UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)
x	QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 2007
or
o	TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from        to

Commission File Number 000-19119

Cephalon, Inc.

(Exact Name of Registrant as Specified in Its Charter)

Delaware	23-2484489
(State or Other Jurisdiction of	(I.R.S. Employer
Incorporation or Organization)	Identification No.)
41 Moores Road
P.O. Box 4011
Frazer, Pennsylvania	19355
(Address of Principal Executive Offices)	(Zip Code)

(610) 344-0200

(Registrant’s Telephone Number, Including Area Code)

Not Applicable

(Former Name, Former Address and Former Fiscal Year, If Changed Since Last Report)

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

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

Large accelerated filer x Accelerated filer o Non-accelerated filer o

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

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

Class	Outstanding as of November 1, 2007
Common Stock, par value $.01	67,051,500 Shares

TABLE OF CONTENTS

Cautionary Note Regarding Forward-Looking Statements			ii
PART I – FINANCIAL INFORMATION
	Item 1.	Consolidated Financial Statements
		Consolidated Balance Sheets – September 30, 2007 and December 31, 2006	1
		Consolidated Statements of Operations – Three and nine months ended September 30, 2007 and 2006	2
		Consolidated Statement of Stockholders’ Equity – Nine months ended September 30, 2007	3
		Consolidated Statements of Cash Flows – Nine months ended September 30, 2007 and 2006	4
		Notes to Consolidated Financial Statements	5
	Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	17
	Item 3.	Quantitative and Qualitative Disclosures About Market Risk	34
	Item 4.	Controls and Procedures	34
PART II – OTHER INFORMATION
	Item 1.	Legal Proceedings	35
	Item 1A.	Risk Factors	35
	Item 5.	Other Information	47
	Item 6.	Exhibits	48
SIGNATURES			49

i

CAUTIONARY NOTE REGARDING FORWARD-LOOKING STATEMENTS

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

•our dependence on sales of PROVIGIL® (modafinil) [C-IV] in the United States and the market prospects and future marketing efforts for PROVIGIL, FENTORA® (fentanyl buccal tablet) [C-II], AMRIX™ (cyclobenzaprine hydrochloride extended-release capsules) and VIVITROL® (naltrexone for extended-release injectable suspension);

•any potential approval of our product candidates, including with respect to TREANDA® (bendamustine HCl);

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

•the timing and unpredictability of regulatory approvals;

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

•the terms of the agreement in principle with the U.S. Attorney’s Office and the finalization of the settlement and corporate integrity agreements;

•the ongoing investigation by and discussions with the Office of the Connecticut Attorney General and the ultimate resolution or settlement of this matter;

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

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

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

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

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

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

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

ii

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

•the loss of key management or scientific personnel;

•the activities of our competitors in the industry, including the continued erosion of ACTIQ® (oral transmucosal fentanyl citrate) [C-II] sales to generic competitors;

•regulatory, legal or other setbacks with respect to the agreement in principle with the U.S. Attorney’s Office, the proposed settlement and corporate integrity agreements related thereto, the ongoing investigation by the Office of the Connecticut Attorney General, our settlements of the PROVIGIL and ACTIQ patent litigations and the ongoing litigation related to such settlements;

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

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

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

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

iii

PART I – FINANCIAL INFORMATION

ITEM 1. CONSOLIDATED FINANCIAL STATEMENTS

CEPHALON, INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

(In thousands, except share data)

(Unaudited)

	September 30,			December 31,
	2007			2006
ASSETS
CURRENT ASSETS:
Cash and cash equivalents	$	661,982		$	496,512
Investments	69,101			25,212
Receivables, net	302,748			270,045
Inventory, net	93,399			85,239
Deferred tax assets, net	204,140			184,518
Other current assets	34,626			47,278
Total current assets	1,365,996			1,108,804
PROPERTY AND EQUIPMENT, net	481,508			453,010
GOODWILL	476,605			467,167
INTANGIBLE ASSETS, net	839,255			793,037
DEFERRED TAX ASSETS, net	103,284			118,192
OTHER ASSETS	132,056			105,287
	$	3,398,704		$	3,045,497
LIABILITIES AND STOCKHOLDERS’ EQUITY
CURRENT LIABILITIES:
Current portion of long-term debt	$	1,237,285		$	1,023,312
Accounts payable	74,528			90,586
Accrued expenses	685,864			263,478
Total current liabilities	1,997,677			1,377,376
LONG-TERM DEBT	4,373			224,992
DEFERRED TAX LIABILITIES, net	66,864			72,491
OTHER LIABILITIES	103,982			61,178
Total liabilities	2,172,896			1,736,037
COMMITMENTS AND CONTINGENCIES	—			—
STOCKHOLDERS’ EQUITY:
Preferred stock, $.01 par value, 5,000,000 shares authorized, 2,500,000 shares issued, and none outstanding	—			—
Common stock, $.01 par value, 400,000,000 and 200,000,000 shares authorized, 69,266,904 and 67,853,389 shares issued, and 67,008,045 and 65,596,227 shares outstanding	693			678
Additional paid-in capital	1,899,761			1,780,749
Treasury stock, at cost, 2,258,859 and 2,257,162 shares outstanding	(151,196		)	(151,068		)
Accumulated deficit	(668,310		)	(425,256		)
Accumulated other comprehensive income	144,860			104,357
Total stockholders’ equity	1,225,808			1,309,460
	$	3,398,704		$	3,045,497

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

1

CEPHALON, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS

(In thousands, except per share data)

(Unaudited)

	Three months ended						Nine months ended
	September 30,						September 30,
	2007			2006			2007			2006
REVENUES:
Sales	$	428,729		$	470,513		$	1,287,802		$	1,246,825
Other revenues	9,692			11,820			34,865			32,562
	438,421			482,333			1,322,667			1,279,387
COSTS AND EXPENSES:
Cost of sales	82,258			83,160			251,970			250,613
Research and development	93,527			86,439			274,078			294,899
Selling, general and administrative	186,456			161,108			527,962			470,158
Settlement reserve	369,000			—			425,000			—
Impairment charge	—			—			—			12,417
	731,241			330,707			1,479,010			1,028,087
INCOME (LOSS) FROM OPERATIONS	(292,820		)	151,626			(156,343		)	251,300
OTHER INCOME (EXPENSE):
Interest income	8,868			7,046			23,485			16,736
Interest expense	(5,660		)	(4,749		)	(15,272		)	(13,523		)
Write-off of deferred debt issuance costs	—			—			—			(13,105		)
Gain on extinguishment of debt	5,319			—			5,319			—
Gain on sale of investment	—			—			5,791			—
Other income (expense), net	2,493			895			3,747			(116		)
	11,020			3,192			23,070			(10,008		)
INCOME (LOSS) BEFORE INCOME TAXES	(281,800		)	154,818			(133,273		)	241,292
INCOME TAX EXPENSE	24,963			59,077			102,613			91,567
NET INCOME (LOSS)	$	(306,763	)	$	95,741		$	(235,886	)	$	149,725
BASIC INCOME (LOSS) PER COMMON SHARE	$	(4.58	)	$	1.58		$	(3.55	)	$	2.48
DILUTED INCOME (LOSS) PER COMMON SHARE	$	(4.58	)	$	1.43		$	(3.55	)	$	2.17
WEIGHTED AVERAGE NUMBER OF COMMON SHARES OUTSTANDING	66,931			60,762			66,398			60,415
WEIGHTED AVERAGE NUMBER OF COMMON SHARES OUTSTANDING – ASSUMING DILUTION	66,931			67,072			66,398			68,921

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

2

CEPHALON, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY

(In thousands, except share data)

(Unaudited)

																				Accumulated
											Additional									Other
	Comprehensive						Common Stock				Paid-in		Treasury Stock				Accumulated			Comprehensive
	Income (Loss)			Total			Shares		Amount		Capital		Shares	Amount			Deficit			Income
BALANCE, JANUARY 1, 2007				$	1,309,460		67,853,389		$	678	$	1,780,749	2,257,162	$	(151,068	)	$	(425,256	)	$	104,357
Net loss	$	(235,886	)	(235,886		)											(235,886		)
Foreign currency translation gain	39,155
Prior service costs and gains on retirement-related plans	59
Change in unrealized investment gains and losses	30
Other comprehensive income	39,244			39,244																39,244
Comprehensive loss	$	(196,642	)
Adoption of SFAS 158, net of tax				1,259																1,259
Adoption of FIN 48				(7,168		)											(7,168		)
Stock options exercised				74,375			1,411,710		15		74,360
Tax benefit from equity compensation				9,712							9,712
Stock-based compensation expense				34,940			1,850		—		34,940
Treasury stock acquired				(128		)							1,697	(128		)
Other				—			(45	)	—
BALANCE, SEPTEMBER 30, 2007				$	1,225,808		69,266,904		$	693	$	1,899,761	2,258,859	$	(151,196	)	$	(668,310	)	$	144,860

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

3

CEPHALON, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

(In thousands)

(Unaudited)

	Nine months ended
	September 30,
	2007			2006
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income (loss)	$	(235,886	)	$	149,725
Adjustments to reconcile net income (loss) to net cash provided by operating activities:
Deferred income tax expense	8,750			64,112
Shortfall tax benefits from stock-based compensation	(222		)	—
Depreciation and amortization	101,206			94,828
Amortization of debt issuance costs	180			387
Write-off of debt issuance costs associated with convertible subordinated notes	—			13,105
Stock-based compensation expense	34,940			32,436
Gain on extinguishment of debt	(5,319		)	—
Gain on sale of investment	(5,791		)	—
Loss on disposals of property and equipment	2,873			2,368
Impairment charge	—			12,417
Changes in operating assets and liabilities:
Receivables	(26,218		)	(30,818		)
Inventory	(1,881		)	15,761
Other assets	(28,552		)	(43,731		)
Accounts payable and accrued expenses	380,776			(45,820		)
Other liabilities	49,465			(13,580		)
Net cash provided by operating activities	274,321			251,190
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of property and equipment	(70,887		)	(97,122		)
Acquisition of intangible assets	(99,152		)	(115,000		)
Proceeds from sale of investment	12,291			—
Sales and maturities of available-for-sale investments	28,212			244,165
Purchases of available-for-sale investments	(71,398		)	(1,505		)
Net cash provided by (used for) investing activities	(200,934		)	30,538
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from exercises of common stock options	74,375			112,794
Windfall tax benefits from stock-based compensation	9,934			21,912
Acquisition of treasury stock	(128		)	(433		)
Payments on and retirements of long-term debt	(2,902		)	(2,528		)
Net cash provided by financing activities	81,279			131,745
EFFECT OF EXCHANGE RATE CHANGES ON CASH AND CASH EQUIVALENTS	10,804			11,830
NET INCREASE IN CASH AND CASH EQUIVALENTS	165,470			425,303
CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD	496,512			205,060
CASH AND CASH EQUIVALENTS, END OF PERIOD	$	661,982		$	630,363

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

4

CEPHALON, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(In thousands, except share and per share data)

(Unaudited)

1. BASIS OF PRESENTATION

The accompanying unaudited consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnote disclosures required by accounting principles generally accepted in the United States of America for complete financial statements. In the opinion of management, all adjustments including normal and recurring accruals that are considered necessary for a fair presentation have been included. These financial statements should be read in conjunction with the consolidated financial statements and notes thereto included in our Annual Report on Form 10-K, filed with the Securities and Exchange Commission, for the year ended December 31, 2006. The results of our operations for any interim period are not necessarily indicative of the results of our operations for any other interim period or for a full year.

Reclassifications

Certain reclassifications of prior year amounts have been made to conform to the current year presentation. The NUVIGIL® (armodafinil) [C-IV] inventory balance of $89.1 million as of December 31, 2006 has been reclassified from inventory to other assets, as we do not presently intend to launch NUVIGIL commercially until around 2010. Amounts reported in prior periods as amortization are included now as a component of cost of sales; amounts previously reported as depreciation (other than depreciation related to facilities used in the production of commercial inventory and previously included in cost of sales) are included as a component of research and development or selling, general and administrative, as appropriate.

Recent Accounting Pronouncements

In July 2006, the Financial Accounting Standards Board (“FASB”) issued FASB Interpretation No. 48, “Accounting for Uncertainty in Income Taxes — an interpretation of FASB Statement No. 109” (“FIN 48”). FIN 48 addresses the determination of whether tax benefits claimed or expected to be claimed on a tax return should be recorded in the financial statements. Under FIN 48, the Company may recognize the tax benefit from an uncertain tax position only if it is more likely than not that the tax position will be sustained on examination by the taxing authorities, based on the technical merits of the position. The tax benefits recognized in the financial statements from such a position should be measured based on the largest benefit that has a greater than fifty percent likelihood of being realized upon ultimate settlement. FIN 48 also provides guidance on derecognition, classification, interest and penalties on income taxes, accounting in interim periods and requires increased disclosures. FIN 48 is effective for fiscal years beginning after December 15, 2006. We adopted the provisions of FIN 48 on January 1, 2007. See Note 12 herein.

In September 2006, the FASB issued Statement of Financial Accounting Standards (“SFAS”) No. 157, “Fair Value Measurements” (“SFAS 157”). SFAS 157 clarifies the definition of fair value, establishes a framework for measuring fair value and expands the disclosures on fair value measurements. SFAS 157 is effective for fiscal years beginning after November 15, 2007. We do not expect the adoption of SFAS 157 to have a significant impact on our consolidated financial statements.

In February 2007, the FASB issued SFAS No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities — Including an amendment of FASB Statement No. 115” (“SFAS 159”). SFAS 159 allows companies to choose, at specific election dates, to measure eligible financial assets and liabilities at fair value that are not otherwise required to be measured at fair value. If a company elects the fair value option for an eligible item, changes in that item’s fair value in subsequent reporting periods must be recognized in current earnings. SFAS 159 is effective for fiscal years beginning after November 15, 2007. We do not expect the adoption of SFAS 159 to have a significant impact on our consolidated financial statements.

