**SECURITIES AND EXCHANGE COMMISSION**

**Washington,D.C. 20549**

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**FORM 10-Q/A**

**AMENDMENT NO.  1**

**(Mark One)**

| **x** | **QUARTERLY REPORT PURSUANT TO SECTION 13 OR  15(d) OF THE SECURITIES EXCHANGE ACT OF 1934** |
|-------|--------------------------------------------------------------------------------------------------------|

 

**Forthe Quarterly Period Ended March 31, 2006**

**or**

| **o** | **TRANSITION REPORT PURSUANT TO SECTION 13 OR  15(d) OF THE SECURITIES EXCHANGE ACT OF 1934** |
|-------|---------------------------------------------------------------------------------------------------------|

 

**Forthe transition periodfrom                  to**

**Commissionfile number 0-19410**

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**Sepracor Inc.**

(Exact name of registrantas specified in its charter)

| **Delaware**                                                     | **22-2536587**                     |
|------------------------------------------------------------------|------------------------------------|
| (State or Other  Jurisdiction of  Incorporation or Organization) | (IRS Employer  Identification No.) |
| **84 Waterford Drive  Marlborough, Massachusetts**               | **01752**                          |
| (Address of  Principal Executive Offices)                        | (Zip Code)                         |

 

Registrant’s telephonenumber, including area code: **(508) 481-6700**

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Indicate by check markwhether the registrant: (1) has filed all reports required to be filed by Section 13or 15(d) of the Securities Exchange Act of 1934 during the preceding12 months (or for such shorter period that the registrant was required tofile such reports) and (2) has been subject to such filing requirementsfor the past 90 days. Yes x  No o

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

Large accelerated file x    Accelerated filer o    Non-acceleratedfiler o

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

Thenumber of shares outstanding of the registrant’s class of Common Stock as of May 1,2006 was: 108,749,416 shares.

 

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**EXPLANATORY NOTE**

**Restatement of ConsolidatedFinancial Statements**

We are filing thisAmendment No. 1 to our Quarterly Report on Form 10-Q for the three months endedMarch 31, 2006, originally filed on May 9, 2006, which werefer to as the March 31, 2006 Form 10-Q, to restate our consolidated balance sheets as ofMarch 31, 2006, our consolidated statements of operations and comprehensiveincome (loss) for the three months ended March 31, 2006 and 2005, and ourconsolidated statements of cash flows for the three months ended March 31, 2006and 2005. Please refer to Note 11 to the accompanying condensed consolidated financial statements for additionalinformation. 

In June 2006, we werecontacted by the Securities and Exchange Commission, or SEC, with respect toour option practices.In June 2006, we appointed a special committee of outside directors to conductan internal review relating to our stock option grants and stock optionpractices. The special committee, with the assistance of outside legal counseland outside accounting specialists, reviewed the stock option grants to ourofficers, directors and employees from 1996 to the present under our variousstock option plans in effect during this period. Our finance department has also reviewed the stockoption grants and stock option practices from 1996 to present.

Based on these reviews, wehave determined that the measurement dates for certain stock option grants toemployees, officers and directors during prior periods differed from therecorded dates for such awards primarily due to the following circumstances:(i) stock option grants which specified effective dates that may have precededthe dates of receipt of all necessary signatures or approvals, finalization oflists specifying stock option grants or an employee’s first date of employment;and (ii) stock option awards that were approved with exercise prices lower thanfair market value on the effective date of grant. In addition, we havedetermined that (a) the modification of certain stock option grants inconnection with an employee’s termination of employment and (b) the exercise ofcertain stock options that had not vested prior to an employee’s termination resulted in a new measurementdate for such stock options. As a result, we are required to record non-cash adjustments for additional stock-based compensation.  Forperiods prior to January 1, 2006, such charges are recorded in accordancewith AccountingPrinciples Board, or APB, No. 25, “Accountingfor Stock Issued to Employees’’, or APB 25, and for subsequent periods inaccordance with Statement of Financial Accounting Standards No. 123(R),“Share-Based Payment”, or SFAS 123(R),  for the three months ended March 31, 2006 and 2005. These non-cash charges had no impact on previouslyreported revenues, cash or cash equivalents or total assets.

Although the specialcommittee has completed its review, the committee will remain in place for theduration of the SEC's inquiry. Should additional information become availableto us in connection with the SEC inquiry, the special committee may be requiredto reopen its review and our current determination of stock-based compensationcould change.

On August 9, 2006, our audit committeeconcluded that our consolidated financial statements referred to above shouldbe restated to record the additional non-cashstock-based compensation expense items that had been incorrectly accounted for under generally acceptedaccounting principles, or GAAP.  As wehave previously announced, the consolidated financial statements and relatedfinancial information contained in such previously filed reports should nolonger be relied upon. We have not modified or updateddisclosures presented in the March 31, 2006 Form 10-Q in this Form 10-Q/A, except as required toreflect the effects of the items discussed above. Accordingly, this Form 10-Q/Adoes not reflect events occurring after the filing of the March 31, 2006 Form 10-Q or modify or update those disclosures affected bysubsequent events or discoveries.  Therefore,this Form 10-Q/A should be read in conjunction with the filings we havemade with the SEC subsequent to the filing of the March 31, 2006 Form 10-Q, including our amended filings.

We have acceptedservice of three stockholderderivative complaints relating to certain of our stock option grants were filedin the Superior Court, Middlesex County, Commonwealth of Massachusetts, namingSepracor as nominal defendant and also naming as defendants certain currentmembers of our board of directors and certain of our current and formeremployees. The complaints allege purported 

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breaches of fiduciary duties and unjust enrichmentin connection with certain stock option grants made by us betweenJune 1998 and May 2001. The complaints seek monetary damages inunspecified amounts, equitable and injunctive relief, including disgorgement ofprofits obtained by certain defendants and other relief as determined by theCourt. On August 30, 2006, the parties in all threeactions moved to consolidate the actions and to transfer them to the BusinessLitigation Session of the Superior Court, Suffolk County.

For the convenience of the reader, thisForm 10-Q/A restates the March 31, 2006 Form 10-Q in its entirety. However, we have only amendeddisclosures presented in the March 31, 2006 Form 10-Q as required to reflect the matters described above and, accordingly, have amendedonly the following items:

·  Part I—Item 1—FinancialInformation

·  Part I—Item 2—Management’sDiscussion and Analysis of Financial Condition and Results of Operations

·  Part I—Item 4—Controlsand Procedures

·  Part II—Item 1—Legal Proceedings

·  Part II—Item 6—Exhibits

In addition, in accordancewith applicable SEC rules, this Form 10-Q/A includes updated certificationsfrom our Chief Executive Officerand Chief Financial Officeras Exhibits 31.1, 31.2, 32.1 and 32.2.

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**SEPRACOR INC.**

**INDEX**

| **Part I—Financial Information** |                                                                                                                              |
|--------------------------------------------|-----------------------------------------------------------------------------------------------------------------------------------|
| Item 1.                                    | Condensed Consolidated Financial Statements  (Unaudited)                                                                          |   |
|                                       | Consolidated  Balance Sheets as of March 31, 2006 and December 31, 2005  (Restated and Unaudited)                       | 3 |
|                                       | Consolidated Statements of Operations for the Three  Months Ended  March 31, 2006 and 2005 (Restated  and Unaudited)    | 4 |
|                                       | Consolidated Statements of Cash Flows for the Three  Months Ended March 31, 2006 and 2005 (Restated and Unaudited) | 5 |
|                                       | Notes to Condensed Consolidated Interim Financial  Statements (Restated and Unaudited)                                            | 6 |
| Item 2.                                    | Management’s  Discussion and Analysis of Financial Condition and Results  of Operations                                      | 15 |
| Item 3.                                    | Quantitative and Qualitative Disclosures About Market  Risk                                                                       | 26 |
| Item 4.                                    | Controls and Procedures                                                                                                           | 26 |
| **Part II—Other Information**    |                                                                                                                              |
| Item  1.                                   | Legal  Proceedings                                                                                                                | 27 |
| Item 1A.                                   | Risk Factors                                                                                                                      | 28 |
| Item 6.                                    | Exhibits                                                                                                                          | 44 |
|                                       | Signatures                                                                                                                        | 45 |
|                                       | Exhibit Index                                                                                                                | 46 |

 

