaxy" shall mean RANBAXY LABORATORIES LIMITED, a corporation existing and operating under the laws of India with principal place of business at Plot 90,

**Portions of the Exhibit have been omitted and have been filed separately purusant to an application for confidential treatment filed with the Securities and Exchange Commission pursuant to Rule 24b-2 under the Securities Exchange Act of 1934, as amended.

3

Sector 32, Gurgaon 122001 (Haryana), India, and its directors, officers, employees, agents and representatives, predecessors, successors, and assigns; its subsidiaries, divisions, groups, and the respective directors, officers, employees, agents and representatives, successors, and assigns of each.

        1.6 "Ranbaxy ANDA Modafinil Product" shall mean [**].

        1.7 "Ranbaxy Modafinil ANDA" shall mean ANDA No. 76-595.

        1.8 "Cephalon" shall mean CEPHALON, INC., a corporation organized and existing under the laws of the State of Delaware, with its principal place of business at 41 Moores Road, Frazer, Pennsylvania, and its directors, officers, employees, agents and representatives, predecessors, successors, and assigns; its subsidiaries, divisions, groups, and the respective directors, officers, employees, agents and representatives, successors, and assigns of each.

        1.9 "Date Certain" shall mean the later of: (a) October 6, 2011 (three years prior to the expiration of the Patent In Suit); or (b) in the event that Cephalon obtains a pediatric extension on the Patent in Suit, April 6, 2012 (three years prior to the expiration of the pediatric extension, if obtained).

        1.10 "Generic Modafinil Product" shall mean any Subject Modafinil Product that is not marketed under the mark PROVIGIL®.

        1.11 "Listed Patents" shall mean [**].

**Portions of the Exhibit have been omitted and have been filed separately purusant to an application for confidential treatment filed with the Securities and Exchange Commission pursuant to Rule 24b-2 under the Securities Exchange Act of 1934, as amended.

4

        1.12 "Modafinil Litigation" shall mean (a) Cephalon, Inc. v. Mylan Pharmaceuticals Inc., et al., Civil Action No. 03-CV-1394 (JCL), pending in the United States District Court for the District of New Jersey; (b) Cephalon, Inc. v. Carlsbad Tech., Inc., Civil Action No. 05-CV-1089 (JCL), pending in the United States District Court for the District of New Jersey; and (c) any action filed under Title 35, United States Code, 35 U.S.C. §§ 271 and 281 against any Modafinil Paragraph IV ANDA Filing Entity.

        1.13 "Modafinil Paragraph IV ANDA Filing Entity" shall mean any entity that has notified or subsequently notifies Cephalon that it has filed an ANDA with a Paragraph IV certification concerning a product containing modafinil as an active ingredient for which PROVIGIL® is the reference listed drug.

        1.14 "Ranbaxy Net Sales" shall mean the gross sales (number of units shipped times the invoiced price per unit) derived in arms-length transactions from the sale of Ranbaxy Generic Modafinil in the United States by Ranbaxy (or by its Affiliates) to independent third parties in the United States for such period less: (a) promotional allowances, rebates, quantity and cash discounts, and other usual and customary discounts to customers, (b) taxes and duties paid, absorbed, or allowed which are directly related to the sale (c) the amount of chargebacks and amounts repaid or credited by reason of rejections, damages or return of goods, or because of retroactive price adjustments justified by trade practices, (d) discounts, rebates or other payments required by law to be made under Medicaid, Medicare, or other governmental special medical assistance programs and (e) any amounts written off as uncollectible payments or debts owed, all determined in accordance with GAAP.

**Portions of the Exhibit have been omitted and have been filed separately purusant to an application for confidential treatment filed with the Securities and Exchange Commission pursuant to Rule 24b-2 under the Securities Exchange Act of 1934, as amended.

5

        Sales or transfers between or among Ranbaxy and its Affiliates shall be excluded from the computation of Ranbaxy Net Sales except where such Affiliates are end users, but Ranbaxy Net Sales shall include the subsequent final sales to third parties by such Affiliates.

        Where (i) Ranbaxy Generic Modafinil is sold as one of a number of items without a separate price; or (ii) the consideration for the Ranbaxy Generic Modafinil shall include any non-cash element; or (iii) the Ranbaxy Generic Modafinil shall be transferred in any manner other than an invoiced sale, the gross sales applicable to any such transaction shall be deemed to be the selling party's average gross sales for the applicable quantity of Ranbaxy Generic Modafinil during the calendar quarter. If there are no independent gross sales of Ranbaxy Generic Modafinil in the United States at that time, then Ranbaxy and Cephalon shall mutually agree on a surrogate measure to be used in lieu thereof.

        1.15 "Other Modafinil Paragraph IV ANDA Filing Entity" shall mean any Modafinil Paragraph IV ANDA Filing Entity besides Ranbaxy or Cephalon or its and their Affiliates.

        1.16 "Patent In Suit" shall mean the RE “516 Patent.

        1.17 "Subject Modafinil Product" shall mean [**].

        1.18 "Manufacturing Costs" shall mean with respect to any calendar year, the actual cost (expressed on a per unit manufactured basis) of manufacturing and/or acquiring the Materials, manufacturing the finished dosage of Ranbaxy Generic Modafinil, Labeling, and Packaging, including and limited to the cost of all Materials (active and inactive ingredients),

**Portions of the Exhibit have been omitted and have been filed separately purusant to an application for confidential treatment filed with the Securities and Exchange Commission pursuant to Rule 24b-2 under the Securities Exchange Act of 1934, as amended.