In June 2007, the Emerging Issues Task Force (“EITF”) reached a final consensus on EITF Issue No. 07-3, “Accounting for Nonrefundable Advance Payments for Goods or Services to Be Used in Future Research and Development Activities” (“EITF 07-3”). EITF 07-3 is effective for fiscal years beginning after December 15, 2007. EITF 07-3 requires non-refundable advance payments for future research and development activities to be capitalized until the goods have been

5

delivered or related services have been performed. Adoption is on a prospective basis and could impact the timing of expense recognition for agreements entered into after December 31, 2007. We do not expect the adoption of EITF 07-3 to have a significant impact on our consolidated financial statements.

2. ACQUISITION

In August 2007, we acquired the North American rights to AMRIX™ (cyclobenzaprine hydrochloride extended-release capsules) from E. Claiborne Robins Company, Inc., a privately-held company d/b/a ECR Pharmaceuticals (“ECR”). We made an initial payment of $100.1 million cash to ECR upon the closing of the acquisition, $0.9 million and $99.2 million of which was capitalized as inventory and an intangible asset, respectively. ECR also could receive up to an additional $255 million in milestone payments that are contingent on attainment of certain agreed-upon sales levels of AMRIX. Two dosage strengths of AMRIX (15 mg and 30 mg) were approved in February 2007 by the U.S. Food and Drug Administration (the “FDA”) for short-term use as an adjunct to rest and physical therapy for relief of muscle spasm associated with acute, painful musculoskeletal conditions.  We made the product available in the United States in October 2007 and will commence a full U.S. launch in November 2007.

3. STOCK-BASED COMPENSATION

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

	Three months ended				Nine months ended
	September 30,				September 30,
	2007		2006		2007		2006
Stock option expense	$	6,393	$	6,736	$	22,570	$	23,933
Restricted stock unit expense	3,920		3,022		12,370		8,503
Total stock-based compensation expense*	$	10,313	$	9,758	$	34,940	$	32,436
Total stock-based compensation expense after-tax	$	6,528	$	6,177	$	22,117	$	20,532

* For each period presented, total stock-based compensation expense was recognized equally between research and development and selling, general and administrative expenses based on the employees’ compensation allocation between these line items.

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

	Three months ended						Nine months ended
	September 30,						September 30,
	2007			2006			2007			2006
Risk free interest rate	4.65		%	4.90		%	4.59		%	4.98		%
Expected term (years)	6.25			6.25			5.46			5.74
Expected volatility	34.9		%	48.7		%	33.4		%	51.3		%
Expected dividend yield	—		%	—		%	—		%	—		%
Estimated fair value per option granted	$	34.09		$	35.51		$	30.91		$	33.22

On May 17, 2007, the Cephalon, Inc. 2004 Equity Compensation Plan (the “2004 Plan”) was amended, following approval by Cephalon stockholders, to increase by 1,000,000 shares the total number of shares of Common Stock authorized for issuance under the 2004 Plan, from 11,450,000 shares to 12,450,000 shares. This amendment also provides that no more than 400,000 shares of Common Stock may be issued pursuant to restricted stock unit awards granted under the 2004 Plan after May 16, 2007.

6

Stock Options

The following tables summarize the aggregate option activity for the nine months ended September 30:

	2007
	Shares		Weighted Average Exercise Price		Weighted Average Remaining Contractual Life (years)	Aggregate Intrinsic Value
Outstanding, January 1,	7,694,298		$	54.90
Granted	110,400		79.05
Exercised	(1,411,710	)	52.72
Forfeited	(148,150	)	57.48
Expired	(11,224	)	64.31
Outstanding, September 30,	6,233,614		$	55.78	6.1	$	108,377
Vested options at end of period	3,909,601		$	54.02	4.9	$	74,906

	2006
	Shares		Weighted Average Exercise Price		Weighted Average Remaining Contractual Life (years)	Aggregate Intrinsic Value
Outstanding, January 1,	9,955,904		$	50.84
Granted	148,300		61.90
Exercised	(2,400,227	)	46.88
Forfeited	(246,125	)	50.01
Expired	(32,699	)	49.80
Outstanding, September 30,	7,425,153		$	52.33	6.4	$	83,738
Vested options at end of period	4,520,567		$	53.96	5.4	$	48,812

As of September 30, 2007, there was $27.9 million of total unrecognized compensation cost related to outstanding options that is expected to be recognized over a weighted-average period of 1.4 years. For the nine months ended September 30, 2007 and 2006, we received net proceeds of $74.4 million and $112.8 million, respectively, from the exercise of stock options.

The intrinsic value of stock options exercised during the nine months ended September 30, 2007 and 2006 was $36.1 million and $65.8 million, respectively. The estimated fair value of shares that vested during the nine months ended September 30, 2007 and 2006 was $4.9 million and $5.8 million, respectively.

Restricted Stock Units

The following tables summarize the restricted stock units activity for the nine months ended September 30:

	2007
	Shares			Weighted Average Fair Value
Nonvested, January 1,	709,900			$	59.49
Granted	—			—
Vested	(1,850		)	71.77
Forfeited	(28,275		)	60.65
Nonvested, September 30,	679,775			$	59.41
Intrinsic Value as of September 30,	$	49,664

7

	2006
	Shares			Weighted Average Fair Value
Nonvested, January 1,	624,575			$	49.52
Granted	5,000			70.50
Vested	—			—
Forfeited	(55,775		)	49.47
Nonvested, September 30,	573,800			$	49.71
Intrinsic Value as of September 30,	$	35,432

As of September 30, 2007, there was $17.1 million of total unrecognized compensation cost related to nonvested restricted stock units that is expected to be recognized over a weighted-average period of 1.4 years.

4. INVENTORY, NET

Inventory, net consisted of the following:

	September 30, 2007
	Commercial			Pre-approval			Total
Raw materials	$	28,074		$	—		$	28,074
Work-in-process	19,535			—			19,535
Finished goods	45,790			—			45,790
Total inventory, net	$	93,399		$	—		$	93,399
Inventory included in other assets	$		117,185	$		—	$		117,185

	December 31, 2006
	Commercial		Pre-approval		Total
Raw materials	$	23,761	$	—	$	23,761
Work-in-process	15,915		—		15,915
Finished goods	45,563		—		45,563
Total inventory, net	$	85,239	$	—	$	85,239
Inventory included in other assets	$	—	$	89,061	$	89,061

We have capitalized 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. In June 2007, we secured final FDA approval of NUVIGIL for the treatment of excessive sleepiness associated with narcolepsy, obstructive sleep apnea/hypopnea syndrome (“OSA/HS”) and shift work sleep disorder (“SWSD”). However, as we do not presently intend to launch NUVIGIL commercially until around 2010, we have included net NUVIGIL inventory balances of $117.2 million and $89.1 million at September 30, 2007 and December 31, 2006, respectively, in other assets, rather than inventory. Based on the expiration dates and our current estimates of sales demand for NUVIGIL, no additional reserve related to NUVIGIL is required at this time.

5. GOODWILL

Goodwill consisted of the following:

	United States			Europe		Total
December 31, 2006	$	267,904		$	199,263	$	467,167
Release of pre-acquisition tax valuation allowance	(1,019		)	—		(1,019		)
Foreign currency translation adjustment	—			10,457		10,457
September 30, 2007	$	266,885		$	209,720	$	476,605

We completed our annual test of impairment of goodwill as of July 1, 2007 and concluded that goodwill was not impaired.

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6. INTANGIBLE ASSETS, NET

Intangible assets consisted of the following:

		September 30, 2007						December 31, 2006
	Estimated Useful Lives	Gross Carrying Amount		Accumulated Amortization		Net Carrying Amount		Gross Carrying Amount		Accumulated Amortization		Net Carrying Amount
Modafinil developed technology	15 years	$	99,000	$	37,950	$	61,050	$	99,000	$	33,000	$	66,000
DURASOLV technology	14 years	70,000		15,217		54,783		70,000		11,565		58,435
ACTIQ marketing rights	10-12 years	75,465		44,319		31,146		75,465		39,010		36,455
GABITRIL product rights	9-15 years	107,164		52,779		54,385		106,232		46,826		59,406
TRISENOX product rights	8-13 years	113,964		20,510		93,454		113,752		13,634		100,118
VIVITROL product rights	15 years	110,000		11,000		99,000		110,000		5,500		104,500
AMRIX product rights	5 years	99,152		1,549		97,603		—		—		—
MYOCET trademark	20 years	198,145		17,339		180,806		192,367		9,618		182,749
Other product rights	5-20 years	269,180		102,152		167,028		259,054		73,680		185,374
		$	1,142,070	$	302,815	$	839,255	$	1,025,870	$	232,833	$	793,037

Intangible assets are amortized over their estimated useful economic life using the straight line method. Amortization expense was $22.3 million and $20.8 million for the three months ended September 30, 2007 and 2006, respectively, and $64.2 million and $60.8 million for the nine months ended September 30, 2007 and 2006, respectively.

7. LONG-TERM DEBT

Long-term debt consisted of the following:

	September 30,			December 31,
	2007			2006
2.0% convertible senior subordinated notes due June 1, 2015	$	820,000		$	820,000
Zero Coupon convertible subordinated notes first putable June 2008 (Old)	264			263
Zero Coupon convertible subordinated notes first putable June 2010 (Old)	94			94
Zero Coupon convertible subordinated notes first putable June 2008 (New)	213,529			213,417
Zero Coupon convertible subordinated notes first putable June 2010 (New)	199,783			199,716
Mortgage and building improvement loans	2,373			8,291
Capital lease obligations	3,248			3,787
Other	2,367			2,736
Total debt	1,241,658			1,248,304
Less current portion	(1,237,285		)	(1,023,312		)
Total long-term debt	$	4,373		$	224,992

Our convertible notes will be classified as current liabilities and presented in current portion of long-term debt on our consolidated balance sheet if our stock price is above the restricted conversion prices of $56.04, $71.40 or $67.80 with respect to the 2.0% Notes, the 2008 Zero Coupon Notes (Old and New) or the 2010 Zero Coupon Notes (Old and New), respectively at the balance sheet date. At December 31, 2006, our stock price was $70.41, and, therefore, our 2.0% Notes and Zero Coupon Notes first putable June 15, 2010 are considered to be current liabilities and are presented in current portion of long-term debt on our consolidated balance sheet. At September 30, 2007, our stock price was $73.06, and, therefore, all of our convertible notes are considered to be current liabilities and are presented in current portion of long-term debt on our consolidated balance sheet. In addition, our Zero Coupon Notes first putable June 15, 2008 are considered to be current liabilities based on maturity.

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.

In November 2002, in connection with our planned relocation to a new corporate headquarters, the Pennsylvania Industrial Development Board (“PIDA”) authorized the forgiveness of the outstanding principal balance of $5.3 million due on a loan granted by PIDA in 1995, subject to certain contingencies. At a meeting held in September 2007, the PIDA Board

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determined to forgive the outstanding principal balance of the loan. As such, we recognized a $5.3 million gain on extinguishment of debt in the third quarter of 2007.

8. LEGAL PROCEEDINGS

PROVIGIL Patent Litigation and Settlements

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

In late 2005 and early 2006, we entered into settlement agreements with each of Teva, Mylan, Ranbaxy and Barr; in August 2006, we entered into a settlement agreement with Carlsbad and its development partner, Watson Pharmaceuticals, Inc., which we understand has the right to commercialize the Carlsbad product if approved by the FDA. As part of these separate settlements, we agreed to grant to each of these parties a non-exclusive royalty-bearing right to market and sell a generic version of PROVIGIL in the United States. These licenses will become effective in April 2012, subject to applicable regulatory considerations. An earlier entry may occur based upon the entry of a generic version of PROVIGIL.

We also 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, 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 that began in 2006, with the aggregate payments over this period totaling approximately $82.6 million.

Each of the settlements has been filed with both the U.S. Federal Trade Commission (the “FTC”) and the Antitrust Division of the U.S. Department of Justice (the “DOJ”) as required by the Medicare Prescription Drug, Improvement and Modernization Act of 2003 (the “Medicare Modernization Act”). The FTC is conducting an investigation of each of the PROVIGIL settlements and has issued a subpoena and requested documents and other information from us. We are cooperating fully with the FTC and its ongoing investigation, and expect to continue to cooperate. The FTC could determine to challenge in an administrative or judicial proceeding any or all of the settlements if it believes that the agreements violate the antitrust laws, although we believe that such a challenge would take years to resolve. We expect that the Commissioners of the FTC will formally decide in the near future whether or not to bring such an action against us.

We also are aware of numerous private antitrust complaints filed in the U.S. District Court for the Eastern District of Pennsylvania, each naming Cephalon, Barr, Mylan, Teva and Ranbaxy as co-defendants and claiming, among other things, that the patent litigation settlements concerning PROVIGIL violate the antitrust laws of the United States and, in some cases, certain state laws. All but one of these actions have been consolidated into a complaint on behalf of a class of direct purchasers of PROVIGIL and a separate complaint on behalf of a class of consumers and other indirect purchasers of PROVIGIL. A separate complaint filed by an indirect purchaser of PROVIGIL was filed in September 2007. The plaintiffs in all of these actions are seeking monetary damages and/or equitable relief. We moved to dismiss the class action complaints in November 2006.

Separately, in June 2006, Apotex, Inc., a subsequent ANDA filer seeking FDA approval of a generic form of modafinil, filed suit against us also in the U.S. District Court for the Eastern District of Pennsylvania alleging similar violations of antitrust laws and state law. Apotex asserts that the PROVIGIL settlement agreements improperly prevent it from obtaining FDA approval of its ANDA, and seeks monetary and equitable remedies. Apotex also seeks a declaratory judgment that the ‘516 Patent is invalid, unenforceable and/or not infringed by its proposed generic. We filed a motion to dismiss the Apotex case in late September 2006. We believe that the complaints described in the preceding paragraph and the Apotex complaint are without merit. While we intend to vigorously defend ourselves and the propriety of the settlement agreements, these efforts will be both expensive and time consuming and, ultimately, due to the nature of litigation, there can be no assurance that these efforts will be successful.