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**SEPRACOR INC.**

**CONSOLIDATED BALANCE SHEETS**

**(Unaudited)**

**(InThousands)**

| ** **                                                                                                                                                                                                                                                             | ** ** | **March 31,  2006** | ** ** | **December 31,  2005** | ** ** |
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|--------------------------|------------|-----------------------------|------------|
| ** **                                                                                                                                                                                                                                                             | ** ** | **(as  restated)**       | ** ** | **(as  restated)**          | ** ** |
| **Assets**                                                                                                                                                                                                                                                             |       |                     |       |                        |       |
| Current assets:                                                                                                                                                                                                                                                        |       |                     |       |                        |       |
| Cash and cash equivalents                                                                                                                                                                                                                                              |       | $                        | 119,335    |                        | $          | 178,144 |   |
| Short-term investments                                                                                                                                                                                                                                                 |       | 685,697                  |       | 666,615                     |       |
| Accounts receivable, net                                                                                                                                                                                                                                               |       | 150,602                  |       | 140,465                     |       |
| Inventories                                                                                                                                                                                                                                                            |       | 42,779                   |       | 38,951                      |       |
| Other assets                                                                                                                                                                                                                                                           |       | 33,355                   |       | 22,370                      |       |
| Total current  assets                                                                                                                                                                                                                                                  |       | 1,031,768                |       | 1,046,545                   |       |
| Long-term investments                                                                                                                                                                                                                                                  |       | 155,169                  |       | 131,442                     |       |
| Property and equipment, net                                                                                                                                                                                                                                            |       | 74,667                   |       | 72,467                      |       |
| Investment in affiliate                                                                                                                                                                                                                                                |       | 5,460                    |       | 5,829                       |       |
| Deferred financing costs and patents, net                                                                                                                                                                                                                              |       | 16,606                   |       | 18,097                      |       |
| Other assets                                                                                                                                                                                                                                                           |       | 117                      |       | 117                         |       |
| Total assets                                                                                                                                                                                                                                                           |       | $                        | 1,283,787  |                        | $          | 1,274,497 |   |
| **Liabilities  and Stockholders’ Equity (Deficit)**                                                                                                                                                                                                               | ** ** | ** **               | ** ** | ** **                  | ** ** |
| Current liabilities:                                                                                                                                                                                                                                                   |       |                     |       |                        |       |
| Accounts payable                                                                                                                                                                                                                                                       |       | $                        | 26,685     |                        | $          | 11,544 |   |
| Accrued expenses                                                                                                                                                                                                                                                       |       | 116,218                  |       | 187,409                     |       |
| Current portion of notes payable and capital lease  obligation                                                                                                                                                                                                         |       | 1,539                    |       | 2,030                       |       |
| Other current liabilities                                                                                                                                                                                                                                              |       | 105,014                  |       | 76,923                      |       |
| Total current  liabilities                                                                                                                                                                                                                                             |       | 249,456                  |       | 277,906                     |       |
| Notes payable and capital lease obligation                                                                                                                                                                                                                             |       | 1,164                    |       | 1,260                       |       |
| Convertible subordinated debt                                                                                                                                                                                                                                          |       | 1,160,820                |       | 1,160,820                   |       |
| Total liabilities                                                                                                                                                                                                                                                      |       | 1,411,440                |       | 1,439,986                   |       |
| Stockholders’  equity (deficit):                                                                                                                                                                                                                                  |       |                     |       |                        |       |
| Preferred stock, $1.00 par value, 1,000 shares  authorized; none outstanding at March 31, 2006 and December 31,  2005                                                                                                                                        |       | —                   |       | —                      |       |
| Common stock, $.10 par value, 240,000 shares  authorized at March 31, 2006 and December 31, 2005, respectively;  108,729 and 108,354 shares issued, 104,468 and 104,093 shares outstanding, at  March 31, 2006 and December 31, 2005, respectively |       | 10,873                   |       | 10,835                      |       |
| Treasury stock, at cost (4,261 and 4,261 shares at  March 31, 2006 and December 31, 2005, respectively)                                                                                                                                                 |       | (232,028                 | )          | (232,028                    | )          |
| Additional paid-in capital                                                                                                                                                                                                                                             |       | 1,728,650                |       | 1,711,653                   |       |
| Accumulated deficit                                                                                                                                                                                                                                                    |       | (1,652,591               | )          | (1,662,627                  | )          |
| Accumulated other comprehensive income                                                                                                                                                                                                                                 |       | 17,443                   |       | 6,678                       |       |
| Total  stockholders’ equity (deficit)                                                                                                                                                                                                                             |       | (127,653                 | )          | (165,489                    | )          |
| Total liabilities and  stockholders’ equity (deficit)                                                                                                                                                                                                             |       | $                        | 1,283,787  |                        | $          | 1,274,497 |   |

 

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

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**SEPRACOR INC.**

**CONSOLIDATED STATEMENTS OF OPERATIONS**

**(Unaudited)**

**(InThousands, Except Per Share Amounts)**

| ** **                                                                      | ** ** | **Three Months Ended**        | ** ** |
|---------------------------------------------------------------------------------|------------|-----------------------------------------|------------|
| ** **                                                                      | ** ** | **March 31,  2006  (as restated)** | ** ** | **March 31,   2005  (as restated)** | ** ** |
| Revenues:                                                                       |       |                                    |       |   |   |   |   |   |   |
| Product sales                                                                   |       |                                    | $          | 277,505 |   |   |   | $ | 106,648 |   |   |
| Royalties                                                                       |       |                                    | 8,173      |   |   |   | 12,397 |   |   |
| Total revenues                                                                  |       |                                    | 285,678    |   |   |   | 119,045 |   |   |
| Costs and expenses:                                                             |       |                                    |       |   |   |   |   |   |   |
| Cost of product sold                                                            |       |                                    | 25,533     |   |   |   | 10,037 |   |   |
| Cost of royalties                                                               |       |                                    | 159        |   |   |   | 203 |   |   |
| Research and development                                                        |       |                                    | 49,269     |   |   |   | 28,569 |   |   |
| Selling, marketing and distribution                                             |       |                                    | 189,991    |   |   |   | 93,207 |   |   |
| General and administrative                                                      |       |                                    | 14,508     |   |   |   | 8,707 |   |   |
| Total costs and expenses                                                        |       |                                    | 279,460    |   |   |   | 140,723 |   |   |
| Income (loss) from operations                                                   |       |                                    | 6,218      |   |   |   | (21,678 | ) |   |
| Other income (expense):                                                         |       |                                    |       |   |   |   |   |   |   |
| Interest income                                                                 |       |                                    | 9,794      |   |   |   | 5,248 |   |   |
| Interest expense                                                                |       |                                    | (5,551     | ) |   |   | (5,842 | ) |   |
| Equity in investee losses                                                       |       |                                    | (258       | ) |   |   | (168 | ) |   |
| Other expense                                                                   |       |                                    | (56        | ) |   |   | (394 | ) |   |
| Income (loss) before income taxes                                               |       |                                    | 10,147     |   |   |   | (22,834 | ) |   |
| Income taxes                                                                    |       |                                    | 111        |   |   |   | — |   |   |
| Net income (loss) after income taxes                                            |       |                                    | $          | 10,036 |   |   |   | $ | (22,834 | ) |   |
| Basic net income (loss) per common share                                        |       |                                    | $          | 0.10 |   |   |   | $ | (0.22 | ) |   |
| Diluted net income (loss) per common share                                      |       |                                    | $          | 0.09 |   |   |   | $ | (0.22 | ) |   |
| Shares used in computing  basic and diluted net income (loss) per common share: |       |                                    |       |   |   |   |   |   |   |
| Basic                                                                           |       |                                    | 104,292    |   |   |   | 103,593 |   |   |
| Diluted                                                                         |       |                                    | 115,470    |   |   |   | 103,593 |   |   |

 

The accompanying notes are an integral part of the condensed consolidated financial statements

4

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**SEPRACOR INC.**

**CONSOLIDATEDSTATEMENTS OF CASH FLOWS**

**(Unaudited)**

**(In Thousands)**

| ** **                                                                            | ** ** | **Three Months Ended**        | ** ** |
|---------------------------------------------------------------------------------------|------------|-----------------------------------------|------------|
| ** **                                                                            | ** ** | **March 31,  2006  (as restated)** | ** ** | **March 31,  2005  (as restated)** | ** ** |
| Cash flows from  operating activities:                                                |       |                                    |       |   |   |   |   |   |   |
| Net income (loss)                                                                     |       |                                    | $          | 10,036 |   |   |   | $ | (22,834 | ) |   |
| Adjustments to reconcile  net income (loss) to net cash used in operating activities: |       |                                    |       |   |   |   |   |   |   |
| Depreciation and amortization                                                         |       |                                    | 4,968      |   |   |   | 4,256 |   |   |
| Equity in investee losses                                                             |       |                                    | 258        |   |   |   | 168 |   |   |
| Stock compensation                                                                    |       |                                    | 10,048     |   |   |   | 261 |   |   |
| Changes in operating  assets and liabilities:                                         |       |                                    |       |   |   |   |   |   |   |
| Accounts receivable                                                                   |       |                                    | (10,137    | ) |   |   | 6,657 |   |   |
| Inventories                                                                           |       |                                    | (3,836     | ) |   |   | (2,888 | ) |   |
| Other current assets                                                                  |       |                                    | (10,976    | ) |   |   | (2,537 | ) |   |
| Accounts payable                                                                      |       |                                    | 15,138     |   |   |   | (1,095 | ) |   |
| Accrued expenses                                                                      |       |                                    | (71,196    | ) |   |   | (40,389 | ) |   |
| Other current liabilities                                                             |       |                                    | 28,130     |   |   |   | (2,850 | ) |   |
| Net cash used in  operating activities                                                |       |                                    | (27,567    | ) |   |   | (61,251 | ) |   |
| Cash flows from  investing activities:                                                |       |                                    |       |   |   |   |   |   |   |
| Purchases of short and long-term investments                                          |       |                                    | (333,674   | ) |   |   | (278,090 | ) |   |
| Sales and maturities of short and long-term  investments                              |       |                                    | 310,825    |   |   |   | 84,881 |   |   |
| Additions to property and equipment                                                   |       |                                    | (5,833     | ) |   |   | (2,636 | ) |   |
| Investment in non-affiliate                                                           |       |                                    | (8,939     | ) |   |   | (7,143 | ) |   |
| Net cash used in  investing activities                                                |       |                                    | (37,621    | ) |   |   | (202,988 | ) |   |
| Cash flows from  financing activities:                                                |       |                                    |       |   |   |   |   |   |   |
| Net proceeds from issuance of common stock                                            |       |                                    | 6,987      |   |   |   | 4,074 |   |   |
| Repayments of long-term debt and capital  leases                                      |       |                                    | (588       | ) |   |   | (463 | ) |   |
| Net cash provided  by financing activities                                            |       |                                    | 6,399      |   |   |   | 3,611 |   |   |
| Effect of exchange  rate changes on cash and cash equivalents                         |       |                                    | (20        | ) |   |   | (15 | ) |   |
| Net decrease in  cash and cash equivalents                                            |       |                                    | (58,809    | ) |   |   | (260,643 | ) |   |
| Cash and cash  equivalents at beginning of period                                     |       |                                    | $          | 178,144 |   |   |   | $ | 435,905 |   |   |
| Cash and cash  equivalents at end of period                                           |       |                                    | $          | 119,335 |   |   |   | $ | 175,262 |   |   |