6

Direct Labor and Benefits, and Direct Overhead for manufacturing and quality control, all determined in accordance with GAAP.

        1.19 "Materials" shall mean all ingredients, items or substances used or required to be used to manufacture Ranbaxy Generic Modafinil, including API, excipients, packaging components, printed materials and manufacturing materials associated with Ranbaxy Generic Modafinil.

        1.20 "Operating Profit" shall mean an amount determined by deducting from Ranbaxy Net Sales: (a) Ranbaxy's Manufacturing Costs, and (b) a Sales, Marketing, and Distribution allowance equal to [**].

        1.21 "Intellectual Property Rights" means the international applications published under the Patent Cooperation Treaty ("PCT") having the International Publication Numbers [**], and any and all related patents and patent applications (whether now pending or subsequently filed), including without limitation any provisional, non-provisional, United States, PCT, foreign or international issued patents or pending patent applications, and any continuations, continuations-in-part (but not continuations-in-part claiming patentably distinct subject matter), divisions, or any substitute applications thereof, any patent that has issued or subsequently issues with respect to any such applications, any reissue, re-examination, renewal or extension (including any supplemental patent certificate) of any such patent, and any confirmation patent or registration patent or patent of addition based on any such patent, and any and all United States and foreign counterparts of any of the foregoing.

**Portions of the Exhibit have been omitted and have been filed separately purusant to an application for confidential treatment filed with the Securities and Exchange Commission pursuant to Rule 24b-2 under the Securities Exchange Act of 1934, as amended.

7

2.     OBLIGATIONS OF THE PARTIES

        2.1 Ranbaxy Warranty.

        The parties agree that this Agreement includes a settlement which is a compromise of a disputed claim and that acceptance of the consideration herein is not to be construed as an admission by either party as to the underlying merits of the Action. However, as an express inducement to Cephalon to enter into this settlement, in consideration of the terms hereof, Ranbaxy hereby warrants, represents and agrees that Ranbaxy, on behalf of itself and its Affiliates, will not make, use, offer to sell, or sell, or actively induce or assist any other entity to make, use, offer to sell, or sell Ranbaxy ANDA Modafinil Product within the United States, or import or cause to be imported any Ranbaxy ANDA Modafinil Product into the United States, except as otherwise permitted under, and according to the terms of, the license granted by Cephalon in connection with this Agreement. The parties agree that, as used in this Section 2.1, "induce" and "assist" shall include Ranbaxy's provision of modafinil API to parties it knows or has reason to know will use the API provided by Ranbaxy to make, use, offer to sell, sell, import or cause to be imported into the United States a Subject Modafinil Product.

        2.2 On [**], Cephalon shall make a one-time payment to Ranbaxy of [**], in recognition of the savings inuring to Cephalon in terms of the avoidance of costs, expenditure of time and resources, disruption and burden associated with prosecuting the Action against Ranbaxy.

**Portions of the Exhibit have been omitted and have been filed separately purusant to an application for confidential treatment filed with the Securities and Exchange Commission pursuant to Rule 24b-2 under the Securities Exchange Act of 1934, as amended.

8

        2.3 Modafinil API Supply Agreement.

        Cephalon and Ranbaxy shall enter into a supply agreement, by which Ranbaxy shall supply, and Cephalon shall purchase in the United States, the following annual volumes of modafinil API per Cephalon specifications at the below prices, and upon such other reasonable and customary terms in the industry as the parties shall negotiate in good faith, it being understood that Ranbaxy shall use its commercially reasonable efforts to work continuously in good faith to reduce associated costs and increase efficiencies while consistently meeting Cephalon specifications, and to reflect all such cost reductions and efficiencies through appropriate reductions to the per kilogram price. In addition, the parties agree to cooperate in good faith to work together to help reduce costs.

        For purposes of this Section, the parties agree that the initial year ("Year 1") of this five year supply commitment shall be calendar year 2006, and also agree that, assuming Ranbaxy is qualified under applicable regulations to and does produce or provide the Year 1 volume of conforming API for Cephalon hereunder during calendar year 2006, Cephalon will purchase such Year 1 volume of API set forth below in 2006. Cephalon also agrees that it will purchase from Ranbaxy at least [**] of the Year 1 volume set forth below by [**] (again assuming that Ranbaxy is qualified under applicable regulations to and does produce or provide [**] of conforming API for Cephalon hereunder by [**]). The parties further agree that they shall undertake to work together in good faith promptly following the Effective Date to qualify Ranbaxy API material in Cephalon's regulatory filings for modafinil.

**Portions of the Exhibit have been omitted and have been filed separately purusant to an application for confidential treatment filed with the Securities and Exchange Commission pursuant to Rule 24b-2 under the Securities Exchange Act of 1934, as amended.

9

        Ranbaxy agrees to supply, and Cephalon agrees to purchase, modafinil API per Cephalon specifications at the below minimum quantities as follows:

Contract Year	Kg Price		Volume	Total Payment
1	[**]	*	[**]	[**]	*
2	[**]	*	[**]	[**]	*
3	[**]	*	[**]	[**]	*
4	[**]	*	[**]	[**]	*
5	[**]	*	[**]	[**]	*

*

subject to Ranbaxy's agreement to use commercially reasonable efforts to work continuously in good faith to reduce costs and create efficiencies while consistently meeting specifications and to reflect all such reductions and efficiencies through appropriate reductions to the associated per kilogram price. The parties agreed that the prices charged herein shall be adjusted [**].

