ACQUISITIONS AND TRANSACTIONS

6 Months Ended

Jun. 30, 2011

ACQUISITIONS AND TRANSACTIONS

ACQUISITIONS AND TRANSACTIONS

2.   ACQUISITIONS AND TRANSACTIONS

Merger Agreement with Teva Pharmaceuticals, Ltd.

On May 2, 2011, we entered into a definitive Agreement and Plan of Merger (the “Merger Agreement”) with Teva Pharmaceutical Industries Ltd. (“Teva”), pursuant to which, upon consummation of the merger, the Company will become a wholly owned subsidiary of Teva.

Pursuant to the terms of the Merger Agreement and subject to the conditions thereof, stockholders of the Company will be entitled to receive $81.50 per share in cash for each share of our common stock.  Also, each outstanding Company stock option and stock appreciation right will be converted into an amount in cash per share equal to the excess, if any, of $81.50 over the exercise price per share.

The Merger Agreement may be terminated under certain circumstances.  If the Merger Agreement is terminated pursuant to specific conditions, we will be required to pay Teva a termination fee of $275 million.

The transaction is subject to the satisfaction of customary closing conditions, including expiration of the waiting period under the Hart-Scott-Rodino Antitrust Improvements Act and clearance by the European Commission under the EC Merger Regulation.  In July 2011, at a special meeting of our stockholders, our stockholders approved the proposed merger with Teva.  The transaction is expected to be completed in October 2011.

ChemGenex Pharmaceuticals Limited

In 2010, we signed a convertible note subscription agreement with ChemGenex Pharmaceuticals Limited, an Australian-based oncology focused biopharmaceutical company (“ChemGenex”).  Under the terms of the agreement, we provided Australian Dollar (“A$”) $15 million to ChemGenex in return for a note that was convertible at A$0.50 per share.  The funding will support ChemGenex operations, including clinical activities to complete a planned New Drug Application submission to the U.S. Food and Drug Administration for their lead product candidate, OMAPRO® for the treatment of chronic myelogenous leukemia (CML) patients who have failed two or more tyrosine kinase inhibitor (TKIs).  Separately, we also entered into option agreements with two of ChemGenex’s major shareholders, Stragen International N.V. and Merck Santé S.A.S.  Under those option agreements, we had the right to acquire up to an additional 19.9% of ChemGenex’s outstanding shares at A$0.70 per share before the later of March 31, 2011, and ten business days after receipt of certain clinical trial data and related analyses from ChemGenex (the “Exercise Period”).  At December 31, 2010 the notes were accounted for under the fair value option.  Additionally, the option to purchase the 19.9% of ChemGenex shares was a freestanding derivative and was marked to market. The convertible notes and purchase option assets of $9.9 million and $0.9 million were included within long-term investments and other current assets on our December 31, 2010 consolidated balance sheet, respectively.

In March 2011, we provided notice to convert our convertible notes and elected to exercise our call options for $40.6 million resulting in the acquisition of a 27.6% interest of total issued share capital in ChemGenex.  The change in fair value of our investment in ChemGenex notes and the purchase options between December 31, 2010 and the conversion date was recorded as a change in fair value of investments within other income (expense) on the consolidated statement of operations.  At March 31, 2011, we believed our 27.6% interest in ChemGenex allowed us to exercise significant influence over ChemGenex and therefore considered our investment to be an equity method investment.  We elected to account for our equity method investment under the fair value option.  We measured the fair value of our investment utilizing the company’s publicly traded stock price. On March 31, 2011, the ChemGenex stock price was A$0.64 and we remeasured the fair value of our equity interest at $56.7 million.  We recorded the difference between the consideration paid for the options and fair value at the date of acquisition as a change in fair value of investments within other income (expense) on the statement of operations.