 

 

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

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**NOTESTO CONDENSED CONSOLIDATED INTERIM FINANCIAL STATEMENTS(RESTATED AND UNAUDITED)**

**1.**   Basisof Presentation

The accompanying condensed consolidated interimfinancial statements are unaudited and have been prepared on a basissubstantially consistent with the audited financial statements. Certaininformation and footnote disclosures normally included in our annual financialstatements have been condensed or omitted. The year-end consolidated balancesheet data was derived from audited financial statements but does not includeall disclosures required by generally accepted accounting principles. Theconsolidated interim financial statements, in the opinion of our management,reflect all adjustments (consisting of normal recurring accruals) necessary fora fair presentation of the results for the interim periods ended March 31,2006 and 2005.

The condensed consolidated financial statementsinclude our accounts and the accounts of our wholly-owned subsidiaries,including Sepracor Canada Limited. We also have an investment in BioSphereMedical, Inc., or BioSphere, which we record under the equity method.

The consolidated results of operations for the interimperiods are not necessarily indicative of the results of operations to beexpected for the full fiscal year. These condensed consolidated interimfinancial statements should be read in conjunction with the audited financialstatements for the year ended December 31, 2005, which are contained inour annual report on Form 10-K/Afor the year ended December 31, 2005, filed with the Securities andExchange Commission, or SEC.

The preparation offinancial statements in conformity with generally accepted accountingprinciples requires management to make estimates and assumptions that affectthe following: (1) the reported amounts of assets and liabilities, (2) thedisclosure of contingent assets and liabilities at the dates of the financialstatements and (3) the reported amounts of revenues and expenses duringthe reporting periods. Actual results could differ from those estimates.

**2.**   RecentAccounting Pronouncements

In December 2004, theFinancial Accounting Standards Board, or FASB,issued Statement of Financial Accounting Standards, or SFAS, No. 123(R) (revised2004), “Share-Based Payment”, or SFAS 123(R). SFAS 123(R) isa revision of FASB Statement No. 123, “Accounting for Stock-Based Compensation”, supersedesAccounting Principles BoardOpinion No. 25, or APB 25,  “Accountingfor Stock Issued to Employees”, and amends FASB Statement No. 95, “Statement of Cash Flows”. SFAS 123(R) requiresall share-based payments to employees, including grants of employee stockoptions and stock purchases under employee stock purchase plans, to berecognized in the financial statements based on their fair values. We adoptedSFAS 123(R) using the modified prospective method during the quarter endedMarch 31, 2006. As noted in footnote 4 below, the adoption of SFAS 123(R) hada material impact on our condensed consolidated statements of operations andnet income per share.

**3.**   Basicand Diluted Net Loss Per Common Share

Basic earnings (loss) per share, or EPS, excludesdilution and is computed by dividing net income by the weighted-averagenumber of common shares outstanding for the period. Diluted EPS is based uponthe weighted average number of common shares outstanding during the period plusthe additional weighted average potential common shares during the period.Potential common shares are not included in the per share calculation when theeffect of their inclusion would be anti-dilutive. Potential common sharesresult from the assumed conversion of convertible subordinated debt, vesting ofrestricted stock awards and the assumed exercise of outstanding stock options,the proceeds of which are then assumed to have been used to repurchase outstandingstock options using the treasury stock method. Purchased call 

6

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options are also notincluded in the per share calculations for the period ending March 31,2005 because including them would be anti-dilutive. There were no outstandingpurchased call options as of March 31, 2006.

For the three months ended March 31, 2006, basicand diluted net income per common share is computed based on the weighted-averagenumber of common shares outstanding during the period; however, diluted netincome for that period also includes the dilutive effect of potential common shares.For the three months ended March 31, 2005 basic and diluted net loss percommon share is computed based on the weighted-average number of commonshares outstanding during the period because the effect of potential commonshares would be anti-dilutive. Certain securities were not included in thecomputation of diluted earnings per share because they would have ananti-dilutive effect due to exercise price or net losses for such periods.These securities include the following:

a.   Optionsto purchase shares of common stock:

| ** **            | ** ** | **March 31, 2006**                                                  | ** **      | **March 31, 2005** | ** ** |
|-----------------------|------------|-------------------------------------------------------------------------------|-----------------|------------------------------|------------|
| ** **            | ** ** | **(in thousands, except price per share data)** | ** **      |
| Number of options     |       | 7,853                                                                         |            | 13,048                       |       |
| Price range per share |       | $                                                                             | 44.15 to $87.50 |                         | $          | 5.00 to $87.50 |   |
|                       |            |                                                                               |                 |                              |            |  |  |

 

b.   Sharesof common stock reserved for issuance upon conversion of convertiblesubordinated debt:

| ** **                                                            | ** ** | **March 31,  2006** | ** ** | **March 31,  2005** | ** ** |
|-----------------------------------------------------------------------|------------|--------------------------|------------|--------------------------|------------|
| ** **                                                            | ** ** | **(in thousands)**  | ** ** |
| 5% convertible  subordinated debentures due 2007                 |       |                     | 4,763      |                     |       |   | 4,763 |   |   |
| 0% Series A  convertible senior subordinated notes due 2008 |       |                     | —     |                     |       |   | 2,283 |   |   |
| 0% Series B  convertible senior subordinated notes due 2010 |       |                     | —     |                     |       |   | 4,961 |   |   |
| Total                                                                 |       |                     | 4,763      |                     |       |   | 12,007 |   |   |

 

We have issued 0%convertible subordinated notes due 2024, which were not convertible as of March 31,2006 and 2005 or at any time during the three months ended March 31, 2006and 2005. Once these notes become convertible, shares of common stock will bereserved under the conversion formula for issuance upon conversion if and whenour common stock price exceeds $67.20 per share on the Nasdaq National Market.Prior to such occurrence, the notes are only convertible into cash.

**4.**   Accountingfor Stock-Based Compensation

Effective January 1, 2006, we adopted theprovisions of SFAS 123(R), which establishes accounting for equityinstruments exchanged for employee services. Under the provisions ofSFAS 123(R), stock-based compensation cost is measured at the grant date,based on the fair value of the award, and is recognized as an expense over theemployee’s requisite service period (generally the vesting period of the equityaward). Prior to January 1, 2006, we accounted for share-basedcompensation to employees in accordance with APB 25 and relatedinterpretations. We also followed the disclosure requirements of SFAS 123.We elected to adopt the modified prospective transition method as provided bySFAS 123(R) and, accordingly, financial statement amounts for theprior periods presented in this Form 10-Q have not been restated toreflect the fair value method of expensing stock-based compensation.

Our stock option plans were adopted in 1997, 1999,2000 and 2002 (“option plans”). Options granted under the option plans aregenerally non-qualified stock options but the option plans permit some optionsgranted to qualify as “incentive stock options” under the U.S. Internal RevenueCode. The exercise price of a stock option generally is equal to the fairmarket value of our common stock on the option grant date. The contractual termof options granted is generally 10 years.

7

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Under the option plans, in addition to options, wegranted certain employees restricted stock awards. Restricted stock awards arenon-vested stock awards. Restricted stock awards are independent of optiongrants and are subject to forfeiture if employment terminates prior to therelease of the restrictions. Such awards generally vest annually over a two tofive year period from the date of grant. Ownership of restricted stocktypically cannot be transferred until the shares have vested. In connectionwith restricted stock grants, we record compensation expense based on the fair valueof the shares granted. This stock compensation is being amortized on astraight-line basis over the vesting periods.

The 1998 Employee Stock Purchase Plan, or 1998 ESPP,permits an aggregate of 900,000 shares of common stock to be purchased byemployees at 85% of market value on the first or last day of each six-monthoffering period, whichever is lower, through accumulation of payroll deductionsranging from 1% to 10% of compensation as defined, subject to certainlimitations.

As required by SFAS 123(R), management has made anestimate of expected forfeitures and is recognizing compensation costs only forthose equity awards expected to vest.