        2.4 Ranbaxy Generic Rights. Cephalon shall also grant to Ranbaxy the non-exclusive generic rights set forth in Section 3 below.

**Portions of the Exhibit have been omitted and have been filed separately purusant to an application for confidential treatment filed with the Securities and Exchange Commission pursuant to Rule 24b-2 under the Securities Exchange Act of 1934, as amended.

10

        2.5 License to Cephalon.

(a)

Ranbaxy hereby grants to Cephalon a non-exclusive, worldwide license to all Intellectual Property Rights for the manufacture, development, formulation, use, sale, offer for sale, and importation of API and finished pharmaceutical products. As an express inducement to Ranbaxy to enter into this Agreement, and in consideration of the terms hereof, Cephalon hereby warrants, represents and agrees that Cephalon, on behalf of itself and its Affiliates, will not challenge or otherwise dispute any issued patents included in the Intellectual Property Rights.



(b)

In consideration of the license set forth in Section 2.5(a) above, Cephalon shall make royalty payments to Ranbaxy as follows:



(i)

within [**] of the execution of this Agreement: a lump sum royalty payment of [**];



(ii)

within [**] of the date of issuance of the first United States patent included in the Intellectual Property Rights that [**] ("First Issue Date"): a lump sum royalty payment of [**];



(iii)

on or before [**] First Issue Date: a lump sum royalty payment of [**];



(iv)

on or before [**] First Issue Date: a lump sum royalty payment of [**]; and

**Portions of the Exhibit have been omitted and have been filed separately purusant to an application for confidential treatment filed with the Securities and Exchange Commission pursuant to Rule 24b-2 under the Securities Exchange Act of 1934, as amended.

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(v)

on or before [**] First Issue Date: a lump sum royalty payment of [**].



(c)

It is understood and agreed that upon the date of the lump sum royalty payment set forth in Section 2.5(b)(v) above, Cephalon's royalty obligation shall cease and Cephalon shall thereupon have a fully-paid up, non-exclusive worldwide license to all Intellectual Property Rights owned by Ranbaxy.



(d)

[**].

3.     RANBAXY GENERIC RIGHTS

        3.1 Cephalon grants to Ranbaxy the non-exclusive right (without the right to grant sublicenses) under the Listed Patents and all other modafinil-related patents owned or subsequently acquired by Cephalon, or to which Cephalon has or subsequently acquires sublicense rights, to manufacture, have manufactured, use, market and sell Generic Modafinil Product in the United States according to the following terms:

        3.1.1. Ranbaxy's non-exclusive generic rights under section 3.1 shall be effective on the Date Certain. Ranbaxy shall pay Cephalon a royalty equal to: (a) [**] (provided market entry by Ranbaxy and [**] generic market entrants, including any authorized generic entrant), (b) [**] (provided market entry by Ranbaxy and [**] generic market entrants, including any authorized generic entrant), (c) [**] (provided market entry by Ranbaxy and [**] generic market entrants, including any authorized generic entrant) from all Ranbaxy Generic Modafinil sold by

**Portions of the Exhibit have been omitted and have been filed separately purusant to an application for confidential treatment filed with the Securities and Exchange Commission pursuant to Rule 24b-2 under the Securities Exchange Act of 1934, as amended.

12

Ranbaxy and/or its Affiliates in the United States on or after the Date Certain until the later of (i) the expiration of all Listed Patents or (ii) the end of any pediatric extension on the Patent in Suit, subject to any subsequent negotiation concerning an extension of generic rights.

        3.1.2. Notwithstanding Section 3.1.1, in the event that Cephalon licenses or permits any other entity to sell any Generic Modafinil Product in the United States prior to the Date Certain, Ranbaxy's non-exclusive generic rights under section 3.1 shall become effective on the date on which such other licensed entity begins selling a Generic Modafinil Product in the United States. In the event that Ranbaxy is permitted to sell Ranbaxy Generic Modafinil in the United States prior to the Date Certain under the terms of this Section, Ranbaxy shall pay Cephalon a royalty equal to: (a) [**] (provided market entry by Ranbaxy and [**] generic market entrants, including any authorized generic entrant), (b) [**] (provided market entry by Ranbaxy and [**] generic market entrants, including any authorized generic entrant), (c) [**] (provided market entry by Ranbaxy and [**] generic market entrants, including any authorized generic entrant) from all Ranbaxy Generic Modafinil sold by Ranbaxy and/or its Affiliates in the United States prior to the Date Certain. However, the parties expressly acknowledge and agree that sales by a third party of Generic Modafinil Product in the United States prior to the Date Certain pursuant to a license granted by Cephalon (whether by settlement or otherwise) that is subject to suspension provisions similar to those set forth in

**Portions of the Exhibit have been omitted and have been filed separately purusant to an application for confidential treatment filed with the Securities and Exchange Commission pursuant to Rule 24b-2 under the Securities Exchange Act of 1934, as amended.

13

Sections 3.1.3.3 and 3.1.3.6 shall not trigger Ranbaxy's rights under this Section 3.1.2.