In April 2011 we launched our takeover offer for ChemGenex (through our wholly owned subsidiary Cephalon CXS Holdings Pty ltd.).  The offer terms consist of the following:

· Payment of  A$0.70 cash for each ChemGenex Share, cum dividend rights

· An offer of A$0.02 cash for each ASX listed ChemGenex Option

The offer has the support of the ChemGenex independent directors and was recommended to ChemGenex shareholders in the absence of a superior offer. The offer was subject to certain basic conditions including a 90% minimum acceptance condition.  The acquisition of ChemGenex (including its lead product OMAPRO) allows us to further diversify our oncology pipeline.

On June 6, 2011, Cephalon had acquired a total of 90.6% of the ChemGenex shares.  As a result, effective on that date, we have included ChemGenex in our consolidated financial statements.  As of June 30, 2011, Cephalon had a 93.4% interest and Cephalon achieved a 100% relevant interest in ChemGenex on July 21, 2011.   At a price of A$0.70 per ordinary share, acquired pursuant to the takeover offer and the compulsory acquisition, the funds used to acquire ChemGenex shares were approximately $164.6 million, net of $5.6 million in gains on foreign exchange contracts, of which approximately $14.9 million is for shares to be acquired after June 30, 2011.  Total consideration to be paid for ChemGenex Shares including the convertible notes and share options exercised in the first quarter of 2011 is $220.0 million.

The fair value of our ChemGenex holdings of approximately 27.6% immediately prior to the acquisition on June 6, 2011 was $64.9 million.  The investment was remeasured to fair value on the acquisition date, with the increase of $8.3 million over the March 31, 2011 value recognized in change in fair value of investment in other income (expense) during the second quarter of 2011.

The following summarizes the carrying amounts and classification of ChemGenex’s assets and liabilities included in our consolidated balance sheet as of June 6, 2011:

	June 6, 2011
Cash and cash equivalents	$	11,114
Other current assets	239
Property and equipment, net	153
Goodwill	393
Intangible assets	230,700
Deferred tax assets	3,007
Accounts payable	3,950
Accrued expenses	5,989
Noncontrolling interest	22,075

The acquisition accounting is being finalized.  There is no goodwill recognized or deductible for tax purposes.  Intangible assets are attributable to OMAPRO and are recognized as in process research and development.

In 2011, we entered into a series of foreign exchange forward contracts and foreign exchange option contracts related to our ChemGenex transaction.  Together, these contracts protect against fluctuations between the Australian dollar and the U.S Dollar and changes in the value of these contracts are recognized within net income.  These forward exchange contracts settled in June 2011.  For the three and six months ended June 30, 2011, we recognized a gain of $5.6 million from the increase in fair value of these foreign exchange contracts.  For the three and six months ended June 30, 2011, we have included of $2.5 million of net losses related to ChemGenex in our consolidated results.  If we had acquired ChemGenex at the beginning of 2010, we would have recognized an additional $16.0 million of operating expenses for the year ended December 31, 2010.

Gemin X Pharmaceuticals

In April 2011, we acquired all of the outstanding capital stock of Gemin X Pharmaceuticals, Inc. (“Gemin X”), a privately-held biopharmaceutical company developing first-in-class cancer therapeutics, for $225 million cash on a cash-free, debt-free basis, or $190 million closing date cash consideration net of cash, debt, and transaction costs. Gemin X stockholders could also receive up to $300 million in cash payments upon the achievement of certain regulatory and sales milestones. There are no royalty obligations to Gemin X stockholders. The fair value of the consideration transferred to acquire Gemin X was $287.1 million. Gemin X lead product candidate, OBATOCLAX ®, is a Pen Bel-2 inhibitor with particular potency for the dominant protein Mel-1, for use in patients with small cell lung cancer. The acquisition of Gemin X allows us to further diversify our oncology pipeline.

The following summarizes the carrying amounts and classification of Gemin X’s assets and liabilities included in our consolidated balance sheet as of April 18, 2011:

	April 18, 2011
Cash and cash equivalents	$	5,828
Accounts receivable	248
Other current assets	196
Property and equipment, net	722
Goodwill	3,970
Intangible assets	333,300
Deferred tax assets	2,276
Current portion of long-term debt	836
Accrued expenses	7,743
Deferred tax liabilities, net	17,299
Long-term debt	33,526

The acquisition accounting is being finalized.  Goodwill is attributable to deferred taxes and is allocated to the United States segment. There is no goodwill recognized or deductible for tax purposes.  Intangible assets are attributable to OBATOCLAX and are recognized as in process research and development.