Thefollowing table presents stock-based employee compensation expenses included inour unaudited condensed consolidated statements of operations:

|                                     | ** ** | ** Three Months Ended**                    | ** ** |
|-------------------------------------|------------|-----------------------------------------------------------|------------|
| ** **                          | ** ** | ** March 31,  2006    (as restated)** | ** ** | ** March 31,  2005    (as restated)** | ** ** |
| ** **                          | ** ** | **(in  thousands)**                                       | ** ** |
| Cost of products sold               |       |                                                      | $          | 134 |   |   |   | $ | — |   |   |
| Research and development            |       |                                                      | 2,425      |   |   |   | — |   |   |
| Selling, marketing and distribution |       |                                                      | 3,304      |   |   |   | 35 |   |   |
| General and administrative          |       |                                                      | 4,185      |   |   |   | 226 |   |   |
| Stock-based compensation expense    |       |                                                      | $          | 10,048 |   |   |   | $ | 261 |   |   |

 

As a result of adopting SFAS 123(R), our netincome for the quarter ended March 31, 2006, is $9,825,000 less than if wehad continued to account for stock-based compensation under APB 25. Basicand diluted income per share for the quarter ended March 31, 2006 were alsoless by $0.09 and $0.08, respectively, due to the adoption of SFAS 123(R).

Thefollowing table presents stock-based employee compensation expenses by type ofaward:

| ** **                       | ** ** | ** Three Months Ended**                    | ** ** |
|----------------------------------|------------|-----------------------------------------------------------|------------|
| ** **                       | ** ** | ** March 31,  2006    (as restated)** | ** ** | ** March 31,  2005    (as restated)** | ** ** |
| ** **                       | ** ** | **(in  thousands)**                                       | ** ** |
| Employee stock options           |       |                                                      | $          | 9,262 |   |   |   | $ | 261 |   |   |
| Restricted shares                |       |                                                      | 302        |   |   |   | — |   |   |
| Employee stock purchase plan     |       |                                                      | 484        |   |   |   | — |   |   |
| Stock-based compensation expense |       |                                                      | $          | 10,048 |   |   |   | $ | 261 |   |   |

 

Weestimate the fair value of stock options using the Black-Scholes valuationmodel. This valuation model takes into account the exercise price of the award,as well as a variety of assumptions. These assumptions used to estimate thefair value of stock options include the expected term, the expected volatilityof our stock over the expected term, the risk-free interest rate over theexpected term, and our expected annual dividend yield. We believe that thevaluation technique and the approach utilized to develop the underlyingassumptions are appropriate in calculating the fair values of the stock options

8

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granted in the three months ended March 31,2006. Estimates of fair value are not intended to predict actual future eventsor the value ultimately realized by persons who receive equity awards.

Assumptionsused to determine the fair value of options granted during the three monthsended March 31, 2006, using the Black-Scholes valuation model were:

| ** **                      | ** ** | **Three Months Ended  March 31, 2006** | ** ** |
|---------------------------------|------------|------------------------------------------------------------|------------|
| ** **                      | ** ** | **Employee Stock  Option Plans**                 | ** ** | **Employee Stock   Purchase Plan** | ** ** |
| Expected term                   |       |                                                       | 5.7 years  |   |   |   | 0.5 years |   |   |
| Expected  volatility factor     |       |                                                       | 28.6       | % |   |   | 28.6 | % |   |
| Risk-free  interest rate        |       |                                                       | 4.6        | % |   |   | 4.3 | % |   |
| Expected annual dividend  yield |       |                                                       | —     |   |   |   | — |   |   |

 

Priorto January 1, 2006, we accounted for stock-based compensation to employeesin accordance with APB 25. We also had previously adopted the disclosureprovisions of SFAS 123, which required disclosure only of stock-basedcompensation and its impact on net loss and net loss per share. The followingtable illustrates the effects on net loss and net loss per share for the threemonths ended March 31, 2005 as if we had applied the fair valuerecognition provisions of SFAS 123 to stock-based employee awards.

| ** **                                                                                     | ** ** | **Three Months Ended  March 31, 2005  (as restated)** | ** ** |
|------------------------------------------------------------------------------------------------|------------|---------------------------------------------------------------------------|------------|
| ** **                                                                                     | ** ** | **(in thousands, except  price per share data)** | ** ** |
| Net loss as reported                                                                           |       |                                                                      | $          | (22,834 | ) |   |
| Add: Stock-based employee compensation expense  included in restated results                   |       |                                                                      | 261        |   |   |
| Less: Total  stock-based employee compensation expense determined under the fair value  method |       |                                                                      | (12,114    | ) |   |
| Pro forma net  loss                                                                            |       |                                                                      | $          | (34,687 | ) |   |
| Net loss per  share:                                                                           |       |                                                                      |       |   |   |
| Basic and  Diluted—as reported                                                       |       |                                                                      | $          | (0.22 | ) |   |
| Basic and  Diluted—pro-forma                                                              |       |                                                                      | $          | (0.33 | ) |   |

 

Indetermining the stock-based compensation expense to be disclosed under SFAS123, we were required to estimate the fair value of stock awards granted toemployees using a Black-Scholes valuation model. However, differences betweenthe requirements of SFAS 123(R) and SFAS 123 resulted in a different set ofassumptions for our valuation model, including the utilization of a forfeiturerate. Assumptions used to determine the fair value of options granted underSFAS 123 during the three months ended March 31, 2005 were:

| ** **               | ** ** | **Three Months Ended March 31, 2005** | ** **     |
|--------------------------|------------|----------------------------------------------------------------|----------------|
| ** **               | ** ** | **Employee Stock   Option Plans**               | ** **     | ** 1998 Employee Stock   Purchase Plan** | ** ** |
| Expected term            |       |                                                           | 5.0 years |   |   |   | 0.5 years |   |   |
| Volatility               |       |                                                           | 80.0%          |   |   |   | 36.0% |   |   |
| Risk-free  interest rate |       |                                                           | 3.9%           |   |   |   | 2.4% |   |   |
| Dividend yield           |       |                                                           | —         |   |   |   | — |   |   |

 

We issue common stock from previously authorized butunissued shares to satisfy option exercises, restricted stock grants andpurchases under the 1998 Employee Stock Purchase Plan.

9

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Asummary of our stock option activity for the three months ended March 31,2006 is as follows:

| ** **                           | ** ** | **Number of  Options  (in thousands)** | ** ** | **Weighted  Average  Exercise Price** | ** ** | **Weighted  Average  Remaining  Contractual  Term   (in years)** | ** ** |
|--------------------------------------|------------|--------------------------------------------------|------------|--------------------------------------------|------------|----------------------------------------------------------------------------|------------|
| Outstanding,  December 31, 2005 |       |                                             | 10,859     |                                       |       |                                                                       | $          | 32.78 |   |   |   |   |   |   |
| Granted                              |       |                                             | 1,393      |                                       |       |                                                                       | $          | 55.54 |   |   |   |   |   |   |
| Exercised                            |       |                                             | (375       | )                                          |       |                                                                       | $          | 18.63 |   |   |   |   |   |   |
| Cancelled                            |       |                                             | (90        | )                                          |       |                                                                       | $          | 43.41 |   |   |   |   |   |   |
| Outstanding,  March 31, 2006    |       |                                             | 11,787     |                                       |       |                                                                       | $          | 35.83 |   |   |   | 6.2 |   |   |
| Exercisable at  March 31, 2006  |       |                                             | 6,475      |                                       |       |                                                                       | $          | 26.80 |   |   |   | 2.9 |   |   |

 

All options granted during the three months ended March 31,2006 and 2005 were granted with exercise prices equal to the fair market valueof our common stock on the grant date and had weighted average grant date fairvalues of $20.50 and $42.85, respectively.

At March 31, 2006, the aggregate intrinsic valueof options outstanding and options exercisable was $201,139,000 and$172,822,000, respectively. The intrinsic value of a stock option is the amountby which the market value of the underlying stock exceeds the exercise price ofthe option.

The aggregate intrinsic value of options exercisedduring the three months ended March 31, 2006 was $13,973,000.