        3.1.3. Notwithstanding Section 3.1.1, in the event that any Other Modafinil Paragraph IV ANDA Filing Entity sells in the United States any Subject Modafinil Product prior to a non-appealable final judgment in any Modafinil Litigation to which such Other Modafinil Paragraph IV ANDA Filing Entity is a party, Ranbaxy's non-exclusive generic rights shall be effective at the same time, subject to the following restrictions:

        3.1.3.1 Ranbaxy shall pay to Cephalon a royalty equal to: (a) [**] (provided market entry by Ranbaxy and [**] generic market entrants, including any authorized generic entrant), (b) [**] (provided market entry by Ranbaxy and [**] generic market entrants, including any authorized generic entrant), (c) [**] (provided market entry by Ranbaxy and [**] generic market entrants, including any authorized generic entrant) from all Ranbaxy Generic Modafinil sold by Ranbaxy and/or its Affiliates in the United States pursuant to Section 3.1.3.

        3.1.3.2 In the event that Cephalon seeks a temporary restraining order or other relief against such Other Modafinil Paragraph IV ANDA Filing Entity to stop such Entity from offering to sell or selling in the United States its Subject Modafinil Product, Ranbaxy and/or its Affiliates may continue to market and sell Ranbaxy Generic Modafinil in the United States until a

**Portions of the Exhibit have been omitted and have been filed separately purusant to an application for confidential treatment filed with the Securities and Exchange Commission pursuant to Rule 24b-2 under the Securities Exchange Act of 1934, as amended.

14

court of competent jurisdiction renders a decision on Cephalon's request for a temporary restraining order or other relief, as further described in Sections 3.1.3.3 through 3.1.3.4

        3.1.3.3 If Cephalon obtains a temporary restraining order or other relief sufficient to stop further offers to sell or sales in the United States of Subject Modafinil Product by any Other Modafinil Paragraph IV ANDA Filing Entity, Ranbaxy's generic rights shall be suspended until the Date Certain, and Ranbaxy and/or its Affiliates shall immediately cease offering to sell and/or selling any Ranbaxy Generic Modafinil as of the earliest date on which such injunctive or other relief may be enforced. [**].

        3.1.3.4 If Cephalon requests but does not obtain a temporary restraining order or other relief, Ranbaxy may continue to market and sell Ranbaxy Generic Modafinil in the United States until the resolution of pending Modafinil Litigation. Ranbaxy shall continue to pay to Cephalon a royalty equal to: (a) [**] (provided market entry by Ranbaxy and [**] generic market entrants, including any authorized generic entrant), (b) [**] (provided market entry by Ranbaxy and [**] generic market entrants, including any authorized generic entrant), (c) [**] (provided market entry by Ranbaxy and [**] generic market entrants, including any authorized generic entrant) from all Ranbaxy Generic Modafinil sold by Ranbaxy and/or its Affiliates in the United States as set forth in Section 3.1.3.1 above.

**Portions of the Exhibit have been omitted and have been filed separately purusant to an application for confidential treatment filed with the Securities and Exchange Commission pursuant to Rule 24b-2 under the Securities Exchange Act of 1934, as amended.

15

        3.1.3.5 Nothing in this Section or the Agreement shall obligate Cephalon to seek injunctive or other relief to stop such Other Modafinil Paragraph IV ANDA Filing Entity from offering to sell or selling Subject Modafinil Product in the United States.

        3.1.3.6 In the event that Cephalon prevails against such Other Modafinil Paragraph IV ANDA Filing Entity in Modafinil Litigation, such that offers to sell or sales in the United States of Subject Modafinil Product by such Other Modafinil Paragraph IV ANDA Filing Entity are admitted by such Other Modafinil Paragraph IV ANDA Filing Entity or held by the court to infringe one or more valid and enforceable claims of the Listed Patents, Ranbaxy's generic rights shall be suspended until the Date Certain and Ranbaxy and/or its Affiliates shall immediately cease marketing and/or selling Ranbaxy Generic Modafinil until the Date Certain. [**].

        3.1.3.7 Notwithstanding Section 3.1.1., in the event that a final, non-appealable judgment in Modafinil Litigation is entered prior to the Date Certain declaring that one or more Other Modafinil Paragraph IV ANDA Filing Entities may offer to sell or sell Subject Modafinil Product in the United States without infringing any valid, enforceable claim of any Listed Patent on which Cephalon has brought suit, Ranbaxy may then market and sell Ranbaxy Generic Modafinil in the United States, with royalties to Cephalon determined as follows: Ranbaxy shall pay to Cephalon a royalty

**Portions of the Exhibit have been omitted and have been filed separately purusant to an application for confidential treatment filed with the Securities and Exchange Commission pursuant to Rule 24b-2 under the Securities Exchange Act of 1934, as amended.

16

equal to [**] from all Ranbaxy Generic Modafinil sold by Ranbaxy and/or its Affiliates in the United States. Provided, however, that in the event that the final, non-appealable judgment referenced earlier in this Section 3.1.3.7 is based on a finding that the RE "516 Patent is invalid, unenforceable, dedicated to the public, lapsed, or null and void for any reason, Ranbaxy and/or its Affiliates may market and sell Ranbaxy Generic Modafinil in the United States as of the date of such judgment with no royalty obligation to Cephalon.

        3.1.3.8 In the event that a United States District Court enters a judgment prior to the Date Certain declaring that the RE "516 Patent is invalid, unenforceable, dedicated to the public, lapsed, or null and void for any reason, Ranbaxy shall pay any royalties due under this Section 3 on or after the date of such judgment into an escrow account (the terms of the escrow account to be established in the underlying license agreement to be negotiated by the parties pursuant to Section 7.1). In the event that (i) such District Court judgment is affirmed in a final, non-appealable

**Portions of the Exhibit have been omitted and have been filed separately purusant to an application for confidential treatment filed with the Securities and Exchange Commission pursuant to Rule 24b-2 under the Securities Exchange Act of 1934, as amended.