The acquisition of Gemin X includes contingent consideration arrangements that may require additional consideration to be paid by the company in the form of milestone payments. It is currently estimated that milestone payments will occur in the years 2015, 2016, 2019 and 2021. The range of undiscounted amounts we could be required to pay under our agreement is between zero and $300.0 million. We determined the fair value of the liability for the contingent consideration based on a probability-weighted discounted cash flow analysis. This fair value measurement is based on significant inputs not observable in the market and thus represents a Level 3 measurement within the fair value hierarchy. The fair value of the contingent consideration liability associated with future milestone payments was based on several factors described more fully in Note 7 herein.

The fair value of the liability for the contingent consideration recognized on the acquisition date of Gemin X was $97.1 million. The contingent consideration payments have been recorded as a liability and the fair value will be evaluated quarterly or more frequently if circumstances dictate. Changes in the fair value of contingent consideration will be recorded in earnings. The change in fair value that was recognized as an operating expense for the period between April 18 and June 30, 2011 was $0.9 million. At June 30, 2011, the fair value of the liability was $98.0 million.  For the quarter ended June 30, 2011, we have included of $3.0 million of net losses related to Gemin X in our consolidated results.  If we had acquired Gemin X at the beginning of 2010, we would have recognized an additional $13.5 million of operating expenses for the year ended December 31, 2010.

Alba Therapeutics Corporation

In February 2011, we entered into agreements with Alba Therapeutics Corporation (“Alba”), a privately held biopharmaceutical company, providing us an option to purchase all of Alba’s assets relating to larazotide acetate, a tight junction modulator, progressing toward a Phase IIb clinical trial for the treatment of celiac disease. Under the terms of the option agreement, we paid Alba a $7 million upfront option payment and agreed to provide a credit facility of up to $22 million to fund Alba’s Phase IIb clinical trial expenses. We may exercise the option at any time prior to expiration of a specified period after receipt of the final study report for the Phase IIb clinical trial. If we exercise the option, we will purchase all of Alba’s assets relating to larazotide acetate for $15 million.  As of June 30, 2011, we have provided $10.0 million in loans to Alba under the credit facility.  Alba could receive additional payments related to clinical and regulatory milestones.

We have determined that, because of our rights under the Alba option agreement, effective February 9, 2011, Alba is a variable interest entity (“VIE”) for which we are the primary beneficiary.  As a result, as of February 9, 2011 we have included the financial condition and results of operations of Alba in our consolidated financial statements.  However, we do not have an equity interest in Alba and, therefore, we have allocated the Alba losses to noncontrolling interest in the consolidated statement of operations.   If the Alba option expires unexercised, we will deconsolidate Alba and recognize a loss of $7.0 million, equal to our investment in Alba, plus any outstanding borrowings under the credit facility.  It is also expected the loans under the $22 million credit facility will be forgiven in all cases with the exception of an event of default by Alba.  We have therefore, considered the $22 million in estimating the fair value of Alba. Alba did not have a material impact on our revenues or earnings attributable to our Cephalon shareholders for the period ended June 30, 2011 or on a pro forma basis for the periods ended June 30, 2011 and 2010.  Alba is included in our U. S. operating segment.

The following summarizes the carrying amounts and classification of Alba’s assets and liabilities included in our consolidated balance sheet as of February 9, 2011 and June 30, 2011:

	February 9,  2011		June 30, 2011
Cash and cash equivalents	$	15,513	$	9,890
Other current assets	45		168
Property and equipment, net	4		18
Goodwill	2,118		2,118
Intangible assets	40,000		40,000
Current portion of long-term debt, net	3,560		3,560
Accounts payable	3,167		586
Accrued expenses	953		1,159
Noncontrolling interest	33,000		29,797

Alba’s intangible assets represent in process research and development related to larazotide acetate.