Thefollowing table summarizes the stock options outstanding at March 31,2006:

| ** **                         | ** ** | **Options Outstanding**    | ** ** | **Options Exercisable**           | ** ** |
|------------------------------------|------------|---------------------------------|------------|----------------------------------------|------------|
| **Exercise Price Range** | ** ** | **Number  (in thousands)** | ** ** | **Weighted  Average  Exercise  Price** | ** ** | **Weighted Average  Remaining  Contractual  Term (in years)** | ** ** | **Number  (in thousands)** | ** ** | **Weighted  Average  Exercise  Price** | ** ** |
| $5.75-  $8.31                      |       |                            | 738        |                                   |       |   | $ | 6.31 |   |   |   | 6.4 |   |   |   | 719 |   |   |   | $ | 6.27 |   |   |
| $11.25-  $16.78                    |       |                            | 2,199      |                                   |       |   | $ | 13.06 |   |   |   | 4.7 |   |   |   | 1,627 |   |   |   | $ | 12.70 |   |   |
| $18.38-  $27.15                    |       |                            | 2,561      |                                   |       |   | $ | 21.25 |   |   |   | 4.8 |   |   |   | 1,840 |   |   |   | $ | 20.60 |   |   |
| $27.70-  $39.07                    |       |                            | 1,098      |                                   |       |   | $ | 34.43 |   |   |   | 4.4 |   |   |   | 966 |   |   |   | $ | 35.30 |   |   |
| $42.38-  $59.45                    |       |                            | 4,032      |                                   |       |   | $ | 52.26 |   |   |   | 8.2 |   |   |   | 1,053 |   |   |   | $ | 53.15 |   |   |
| $64.50-  $87.50                    |       |                            | 1,159      |                                   |       |   | $ | 74.31 |   |   |   | 6.8 |   |   |   | 270 |   |   |   | $ | 75.43 |   |   |
| $5.75-$87.50                       |       |                            | 11,787     |                                   |       |   | $ | 35.83 |   |   |   | 6.2 |   |   |   | 6,475 |   |   |   | $ | 26.80 |   |   |

 

Ournon-vested share activity for the three months ended March 31, 2006 was asfollows:

| ** **                            | ** ** | **Stock Options**                          | ** ** | **Restricted Stock**                                   | ** ** |
|---------------------------------------|------------|-------------------------------------------------|------------|-------------------------------------------------------------|------------|
| ** **                            | ** ** | **Number of  Shares  (in thousands)** | ** ** | **Weighted  Average  grant date**

**Fair Value** | ** ** | **Number of  Shares  (in thousands)** | ** ** | **Weighted  Average  grant date  Fair Value** | ** ** |
| Non-vested at  December 31, 2005 |       |                                            | 4,563      |                                                        |       |   | $ | 43.77 |   |   |   | — |   |   |   | $ | — |   |   |
| Granted                               |       |                                            | 1,393      |                                                        |       |   | $ | 55.54 |   |   |   | 174 |   |   |   | $ | 55.54 |   |   |
| Vested                                |       |                                            | (554       | )                                                           |       |   | $ | 32.44 |   |   |   | — |   |   |   | — |   |   |
| Forfeited                             |       |                                            | (90        | )                                                           |       |   | $ | 43.40 |   |   |   | — |   |   |   | — |   |   |
| Non-vested at  March 31, 2006    |       |                                            | 5,312      |                                                        |       |   | $ | 48.05 |   |   |   | 174 |   |   |   | $ | 55.54 |   |   |

 

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At March 31, 2006, unrecognized compensationexpense related to non-vested stock options and restricted stock was $112,113,000, and $8,974,000, respectively, which are expectedto be recognized over weighted average periods of 3.75 years and 4.34 years,respectively.

The fair market value ofthe December 1, 2005 offering period of the 1998 ESPP, which concludes on May 31,2006, was determined to be $968,000, or approximately $11.91 per share. Theassociated expense is amortized on a straight-line basis over the offeringperiod. For the three months ended March 31, 2006, we recorded $484,000 ofexpense related to an ongoing ESPP offering period. No offering periodsconcluded during the three months ended March 31, 2006.

**5.**   Inventories

Inventoriesconsist of the following:

| ** **     | ** ** | **March 31,  2006** | ** ** | **December 31,  2005** | ** ** |
|----------------|------------|--------------------------|------------|-----------------------------|------------|
| ** **     | ** ** | **(in thousands)**  | ** ** |
| Raw materials  |       |                     | $          | 23,012                      |       |   |   | $ | 21,780 |   |   |
| Finished goods |       |                     | 19,767     |                        |       |   | 17,171 |   |   |
| Total          |       |                     | $          | 42,779                      |       |   |   | $ | 38,951 |   |   |

 

**6.**   DeferredFinancing and Patents Costs

Thefollowing schedule details the carrying value of our patents and deferredfinancing costs:

| ** **                       | ** ** | **March 31,  2006** | ** ** | **December 31,  2005** | ** ** |
|----------------------------------|------------|--------------------------|------------|-----------------------------|------------|
| ** **                       | ** ** | **(in thousands)**  | ** ** |
| Deferred  financing costs, gross |       | $                        | 34,440     |                        |       | $ | 34,440 |   |   |
| Accumulated  amortization        |       | (18,909                  | )          |                        | (17,474    | ) |   |
| Deferred  financing costs, net   |       | $                        | 15,531     |                        |       | $ | 16,966 |   |   |
| Patents, gross                   |       | $                        | 2,785      |                        |       | $ | 2,785 |   |   |
| Accumulated  amortization        |       | (1,710                   | )          |                        | (1,654     | ) |   |
| Patents, net                     |       | $                        | 1,075      |                        |       | $ | 1,131 |   |   |

 

Thefollowing schedule details our amortization expense related to patents anddeferred financing costs:

| ** **                                | ** ** | **Three Months Ended** | ** ** |
|-------------------------------------------|------------|----------------------------------|------------|
| ** **                                | ** ** | **March 31,  2006**         | ** ** | **March 31,  2005** | ** ** |
| ** **                                | ** ** | **(in thousands)**          | ** ** |
| Amortization of  deferred financing costs |       |                             | $          | 1,435 |   |   |   | $ | 903 |   |   |
| Amortization of  patents                  |       |                             | 56         |   |   |   | 153 |   |   |
| Total                                     |       |                             | $          | 1,491 |   |   |   | $ | 1,056 |   |   |

 

We currently estimate thatour amortization expense will be $4,482,000,$4,344,000, $3,994,000, $2,861,000 and $729,000 for the remainder of 2006 andfor the years ending December 31, 2007, 2008, 2009 and 2010,respectively.

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**7.**   ConvertibleSubordinated Debt

Convertiblesubordinated debt consists of the following:

| ** **                                                       | ** ** | **March 31,  2006** | ** ** | **December 31,  2005** | ** ** |
|------------------------------------------------------------------|------------|--------------------------|------------|-----------------------------|------------|
| ** **                                                       | ** ** | **(in thousands)**  | ** ** |
| 5% convertible  subordinated debentures due 2007                 |       |                     | $          | 440,000                     |       |   |   | $ | 440,000 |   |   |
| 0% Series A  convertible senior subordinated notes due 2008 |       |                     | 72,800     |                        |       |   | 72,800 |   |   |
| 0% Series B  convertible senior subordinated notes due 2010 |       |                     | 148,020    |                        |       |   | 148,020 |   |   |
| 0% convertible  senior subordinated notes due 2024               |       |                     | 500,000    |                        |       |   | 500,000 |   |   |
| Total                                                            |       |                     | $          | 1,160,820                   |       |   |   | $ | 1,160,820 |   |   |

 

**8.**   ComprehensiveIncome (Loss)

Totalcomprehensive income (loss) consists of net income (loss), net foreign currencytranslation adjustments and net unrealized gain (loss) on available-for-salesecurities.

| ** **                                               | ** ** | **Three Months Ended**             | ** ** |
|----------------------------------------------------------|------------|----------------------------------------------|------------|
| ** **                                               | ** ** | **March 31,  2006  (as restated)** | ** ** | **March 31,  2005  (as restated)** | ** ** |
| ** **                                               | ** ** | **(in thousands)**                      | ** ** |
| Comprehensive  income (loss):                            |       |                                         |       |   |   |   |   |   |   |
| Net income (loss)                                        |       |                                         | $          | 10,036 |   |   |   | $ | (22,834 | ) |   |
| Net foreign  currency translation adjustment             |       |                                         | (41        | ) |   |   | (82 | ) |   |
| Unrealized gain  (loss) on available-for-sale securities |       |                                         | 10,806     |   |   |   | (1,485 | ) |   |
| Total comprehensive  income (loss)                       |       |                                         | $          | 20,801 |   |   |   | $ | (24,401 | ) |   |

 

**9.**   LegalProceedings

We and several of our current and former officers anda current director are named as defendants in several class action complaintswhich have been filed on behalf of certain persons who purchased our commonstock and/or debt securities during different time periods, beginning onvarious dates, the earliest being May 17, 1999, and all ending on March 6,2002. These complaints allege violations of the Securities Exchange Act of1934, as amended, and the rules and regulations promulgated thereunder by theSecurities and Exchange Commission. Primarily, they allege that the defendantsmade certain materially false and misleading statements relating to thetesting, safety and likelihood of approval of tecastemizole by the UnitedStates Food and Drug Administration, or FDA. In both the debt purchasers’action and equity purchasers’ action, the court has granted the plaintiffs’motion for class certification. In late February 2006, two corrected andamended consolidated complaints were filed, one on behalf of the purchasers ofour common stock and the other on behalf of the purchasers of our debtsecurities. These corrected and amended consolidated complaints reiterate theallegations contained in the previously filed complaints and define the allegedclass periods as May 17, 1999 through March 6, 2002. The parties are currentlyengaged in discovery. We are unable to reasonably estimate any possible rangeof loss related to the lawsuits due to their uncertain resolution. However, anyconclusion of these matters in a manner adverse to us would have a materialadverse effect on our financial position and results of operations.