17

judgment that is based on a finding that the RE "516 Patent is invalid, unenforceable, dedicated to the public, lapsed, or null and void for any reason, or (ii) Cephalon does not file an appeal of such District Court judgment within the time allowed under applicable rules of civil procedure, all escrowed royalties shall be paid to Ranbaxy. In that event that (i) such District Court judgment is reversed in a final, non-appealable judgment, or (ii) such District Court judgment is affirmed in a final, non-appealable judgment that is not based on a finding that the RE "516 Patent is invalid, unenforceable, dedicated to the public, lapsed, or null and void for any reason, all escrowed royalties shall be paid to Cephalon.

        3.2 Ranbaxy shall have the right to commence manufacturing activities in preparation of launch a reasonable period of time prior to the agreed upon effective date of the non-exclusive generic rights granted to Ranbaxy hereunder, provided however, that Ranbaxy shall not have the right to launch in advance of such effective date, nor to communicate its ability to do so to third parties earlier than 10 days prior to the anticipated launch date, without prior written consent of Cephalon. In the event that Ranbaxy commences manufacturing activities in preparation of a launch under this provision, but is precluded from such launch due to any action (including litigation activity) by Cephalon, [**].

        3.3 In order for Ranbaxy to exercise the rights under the Listed Patents as contemplated by this Section 3, Cephalon agrees to provide appropriate waivers of exclusivities or evidence of patent licenses as reasonably necessary for Ranbaxy to obtain regulatory approval of Ranbaxy Generic Modafinil in the United States.

        3.4 Notwithstanding the terms of this Section 3, Cephalon covenants that it will not sue Ranbaxy for infringement under the Listed Patents, or any other patents owned or subsequently acquired by Cephalon, or to which Cephalon has or subsequently acquires rights, for any sales by Ranbaxy in the United States of a product that is manufactured or sold pursuant

**Portions of the Exhibit have been omitted and have been filed separately purusant to an application for confidential treatment filed with the Securities and Exchange Commission pursuant to Rule 24b-2 under the Securities Exchange Act of 1934, as amended.

18

to an ANDA for which [**], provided that any such sales are not otherwise in breach of this Agreement. Ranbaxy agrees that it will not challenge the validity or enforceability of [**] in any context or forum. Cephalon agrees that it will not assert [**] against Ranbaxy in any context or forum, except in the event of a breach by Ranbaxy of any provision of Section 2.1 of this Agreement.

        3.5 (a) Ranbaxy shall have the one time right, to be exercised upon thirty (30) days' written notice from Ranbaxy to Cephalon, and at any time following Ranbaxy's first commercial marketing of Ranbaxy Generic Modafinil in accordance with the terms of this Agreement, to request that Cephalon provide to a mutually agreeable independent third-party accounting firm [**]. The [**] provided by Cephalon to the third-party accounting firm [**], and Cephalon shall take any other steps necessary to facilitate compliance with any confidentiality obligations owed by Cephalon and the requirements of applicable laws, while still providing sufficient information about [**]. These [**] shall not be disclosed to Ranbaxy, except to the extent contemplated in Section 3.5(d) below.

        (b) The information provided to the third-party accounting firm shall be limited solely to [**], and shall not include [**].

        (c) Cephalon shall provide [**] to the third-party accounting firm for the sole purpose of enabling said accounting firm [**], so that said accounting firm may determine (in good faith and in accordance with the professional standards of the industry and principles of US GAAP, consistently applied) [**]. All fees and expenses of the third-party accounting firm shall be paid by Ranbaxy.

**Portions of the Exhibit have been omitted and have been filed separately purusant to an application for confidential treatment filed with the Securities and Exchange Commission pursuant to Rule 24b-2 under the Securities Exchange Act of 1934, as amended.

19

        (d) In the event that said accounting firm determines in good faith that [**], the accounting firm shall promptly notify Ranbaxy of [**] (and also provide Cephalon a copy of such notice). By way of clarification, the accounting firm is not to determine [**], but rather is simply to provide Ranbaxy with a copy of [**]. Ranbaxy shall then have the one-time option (exercisable upon written notice to Cephalon, to be given within ten days of receipt of the notice from the accounting firm) to elect either [**].

        (e) The license agreement contemplated by Section 7.1 below shall include a dispute resolution provision pursuant to which Cephalon can submit any dispute it might have with the conclusion reached by the third-party accounting firm. In the event of such a dispute, [**] shall continue to apply until the dispute is resolved, [**].

        (f) The parties agree that, if at any time after the parties have completed the review process set forth in this Section 3.5, [**].

4.     DISMISSAL

        4.1 Upon the execution of this Agreement, Cephalon and Ranbaxy shall execute and file with the United States District Court for the District of New Jersey a Joint Stipulation for Dismissal, in the form attached hereto as Exhibit A. Each party shall bear its own costs with respect to the settlement of the Action.

        4.2 Cephalon and Ranbaxy waive any right to appeal any order previously entered in the Action.

**Portions of the Exhibit have been omitted and have been filed separately purusant to an application for confidential treatment filed with the Securities and Exchange Commission pursuant to Rule 24b-2 under the Securities Exchange Act of 1934, as amended.

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5.     MUTUAL RELEASES

        5.1 Ranbaxy, on behalf of itself and its subsidiaries, successors, and assigns, hereby releases, acquits, and forever discharges Cephalon from and against any and all claims, demands, liabilities, causes of action, damages, duties, or obligations arising under, concerning, or relating to the Action, but specifically excluding a breach by Cephalon of its covenants and obligations under this Agreement.