Although Alba is included in our consolidated financial statements, our interest in Alba’s assets are limited to that accorded to us in the agreements with Alba as described above.  Alba’s creditors have no recourse to the general credit of Cephalon.

SymBio Pharmaceuticals Limited

In February 2011 Cephalon purchased additional common shares of SymBio for approximately $9.4 million.  As of June 30, 2011, Cephalon holds an 18.5% interest in SymBio.  Our investment in Symbio is recorded as a cost basis investment.

Mesoblast Limited

In December, 2010, we entered into a strategic alliance with Mesoblast Limited (“Mesoblast”) to develop and commercialize novel adult Mesenchymal Precursor Stem Cell (MPC) therapeutics for degenerative conditions of the cardiovascular and central nervous systems. These conditions include Congestive Heart Failure, Acute Myocardial Infarction, Parkinson’s Disease, and Alzheimer’s Disease. The alliance also extends to products for augmenting hematopoietic stem cell transplantation in cancer patients.

As part of the development and commercialization agreement, in exchange for exclusive world-wide rights to commercialize specific products based on Mesoblast’s proprietary adult stem cell technology platform, we agreed to pay Mesoblast a nonrefundable up front payment of $130 million. In December 2010, we paid $100.0 million, which was expensed as acquired in process research and development expense.  In February 2011, we paid and expensed, as acquired in process research and development expense, the remaining $30 million of upfront fees as part of the collaboration agreement, as we received Mesoblast shareholder and regulatory approval for us to purchase additional shares, as agreed to under our share purchase agreement.

Additionally, in 2010 we made a $133.9 million equity investment in Mesoblast common stock, representing a 12.2% interest in the company, included in non-current assets on our consolidated balance sheet. In February 2011, we acquired an additional 7.8% interest in Mesoblast, for $109.1 million.  We believe we exercise significant influence over the company due to our ownership of 20.0%, our Chief Executive Officer holding a voting seat on the Mesoblast Board of Directors and the existence of various revenue arrangements between us and Mesoblast. Therefore, we consider our investment in Mesoblast to be an equity method investment.  We have elected to account for our equity method investment under the fair value option. We measured the fair value of our investment at the date of acquisition and prospectively utilizing the company’s publicly traded stock price.  As of December 31, 2010, our existing 12.2% interest was valued at A$4.67 per share or $145.9 million.  On the date we acquired the additional 7.8% interest, Mesoblast’s share price was A$5.57 per share and the fair value of our additional investment was $138.1 million.  We recorded the difference between the consideration paid and fair value at the date of acquisition as a change in fair value of investments within other income (expense) on the statement of operations.  On June 30, 2011, Mesoblast’s share price was A$8.65 and we remeasured the fair value of our entire  investment at $505.8 million.  The change in fair value between December 31, 2010 for our existing 12.2% investment and since the date of acquisition for our additional 7.8% investment in February 2011 was also recorded as a change in fair value of investments within other income (expense) on the consolidated statement of operations.  The total change in fair value of investments recorded for the three and six months ended June 30, 2011 was $91.2 million and $250.8 million, respectively.  We consider Mesoblast a related party.

With respect to each product the Company chooses to commercialize, Mesoblast could receive up to $1.7 billion upon the achievement of certain regulatory milestones.  The $1.7 billion of milestone payments is estimated based on the approval of the product for the treatment of ten indications in various territories.  Mesoblast will be responsible for the conduct and expenses of certain Phase IIa clinical trials and commercial supply of the products.  Cephalon will be responsible for the conduct and expenses of all Phase IIb and III clinical trials and subsequent commercialization of the products.  If the products are commercially sold, Mesoblast will retain all manufacturing rights and will receive a percentage of net product sales.

Mepha GmbH

During the first quarter of 2011, we finalized the acquisition accounting for certain tax liabilities, which resulted in an adjustment to goodwill of $3.0 million.  The acquisition accounting for the Mepha acquisition is now complete.