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In November 2005 and March 2006, we received notice that Caraco Pharmaceutical Laboratories, Ltd. and Apotex, Inc., respectively, also filed Paragraph IV ANDAs with the FDA in which each firm is seeking to market a generic form of PROVIGIL. We have not filed a patent infringement lawsuit against either Caraco or Apotex as of the filing date of this report, although Apotex has filed suit against us, as described above.

ACTIQ Patent Litigation and Settlement

In early 2006, we settled 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 (“generic OTFC”). Under the settlement, we granted to Barr an exclusive royalty bearing right to market and sell generic OTFC in the United States. The settlement with Barr related to ACTIQ® (oral transmucosal fentanyl citrate) [C-II] has been filed with both the FTC and 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.

U.S. Attorney’s Office and Connecticut Attorney General Investigations and Related Matters

In early November 2007, we announced that we had reached an agreement in principle with the U.S. Attorney’s Office (“USAO”) in Philadelphia and the DOJ with respect to the USAO investigation that began in September 2004. The investigation has focused on our sales and promotional practices with respect to ACTIQ, GABITRIL® (tiagabine hydrochloride) and PROVIGIL. Under this agreement, we now expect to pay $425.0 million as part of a comprehensive settlement of all Federal and related state Medicaid claims. During the third quarter of 2007, we increased our existing reserve by $369.0 million to $425.0 million in contemplation of this payment. In addition, the Company will agree to a single federal misdemeanor violation of the Federal Food, Drug and Cosmetic Act and will enter into a corporate integrity agreement with the Office of Inspector General of the U.S. Department of Health and Human Services. The terms described above are subject to negotiation and the execution of the final settlement and corporate integrity agreements. There can be no assurance that the settlement will be finalized on the terms outlined above.

In September 2004, we announced that we had received a voluntary request for information from the Office of the Connecticut Attorney General that also appears to be focused on our sales and promotional practices with respect to ACTIQ, GABITRIL and PROVIGIL. We are cooperating with this Office, are providing documents and other information in response to these and additional requests and are engaged in ongoing discussions with them. In late October 2007, we also received a civil demand for information from the Office of the Massachusetts Attorney General that is focused on sales and promotional practices with respect to ACTIQ, FENTORA® (fentanyl buccal tablet) [C-II] and certain of our other products. We intend to cooperate with this request as well. Both of these matters may involve civil penalties and/or fines. The payment of any settlement or judgment amount and/or fines could have a material adverse effect on our financial position, liquidity and results of operations. Furthermore, it is reasonably likely that we will face future additional requests for information from other state attorneys general focused on historical sales and promotional practices for our U.S. products. If civil penalties and/or fines were to result from such investigations, it could materially and adversely effect our financial position, liquidity and results of operations.

In November 2007, we were served with a putative class action complaint filed on behalf of entities that claim to have purchased ACTIQ for use in non-cancer patients. The complaint alleges violations of various state consumer protection laws, as well as the violation of the common law of unjust enrichment, and seeks an unspecified amount of money in actual, punitive and/or treble damages, with interest, and/or disgorgement of profits. We believe the allegations in the complaint are without merit, and we intend to vigorously defend ourselves in this matter and in any similar actions that may be filed in the future.

In March 2007, we received a letter requesting information related to ACTIQ and FENTORA from Congressman Henry A. Waxman in his capacity as Chairman of the House Committee on Oversight and Government Reform. The letter cites two articles concerning ACTIQ published in The Wall Street Journal in November 2006 and requests information concerning our sales and marketing practices for ACTIQ and FENTORA, among other things. We are cooperating with this request and are continuing to provide documents and other information to the Committee.

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Other Matters

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

9. COMPREHENSIVE INCOME (LOSS)

The components of total comprehensive income (loss) are as follows:

	Three months ended						Nine months ended
	September 30,						September 30,
	2007			2006			2007			2006
Net income (loss)	$	(306,763	)	$	95,741		$	(235,886	)	$	149,725
Foreign currency translation gains	21,681			13,209			39,155			47,635
Prior service costs and gains on retirement-related plans	14			—			59			—
Change in unrealized investment gains and losses	36			(159		)	30			871
Other comprehensive income	21,731			13,050			39,244			48,506
Comprehensive income (loss)	$	(285,032	)	$	108,791		$	(196,642	)	$	198,231

10. EARNINGS PER SHARE (“EPS”)

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

Treasury Stock Method:

Employee stock options

Restricted stock units

Zero Coupon Convertible Notes issued in December 2004 (the “New Zero Coupon Notes”)

2.0% Notes

Warrants

“If-Converted” Method:

2.5% Notes (outstanding through December 2006)

Zero Coupon Convertible Notes issued in June 2003 (the “Old Zero Coupon Notes”)

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” (“EITF 90-19”); therefore, these notes are included in the dilutive earnings per share calculation using the treasury stock method. Under the treasury stock method, we must calculate the number of shares issuable under the terms of these notes based on the average market price of the stock during the period (assuming the average market price is above the applicable conversion prices of the 2.0% and New Zero Coupon Notes), and include that number in the total diluted shares figure for 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. SFAS No. 128, “Earnings Per Share” (“SFAS 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 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, 2006 had been $75.00, $85.00 or $95.00, the shares from the warrants to be included in diluted EPS would have been 2.1 million, 5.0 million and 7.3 million shares, respectively. The total number of shares that could potentially be included under the warrants is 26.8 million.

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

	Three months ended					Nine months ended
	September 30,					September 30,
(In thousands, except per share data)	2007*		2006			2007*		2006
Average market price per share of Cephalon stock	$	74.80	$	60.29		$	75.15	$	64.30
Shares included in diluted EPS calculation:
2.0% Notes	—		4,440			—		5,392
New Zero Coupon Notes	—		500			—		1,276
Warrants related to 2.0% Notes	—		—		†	—		—		†
Warrants related to New Zero Coupon Notes	—		—		†	—		—		†
Total (Treasury Stock Method)	—		4,940			—		6,668
Other (“If-Converted” Method)	—		130			—		130
Total	—		5,070			—		6,798

* Since there was a net loss for the three and nine months ended September 30, 2007, there is no impact from these notes or warrants on the number of diluted shares included in the diluted EPS calculation.

† No shares are included because the average market price per share of our common stock did not exceed the warrant strike prices of the 2.0% Notes or New Zero Coupon Notes.

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

	Three months ended					Nine months ended
	September 30,					September 30,
(In thousands, except per share data)	2007			2006		2007			2006
Basic income (loss) per common share computation:
Numerator:
Net income (loss) used for basic income (loss) per common share	$	(306,763	)	$	95,741	$	(235,886	)	$	149,725
Denominator:
Weighted average shares used for basic income (loss) per common share	66,931			60,762		66,398			60,415
Basic income (loss) per common share	$	(4.58	)	$	1.58	$	(3.55	)	$	2.48
Diluted income (loss) per common share computation:
Numerator:
Net income (loss) used for basic income (loss) per common share	$	(306,763	)	$	95,741	$	(235,886	)	$	149,725
Interest on convertible notes (net of tax)	—			40		—			121
Net income (loss) used for diluted income (loss) per common share	$	(306,763	)	$	95,781	$	(235,886	)	$	149,846
Denominator:
Weighted average shares used for basic income (loss) per common share	66,931			60,762		66,398			60,415
Effect of dilutive securities:
Convertible subordinated notes and warrants	—			5,070		—			6,798
Employee stock options and restricted stock units	—			1,240		—			1,708
Weighted average shares used for diluted income (loss) per common share	66,931			67,072		66,398			68,921
Diluted income (loss) per common share	$	(4.58	)	$	1.43	$	(3.55	)	$	2.17

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

	Three months ended		Nine months ended
	September 30,		September 30,
(In thousands)	2007	2006	2007	2006
Weighted average shares excluded:
Convertible subordinated notes and warrants	35,020	32,640	35,096	32,640
Employee stock options and restricted stock units	2,934	2,513	3,028	2,343
	37,954	35,153	38,124	34,983

11. SEGMENT INFORMATION

Revenues by segment for the three months ended September 30:

	2007									2006
	United States			Europe			Total			United States			Europe			Total
Sales:
PROVIGIL	$	202,202		$	14,904		$	217,106		$	193,462		$	11,081		$	204,543
GABITRIL	12,952			881			13,833			14,604			723			15,327
Central Nervous System (“CNS”) disorders	215,154			15,785			230,939			208,066			11,804			219,870
ACTIQ	45,946			10,007			55,953			179,651			7,585			187,236
Generic OTFC	32,689			—			32,689			—			—			—
FENTORA	33,193			—			33,193			—			—			—
Pain	111,828			10,007			121,835			179,651			7,585			187,236
Other	19,291			56,664			75,955			13,292			50,115			63,407
Total Sales	346,273			82,456			428,729			401,009			69,504			470,513
Other Revenues	8,823			869			9,692			9,189			2,631			11,820
Total External Revenues	355,096			83,325			438,421			410,198			72,135			482,333
Inter-Segment Revenues	1,356			13,051			14,407			3,233			28,176			31,409
Elimination of Inter-Segment Revenues	(1,356		)	(13,051		)	(14,407		)	(3,233		)	(28,176		)	(31,409		)
Total Revenues	$	355,096		$	83,325		$	438,421		$	410,198		$	72,135		$	482,333

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Revenues by segment for the nine months ended September 30:

	2007									2006
	United States			Europe			Total			United States			Europe			Total
Sales:
PROVIGIL	$	593,394		$	39,171		$	632,565		$	500,941		$	29,219		$	530,160
GABITRIL	39,814			6,268			46,082			42,166			3,510			45,676
CNS	633,208			45,439			678,647			543,107			32,729			575,836
ACTIQ	157,097			28,638			185,735			457,679			19,213			476,892
Generic OTFC	97,562			—			97,562			—			—			—
FENTORA	101,224			—			101,224			—			—			—
Pain	355,883			28,638			384,521			457,679			19,213			476,892
Other	53,867			170,767			224,634			41,661			152,436			194,097
Total Sales	1,042,958			244,844			1,287,802			1,042,447			204,378			1,246,825
Other Revenues	32,315			2,550			34,865			26,510			6,052			32,562
Total External Revenues	1,075,273			247,394			1,322,667			1,068,957			210,430			1,279,387
Inter-Segment Revenues	15,702			51,222			66,924			12,073			76,370			88,443
Elimination of Inter-Segment Revenues	(15,702		)	(51,222		)	(66,924		)	(12,073		)	(76,370		)	(88,443		)
Total Revenues	$	1,075,273		$	247,394		$	1,322,667		$	1,068,957		$	210,430		$	1,279,387

Income (loss) before income taxes by segment:

	Three months ended						Nine months ended
	September 30,						September 30,
	2007			2006			2007			2006
United States	$	(279,352	)	$	160,358		$	(125,375	)	$	280,907
Europe	(2,448		)	(5,540		)	(7,898		)	(39,615		)
Total	$	(281,800	)	$	154,818		$	(133,273	)	$	241,292

Total assets by segment:

	September 30,		December 31,
	2007		2006
United States	$	2,280,574	$	2,075,530
Europe	1,118,130		969,967
Total	$	3,398,704	$	3,045,497

12. INCOME TAXES

In July 2006, the FASB issued FIN 48 which addresses the determination of whether tax benefits claimed or expected to be claimed on a tax return should be recorded in the financial statements. Under FIN 48, a company may recognize the tax benefit from an uncertain tax position only if it is more likely than not that the tax position will be sustained on examination by the taxing authorities, based on the technical merits of the position. The tax benefits recognized in the financial statements from such a position should be measured based on the largest benefit that has a greater than fifty percent likelihood of being realized upon ultimate settlement. FIN 48 also provides guidance on derecognition, classification, interest and penalties on income taxes, accounting in interim periods and requires increased disclosures. FIN 48 is effective for fiscal years beginning after December 15, 2006.

We adopted the provisions of FIN 48 on January 1, 2007. As a result of the adoption of FIN 48, we recognized a $33.9 million increase in the liability for unrecognized tax benefits. This increase in liability resulted in a decrease to the January 1, 2007 retained earnings balance in the amount of $7.2 million and a net reduction in deferred tax liabilities of $18.5 million. The amount of unrecognized tax benefits at January 1, 2007 is $50.6 million of which $20.1 million would impact our effective tax rate, if recognized.

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The impact to net income of accrued interest and penalties related to uncertain tax positions is not significant.

For the nine months ended September 30, 2007, we recorded reserves totaling $425.0 million related to the potential resolution of the U.S. Attorney’s investigation discussed in Note 8. At this time, we have not recognized a tax benefit for the settlement reserve due to the uncertainty associated with the tax treatment of any potential settlement.

The Internal Revenue Service (“IRS”) currently is examining Cephalon, Inc.’s 2004 federal income tax return and we remain open for examination by the IRS for the years 2003 through 2006. Based on the current status of the ongoing examination by the IRS, which could include formal legal proceedings, at this time it is not possible to estimate the outcome of the examination and the impact, if any, to our uncertain tax positions. All U.S. federal income tax returns of Anesta Corp. and CIMA LABS, which were acquired by Cephalon, are closed through 1994 and 1992, respectively. For Salmedix, Inc., the years 2000 through 2005 are open due to limitations on the use of the net operating loss carry forwards. In France, we are under examination for the period 2004 and 2005, while Zeneus France is under examination for 1999 to 2004. In Germany, we are under examination for the period 2000 to 2004. In other foreign jurisdictions, the tax years that remain open for potential examination range from 1999 to 2006.