        5.2 Cephalon, on behalf of itself and its subsidiaries, successors, and assigns, hereby releases, acquits, and forever discharges Ranbaxy from any and all claims, demands, liabilities, causes of action, damages, duties, or obligations arising under, concerning, or relating to the Action, but specifically excluding a breach by Ranbaxy of its covenants and obligations under this Agreement.

6.     CONFIDENTIALITY

        6.1 Cephalon and Ranbaxy shall continue to be bound by and to comply with the terms of the Stipulated Protective Order previously executed in the Action and the confidentiality obligations agreed upon between the parties on November 25, 2005.

        6.2 Cephalon and Ranbaxy agree that the terms of this Agreement shall remain confidential and shall not be disclosed to third parties except subject to a nondisclosure agreement, and pursuant to business discussions relating to asset sales, mergers, or change of control transactions, or upon order of a court of competent jurisdiction or to the extent required by law or governmental regulation. Cephalon and Ranbaxy agree that within 10 days of the

**Portions of the Exhibit have been omitted and have been filed separately purusant to an application for confidential treatment filed with the Securities and Exchange Commission pursuant to Rule 24b-2 under the Securities Exchange Act of 1934, as amended.

21

execution of this Agreement, they will jointly agree in good faith upon the text of and disseminate appropriate press releases respecting the subject matter of this agreement, and that they will not otherwise publicize the terms and conditions this Agreement or make any statements or comments to any news media and/or trade publication, or any third person or entity (except as set forth above) regarding the terms and conditions of this Agreement, except as may be required by law, and then only after having conferred in good faith to obtain the reasonable agreement of the party. Information otherwise in the public domain is not subject to the provisions of this Section.

7.     MISCELLANEOUS

        7.1 Cephalon and Ranbaxy agree that, [**] of the date of this Agreement, they shall prepare and execute whatever documents are necessary (including license and supply agreements, as appropriate) to carry out the terms of Sections 2 and 3 above. However, subject to applicable laws, the terms and conditions contained in this Agreement are binding notwithstanding the failure of the parties to enter into the agreements referenced in this Section 7.1.

        7.2 The terms of this Agreement shall be binding upon and inure to the benefit of the parties hereto, their respective successors, heirs, and assigns.

        7.3 No party shall assign any of its rights or obligations hereunder to any non-Affiliated third party without first obtaining the written consent of the other party hereto, which consent may not be unreasonably withheld.

**Portions of the Exhibit have been omitted and have been filed separately purusant to an application for confidential treatment filed with the Securities and Exchange Commission pursuant to Rule 24b-2 under the Securities Exchange Act of 1934, as amended.

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        7.4 The Agreement shall be interpreted in accordance with and governed by the law of the State of Delaware.

        7.5 Cephalon and Ranbaxy agree that the United States District Court for the District of New Jersey shall be the proper and exclusive forum for any action to enforce this Agreement. Each party consents to the personal jurisdiction of that court for such purposes.

        7.6 Notices under this Agreement shall be sent by overnight or first class mail, return receipt or other proof of delivery requested, to the following:

If to Cephalon:

Legal Department
Cephalon, Inc.
41 Moores Road
Frazer, PA 19355
Attn: John E. Osborn
Sr. Vice President, General Counsel & Secretary
Telephone: (610)-738-6337
Fax: (610)-738-6590

If to Ranbaxy:

President
Ranbaxy Inc.
600 College Road East
Princeton, NJ 08540
Telephone: (609)-720-9200
Fax: (609)-720-1155

        7.7 This Agreement may not be modified, amended, supplemented or repealed except by written agreement executed by duly authorized representatives of the parties.

**Portions of the Exhibit have been omitted and have been filed separately purusant to an application for confidential treatment filed with the Securities and Exchange Commission pursuant to Rule 24b-2 under the Securities Exchange Act of 1934, as amended.

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        7.8 Each party shall have the right, at its own expense, once each fiscal year upon reasonable advance notice, to have a mutually acceptable independent auditor conduct an audit (consistent with US GAAP and applicable laws) of the financial books and accounts of the other party for the purposes of ascertaining the payments due under this Agreement as well as the compliance with all financial obligations hereunder.

        7.9 This Agreement represents the entire agreement between Cephalon and Ranbaxy with respect to the subject matter of this Agreement and supersedes all prior or contemporaneous agreements, proposals or understandings, whether written or oral, between Cephalon and Ranbaxy with respect to that subject matter.

        7.10 If one or more provisions of this Agreement are ruled wholly or partly invalid or unenforceable by a court or other government body of competent jurisdiction, then the validity and enforceability of all other provisions of this Agreement shall not in any way be affected or impaired.

        7.11 No waiver of, failure of a party to object to, or failure of a party to take affirmative action with respect to any default, term, or condition of this Agreement, or any breach thereof, shall be deemed to imply or constitute a waiver of any other like default, term, or condition of this Agreement, or subsequent breach thereof.

        7.12 Nothing in this Agreement shall be construed so as to result in a license under, or waiver of, any right of a party, in each case, without an express license or waiver by such party in writing, either hereunder or in a separate writing signed by the parties. For the avoidance of doubt:

**Portions of the Exhibit have been omitted and have been filed separately purusant to an application for confidential treatment filed with the Securities and Exchange Commission pursuant to Rule 24b-2 under the Securities Exchange Act of 1934, as amended.