In September 2005, we received notification that theFDA had received an abbreviated new drug application, or ANDA, from BreathLimited seeking approval of a generic version of our 1.25 mg, 0.63 mg and 0.31mg levalbuterol hydrochloride inhalation solution. Breath Limited’s submissionincludes a Paragraph IV certification alleging that our patents listed in theFDA publication entitled “Approved Drug Products With Therapeutic EquivalenceEvaluations,” commonly referred to as the “Orange Book,” for XOPENEX InhalationSolution are invalid, unenforceable or not infringed by Breath Limited’sproposed 

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product. We have filed acivil action against Breath Limited for patent infringement. We were notifiedin January 2006 of a second ANDA seeking approval of a generic version of our1.25 mg, 0.63 mg and 0.31 mg levalbuterol hydrochloride inhalation solutionincluding a Paragraph IV certification, which was submitted to the FDA by Dey,L.P. We have filed a civil action against Dey, L.P. for patent infringement. InApril 2006, we were notified of a third ANDA seeking approval of a genericversion of our 1.25 mg, 0.63 mg and 0.31 mg levalbuterol hydrochlorideinhalation solution including a Paragraph IV certification, which was submittedto the FDA by Watson Laboratories, Inc. We have yet to decide whether we willfile a civil action against Watson Laboratories, Inc. for patent infringement. 

Should we successfullyenforce our patents, ANDA approval will not occur until the expiration of theapplicable patents. Otherwise, the FDA will stay its approval of the relevantANDA until 30 months following the date we received notice of such ANDA oruntil a court decides that our patents are invalid, unenforceable or notinfringed, whichever is earlier.

**10.**   Investmentin ACADIA

On January 13, 2006, we completed the second$10 million purchase of ACADIA Pharmaceuticals Inc. common stock inconnection with the collaboration between the two companies formed in January 2005.Our purchase was made at a price of approximately $12.29 per share, whichrepresented a 25 percent premium over the 30-day trailing averageclosing price of ACADIA’s common stock on the Nasdaq National Market andresulted in the issuance to us of 813,393 shares of ACADIA common stock. Werecorded the premium amount of $1,061,000 as research and development expenseand the remaining amount of $8,939,000 as an investment in ACADIA.

On January 10, 2005,we completed the initial $10 million purchase of ACADIAPharmaceuticals Inc. common stock in connection with the collaboration.Our purchase was made at a price of approximately $9.28 per share, whichrepresented a 40 percent premium over the 30-day trailing averageclosing price of ACADIA’s common stock on the Nasdaq National Market andresulted in the issuance to us of 1,077,029 shares of ACADIA common stock. Werecorded the premium amount of $2,857,000 as research and development expenseand the remaining amount of $7,143,000 as an investment in ACADIA.

**11.   Restatement of Financial Statements Based on Reviewof Stock Option Practices**

Subsequent to the filing ofour Form 10-Q for the period ended March 31, 2006, we concluded that based onerrors identified in a stock option investigation, we would need to restate ourfinancial statements for the three months ended March 31, 2006 and 2005.

As previously announced,the Securities and Exchange Commission, or SEC, is conducting an informalinquiry into our stock option practices.  In June 2006, we appointed a special committee ofoutside directors to conduct an internal review relating to our stock option grantsand stock option practices.  Thespecial committee, with the assistance of outside legal counsel and outside accounting specialists, has reviewed our stockoption grants to our officers, directors and employees from 1996 to the presentunder our various stock option plans in effect during this period.

Based on these reviews, we have determined that themeasurement dates for certain stock option grants to employees, officers anddirectors during prior periods differed from the recorded dates for such awardsprimarily due to the following circumstances: (i) stock option grants whichspecified effective dates that may have preceded the dates of receipt of allnecessary signatures or approvals, finalization of lists specifying stockoption grants or an employee’s first date of employment; and (ii) stock optionawards that were approved with exercise prices lower than fair market value onthe effective date of grant.  Inaddition, we have determined that (a) the modification of certain stock optiongrants in connection with an employee’s termination of employment and (b) theexercise of certain stock options that had not vested prior to an employee’stermination resultedin a new measurement date for such stock options.  As a result, 

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we are required to record non-cash adjustmentsfor stock-based compensation expense for the three months ended March 31, 2006and 2005.  For periods prior toJanuary 1, 2006, such charges are recorded in accordance with APB 25 and for subsequent periods in accordance with SFAS123(R). These non-cash charges had no impact on reported revenue, cash or cashequivalents.

The table below sets forth the impact of thenon-cash charges for stock-based compensation expense within our consolidatedstatement of operations that we recorded for the three months ended March 31,2006 and 2005.

| ** **                                                         | ** ** | ** Three Months Ended **                   | ** ** |
|--------------------------------------------------------------------|------------|----------------------------------------------------------------|------------|
| ** **                                                         | ** ** | ** March 31, **                                 | ** ** | ** March 31, ** | ** ** |
| ** **                                                         | ** ** | **2006**                                                       | ** ** | **2005** | ** ** |
| ** **                                                         | ** ** | **(in thousands, except  per share data)** | ** ** |
| Net income (loss) as previously reported                           |       |                                                           | $          | 10,259 |   |   |   | $ | (22,573 | ) |   |
| Charge for additional stock-based compensation                     |       |                                                           | (223       | ) |   |   | (261 | ) |   |
| Net income (loss) as restated                                      |       |                                                           | $          | 10,036 |   |   |   | $ | (22,834 | ) |   |
| Basic net income (loss) per common share as  previously reported   |       |                                                           | $          | 0.10 |   |   |   | $ | (0.22 | ) |   |
| Basic  net income (loss) per common share as restated              |       |                                                           | $          | 0.10 |   |   |   | $ | (0.22 | ) |   |
| Diluted net income (loss) per common share as  previously reported |       |                                                           | $          | 0.09 |   |   |   | $ | (0.22 | ) |   |
| Diluted net income (loss)  per common share as restated            |       |                                                           | $          | 0.09 |   |   |   | $ | (0.22 | ) |   |

 

The table below sets forth the impact of thenon-cash charges for stock-based compensation expense within our consolidatedbalance sheet that we recorded for the quarters ended March 31, 2006 and 2005.

| ** **                  | ** ** | **Periods Ended**        | ** ** |
|-----------------------------|------------|-------------------------------|------------|
| ** **                  | ** ** | ** March 31,**      | ** ** | **December 31,** | ** ** |
| ** **                  | ** ** | **2006**                      | ** ** | **2005** | ** ** |
| ** **                  | ** ** | ** (in thousands)** | ** ** |
| Additional paid-in  capital |       |                          |       |   |   |
| As previously reported      |       | $                             | 1,686,315  |   | $ | 1,669,541 |   |
| As restated                 |       | $                             | 1,728,650  |   | $ | 1,711,653 |   |
| Accumulated deficit         |       |                          |       |   |   |
| As previously reported      |       | $                             | (1,610,256 | ) | $ | (1,620,515 | ) |
| As restated                 |       | $                             | (1,652,591 | ) | $ | (1,662,627 | ) |

 

Althoughthe special committee has completed its review, the committee will remain inplace for the duration of the SEC's inquiry. Should additional informationbecome available to us in connection with the SEC inquiry, the specialcommittee may be required to reopen its review and our current determination ofstock-based compensation could change.

**Derivative StockholderComplaints Relating to Stock Option Grants**

We have accepted service of three stockholder derivative complaints relatingto certain of our stock option grants that were filed in the Superior Court, Middlesex County,Commonwealth of Massachusetts, naming Sepracor as nominal defendant and alsonaming as defendants certain current members of our board of directors andcertain of our current and former employees. The complaints allege purportedbreaches of fiduciary duties and unjust enrichment in connection with certainstock option grants made by us between June 1998 and May 2001. Thecomplaints seek monetary damages in unspecified amounts, equitable andinjunctive relief, including disgorgement of profits obtained by certaindefendants and other relief as determined by the Court. On August 30, 2006, the parties in all threeactions moved to consolidate the actions and to transfer them to the BusinessLitigation Session of the Superior Court, Suffolk County.

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**ITEM2.**                MANAGEMENT’SDISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

**Restatement of FinancialStatements Based on Review of Stock Option Practices**

In June 2006, weannounced that the Securitiesand Exchange Commission,  or SEC, had initiatedan informal inquiry into our stock option practices. We appointed a specialcommittee of outside directors in June 2006 to conduct an internal reviewrelating to our stock option grants and stock option practices. The specialcommittee, with the assistance of outside legal counsel and outside accounting specialists, has reviewed the stockoption grants to our officers, directors and employees from 1996 to the presentunder our various stock option plans in effect during this period.  We have been cooperating with this review andour finance department has also reviewed the stock option grants and stockoption practices from 1996 to present. Although the special committee has completed itsreview, the committee will remain in place for the duration of the SEC'sinquiry. Should additional information become available to us in connectionwith the SEC inquiry, the special committee may be required to reopen itsreview and our current determination of stock-based compensation could change.

The discussion and analysis set forth in thisItem 2 has been amended to reflect the restatement as described in theExplanatory Note at the beginning ofthis quarterly report on Form 10-Q/A and in Note 11 to our condensed consolidated financial statements. The impact of additional stock-based compensationexpense for the three months ended March 31, 2006 and 2005 isapproximately $223,000 and $261,000, respectively. See the Explanatory Note and Note 11 for additional information about thereview and restatement.