In the regular course of business, various state and local tax authorities also conduct examinations of our state and local income tax returns. Depending on the state, state income tax returns are generally subject to examination for a period of three to five years after filing. The state impact of any federal changes from the 2004 examination remains subject to examination by various states for a period of up to one year after formal notification to the states. We currently have several state income tax returns in the process of examination.

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

Management’s Discussion and Analysis of Financial Condition and Results of Operations (“MD&A”) is intended to provide information to assist you in better understanding and evaluating our financial condition and results of operations. We encourage you to read this MD&A in conjunction with our consolidated financial statements included in Part I, Item 1 of this Quarterly Report on Form 10-Q, our Annual Report on Form 10-K for the year ended December 31, 2006 and the “Risk Factors” contained in Part II, Item 1A of this Quarterly Report on Form 10-Q.

EXECUTIVE SUMMARY

Cephalon is an international biopharmaceutical company dedicated to the discovery, development and marketing of innovative products to treat human diseases. We currently focus our efforts in four core therapeutic areas: central nervous system (“CNS”) disorders, pain, oncology and addiction. In addition to conducting an active research and development program, we market seven proprietary products in the United States and numerous products in various countries throughout Europe. Consistent with our core therapeutic areas, we have aligned our approximately 740-person U.S. field sales and sales management teams by area. In Europe, we have a sales and marketing organization numbering approximately 410 persons that supports our presence in nearly 20 European countries, including France, the United Kingdom, Germany, Italy and Spain.

In early November 2007, we announced that we had reached an agreement in principle with the U.S. Attorney’s Office (“USAO”) in Philadelphia and the U.S. Department of Justice with respect to the USAO investigation that began in September 2004. The investigation has focused on our sales and promotional practices with respect to ACTIQ® (oral transmucosal fentanyl citrate) [C-II], GABITRIL® (tiagabine hydrochloride) and PROVIGIL. Under this agreement, we now expect to pay $425.0 million as part of a comprehensive settlement of all Federal and related state Medicaid claims. During the third quarter of 2007, we increased our existing reserve by $369.0 million to $425.0 million in contemplation of this payment. In addition, the Company will agree to a single federal misdemeanor violation of the Federal Food, Drug and Cosmetic Act and enter into a corporate integrity agreement with the Office of Inspector General of the U.S. Department of Health and Human Services. The terms described above are subject to negotiation and the execution of the final settlement and corporate integrity agreements. There can be no assurance that the settlement will be finalized on the terms outlined above.

Our most significant product is PROVIGIL, which comprised 49% of our total consolidated net sales for the nine months ended September 30, 2007, of which 94% was in the U.S. market. For the nine months ended September 30, 2007, consolidated net sales of PROVIGIL increased 19% over the nine months ended September 30, 2006. Under our co-promotion agreement with Takeda Pharmaceuticals North America, Inc., 500 Takeda sales representatives began promoting PROVIGIL in the second position to primary care physicians and other appropriate health care professionals in the United States beginning July 1, 2006. Effective January 1, 2007, an additional 250 Takeda sales representatives were added, all of whom are detailing PROVIGIL in the first position. Together with our CNS field sales and sales management teams, we now have nearly 1,200 persons focused on detailing PROVIGIL in the United States.

Our second most significant product is ACTIQ (including our generic version of ACTIQ (“generic OTFC”)), which comprised 22% of our total consolidated net sales for the nine months ended September 30, 2007, of which 90% was in the U.S. market. In late September 2006, Barr Laboratories, Inc. entered the U.S. market with generic OTFC pursuant to our license and supply agreement. As a result, ACTIQ sales have been meaningfully eroded by generic OTFC products sold by Barr and by us through our sales agent, Watson Pharmaceuticals, Inc., and we expect this erosion will continue during the remainder of 2007. In addition, under our license and supply agreement with Barr, we are obligated to sell generic OTFC to Barr for its resale in the United States. While we currently have available fentanyl quota to produce ACTIQ and generic OTFC, in the future we could face shortages of quota that could negatively impact our ability to supply product to Barr or to produce ACTIQ or our generic OTFC product. If we are unable to provide product to Barr, it is possible that either Barr or the U.S. Federal Trade Commission (the “FTC”) could claim that this failure is a breach of our agreements with these parties.

In August 2007, we acquired the North American rights to AMRIX™ (cyclobenzaprine hydrochloride extended-release capsules) from E. Claiborne Robins Company, Inc., a privately-held company d/b/a ECR Pharmaceuticals (“ECR”). We made an initial payment of $100.1 million cash to ECR upon the closing of the acquisition, $0.9 million and $99.2 million of which was capitalized as inventory and an intangible asset, respectively. ECR also could receive up to an additional $255 million in milestone payments that are contingent on attainment of certain agreed-upon sales levels of AMRIX. Two dosage strengths of AMRIX (15 mg and 30 mg) were approved in February 2007 by the U.S. Food and Drug

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Administration (the “FDA”) for short-term use as an adjunct to rest and physical therapy for relief of muscle spasm associated with acute, painful musculoskeletal conditions.  We made the product available in the United States in October 2007 and will commence a full U.S. launch in November 2007.

In June 2007, we secured final FDA approval of NUVIGIL for the treatment of excessive sleepiness associated with narcolepsy, obstructive sleep apnea/hypopnea syndrome (“OSA/HS”) and shift work sleep disorder (“SWSD”). NUVIGIL is a single-isomer formulation of modafinil, the active ingredient in PROVIGIL. NUVIGIL is protected by a composition of matter patent that will expire on December 18, 2023 and covers a novel polymorphic form of armodafinil, the active pharmaceutical ingredient in NUVIGIL. The final NUVIGIL labeling includes a bolded warning section that characterizes the potential occurrence of serious skin rash and hypersensitivity in patients taking modafinil and armodafinil. In September 2007, we finalized revisions to the label for PROVIGIL that make the NUVIGIL and PROVIGIL labels consistent.

In late September 2006, we received FDA approval of our next-generation proprietary pain product, FENTORA® (fentanyl buccal tablet) [C-II], and launched the product in the United States in early October 2006. FENTORA is indicated for the management of breakthrough pain in patients with cancer who are already receiving and are tolerant to opioid therapy for their underlying persistent cancer pain. We are focusing our longer-term clinical strategy on developing FENTORA for opioid-tolerant patients with breakthrough pain associated with other conditions, including neuropathic pain and back pain. In October 2006, January 2007 and August 2007, we announced positive data from three Phase 3 clinical trials of FENTORA. We plan to submit a sNDA to the FDA in November 2007 that will seek to expand the labeled indications for FENTORA beyond breakthrough pain in opioid-tolerant patients with cancer.

In September 2007, we submitted a new drug application (“NDA”) to the FDA requesting approval of TREANDA® (bendamustine HCl) for the treatment of patients with chronic lymphocytic leukemia. The FDA has accepted this NDA and has granted an orphan drug designation to TREANDA for this indication. In October 2007, we announced positive results from a Phase 3 clinical trial of TREANDA in patients with indolent non-Hodgkin’s lymphoma. We anticipate filing an NDA with FDA for this indication by the end of 2007.

In April 2006, the FDA approved VIVITROL, and we launched the product in June 2006. VIVITROL is indicated for the treatment of alcohol dependent patients who are able to abstain from alcohol in an outpatient setting and are not actively drinking when initiating treatment. Treatment with VIVITROL should be used in combination with psychosocial support, such as counseling or group therapy. Under the license and collaboration agreement we signed with Alkermes, Inc. in June 2005, Alkermes is responsible for manufacturing commercial supplies of VIVITROL and we have primary responsibility for the marketing and sale of the product. While we have made steady progress in increasing sales and physician awareness of this product, we have determined to reduce the level of our sales and marketing expenses for this product, including a reduction in the number of sales representative promoting the product, to what we believe is an appropriate spending level for this product.

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, could materially impact our results of operations. In late 2005 and early 2006, we entered into settlement agreements with each of Teva Pharmaceuticals USA, Inc., Mylan Pharmaceuticals Inc., Ranbaxy Laboratories Limited and Barr Laboratories, Inc. For more information concerning these settlements and the August 2006 settlement with Carlsbad Technology, Inc., see Note 8 to our Consolidated Financial Statements in Part I, Item 1 of this Quarterly Report on Form 10-Q.

Our activities and operations are subject to significant government regulations and oversight. In September 2004, we announced that we had received a voluntary request for information from the Office of the Connecticut Attorney General that appears to be focused on our sales and promotional practices with respect to ACTIQ, GABITRIL and PROVIGIL. We are cooperating with this Office, are providing documents and other information in response to these and additional requests and are engaged in ongoing discussions with them. In late October 2007, we also received a civil demand for information from the Office of the Massachusetts Attorney General that is focused on sales and promotional practices with respect to ACTIQ, FENTORA and certain of our other products. We intend to cooperate with this request as well. Both of these matters may involve civil penalties and/or fines. The payment of any settlement or judgment amount and/or fines could have a material adverse effect on our financial position, liquidity and results of operations. Furthermore, it is reasonably likely that we will face future additional requests for information from other state attorneys general focused on historical sales and promotional

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practices for our U.S. products. If civil or other penalties or fines were to result from such investigations, it could materially and adversely effect our financial position, liquidity and results of operations. For more information concerning related legal matters, see Note 8 to our Consolidated Financial Statements in Part I, Item 1 of this Quarterly Report on Form 10-Q.

We have significant levels of indebtedness outstanding, nearly all of which consists of convertible notes. Under the terms of the indentures governing nearly all of our 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 7 to our Consolidated Financial Statements included in Part I, Item 1 of this Quarterly Report on Form 10-Q and Note 10 to our Consolidated Financial Statements included in Part II, Item 8 of our Annual Report on Form 10-K for the fiscal year ended December 31, 2006. 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 September 30, 2007, 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. 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 under the current terms. In the unlikely event that a significant conversion did occur, we believe that we have the ability to raise sufficient cash to repay the principal amounts due through a combination of utilizing our existing cash on hand, 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.

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

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RESULTS OF OPERATIONS

(In thousands)

Three months ended September 30, 2007 compared to three months ended September 30, 2006:

	Three months ended
	September 30,
	2007						2006						% Increase (Decrease)
	United States		Europe		Total		United States		Europe		Total		United States		Europe		Total
Sales:
PROVIGIL	$	202,202	$	14,904	$	217,106	$	193,462	$	11,081	$	204,543	5	%	35	%	6	%
GABITRIL	12,952		881		13,833		14,604		723		15,327		(11	)%	22	%	(10	)%
CNS	215,154		15,785		230,939		208,066		11,804		219,870		3	%	34	%	5	%
ACTIQ	45,946		10,007		55,953		179,651		7,585		187,236		(74	)%	32	%	(70	)%
Generic OTFC	32,689		—		32,689		—		—		—		100	%	—	%	100	%
FENTORA	33,193		—		33,193		—		—		—		100	%	—	%	100	%
Pain	111,828		10,007		121,835		179,651		7,585		187,236		(38	)%	32	%	(35	)%
Other	19,291		56,664		75,955		13,292		50,115		63,407		45	%	13	%	20	%
Total Sales	346,273		82,456		428,729		401,009		69,504		470,513		(14	)%	19	%	(9	)%
Other Revenues	8,823		869		9,692		9,189		2,631		11,820		(4	)%	(67	)%	(18	)%
Total Revenues	$	355,096	$	83,325	$	438,421	$	410,198	$	72,135	$	482,333	(13	)%	16	%	(9	)%

Sales—In the United States, we sell our proprietary products to pharmaceutical wholesalers, the largest three of which accounted for 65% and 66% of our total consolidated gross sales for the three and nine months ended September 30, 2007, respectively. Decisions made by these wholesalers regarding the levels of inventory they hold (and thus the amount of product they purchase from us) can materially affect the level of our sales in any particular period and thus may not necessarily correlate to the number of prescriptions written for our products as reported by IMS Health Incorporated.

We have distribution service agreements with 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 September 30, 2007, we received information from substantially all of our U.S. wholesaler customers about the levels of inventory they held for our U.S. branded products. Based on this information, which we have not independently verified, we believe that total inventory held at these wholesalers is approximately two to three weeks supply of our U.S. branded products at our current sales levels. At September 30, 2007, we believe that inventory held at wholesalers and retailers of our generic OTFC product, launched in October 2006, is approximately three to four months supply.

For the three months ended September 30, 2007, sales were impacted by changes in the product sales allowances deducted from gross sales as described further below and by changes in the relative levels of the number of units of inventory held at wholesalers and retailers. For the three months ended September 30, 2007, total sales decreased 9% as compared to the three months ended September 30, 2006. The other key factors that contributed to the changes in sales are summarized by product as follows:

•In CNS, sales of PROVIGIL increased 6 percent. Demand for PROVIGIL increased as evidenced by an increase in U.S. prescriptions for PROVIGIL of 7%, according to IMS Health. For the three months ended September 30, 2007, sales of PROVIGIL also were impacted by domestic price increases of 5% from period to period.

•In Pain, sales decreased 35 percent. Sales of ACTIQ were impacted by an increase in domestic prices of 36% from period to period, offset by an 86% decrease in U.S. prescriptions, according to IMS Health, resulting from the introduction of generic competition to ACTIQ in October 2006. For the three months ended September 30, 2007, we recognized $32.7 million of revenue related to sales of our own generic OTFC and shipments of our generic OTFC to Barr and $33.2 million of revenue related to sales of FENTORA. During the remainder of 2007, we expect overall sales of our Pain products to decrease compared to the same period in 2006 and the first three

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quarters of 2007 based on a continued shift in market share from ACTIQ to generic OTFC, partially offset by the sales of FENTORA.

•Other sales, which consist primarily of sales of other products and certain third party products, increased 20 percent. The increase is attributable to an increase of $6.5 million in sales of our European products, primarily driven by sales in France and sales of oncology products in Europe.