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(a)

Nothing in this Agreement shall operate or be construed as granting Ranbaxy a license under, or any other rights with respect to, any patents owned by Cephalon other than the Listed Patents, except as specifically stated in Sections 3.1 and 3.4; and



(b)

Nothing in this Agreement shall operate or be construed as a waiver by Ranbaxy of any rights to challenge any patent owned by Cephalon other than [**].

        7.13 Cephalon and Ranbaxy have had all desired counsel, legal and otherwise, in entering into this Agreement, and do so in accordance with their own free acts and deeds. This Agreement shall therefore be deemed to have been negotiated and prepared at the joint request, direction, and instruction of each of the parties, at arms length, with the advice and participation of counsel, and will be interpreted in accordance with its terms without favor to either party.

        7.14 Each party represents that it is duly existing; that it has the full power and authority to enter into this Agreement; that there are no other persons or entities whose consent to this Agreement or whose joinder herein is necessary to make fully effective the provisions of this Agreement; that this Agreement does not and will not interfere with any other agreement to which it is a party and that it will not enter into any agreement the execution and/or performance of which would violate or interfere with this Agreement.

        7.15 This Agreement may be signed in counterparts, each of which shall be deemed an original hereof, but all of which together shall constitute one and the same instrument.

        7.16 Except as specifically provided in Section 3.4, nothing in this agreement is intended to or shall be construed to preclude Ranbaxy from filing an ANDA, seeking regulatory

**Portions of the Exhibit have been omitted and have been filed separately purusant to an application for confidential treatment filed with the Securities and Exchange Commission pursuant to Rule 24b-2 under the Securities Exchange Act of 1934, as amended.

25

approval for a product, marketing and selling a product, or providing API to any other entity for any product based on [**]. Similarly, nothing in this agreement is intended or shall be construed to preclude Cephalon from filing suit for infringement of any patent [**], or taking any other action with respect to such an ANDA filing or such other actions by Ranbaxy.

**Portions of the Exhibit have been omitted and have been filed separately purusant to an application for confidential treatment filed with the Securities and Exchange Commission pursuant to Rule 24b-2 under the Securities Exchange Act of 1934, as amended.

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        IN WITNESS WHEREOF, Cephalon and Ranbaxy have executed this Agreement effective as of the date first written above.

CEPHALON, INC.		RANBAXY LABORATORIES LIMITED
By:	/s/  FRANK BALDINO, JR.	By:	/s/  RAM S. RAMASUNDAR
	Printed Name: Frank Baldino, Jr., Ph.D.		Printed Name: Ram S. Ramasundar
	Title: Chief Executive Officer		Title: EVP—Finance & CFO
	Date: December 22, 2005		Date: December 22, 2005

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AGREEMENT

EX-12.1

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Exhibit 12.1

Cephalon, Inc.
Computation of Ratio of Earnings to Fixed Charges
(Amounts in thousands of dollars)

	2001			2002		2003		2004			2005
Pre-tax income (loss) from continuing operations	$	(55,484	)	$	62,433	$	130,314	$	(28,184	)	$	(245,118	)
Fixed charges:
Interest expense and amortization of debt discount and premium on all indebtedness		20,630			38,215		28,905		22,186			25,235
Capitalized interest		—			—		—		—			1,044
Appropriate portion of rentals		1,092			1,433		2,286		3,437			5,750
Preferred stock dividend requirements of consolidated subsidiaries		5,664			—		—		—			—
Total fixed charges		27,386			39,648		31,191		25,623			32,029
Pre-tax income (loss) from continuing operations, plus fixed charges, less capitalized interest and preferred stock dividend requirements of consolidated subsidiaries	$	(33,762	)	$	102,081	$	161,505	$	(2,561	)	$	(214,133	)
Ratio of earnings to fixed charges(1)		—			2.57		5.18		—			—

(1)

For the years ended December 31, 2001, 2004 and 2005 no ratios are provided because earnings were insufficient to cover fixed charges and fixed charges and preferred dividends, respectively.

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Cephalon, Inc. Computation of Ratio of Earnings to Fixed Charges (Amounts in thousands of dollars)

EX-21

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Exhibit 21

Cephalon, Inc.
Subsidiaries

Name	Jurisdiction of Incorporation
Anesta Corp.	Delaware
Anesta AG	Switzerland
Anesta UK Limited	United Kingdom
Cell Therapeutics (UK) Limited	United Kingdom
Cephalon (Bermuda) Limited	Bermuda
Cephalon Development Corporation	Delaware
Cephalon Financiere Luxembourg S.a.r.l.	Luxembourg
Cephalon France SAS	France
Cephalon France Holdings SAS	France
Cephalon GmbH	Germany
Cephalon International Holdings, Inc.	Delaware
Cephalon Investments, Inc.	Delaware
Cephalon Luxembourg S.a.r.l	Luxembourg
Cephalon Technologies Partners, Inc.	Delaware
Cephalon Technology, Inc.	Delaware
Cephalon Titrisation	France
Cephalon (UK) Limited	England and Wales
Cephalon Ventures, Inc.	Delaware
CIMA LABS INC.	Delaware
Financiere Lafon SA	France
Organisation de Synthese Mondiale Orsymonde	France
PolaRx Biopharmaceuticals, Inc.	Delaware
Societe Civile Immobiliere Martigny	France
Zeneus Holdings Limited	England
Zeneus Pharma (UK) Limited	England
Zeneus Pharma Italia	Italy
Zeneus Pharma GmbH	Germany
Zeneus Pharma Sarl	France
Zeneus Pharma (Ireland) Limited	Ireland
Zeneus Pharma SI	Spain
Zeneus Pharma BV	The Netherlands
Zeneus Pharma (Schweiz) GmbH	Switzerland
Zeneus Pharma ApS	Denmark
Zeneus Pharma Inc.	Delaware
Zeneus Pharma Sp. z.o.o.	Poland