**Cautionary Statement Regarding Forward-LookingStatements**

This quarterly report on Form 10-Q/Acontains, in addition to historical information, forward-lookingstatements within the meaning of Section 21E of the Securities ExchangeAct of 1934, as amended, which we refer to as the Exchange Act. These forward-lookingstatements involve risks and uncertainties and are not guarantees of futureperformance. Words such as “expect,” “anticipate,” “intend,” “plan,” “believe,”“seek,” “estimate” and variations of these words and similar expressions areintended to identify forward-looking statements. Our actual results coulddiffer significantly from the results we discuss in these forward-lookingstatements. These forward-looking statements represent our expectationsas of the date of our quarterly report on Form 10-Qfor the three months ended March 31, 2006 filed with the Securities andExchange Commission on May 9, 2006. Subsequent eventswill cause our expectations to change. However, while we may elect to updatethese forward-looking statements, we specifically disclaim any obligationto do so. See the section entitled “Risk Factors” below for a discussion ofimportant factors that could cause our actual results to differ materially fromthe results we discuss in our forward-looking statements.

**Executive Overview**

We are a research-basedpharmaceutical company focused on discovering, developing and commercializingdifferentiated products that address large and growing markets, and unmetmedical needs, and can be marketed to primary care physicians through our salesforce.

We currently manufactureand sell three products, XOPENEX® (levalbuterol HCl) Inhalation Solution, ashort-acting bronchodilator, for the treatment or prevention ofbronchospasm in patients with reversible obstructive airway disease; XOPENEXHFAÔ (levalbuterol tartrate) Inhalation Aerosol, ahydrofluoroalkane, or HFA, metered-dose inhaler, or MDI, for the treatment orprevention of bronchospasm in adults, adolescents and children four years ofage and older with reversible obstructive airway disease; and LUNESTAÔ(eszopiclone) for the treatment of insomnia.

We market and sell XOPENEXInhalation Solution, LUNESTA and XOPENEX HFA directly through our sales force. Wehave entered into out-licensing arrangements with respect to several other 

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compounds.We expect to commercialize products that we successfully develop through oursales force, through co-promotion agreements and through out-licensingpartnerships.

**Significant2006 Developments**

On February 23, 2006,we announced that we entered into a licensing agreement with UCB, relating tolevocetirizine, which is an antihistamine being developed by UCB. Under thisagreement, we have exclusively licensed to UCB all of our patents and patentapplications in the U.S. regarding levocetirizine and royalties will be payableto us on U.S. sales of levocetirizine products. Under a separate agreement, wecurrently earn royalties from UCB on sales of levocetirizine in Europeancountries where the product is sold. Levocetirizine is marketed by UCB underthe brand names XYZAL® and XUSALÔin the European Union, or E.U., for treatment of symptoms of seasonal andperennial allergic rhinitis, persistent allergic rhinitis, and chronicidiopathic urticaria, or CIU, also known as hives of unknown cause, in adultsand children aged 6 years and older.

On January 17, 2006,we announced that we had completed the second $10 million purchase ofACADIA Pharmaceuticals Inc., or ACADIA, common stock in connection withour license, option and collaboration agreement, or collaboration, with ACADIAthat we entered into in January 2005. Our purchase was made at a price ofapproximately $12.29 per share, which represented a 25 percent premium tothe 30-day trailing average closing price on the Nasdaq National Marketas of the one-year anniversary of the collaboration, and resulted in theissuance to us, of 813,393 shares of ACADIA common stock.

On January 12, 2006,we announced that we had been notified that the United States Food and DrugAdministration, or FDA had received an abbreviated new drug application, or ANDA,from Dey, L.P. for a generic version of levalbuterol hydrochloride inhalationsolution. Dey’s submission includes a Paragraph IV certification allegingour patents listed in the FDA publication entitled “Approved Drug Products WithTherapeutic Equivalence Evaluations,” commonly referred to as the “Orange Book,”for XOPENEX Inhalation Solution are invalid, unenforceable or not infringed byDey’s proposed product. On September 7, 2005, we announced that the FDAhad received an ANDA from Breath Limited seeking marketing approval for genericcopies of our 1.25 mg, 0.63 mg and 0.31 mg XOPENEX Inhalation Solution(levalbuterol hydrochloride) unit-dose vial product. XOPENEX InhalationSolution Concentrate is not subject to the ANDA. Breath Limited’s submissionincludes a Paragraph IV certification alleging that our patents listed inthe Orange Book for XOPENEX Inhalation Solution are invalid, unenforceable ornot infringed by Breath Limited’s proposed product. We have filed civil actionsagainst Breath Limited and Dey, L.P. for patent infringement. In April2006, we were notified of a third ANDA seeking approval of a generic version ofour 1.25 mg, 0.63 mg and 0.31 mg levalbuterol hydrochloride inhalation solutionincluding a Paragraph IV certification, which was submitted to the FDA byWatson Laboratories, Inc. We have yet to decide whether we will file a civilaction against Watson Laboratories, Inc. for patent infringement.

Should we successfully enforce ourpatents, the FDA will not approve the relevant ANDA until expiration ofthe applicable patents. Otherwise, the FDA will stay its approval of therelevant ANDA for 30 months following the date we received notice ofsuch ANDA or until a court decides that our patents are invalid,unenforceable or not infringed, whichever is earlier.

**Critical Accounting Policies**

We identified criticalaccounting policies in our annual report on Form 10-K/A for the year ended December 31,2005. These critical accounting policies relate to product revenue recognition,royalty revenue recognition, rebate and return reserves, patents, intangiblesand other assets, accounts receivable and bad debt, income taxes, inducedconversion of debt, inventory write-downs and stock-based compensation.These policies require us to make estimates in the preparation of our financialstatements as of a given date. Because of the uncertainty inherent in thesematters, our actual results could differ from 

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theestimates we use in applying the critical accounting policies. Other than theadoption of Statement of Financial Accounting Standards No. 123(R), “Share-BasedPayment,” or SFAS 123(R), no changes to these critical accounting policies havetaken place since December 31, 2005; however, we have expanded thedisclosure of our accounting policies relating to product sale allowances andreserves.

***Product Sales Allowances and Reserves:****  *We record product sales net of thefollowing significant categories of product sales allowances: payment termdiscounts, wholesaler fee for service discounts, government rebates andcontractual discounts (includes Medicaid discounts, Medicare discounts, managedcare discounts, chargebacks and group purchasing organization, or GPO, contractdiscounts), returns and other discounts. Calculating each of these itemsinvolves significant estimates and judgments and requires us to use informationfrom external sources. Based on known market events and trends, internal andexternal historical trends, third party data, customer buying patterns andup-to-date knowledge of contractual and statutory requirements, we are able tomake reasonable estimates of sales discounts. Historically, our estimates havenot materially differed from our actual results.

1)   *Payment Term Discounts—*We offer ourwholesaler customers a 2% prompt-pay cash discount as an incentive to remitpayment within the first thirty days after the date of the invoice. Prompt-paydiscount calculations are based on the gross amount of each invoice. We accountfor these discounts by reducing sales by the 2% discount amount when product issold, and apply earned cash discounts at the time of payment. Since we beganselling our products commercially in 1999, our customers have routinely takenadvantage of this discount. Based on common industry practices and ourcustomers’ overall payment performance, we accrue for cash discounts on productsales recorded during the period. We adjust the accrual to reflect actualexperience as necessary.

2)   *Wholesaler Fee for Service Discounts—*Inthe second quarter of 2005, we entered into letter agreements with certainwholesaler customers that provide these wholesalers with the opportunity toearn discounts in exchange for the performance of certain services. Theseagreements are subject to termination upon thirty days prior written notice.Our effective rate of wholesaler discounts applied across all product sales inthe first quarter of 2006 was approximately 2.5%. If the percentage of grosssales sold to wholesalers with letter agreements increases, our liabilityrelated to wholesaler discounts could increase materially. For example, a 0.5%increase in the effective rate of wholesaler discounts on the first quarter of2006 gross sales from our three marketed products would result in a salesreduction of approximately $1.7 million.

**3)   *Government Rebates and Contractual Discounts—***

*Medicaid Discounts—We***record accruals forrebates to be provided through the Medicaid Drug Rebate Program as a reductionof sales when the product is sold. We rebate individual states for all eligibleunits purchased under the Medicaid program based on a rebate per unitcalculation driven off our Average Manufacturer Price, or AMP. We estimate theexpected rebate per unit to be used and adjust our rebate accruals based onexpected changes in rebate pricing. We also examine the historical rebatetrends and the trend of sales that become eligible for Medicaid programs andany changes expected to these trends. In addition, certain states havesupplemental rebate programs, which provide such states with an additionalrebate. Supplemental rebates, like rebates under the Medicaid Drug RebateProgram, are recorded as a reduction of sales when the product is sold. Rebateamounts are generally invoiced quarterly in arrears and paid thirty days afterthey are invoiced. As a result, our accrual consists of (i) an estimate ofthe amount we expect to be incurred for the current quarter’s prescriptions, (ii) anaccrual for prior quarters’ unpaid rebates and (iii) an accrual forestimated inventory in the distribution channel.

We recorded a provisionfor Medicaid rebates of 6.0% and 8.7% of gross sales for the three months endedMarch 31 2006 and 2005, respectively. The reduction was principally due toa change in product mix, with LUNESTA, which we commercially introduced in2005, having significantly lower Medicaid eligible units than XOPENEXInhalation Solution. Actual Medicaid discounts could exceed historicalexperience and our estimates of expected Medicaid activity and rebate per unitamounts. If the Medicaid discount 

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provisionpercentage were to increase by 0.5% of first quarter 2006 gross sales from ourmarketed products, an additional provision of $1.7 million would result.