Other Revenues—The decrease of 18% from period to period is primarily due to a decrease in revenues from our collaborators including royalties, milestone payments and fees.

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

	Three months ended
	September 30,
	2007			2006			Change			% Change
Gross sales	$	479,065		$	492,385		$	(13,320	)	(3	)%
Product sales allowances:
Prompt payment discounts	7,781			8,007			(226		)	(3	)%
Wholesaler discounts	5,373			437			4,936			1,130	%
Returns	(2,598		)	4,407			(7,005		)	(159	)%
Coupons	8,713			5,887			2,826			48	%
Medicaid discounts	10,648			8,828			1,820			21	%
Medicare Part D discounts	482			226			256			113	%
Managed care and governmental contracts	19,937			(5,920		)	25,857			437	%
	50,336			21,872			28,464
Net sales	$	428,729		$	470,513		$	(41,784	)	(9	)%
Product sales allowances as a percentage of gross sales	10.5		%	4.4		%

Prompt payment discounts, generally granted at 2% of sales, decreased for the three months ended September 30, 2007 as compared to the three months ended September 30, 2006 due to lower sales revenue during the quarter. Wholesaler discounts increased $4.9 million period over period because cumulative price increases as of September 30, 2006 produced wholesaler credits that partially offset the wholesaler discounts that would have been recorded for the same period. Returns decreased both as a result of our historical returns experience, particularly related to our CNS products, that is used in the calculation of our returns reserve requirements, and based on current retail pipeline data. Coupons increased for the three months ended September 30, 2007 as compared to the three months ended September 30, 2006 as a result of the distribution of coupons for FENTORA, which was launched in October 2006, offset by the elimination and expiration of ACTIQ coupons on September 30, 2006.

Medicaid discounts increased for the three months ended September 30, 2007 as compared to the three months ended September 30, 2006 due to increases in our pipeline accruals. Managed care and governmental contracts increased for the three months ended September 30, 2007 as compared to the three months ended September 30, 2006 due to additional rebates for certain managed care and governmental programs, particularly with respect to sales of our generic OTFC product. In addition, we recognized a reduction in the managed care and governmental contracts allowance of $13.3 million in the third quarter of 2006, representing amounts paid to the U.S. Department of Defense (“DoD”) under the Tricare program from October 2004 through June 30, 2006. In October 2006, the DoD announced that it would reimburse all companies that had voluntarily made such payments under the Tricare program due to the U.S. Court of Appeals September 2006 ruling. In the future, we expect product sales allowances as a percentage of gross sales to trend upward due to the impact of potential future price increases on Medicaid discounts and potential increases related to Medicaid, Medicare Part D, managed care and governmental contracts sales.

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	Three months ended
	September 30,
	2007		2006		Change			% Change
Costs and expenses:
Cost of sales	$	82,258	$	83,160	$	(902	)	(1	)%
Research and development	93,527		86,439		7,088			8	%
Selling, general and administrative	186,456		161,108		25,348			16	%
Settlement reserve	369,000		—		369,000			100	%
	$	731,241	$	330,707	$	400,534		121	%

Cost of Sales—The cost of sales was 19.2% of net sales for the three months ended September 30, 2007 and 17.7% of net sales for the three months ended September 30, 2006. This increase is primarily due to an increase in production costs as a percentage of sales as a result of the construction and upgrade of facilities in the U.S. for our Pain products during late 2006 and early 2007 and the mix of product margins of our corresponding product sales, in particular the shift in market share from ACTIQ to generic OTFC for the three months ended September 30, 2007 as compared to the three months ended September 30, 2006. Amortization expense included in cost of sales was $22.3 million for the three months ended September 30, 2007 as compared to $20.8 million for the three months ended September 30, 2006.

Research and Development Expenses—Research and development expenses increased $7.1 million, or 8%, for the three months ended September 30, 2007 as compared to the three months ended September 30, 2006. This increase is primarily attributable to the recognition of a $15.0 million milestone payment related to our NDA filing for TREANDA, partially offset by lower expenses associated with reduced levels of clinical activity in 2007 as compared to 2006.

Selling, General and Administrative Expenses—Selling, general and administrative expenses increased $25.3 million, or 16%, for the three months ended September 30, 2007 as compared to the three months ended September 30, 2006 primarily due to the cessation of the reimbursement of expenses from Alkermes related to the promotion of VIVITROL of $8.7 million, increased sales and marketing spending on oncology products and expenses incurred under our agreements with Takeda and Watson.

Settlement Reserve—During the third quarter of 2007, we increased our existing settlement reserve by $369.0 million related to the terms of the agreement in principle reached with the U.S. Attorney’s Office. See Note 8 to the Consolidated Financial Statements included in Part I, Item 1 of this Quarterly Report on Form 10-Q.

	Three months ended
	September 30,
	2007			2006			Change			% Change
Other income (expense):
Interest income	$	8,868		$	7,046		$	1,822		26	%
Interest expense	(5,660		)	(4,749		)	(911		)	(19	)%
Gain on extinguishment of debt	5,319			—			5,319			100	%
Other income (expense), net	2,493			895			1,598			179	%
	$	11,020		$	3,192		$	7,828		245	%

Other Income (Expense)—Other income (expense) increased $7.8 million for the three months ended September 30, 2007 as compared to the three months ended September 30, 2006. The increase was attributable to the following factors:

•an increase in interest income for the three months ended September 30, 2007 due to higher average investment balances; and

•a $5.3 million gain on extinguishment of debt related to the Pennsylvania Industrial Development Board (“PIDA”) loan forgiveness in the third quarter of 2007.

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	Three months ended
	September 30,
	2007		2006		Change			% Change
Income tax expense	$	24,963	$	59,077	$	(34,114	)	(58	)%

Income Taxes—For the three months ended September 30, 2007, we recognized $25.0 million of income tax expense on loss before income taxes of $281.8 million, as we have not yet recognized a tax benefit for the $369.0 million increase in our settlement reserve recorded in the third quarter of 2007 due to the uncertainty associated with the tax treatment of any potential settlement. This compared to income tax expense for the three months ended September 30, 2006 of $59.1 million on income before income taxes of $154.8 million, resulting in an effective tax rate of 38.2 percent.

Nine months ended September 30, 2007 compared to nine months ended September 30, 2006:

	Nine months ended
	September 30,
	2007						2006						% Increase (Decrease)
	United States		Europe		Total		United States		Europe		Total		United States		Europe		Total
Sales:
PROVIGIL	$	593,394	$	39,171	$	632,565	$	500,941	$	29,219	$	530,160	18	%	34	%	19	%
GABITRIL	39,814		6,268		46,082		42,166		3,510		45,676		(6	)%	79	%	1	%
CNS	633,208		45,439		678,647		543,107		32,729		575,836		17	%	39	%	18	%
ACTIQ	157,097		28,638		185,735		457,679		19,213		476,892		(66	)%	49	%	(61	)%
Generic OTFC	97,562		—		97,562		—		—		—		100	%	—	%	100	%
FENTORA	101,224		—		101,224		—		—		—		100	%	—	%	100	%
Pain	355,883		28,638		384,521		457,679		19,213		476,892		(22	)%	49	%	(19	)%
Other	53,867		170,767		224,634		41,661		152,436		194,097		29	%	12	%	16	%
Total Sales	1,042,958		244,844		1,287,802		1,042,447		204,378		1,246,825		—	%	20	%	3	%
Other Revenues	32,315		2,550		34,865		26,510		6,052		32,562		22	%	(58	)%	7	%
Total Revenues	$	1,075,273	$	247,394	$	1,322,667	$	1,068,957	$	210,430	$	1,279,387	1	%	18	%	3	%

Sales—For the nine months ended September 30, 2007, sales were impacted by changes in the product sales allowances deducted from gross sales as described further below and by changes in the relative levels of the number of units of inventory held at wholesalers and retailers. For the nine months ended September 30, 2007, total sales increased 3% as compared to the nine months ended September 30, 2006. The other key factors that contributed to the changes in sales are summarized by product as follows:

•In CNS, sales of PROVIGIL increased 19 percent. Demand for PROVIGIL increased as evidenced by an increase in U.S. prescriptions for PROVIGIL of 11%, according to IMS Health. For the nine months ended September 30, 2007, sales of PROVIGIL also were impacted by domestic price increases of 6% from period to period.

•In Pain, sales decreased 19 percent. Sales of ACTIQ were impacted by an increase in domestic prices of 58% from period to period, offset by an 82% decrease in U.S. prescriptions, according to IMS Health, resulting from the introduction of generic competition to ACTIQ in October 2006. For the nine months ended September 30, 2007, we recognized $97.6 million of revenue related to sales of our own generic OTFC and shipments of our generic OTFC to Barr and $101.2 million of revenue related to sales of FENTORA. During the remainder of 2007, we expect overall sales of our Pain products to decrease compared to the same period in 2006 and the first three quarters of 2007 based on a continued shift in market share from ACTIQ to generic OTFC, partially offset by the sales of FENTORA.

•Other sales, which consist primarily of sales of other products and certain third party products, increased 16 percent. The increase is attributable to an increase of $18.3 million in sales of our European products, primarily driven by sales in France and sales of oncology products in Europe. In addition, other sales in the U.S. increased $12.2 million, primarily driven by increases in sales of VIVITROL and TRISENOX.

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Other Revenues—The increase of 7% from period to period is primarily due to an increase in revenues from our collaborators including royalties, milestone payments and fees.

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

	Nine months ended
	September 30,
	2007			2006			Change			% Change
Gross sales	$	1,444,003		$	1,356,371		$	87,632		6	%
Product sales allowances:
Prompt payment discounts	23,639			23,226			413			2	%
Wholesaler discounts	15,723			2,629			13,094			498	%
Returns	9,258			14,517			(5,259		)	(36	)%
Coupons	19,895			21,365			(1,470		)	(7	)%
Medicaid discounts	29,277			32,711			(3,434		)	(10	)%
Medicare Part D discounts	1,039			1,468			(429		)	(29	)%
Managed care and governmental contracts	57,370			13,630			43,740			321	%
	156,201			109,546			46,655
Net sales	$	1,287,802		$	1,246,825		$	40,977		3	%
Product sales allowances as a percentage of gross sales	10.8		%	8.1		%

Prompt payment discounts, generally granted at 2% of sales, increased for the nine months ended September 30, 2007 as compared to the nine months ended September 30, 2006 due to the increase in sales revenue. Wholesaler discounts increased $13.1 million period over period because cumulative price increases as of September 30, 2006 produced wholesaler credits that partially offset the wholesaler discounts that would have been recorded for the same period. Returns decreased both as a result of our historical returns experience, particularly related to our CNS products, that is used in the calculation of our returns reserve requirements, and based on current retail pipeline data. Coupons decreased for the nine months ended September 30, 2007 as compared to the nine months ended September 30, 2006 as a result of the elimination and expiration of ACTIQ coupons on September 30, 2006, offset by the distribution of coupons for FENTORA, which was launched in October 2006.

Medicaid discounts decreased for the nine months ended September 30, 2007 as compared to the nine months ended September 30, 2006 due to the lower sales and Medicaid utilization of our Pain products, especially branded ACTIQ. Managed care and governmental contracts increased for the nine months ended September 30, 2007 as compared to the nine months ended September 30, 2006 due to additional rebates for certain managed care and governmental programs, particularly with respect to sales of our generic OTFC product. We recognized a reduction in the managed care and governmental contracts allowance of $13.3 million in the third quarter of 2006, representing amounts paid to the DoD under the Tricare program from October 2004 through June 30, 2006. In October 2006, the DoD announced that it would reimburse all companies that had voluntarily made such payments under the Tricare program due to the U.S. Court of Appeals September 2006 ruling. In the future, we expect product sales allowances as a percentage of gross sales to trend upward due to the impact of potential future price increases on Medicaid discounts and potential increases related to Medicaid, Medicare Part D, managed care and governmental contracts sales.

	Nine months ended
	September 30,
	2007		2006		Change			% Change
Costs and expenses:
Cost of sales	$	251,970	$	250,613	$	1,357		1	%
Research and development	274,078		294,899		(20,821		)	(7	)%
Selling, general and administrative	527,962		470,158		57,804			12	%
Settlement reserve	425,000		—		425,000			100	%
Impairment charge	—		12,417		(12,417		)	(100	)%
	$	1,479,010	$	1,028,087	$	450,923		44	%

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Cost of Sales—The cost of sales was 19.6% of net sales for the nine months ended September 30, 2007 and 20.1% of net sales for the nine months ended September 30, 2006. This decrease is primarily due to lower royalty expenses for ACTIQ resulting from the decline in the royalty rate upon the expiration of the ACTIQ patents in September 2006, the favorable mix of product margins for certain of our product sales for the nine months ended September 30, 2007 as compared to the nine months ended September 30, 2006, the net effect of price increases on our three major U.S. products and an $8.6 million inventory reserve related to SPARLON recorded in the second quarter of 2006. The decrease was partially offset by a charge of $3.5 million in the first quarter of 2007 for the termination of a materials supply agreement and a decrease in product margin for our Pain products resulting from the shift in market share from ACTIQ to generic OTFC. Amortization expense included in cost of sales was $64.2 million for the nine months ended September 30, 2007 as compared to $60.8 million for the nine months ended September 30, 2006.

Research and Development Expenses—Research and development expenses decreased $20.8 million, or 7%, for the nine months ended September 30, 2007 as compared to the nine months ended September 30, 2006. For the nine months ended September 30, 2007 and 2006, we recognized $26.5 million and $45.0 million in up-front payments related to rights acquired to certain development stage products, respectively. We also recognized a $15.0 million milestone payment related to our NDA filing for TREANDA in the third quarter of 2007. This decrease is also attributable to lower expenses associated with reduced levels of clinical activity in 2007 as compared to 2006.