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Cephalon, Inc. Subsidiaries

EX-23.1

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EXHIBIT 23.1

CONSENT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

        We hereby consent to the incorporation by reference in the Registration Statements on Forms S-3 (Nos. 333-122418, 33-74320, 333-20321, 333-75281, 333-88985, 333-94219, 333-62234, 333-59410, 333-82788, 333-89224, 333-108320, 333-112541) and Forms S-8 (Nos. 333-118611, 33-43716, 33-71920, 333-02888, 333-69591, 333-89909, 333-87421, 333-52640, 333-43104, 333-89228, 333-89230, 333-106112, 333-106115) of Cephalon, Inc. of our report dated March 10, 2006, relating to the financial statements, financial statement schedule, management's assessment of the effectiveness of internal control over financial reporting and the effectiveness of internal control over financial reporting, which appears in this Form 10-K.

/s/ PricewaterhouseCoopers LLP

Philadelphia, PA
March 10, 2006

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CONSENT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

EX-31.1

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EXHIBIT 31.1

CERTIFICATIONS

I, Frank Baldino, Jr., certify that:

1.

I have reviewed this annual report on Form 10-K of Cephalon, Inc.;

2.

Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;

3.

Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;

4.

The registrant's other certifying officer(s) and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have:

        (a)   Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;

        (b)   Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;

        (c)   Evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and

        (d)   Disclosed in this report any change in the registrant's internal control over financial reporting that occurred during the registrant's most recent fiscal quarter (the registrant's fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant's internal control over financial reporting; and

5.

The registrant's other certifying officer(s) and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant's auditors and the audit committee of the registrant's board of directors (or persons performing the equivalent functions):

        (a)   All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial information; and

        (b)   Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal control over financial reporting.

Date: March 13, 2006

/s/  FRANK BALDINO, JR. Frank Baldino, Jr., Ph.D.
Chairman and Chief Executive Officer
(Principal executive officer)

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CERTIFICATIONS

EX-31.2

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EXHIBIT 31.2

CERTIFICATIONS

I, J. Kevin Buchi, certify that:

1.

I have reviewed this annual report on Form 10-K of Cephalon, Inc.;

2.

Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;

3.

Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;

4.

The registrant's other certifying officer(s) and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have:

(a)

Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;

(b)

Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;

(c)

Evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and

(d)

Disclosed in this report any change in the registrant's internal control over financial reporting that occurred during the registrant's most recent fiscal quarter (the registrant's fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant's internal control over financial reporting; and

5.

The registrant's other certifying officer(s) and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant's auditors and the audit committee of the registrant's board of directors (or persons performing the equivalent functions):

(a)

All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial information; and

(b)

Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal control over financial reporting.

Date: March 13, 2006

/s/ J. KEVIN BUCHI J. Kevin Buchi
Executive Vice President and Chief Financial Officer
(Principal financial officer)

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CERTIFICATIONS

EX-32.1

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Exhibit 32.1

CERTIFICATION PURSUANT TO
18 U.S.C. SECTION 1350,
AS ADOPTED PURSUANT TO
SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002

        In connection with the Annual Report of Cephalon, Inc. (the "Company") on Form 10-K for the year ended December 31, 2005 as filed with the Securities and Exchange Commission on the date hereof (the "Report"), I, Frank Baldino, Jr., Chairman and Chief Executive Officer of the Company, certify, pursuant to 18 U.S.C. § 1350, as adopted pursuant to § 906 of the Sarbanes-Oxley Act of 2002, based on my knowledge, that:

        (1) The Report fully complies with the requirements of section 13(a) or 15(d) of the Securities Exchange Act of 1934; and

        (2) The information contained in the Report fairly presents, in all material respects, the financial condition and result of operations of the Company.

/s/ FRANK BALDINO, JR. Frank Baldino, Jr., Ph.D.
Chairman and Chief Executive Officer

March 13, 2006

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CERTIFICATION PURSUANT TO 18 U.S.C. SECTION 1350, AS ADOPTED PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002

EX-32.2

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Exhibit 32.2

CERTIFICATION PURSUANT TO
18 U.S.C. SECTION 1350,
AS ADOPTED PURSUANT TO
SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002

        In connection with the Annual Report of Cephalon, Inc. (the "Company") on Form 10-K for the year ended December 31, 2005 as filed with the Securities and Exchange Commission on the date hereof (the "Report"), I, J. Kevin Buchi, Executive Vice President and Chief Financial Officer of the Company, certify, pursuant to 18 U.S.C. § 1350, as adopted pursuant to § 906 of the Sarbanes-Oxley Act of 2002, based on my knowledge, that:

        (1) The Report fully complies with the requirements of section 13(a) or 15(d) of the Securities Exchange Act of 1934; and

        (2) The information contained in the Report fairly presents, in all material respects, the financial condition and result of operations of the Company.

/s/ J. KEVIN BUCHI J. Kevin Buchi
Executive Vice President and Chief Financial Officer

March 13, 2006

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CERTIFICATION PURSUANT TO 18 U.S.C. SECTION 1350, AS ADOPTED PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002