Selling, General and Administrative Expenses—Selling, general and administrative expenses increased $57.8 million, or 12%, for the nine months ended September 30, 2007 as compared to the nine months ended September 30, 2006 primarily due to the cessation of the reimbursement of expenses from Alkermes related to the promotion of VIVITROL of $21.6 million, increased sales and marketing spending on oncology products and expenses incurred under our agreements with Takeda and Watson, offset by $6.0 million of one-time payments made for the nine months ended September 30, 2006 in connection with PROVIGIL settlement agreements.

Settlement Reserve—For the nine months ended September 30, 2007, we recorded a settlement reserve of $425.0 million related to the terms of the agreement in principle reached with the U.S. Attorney’s Office. See Note 8 to the Consolidated Financial Statements included in Part I, Item 1 of this Quarterly Report on Form 10-Q.

Impairment Charge—In June 2006, we announced that data from our Phase 3 clinical program evaluating GABITRIL for the treatment of GAD did not reach statistical significance on the primary study endpoints. As a result, we performed a test of impairment on the carrying value of our investment in GABITRIL product rights and recorded an impairment charge of $12.4 million in the second quarter of 2006 related to our European rights.

	Nine months ended
	September 30,
	2007			2006			Change			% Change
Other income (expense):
Interest income	$	23,485		$	16,736		$	6,749		40	%
Interest expense	(15,272		)	(13,523		)	(1,749		)	(13	)%
Write-off of deferred debt issuance costs	—			(13,105		)	13,105			100	%
Gain on extinguishment of debt	5,319			—			5,319			100	%
Gain on sale of investment	5,791			—			5,791			100	%
Other income (expense), net	3,747			(116		)	3,863			3,330	%
	$	23,070		$	(10,008	)	$	33,078		331	%

Other Income (Expense)—Other income (expense) increased $33.1 million for the nine months ended September 30, 2007 as compared to the nine months ended September 30, 2006. The increase was attributable to the following factors:

•an increase in interest income for the nine months ended September 30, 2007 due to higher investment returns and higher average investment balances;

•a $13.1 million write-off in the first quarter of 2006 of deferred debt issuance costs related to our Zero Coupon Notes;

•a $5.3 million gain on extinguishment of debt related to the PIDA loan forgiveness in the third quarter of 2007;

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•a $5.8 million gain on the sale of an investment in a privately-held company in the second quarter of 2007; and

•a $3.9 million increase in other income (expense), net primarily due to fluctuations in foreign currency gains and losses in the comparable periods.

	Nine months ended
	September 30,
	2007		2006		Change		% Change
Income tax expense	$	102,613	$	91,567	$	11,046	12	%

Income Taxes—For the nine months ended September 30, 2007, we recognized $102.6 million of income tax expense on loss before income taxes of $133.3 million, as we have not yet recognized a tax benefit for the $425.0 million settlement reserve recorded as of September 30, 2007 due to the uncertainty associated with the tax treatment of any potential settlement. This compared to income tax expense for the nine months ended September 30, 2006 of $91.6 million on income before income taxes of $241.3 million, resulting in an effective tax rate of 37.9 percent.

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LIQUIDITY AND CAPITAL RESOURCES

(In thousands, except per share data)

Cash, cash equivalents and investments at September 30, 2007 were $731.1 million, representing 22% of total assets, compared to $521.7 million, representing 17% of total assets at December 31, 2006.

Our working capital deficit, which is calculated as current assets less current liabilities, was $631.7 million at September 30, 2007 compared to $268.6 million at December 31, 2006. Certain of our convertible subordinated notes contain conversion terms that will impact whether these notes are classified as current or long-term liabilities and consequently affect our working capital position. At September 30, 2007 and December 31, 2006, $1,233.7 million and $1,019.8 million, respectively, of our convertible subordinated notes were convertible into cash and shares of common stock and were therefore classified as current liabilities on our consolidated balance sheets.

The change in cash and cash equivalents is as follows:

	Nine months ended
	September 30,
	2007			2006
Net cash provided by operating activities	$	274,321		$	251,190
Net cash provided by (used for) investing activities	(200,934		)	30,538
Net cash provided by financing activities	81,279			131,745
Effect of exchange rate changes on cash and cash equivalents	10,804			11,830
Net increase in cash and cash equivalents	$	165,470		$	425,303

Net Cash Provided by Operating Activities

Cash provided by operating activities is primarily driven by income from sales of our products offset by the timing of receipts and payments in the ordinary course of business. The net loss for the nine months ended September 30, 2007 was offset by changes in accounts payable and accrued expenses resulting from the agreement in principle with the U.S. Attorney’s Office for which $425.0 million has been accrued but not yet paid. See Note 8 to the Consolidated Financial Statements included in Part I, Item 1 of this Quarterly Report on Form 10-Q.

Net Cash Provided by (Used for) Investing Activities

Cash used in investing activities primarily relates to acquisitions of business, technologies, products and product rights and funds invested in our administrative and manufacturing facilities to accommodate our growth. These uses of cash are offset by sales, maturities or purchases of investments associated with our portfolio of available for sale investments.

In August 2007, in association with the acquisition of the North America rights to AMRIX from E. Claiborne Robins Company Inc., we paid $99.2 million for an intangible asset. In addition to other miscellaneous intangible assets acquired during the nine months ended September 30, 2006, in April 2006 we paid $110.0 million to Alkermes following FDA approval of VIVITROL.

In June 2007, we received cash proceeds of $12.3 million on the sale of an investment in a privately-held company. For the nine months ended September 30, 2007 and 2006, we made capital expenditures of $70.9 million and $97.1 million, respectively, which included expenditures associated with our ongoing expansion and improvements of our research and development facilities in France and West Chester, Pennsylvania and other infrastructure improvements such as the SAP® implementation.

Net Cash Provided by Financing Activities

Cash provided by financing activities primarily relates to proceeds and payments on long-term debt and employee stock option activity.

For the nine months ended September 30, 2007 and 2006, proceeds from stock option exercises were $74.4 million and $112.8 million, respectively. The corresponding incremental windfall tax benefits from stock-based compensation for those same periods were $9.9 million and $21.9 million, respectively.

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Contractual Obligations

During the fourth quarter of 2007, we expect to pay the former Salmedix shareholders a $15.0 million milestone payment following the FDA’s acceptance of our NDA filing for TREANDA. Upon FDA approval of TREANDA, we will become obligated to pay the former Salmedix shareholders an additional $25.0 million milestone payment. There have been no other material changes to the table presented in our Annual Report on Form 10-K for the year ended December 31, 2006. The table excludes our liability for net unrecognized tax benefits, which totaled $42.9 million as of January 1, 2007 and $44.7 million as of September 30, 2007, since we cannot predict with reasonable reliability the timing of cash settlements to the respective taxing authorities.

Outlook

We expect to use our cash, cash equivalents and investments for working capital and general corporate purposes, including the expected payment of the $425.0 million settlement with the U.S. Attorney’s Office, acquisition of businesses, products, product rights, or technologies, the settlement of outstanding litigation or the resolution of the ongoing investigation by the Office of the Connecticut Attorney General described above, the payment of contractual obligations, including scheduled interest payments on our convertible notes and regulatory or sales milestones that may become due, and/or the purchase, redemption or retirement of our convertible notes, including the likely repayment in June 2008 of $213.2 million of our 2008 Zero Coupon Convertible Notes. However, 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 continue to generate positive cash flow from operations during the remainder of 2007 and in 2008. At this time, we cannot accurately predict the effect of certain developments on the rate of sales growth in 2009 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 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 depends, in part, on the continued effectiveness of the various settlement agreements we entered into in late 2005 and early 2006, as well as our maintenance of protection in the United States and abroad of the modafinil particle-size patent through its expiration beginning in 2014. See Note 8 to the Consolidated Financial Statements included in Part I, Item 1 of this Quarterly Report on Form 10-Q. Finally, growth of our modafinil-based product sales in the future may depend in part on our ability to successfully launch NUVIGIL around 2010.

The growth of our pain franchise depends in large part on our ability to successfully market FENTORA, which we launched in the United States in October 2006. Sales of our other pain product, ACTIQ, have been meaningfully eroded by the entry of generic competition in late September 2006 and we expect this erosion will continue during the remainder of 2007. In addition, sales of our own generic OTFC could be significantly impacted by the entrance into the market of additional generic OTFC products, which could occur at any time.

For VIVITROL, our ability to achieve commercial success with this product in the future will be impacted by our success in building awareness and acceptance of the product among the 2,000 – 3,000 addiction specialists and physicians who have been actively treating alcohol dependence with pharmacotherapy and our work towards educating the counseling community about VIVITROL. During the first few months of launch, we focused our efforts on establishing the logistical platform to effectively deliver the product to patients. In 2007, we have focused more of our sales and marketing efforts on driving product demand by educating physicians about VIVITROL’s benefits. While we have made steady progress in increasing sales and physician awareness of this product, we have determined to reduce the level of our sales and marketing expenses for this product, including a reduction in the number of sales representative promoting the product, to what we believe is an appropriate spending level for this product.

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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. During the remainder of 2007 and in 2008, we expect to continue to incur significant levels of research and development expenditures. We also expect to continue or begin a number of significant clinical programs including, among others: possible studies of TREANDA for the treatment of small cell lung cancer and mantle cell lymphoma; a Phase 3 program evaluating CEP-701 for the treatment of acute myelogenous leukemia and other possible studies in patients with myeloproliferative disorder; and clinical programs with NUVIGIL focused on excessive sleepiness, fatigue and cognition in diseases such as Parkinson’s disease, cancer, schizophrenia and bi-polar depression. We may seek to mitigate the risk in, and expense of, our research and development programs by entering into 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

During the remainder of 2007 and in 2008, we expect to continue to incur significant expenditures associated with manufacturing, selling and marketing our products. We expect to continue in-process capital expenditure projects at our research and development facilities in France and West Chester. The aggregate amount of our sales and marketing expenses in 2008 is expected to be higher than that incurred in 2007, primarily as a result of higher expenses associated with our promotional efforts related to PROVIGIL and AMRIX and launch expenses associated with TREANDA, assuming FDA approval.

Indebtedness

We have significant indebtedness outstanding, consisting principally of indebtedness on convertible subordinated notes. The following table summarizes the principal terms of our most significant convertible subordinated notes outstanding as of September 30, 2007:

Security	Outstanding		Conversion Price			Redemption Rights and Obligations
	(in millions)
2.0% Convertible Senior Subordinated Notes due June 2015 (the “2.0% Notes”)	$	820.0	$	46.70	*	Generally not redeemable by the holder prior to December 2014.
Zero Coupon Convertible Notes due June 2033, first putable June 15, 2008 (the “2008 Zero Coupon Notes”)	$	213.2	$	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”)	$	199.5	$	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. For a more complete description of these notes, including the associated convertible note hedge, see Note 10 to our Consolidated Financial Statements included in Part II, Item 8 of our Annual Report on Form 10-K for the year ended December 31, 2006.

All of our notes are convertible as of September 30, 2007 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 Quarterly Report on Form 10-Q, we do not have available cash, cash equivalents and investments sufficient to repay all of the convertible notes, if presented. In addition, there are no restrictions on our use of this cash and the cash available to repay indebtedness may decline over time. If we do not have sufficient funds available to repay any principal balance of notes presented for conversion, we will be required to raise additional funds. Because the financing markets may be unwilling to provide funding to us or may only be willing to provide funding on terms that we would consider unacceptable, we may not have cash available or be able to obtain funding to permit us to meet our repayment obligations, thus adversely affecting the market price for our securities.

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As of September 30, 2007, all of our notes are convertible because the closing price of our common stock on that date was higher than the restricted conversion prices of these notes. As a result, such notes have been classified as current liabilities on our consolidated balance sheet as of September 30, 2007. In addition, our Zero Coupon Notes first putable June 15, 2008 are considered to be current liabilities based on maturity. See Note 10 of our Consolidated Financial Statements included in Part II, Item 8 of our Annual Report on Form 10-K for the year ended December 31, 2006 for summary of our convertible debt, note hedge and call warrant. As of November 1, 2007, 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 the Zero Coupon Notes will present significant amounts of such notes for conversion under the current terms. In the unlikely event that a significant conversion did occur, we believe that we have the ability to raise sufficient cash to repay the principal amounts due through a combination of utilizing our existing cash on hand, 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 September 30, 2007 are $16.4 million, payable semi-annually on June 1 and December 1. In the future, we may agree to exchanges of the notes for shares of our common stock or debt, or may determine to use a portion of our existing cash on hand to purchase or retire all or a portion of the outstanding convertible notes.

Our 2.0% Notes and 2008 and 2010 Zero Coupon Notes each are considered Instrument C securities as defined by Emerging Issues Task Force (“EITF”) Issue No. 90-19, “Convertible Bonds with Issuer Option to Settle for Cash upon Conversion” (“EITF 90-19”); therefore, these notes are included in the dilutive earnings per share calculation using the treasury stock method. Under the treasury stock method, we must calculate the number of shares issuable under the terms of these notes based on the average market price of our common stock during the period, and include that number in the total diluted shares figure for the period. At the time we sold our 2.0% Notes 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, “Earnings Per Share” (“SFAS 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 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 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	5,710	—	5,710	(5,710	)	—
$	75.00	8,239	2,137	10,376	(8,239	)	2,137
$	85.00	10,173	5,041	15,214	(10,173	)	5,041
$	95.00	11,699	7,334	19,033	(11,699	)	7,334
$	105.00	12,935	9,189	22,124	(12,935	)	9,189

(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.

The Financial Accounting Standards Board (“FASB”) recently published proposed Staff Position (“FSP”) No. APB 14-a, “Accounting for Convertible Debt Instruments That May Be Settled in Cash Upon Conversion (Including Partial Cash Settlement).”  The proposed FSP would be applicable to substantially all of our convertible debt. If the proposed FSP is finalized in its current form, convertible debt would be bifurcated into its respective debt and equity components. The debt component would be recorded at the fair market value of the debt assuming there were no equity conversion features. The

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difference between the debt proceeds and the fair value of the debt component would be recorded as an increase to equity and recognized as interest expense over the expected life of the debt. If adopted, the proposed guidance would be effective for fiscal years beginning after December 15, 2007 and would have a significant impact on our 2008 consolidated financial statements and also would require restating all prior periods presented to reflect the revised accounting treatment retrospectively.

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 launches;

•marketing and other expenses;

•manufacturing or supply disruptions; and

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

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CRITICAL ACCOUNTING POLICIES AND ESTIMATES

(In thousands)

Management’s Discussion and Analysis of Financial Condition and Results of Operations discusses our consolidated financial statements, which we have prepared in accordance with accounting principles generally accepted in the United States of America. In preparing these financial statements, we must make estimates and assumptions that affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities at the date of the financial statements, and the reported amounts of revenues and expenses during the reporting period. We develop and periodically change these estimates and assumptions based on historical experience and on various other factors that we believe are reasonable under the circumstances. Actual results may differ from these estimates under different assumptions or conditions. A summary of significant accounting policies and a description of accounting policies that are considered critical may be found in Part II, Item 8 of our Annual Report on Form 10-K for the year ended December 31, 2006 in the “Critical Accounting Policies and Estimates” section.

Product Sales Allowances—We record product sales net of the following significant categories of product sales allowances, each of which is described in more detail included in Part II, Item 7 of our Annual Report on Form 10-K for the year ended December 31, 2006: prompt payment discounts, wholesaler discounts, returns, coupons, Medicaid discounts, Medicare Part D discounts and managed care and governmental contracts. Calculating each of these items involves significant estimates and judgments and requires us to use information from external sources. In certain of the product sales allowance categories, we have calculated the impact of changes in our estimates, which we believe represent reasonably likely changes to these estimates based on historical data adjusted for certain unusual items such as changes in government contract rules.

The following table summarizes activity in each of the above categories for the year ended December 31, 2006 and the nine months ended September 30, 2007:

	Prompt Payment Discounts			Wholesaler Discounts			Returns*			Coupons			Medicaid Discounts			Medicare Part D Discounts			Managed Care & Governmental Contracts			Total
Balance at January 1, 2006	$	(1,917	)	$	(2,728	)	$	(22,598	)	$	(4,695	)	$	(33,454	)	$	—		$	(6,566	)	$	(71,958	)
Provision:
Current period	(32,384		)	(2,939		)	(24,735		)	(26,169		)	(45,990		)	(2,217		)	(43,712		)	(178,146		)
Prior periods	—			—			—			(684		)	723			—			7,443			7,482
Total	(32,384		)	(2,939		)	(24,735		)	(26,853		)	(45,267		)	(2,217		)	(36,269		)**	(170,664		)
Actual:
Current period	28,836			2,629			—			21,508			19,588			545			25,889			98,995
Prior periods	1,917			2,728			18,490			5,378			32,731			—			(877		)	60,367
Total	30,753			5,357			18,490			26,886			52,319			545			25,012		**	159,362
Balance at December 31, 2006	$	(3,548	)	$	(310	)	$	(28,843	)	$	(4,662	)	$	(26,402	)	$	(1,672	)	$	(17,823	)	$	(83,260	)
Provision:
Current period	(23,644		)	(15,723		)	(11,935		)	(20,067		)	(29,430		)	(1,488		)	(57,130		)	(159,417		)
Prior periods	5			—			2,677			172			153			449			(240		)	3,216
Total	(23,639		)	(15,723		)	(9,258		)	(19,895		)	(29,277		)	(1,039		)	(57,370		)	(156,201		)
Actual:
Current period	20,330			10,350			—			11,840			12,276			177			35,944			90,917
Prior periods	3,543			310			12,701			4,489			25,805			929			18,065			65,842
Total	23,873			10,660			12,701			16,329			38,081			1,106			54,009			156,759
Balance at September 30, 2007	$	(3,314	)	$	(5,373	)	$	(25,400	)	$	(8,228	)	$	(17,598	)	$	(1,605	)	$	(21,184	)	$	(82,702	)

*	Given our return goods policy, we assume that all returns in a current year relate to prior period sales.
**	Includes $13.3 million related to the DoD Tricare program of which $5.5 million related to the current period and $7.8 million related to prior periods.

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Inventories– The following is in addition to, and should be read in conjunction with, the inventories critical accounting policy included in Part II, Item 7 of our Annual Report on Form 10-K for the year ended December 31, 2006.

We expense pre-approval inventory unless we believe it is probable that the inventory will be saleable. We have capitalized 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. With respect to capitalization of unapproved product candidates, we seek to produce inventory in preparation for the launch of the product and in amounts sufficient to support forecasted initial market demand. Typically, capitalization of this inventory does not begin until the product candidate is considered to have a high probability of regulatory approval. This may occur when either the product candidate is in Phase 3 clinical trials or when it is a new formulation or dosage strength of a presently approved product for which we believe there is a high probability of receiving FDA approval. If we are aware of any specific risks or contingencies that are likely to impact the expected regulatory approval process or if there are any specific issues identified during the research process relating to safety, efficacy, manufacturing, marketing or labeling of the product candidate, we would not capitalize the related inventory.

When manufacturing and capitalizing inventory costs of product candidates and at each subsequent balance sheet date, we consider both the expiration dates of the inventory and anticipated future sales once approved. Since expiration dates are impacted by the stage of completion, we seek to avoid product expiration issues by managing the levels of inventory at each stage to optimize the shelf life of the inventory relative to anticipated market demand following launch.

Once we have determined to capitalize inventory for a product candidate that is not yet approved, we will monitor, on a quarterly basis, the status of this candidate within the regulatory approval process. We could be required to expense previously capitalized costs related to pre-approval inventory upon a change in our judgment of future commercial use and net realizable value, due to a denial or delay of approval by regulatory bodies, a delay in the timeline for commercialization or other potential factors.

On a quarterly basis, we evaluate all inventory, including inventory capitalized for which regulatory approval has not yet been obtained, to determine if any lower of cost or market adjustment is required. As it relates to pre-approval inventory, we consider several factors including expected timing of FDA approval, projected sales volume and estimated selling price. Projected sales volume is based on several factors including market research, sales of similar products and competition in the market. Estimated sales price is based on the price of existing products sold for the same indications and expected market demand.

Income Taxes— The following is in addition to, and should be read in conjunction with, the income taxes critical accounting policy included in Part II, Item 7 of our Annual Report on Form 10-K for the year ended December 31, 2006.

In July 2006, the FASB issued FIN 48 which addresses the determination of whether tax benefits claimed or expected to be claimed on a tax return should be recorded in the financial statements. Under FIN 48, a company may recognize the tax benefit from an uncertain tax position only if it is more likely than not that the tax position will be sustained on examination by the taxing authorities, based on the technical merits of the position. The tax benefits recognized in the financial statements from such a position should be measured based on the largest benefit that has a greater than fifty percent likelihood of being realized upon ultimate settlement. FIN 48 also provides guidance on derecognition, classification, interest and penalties on income taxes, accounting in interim periods and requires increased disclosures. FIN 48 is effective for fiscal years beginning after December 15, 2006. We adopted the provisions of FIN 48 on January 1, 2007. See Note 12 herein.

The recognition and measurement of certain tax benefits includes estimates and judgments by management and inherently includes subjectivity. Changes in estimates may create volatility in our effective tax rate in future periods due to settlements with various tax authorities (either favorable or unfavorable), the expiration of the statute of limitations on some tax positions and obtaining new information about particular tax positions that may cause management to change its estimates.

RECENT ACCOUNTING PRONOUNCEMENTS

See Note 1 to our Consolidated Financial Statements in Part I, Item 1 of this Quarterly Report on Form 10-Q.

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ITEM 3. 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 nine months ended September 30, 2007, 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 $24.7 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.

ITEM 4. 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 Quarterly Report on Form 10-Q. 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 report have been designed and are functioning effectively to provide reasonable assurance that the information required to be disclosed by us in reports filed under the Securities Exchange Act of 1934 is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms. We believe that a controls system, no matter how well designed and operated, cannot provide absolute assurance that the objectives of the controls system are met, and no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within a company have been detected.

(b) Change in Internal Control over Financial Reporting

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

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PART II – OTHER INFORMATION

ITEM 1. LEGAL PROCEEDINGS

The information required by this Item is incorporated by reference to Note 8 of the Consolidated Financial Statements included in Part I, Item 1 of this Report.

ITEM 1A. RISK FACTORS

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

A significant portion of our revenue is derived from our two largest products, and our future success will depend on the continued growth and acceptance of PROVIGIL and the growth of FENTORA.

For the nine months ended September 30, 2007, 22% and 49% of our total consolidated net sales were derived from sales of ACTIQ (including our generic OTFC product) and PROVIGIL, respectively. In September 2006, Barr entered the market with generic OTFC. Since that time, we have experienced meaningful erosion of branded ACTIQ sales in the United States and we expect this erosion will continue during the remainder of 2007 and into 2008. In addition, sales of our own generic OTFC product could be significantly impacted by the entrance into the market of additional generic OTFC products, which could occur at any time. To counter the impact from existing and potential generic competition, we will need FENTORA, our next-generation pain product launched in October 2006, to achieve projected levels of growth. In September 2007, we issued a letter to healthcare professionals to clarify the appropriate patient selection, design and administration for FENTORA, following reports of serious adverse events in connection with the use of the product. With respect to PROVIGIL, we cannot be certain that it will continue to be accepted in its market. Specifically, the following factors, among others, could affect the level of market acceptance of these products:

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

•the level and effectiveness of our sales and marketing efforts and, with respect to PROVIGIL, those of Takeda;

•any unfavorable publicity regarding these or similar products;

•the price of the products relative to other competing drugs or treatments, including the impact of the availability of generic OTFC products on market acceptance of FENTORA;

•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, including, for example, the impact of recent changes to the PROVIGIL label resulting from the approved NUVIGIL label.

Any adverse developments with respect to the sale or use of PROVIGIL or FENTORA 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 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

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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 / NUVIGIL

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 of PROVIGIL. With respect to NUVIGIL, we successfully obtained issuance of a U.S. patent in November 2006 claiming the Form I polymorph of armodafinil, the active drug substance in NUVIGIL. This patent is currently set to expire in 2023. Foreign patent applications directed to the use of the Form I polymorph of armodafinil in treating sleep disorders are pending in Europe and elsewhere. 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 our modafinil-based products would significantly and negatively impact future sales.

As of the filing date of this Quarterly Report on Form 10-Q, we are aware of seven 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 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. 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 early 2005, we also filed a patent infringement lawsuit against Carlsbad Technology, Inc. based upon the Paragraph IV ANDA related to modafinil that Carlsbad filed with the FDA.

In late 2005 and early 2006, we entered into settlement agreements with each of Teva, Mylan, Ranbaxy and Barr. In August 2006, we entered into a settlement agreement with Carlsbad and its development partner, Watson Pharmaceuticals, Inc., which we understand has the right to commercialize the Carlsbad modafinil product if approved by the FDA. As part of these separate settlements, we agreed to grant to each of these parties a non-exclusive royalty-bearing right to market and sell a generic version of PROVIGIL in the United States. These licenses will become effective in April 2012, subject to applicable regulatory considerations. An earlier entry may occur based upon the entry of a generic version of PROVIGIL. Each of these settlements has been filed with both the FTC and the Antitrust Division of the U.S. Department of Justice (the “DOJ”) as required by the Medicare Modernization Act. The FTC is conducting an investigation of each of the PROVIGIL settlements and has issued a subpoena and requested documents and other information from us. We are cooperating fully with the FTC and its ongoing investigation, and expect to continue to cooperate. The FTC could determine to challenge in an administrative or judicial proceeding any or all of the settlements if it believes that the agreements violate the antitrust laws, although we believe that such a challenge would take years to resolve. We expect that the Commissioners of the FTC will formally decide in the near future whether or not to bring such an action against us.

We also are aware of numerous private antitrust complaints filed in the U.S. District Court for the Eastern District of Pennsylvania, each naming Cephalon, Barr, Mylan, Teva and Ranbaxy as co-defendants and claiming, among other things, that the patent litigation settlements concerning PROVIGIL violate the antitrust laws of the United States and, in some cases, certain state laws. All but one of these actions have been consolidated into a complaint on behalf of a class of direct purchasers of PROVIGIL and a separate complaint on behalf of a class of consumers and other indirect purchasers of PROVIGIL. A separate complaint filed by an indirect purchaser of PROVIGIL was filed in September 2007. The plaintiffs in all of these actions are seeking monetary damages and/or equitable relief. We moved to dismiss the class action complaints in November 2006.

Separately, in June 2006, Apotex, Inc., a subsequent ANDA filer seeking FDA approval of a generic form of

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modafinil, filed suit against us also in the U.S. District Court for the Eastern District of Pennsylvania alleging similar violations of antitrust laws and state law. Apotex asserts that the PROVIGIL settlement agreements improperly prevent it from obtaining FDA approval of its ANDA, and seeks monetary and equitable remedies. Apotex also seeks a declaratory judgment that our U.S. Patent No. RE37,516 (the “‘516 Patent”) covering PROVIGIL is invalid, unenforceable and/or not infringed by its proposed generic. We filed a motion to dismiss the Apotex case in late September 2006. We believe that the complaints described in the preceding paragraph and the Apotex complaint are without merit. While we intend to vigorously defend ourselves and the propriety of the settlement agreements, these efforts will be both expensive and time consuming and, ultimately, due to the nature of litigation, there can be no assurance that these efforts will be successful.

In November 2005 and March 2006, we received notice that Caraco Pharmaceutical Laboratories, Ltd. and Apotex, Inc., respectively, also filed Paragraph IV ANDAs with the FDA in which each firm is seeking to market a generic form of PROVIGIL. We have not filed patent infringement lawsuits against either Caraco or Apotex as of the filing date of this report, although Apotex has filed suit against us, as described above.

ACTIQ

With respect to ACTIQ, the U.S. patents covering the currently marketed compressed powder pharmaceutical composition and methods for administering fentanyl via this composition expired on September 5, 2006. 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.

Under two separate agreements with Barr, we licensed to Barr our U.S. rights to any intellectual property related to ACTIQ. The rights we granted to Barr became effective on September 5, 2006 and Barr entered the market with generic OTFC on September 27, 2006. As a result, ACTIQ sales have been meaningfully eroded and we expect this erosion will continue during the remainder of 2007 and into 2008. Moreover, sales of our own generic OTFC could be significantly impacted by the entrance into the market of additional generic OTFC products, which could occur at any time.

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

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

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

•fines, recalls or seizures of products;

•total or partial suspension of manufacturing or commercial activities;

•non-approval of product license applications;

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

•criminal prosecution.

Over the past few years, a significant number of pharmaceutical and biotechnology companies have been the target of inquiries and investigations by various federal and state regulatory, investigative, prosecutorial and administrative entities,

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including the DOJ and various U.S. Attorney’s Offices, the Office of Inspector General of the Department of Health and Human Services, the FDA, the FTC and various state Attorneys General offices. These investigations have alleged violations of various federal and state laws and regulations, including claims asserting antitrust violations, violations of the Food, Drug and Cosmetic Act, the False Claims Act, the Prescription Drug Marketing Act, anti-kickback laws, and other alleged violations in connection with off-label promotion of products, pricing and Medicare and/or Medicaid reimbursement.

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

In early November 2007, we announced that we had reached an agreement in principle with the U.S. Attorney’s Office (“USAO”) in Philadelphia and the DOJ with respect to the USAO investigation that began in September 2004. The investigation has focused on our sales and promotional practices with respect to ACTIQ, GABITRIL® (tiagabine hydrochloride) and PROVIGIL. Under this agreement, we now expect to pay $425.0 million as part of a comprehensive settlement of all Federal and related state Medicaid claims. During the third quarter of 2007, we increased our existing reserve by $369.0 million to $425.0 million in contemplation of this payment. In addition, the Company will agree to a single federal misdemeanor violation of the Federal Food, Drug and Cosmetic Act and enter into a corporate integrity agreement with the Office of Inspector General of the U.S. Department of Health and Human Services. The terms described above are subject to negotiation and the execution of the final settlement and corporate integrity agreements. There can be no assurance that the settlement will be finalized on the terms outlined above.

In September 2004, we announced that we had received a voluntary request for information from the Office of the Connecticut Attorney General that also appears to be focused on our sales and promotional practices with respect to ACTIQ, GABITRIL and PROVIGIL. We are cooperating with this Office, are providing documents and other information in response to these and additional requests and are engaged in ongoing discussions with them. In late October 2007, we also received a civil demand for information from the Office of the Massachusetts Attorney General that is focused on sales and promotional practices with respect to ACTIQ, FENTORA and certain of our other products. We intend to cooperate with this request. Both of these matters may involve civil penalties and/or fines. The payment of any settlement or judgment amount and/or fines could have a material adverse effect on our financial position, liquidity and results of operations. Furthermore, it is reasonably likely that we will face future additional requests for information from other state attorneys general focused on historical sales and promotional practices for our U.S. products. If civil penalties and/or fines were to result from such investigations, it could materially and adversely effect our financial position, liquidity and results of operations.

In November 2007, we were served with a putative class action complaint filed on behalf of entities that claim to have purchased ACTIQ for use in non-cancer patients. The complaint alleges violations of various state consumer protection laws, as well as the violation of the common law of unjust enrichment, and seeks an unspecified amount of money in actual, punitive and/or treble damages, with interest, and/or disgorgement of profits. We believe the allegations in the complaint are without merit, and we intend to vigorously defend ourselves in this matter and in any similar actions that may be filed in the future.

In March 2007, we received a letter requesting information related to ACTIQ and FENTORA from Congressman Henry A. Waxman in his capacity as Chairman of the House Committee on Oversight and Government Reform. The letter cites two articles concerning ACTIQ published in The Wall Street Journal in November 2006 and requests information concerning our sales and marketing practices for ACTIQ and FENTORA, among other things. We are cooperating with this request and are continuing to provide documents and other information to the Committee.

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

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medical authority. The approval process is highly uncertain and requires substantial time, effort and financial resources. Ultimately, we may never obtain approval in a timely manner, or at all. Without these required approvals, our ability to substantially grow revenues in the future could be adversely affected.

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

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

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

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

We also must comply with all applicable regulatory requirements of the DEA and analogous foreign authorities for certain of our products that contain controlled substances. The DEA also has authority to grant or deny requests for quota of controlled substances such as the fentanyl citrate that is the active ingredient in ACTIQ and generic OTFC. Under our license and supply agreement with Barr, we are obligated to sell generic OTFC to Barr for its resale in the United States. While we currently have available fentanyl quota to produce ACTIQ and generic OTFC, in the future we could face shortages of quota that could negatively impact our ability to supply product to Barr or to produce ACTIQ or our generic OTFC product. If we are unable to provide product to Barr, it is possible that either Barr or the FTC could claim that such a failure would constitute a breach of our agreements with these parties.

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

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

During research and development, the use of pharmaceutical products, such as ours, is limited principally to clinical trial patients under controlled conditions and under the care of expert physicians. The widespread commercial use of our products could identify undesirable or unintended side effects that have not been evident in our clinical trials or the commercial use as of the filing date of this report. For example, in June 2007, the FDA approved our new drug application

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for NUVIGIL. The NUVIGIL label includes a bolded warning section that characterizes the potential occurrence of serious skin rash and hypersensitivity in patients taking modafinil and armodafinil; in September 2007, we finalized revisions to the PROVIGIL label to make the PROVIGIL and NUVIGIL labels consistent. In September 2007, we issued a letter to healthcare professionals to clarify the appropriate patient selection, design and administration for FENTORA, following reports of serious adverse events in connection with the use of the product. Likewise, in February 2005, working with the FDA, we updated our prescribing information for GABITRIL to include a bolded warning describing the risk of new onset seizures in patients without epilepsy. In addition, in patients who take multiple medications, drug interactions could occur that can be difficult to predict. Additionally, incidents of product misuse, product diversion or theft may occur, particularly with respect to products such as FENTORA, ACTIQ, generic OTFC 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, FENTORA and ACTIQ have been approved under regulations concerning drugs with certain safety profiles, under which the FDA has established special restrictions to ensure safe use. Any violation of these special restrictions could lead to the imposition of further restrictions or withdrawal of the product from the market.

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

Our long-term prospects, particularly with respect to the growth of our future sales and earnings, depend to a large extent on our ability to obtain FDA approval for our product candidates. There can be no assurance that our applications to market our product candidates will be submitted or reviewed in a timely manner or that our applications will be approved by the FDA on the basis of the data contained in the applications. Should approval be granted to market a product candidate, there can be no assurance that we will be able to successfully commercialize the product or achieve a profitable level of sales.

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

•cost of product sales;

•achievement and timing of research and development milestones;

•collaboration revenues;

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

•marketing and other expenses;

•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.

All of our convertible notes outstanding contain restricted conversion prices that are either below or close to our stock price as of September 30, 2007. As a result, our convertible notes have been classified as current liabilities on our consolidated balance sheet at September 30, 2007. Under the terms of the indentures governing the notes, we are obligated to repay in cash the aggregate principal balance of any such notes presented for conversion. As of the filing date of this report, we do not have available cash, cash equivalents and investments sufficient to repay all of the convertible notes, if presented. In addition, 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 have an agreement with Takeda under which it will co-promote PROVIGIL until mid-2009. If Takeda fails to meet its obligations under the co-promotion agreement, is ineffective in its efforts, or  if we or they determine to terminate the agreement prior to the end of its term, the growth of PROVIGIL sales could be impacted.

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

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

•the design and execution of clinical studies;

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

•marketing and selling of an approved product.

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

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

In certain foreign markets, pricing or profitability of pharmaceutical products is subject to various forms of direct and indirect governmental control, including the control over the amount of reimbursements provided to the patient who is prescribed specific pharmaceutical products. For example, we are aware of governmental efforts in France to limit or eliminate reimbursement for some of our products, particularly FONZYLANE, FONLIPOL and OLMIFON, which could impact revenues from our French operations.

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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.

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

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

The conditions that our products treat, and some of the other disorders for which we are conducting additional studies, are currently treated with many drugs, several of which have been available for a number of years or are available in inexpensive generic forms. With respect to PROVIGIL, and, when launched, 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. With respect to FENTORA, we face competition from numerous short-and long-acting opioid products, including three products—Johnson & Johnson’s DURAGESIC® and Purdue Pharmaceutical’s OXYCONTIN® and MS-CONTIN®—that dominate the market. In addition, we are aware of numerous other companies developing other technologies for rapidly delivering opioids to treat breakthrough pain that will compete against FENTORA in the market for breakthrough cancer pain in opioid-tolerant patients. It also is possible that the existence of generic OTFC could negatively impact the growth of FENTORA. With respect to ACTIQ, generic competition from Barr has meaningfully eroded branded ACTIQ sales and impacted sales of our own generic OTFC through Watson. Our generic sales also could be significantly impacted by the entrance into the market of additional generic OTFC products, which could occur at any time. With respect to VIVITROL, we face competition from CAMPRAL® and oral naltrexone. With respect to TRISENOX, the pharmaceutical market for the treatment of patients with relapsed or refractory APL is served by a number of available therapeutics, such as VESANOID® by Roche in combination with chemotherapy. With respect to AMRIX, we face significant competition from SKELAXIN®, FLEXERIL® and other inexpensive generic forms of muscle relaxants.

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.

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

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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 acquisitions of Zeneus, Salmedix and TRISENOX and the license and collaboration agreement with Alkermes in 2005, 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. Integration efforts often take a significant amount of time, place a significant strain on our managerial, operational and financial resources and could prove to be more difficult and expensive than we predicted. The diversion of our management’s attention and any delays or difficulties encountered in connection with these recent acquisitions, and any future acquisitions we may consummate, could result in the disruption of our ongoing business or inconsistencies in standards, controls, procedures and policies that could negatively affect our ability to maintain relationships with customers, suppliers, employees and others with whom we have business dealings.

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

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

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

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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, 2006 through November 1, 2007 our common stock traded at a high price of $84.83 and a low price of $51.58. 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 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.

During 2008, we expect to expand our SAP® implementation to include additional capabilities. This expansion will require changes to certain aspects of our existing system of internal controls over financial reporting. Due to the number of controls to be examined, both with respect to this phase of the implementation and our other internal controls over financial reporting, the complexity of our processes, 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 nine months ended September 30, 2007, 19% of our revenues were denominated in currencies other than the U.S. dollar. We translate revenues earned and expenses incurred into U.S. dollars at the average exchange rate

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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 66% of our total consolidated gross sales for the nine months ended September 30, 2007. 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.

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 8 of the Consolidated Financial Statements included in Part I, Item 1 of this Quarterly Report on Form 10-Q. 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

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fines and remedial costs. These damages could require payment by us of significant amounts over a number of years, which could adversely affect our results of operations and financial condition.

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

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

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

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ITEM 5. OTHER INFORMATION

(In thousands)

Computation of Ratios of Earnings to Fixed Charges

	Year ended												Nine months  ended
	December 31,												September 30,
	2002		2003		2004			2005			2006		2007
Determination of earnings:
Pre-tax income (loss) from continuing operations	$	62,433	$	130,314	$	(28,184	)	$	(245,118	)	$	238,254	$	(133,273	)
Add:
Amortization of interest capitalized in current or prior periods	—		—		—			—			52		74
Fixed charges	39,648		31,191		25,623			30,985			28,171		21,922
Total earnings	$	102,081	$	161,505	$	(2,561	)	$	(214,133	)	$	266,477	$	(111,277	)
Fixed charges:
Interest expense and amortization of debt discount and premium on all indebtedness	38,215		28,905		22,186			25,235			18,922		15,272
Appropriate portion of rentals	1,433		2,286		3,437			5,750			9,249		6,650
Fixed charges	39,648		31,191		25,623			30,985			28,171		21,922
Capitalized interest	—		—		—			1,044			1,766		580
Total fixed charges	$	39,648	$	31,191	$	25,623		$	32,029		$	29,937	$	22,502
Ratio of earnings to fixed charges(1)	2.57		5.18		—			—			8.90		—
Deficiency of earnings to fixed charges	—		—		28,184			246,162			—		133,779

(1)For the years ended December 31, 2004 and 2005 and the nine months ended September 30, 2007, no ratios are provided because earnings were insufficient to cover fixed charges.

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ITEM 6. EXHIBITS

Exhibit No.	Description
10.1*	Asset Purchase Agreement by and between Anesta AG and E. Claiborne Robins Company, Inc., dated as of August 23, 2007. (1)
31.1*	Certification of Frank Baldino, Jr., Ph.D., Chairman and Chief Executive Officer of the Company, as required pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
31.2*	Certification of J. Kevin Buchi, Executive Vice President and Chief Financial Officer of the Company, as required pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
32.1#	Certification of Frank Baldino, Jr., Ph.D., Chairman and Chief Executive Officer of the Company, as required pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
32.2#	Certification of J. Kevin Buchi, Executive Vice President and Chief Financial Officer of the Company, as required pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

*Filed herewith.

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

(1)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.

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SIGNATURES

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

	CEPHALON, INC.
	(Registrant)
November 8, 2007	By	/s/ FRANK BALDINO, JR.
		Frank Baldino, Jr., Ph.D.
		Chairman and Chief Executive Officer
		(Principal executive officer)
	By	/s/ J. KEVIN BUCHI
		J. Kevin Buchi
		Executive Vice President and Chief Financial Officer
		(Principal financial and accounting officer)

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