*Medicare Discounts—Part B—**We*record accrualsfor rebates to be provided through Medicare programs as a reduction of saleswhen the product is sold. We provide rebates to medicare pharmacy providers, orMPPs, on XOPENEX Inhalation Solution that is dispensed to Medicarebeneficiaries. XOPENEX is covered under a Medicare code for drugs used withdurable medical equipment, in our case, nebulizers. We estimate the expectedrebate using historical data and by examining trends and expected changes inMedicare codes. Medicare payments are paid to MPPs primarily on a monthlybasis. Accordingly, the provision typically relates to the activity over aone-month period and, as a result, the total provision consists of (i) anestimate of the amount expected to be incurred for the current month’sprescriptions, (ii) an accrual for prior months’ unpaid rebates and(iii) an accrual for estimated inventory in the distribution channel.

*Medicare Discounts—Part D—**Effective*January 1,2006, Medicare created a prescription drug benefit for its beneficiaries knownas Medicare Part D. CMS, the Centers for Medicare and Medicaid Services,contracted with numerous health plans and prescription drug benefit plans todesign and administer the drug benefit, including the development of aformulary (which defines which products are covered and at what co-pay level).We pay rebates to certain Part D health plans and prescription drug plans onthe sale of Lunesta and Xopenex HFA. Xopenex UDV has been and will remaincovered as a Part B product, resulting in minimal Part D utilization.Our accruals for Part D are for rebates required for Lunesta and XopenexHFA and are estimated based on projected sales volumes through the contactedhealth and drug plans.

The provision for Medicarerebates was less than 1% of gross sales for both the three months ended March 31,2006 and 2005. Actual Medicare discounts could change significantly in thefuture based on future Medicare reimbursement classifications. If the Medicarediscount provision percentage were to increase by 0.5% of first quarter 2006gross sales of our marketed products, we would incur an additional provision ofapproximately $1.7 million.

*Managed Care Discounts**—We*have entered intoagreements with certain managed care organizations, or MCOs, whereby we provideagreed upon discounts to such entities based on the achievement of sales volumeand/or market share purchasing targets. We record accruals for these discountsas a reduction of sales when product is sold based on discount rates andexpected levels of sales volumes of these MCOs during a period. We estimateeligible sales based on historical amounts and sales trends and expectedchanges to these trends. Discounts are generally invoiced and paid quarterly inarrears. Accordingly, our accrual consists of (i) the amount expected tobe incurred for the current quarter’s prescriptions, (ii) an accrual forprior quarters unpaid discounts and (iii) an accrual for estimatedinventory in the distribution channel.

The provision for MCOrebates was approximately 1.6% and 1.1% of gross sales in the three monthsended March 31, 2006 and 2005, respectively. Actual MCO discounts couldexceed historical experience and our estimates of expected future participationin these programs. If the MCO discount provision percentage were to increase by0.5% of first quarter 2006 gross sales of our marketed products, an additionalprovision of approximately $1.7 million would result.

*Chargebacks and GPO ContractDiscounts**—We*have entered into agreementswith certain group purchasing organizations, or GPOs, in which its members canpurchase product from our wholesalers at a specified price. GPOs areorganizations that represent a group of end buyers in the purchase of goods.These agreements involve the wholesalers who receive a stated margin on salesto GPOs. When the difference between the wholesaler’s purchase price and theGPO’s price creates a margin less than the amount agreed between us and thewholesaler, the wholesaler requests a credit, which is referred to as achargeback. We record accruals for these discounts as a reduction of sales whenproduct is sold. We 

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estimateeligible sales based on a history of the average actual chargebacks and anaverage of the chargeback cycle time, which is the time from when a wholesalersells to a GPO until we issue a credit to the wholesaler. We examine thehistory of sales that qualify for chargebacks and monitor sales trends andcontractual changes. Our accrual consists of the amount we expect to beincurred for the current sales in the calculated chargeback cycle, plus anaccrual for estimated inventory in the distribution channel.

The provision forchargebacks and GPO contract credits was approximately 3.5% and 1.8% of grosssales in the three months ended March 31, 2006 and 2005, respectively. Theincrease in the three months ended March 31, 2006 as compared to March 31, 2005is mainly due to chargebacks related to sales discounts on XOPENEX HFA unitsthat were ultimately sold to the Veterans Administration, or VA. Actualchargeback and GPO contract credits could exceed historical experience and ourestimates of expected future participation in these programs. Additionally ourestimate of the average chargeback cycle time could vary. If the provision forchargeback and GPO contract credits was to increase by 0.5% of first quarter2006 gross sales of our marketed products, then an additional provision ofapproximately $1.7 million would result.

4)   *Return*s—Customers can return short-datedor expired product that meets the guidelines set forth in our returns goodpolicy. Product shelf life from the date of manufacture for XOPENEX InhalationSolution is 15 months, XOPENEX HFA is 21 months and LUNESTA is 15-24months. Returns are accepted from wholesalers and retail pharmacies. Customerscan return product with six months or less of shelf life remaining and expiredproduct within twelve months following the expiration date. We record anestimate for returns as reductions of revenue at the time product sales arerecorded. We base our estimates of product returns on the percentage of returnsthat we have experienced historically and on a historical aging of the averagetime a return occurs from the time the product was sold. For products withinsufficient return history, we estimate by examining data of similar drugs.For example, with LUNESTA we researched industry data on return patterns ofwidely prescribed insomnia drugs. We may adjust our estimate of productreturns if we are aware of other factors that we believe could significantlyimpact our expected return percentages. These factors include our estimate ofinventory levels of our products in the distribution channel, competitiveissues such as new product entrants and other known changes in sales trends.

The provision for returnswas approximately 1.9% and 2.5% for the three months ended March 31, 2006and 2005, respectively. The decrease in return percentage provision in 2006from 2005 is due to the introduction of LUNESTA in the second quarter of 2005,which has a significantly lower return percentage than XOPENEX InhalationSolution. Actual returns could exceed historical experience and, accordingly,our estimates of expected future returns due to factors such as wholesaler andretailer stocking patterns and inventory levels and/or competitive changes. Ifthe returns provision percentage were to increase by 0.5% of first quarter 2006gross sales for each of these products, then an additional provision of $1.7million would be necessary.

Many of our accrualsinclude an estimate of inventory in the distribution pipeline. At March 31,2006, we believe a reasonable estimate of the value of our pipeline inventoryis approximately $63.0 million for XOPENEX Inhalation Solution, $11.0 millionfor XOPENEX HFA and $74.0 million for LUNESTA.

5)   *Other Discounts—*At times we offer specialprograms and discounts. In 2005, we implemented discount programs related tothe launch of LUNESTA and XOPENEX HFA to support the goal of making theproducts widely available. These programs include discounts for auto-shipmentsto pharmacies, coupons and vouchers. Under the auto-shipments to pharmaciesprogram, we give a discount to wholesalers that provide evidence that they havedelivered product to an agreed upon number of pharmacies in a timely manner.Under the coupon program, physicians give patients coupons to purchase theprescribed drug at a discount from any retail pharmacy. We reimburse retailpharmacies for these discounts through a third party administrator. Under thevoucher program, physicians give patients vouchers to obtain free samples ofthe prescribed drug from any retail pharmacy. We reimburse retail 

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pharmaciesfor the cost of these products through a third party administrator. We use thevoucher program primarily in states where samples cannot be shipped directly tophysicians.

In each case mentionedabove, we estimate the cost of reimbursement as a reduction of gross sales whenthe product is sold. In addition, we maintain an accrual for unused coupons andvouchers based on outstanding total coupons and vouchers and their historicalusage rates and adjust this accrual whenever changes in such historical usagerate occur. Each of these programs has a defined expiration date.

Thefollowing table summarizes activity in each of the above product sales allowances and reservecategories for the period ended December 31, 2005 and the three monthsended March 31, 2006:

| ** **                             | ** ** | **Payment Terms  Discount** | ** ** | **Wholesaler Fee  for Service** | ** ** | **Government  Rebates and  Contractual  Discounts** | ** ** | **Returns** | ** ** | **Other  Discounts** | ** ** | **Total** | ** ** |
|----------------------------------------|------------|----------------------------------|------------|-------------------------------------------|------------|----------------------------------------------------------|------------|-------------|------------|----------------------|------------|-----------|------------|
| ** **                             | ** ** | **(in thousands)**          | ** ** |
| **Balance at December 31,  2005** |       |                             | $          | (2,632                                    | )          |                                                     |       | $           | (9,503     | )                    |       |      | $          | (47,462 | ) |   | $ | (16,269 | ) |   | $ | (553 | ) |   | $ | (76,419 | ) |
| Current provision:                     |       |                             | (6,885     | )                                         |       |                                                     | (8,561     | )           |       |                 | (40,192    | )         |       | (6,282 | ) |   | (990 | ) |   | (62,910 | ) |
| Actual:                                |       |                             |       |                                      |       |                                                     |       |        |       |                 |       |      |       |   |   |   |   |   |   |   |   |
| Current periods                        |       |                             | 3,577      |                                      |       |                                                     | —     |        |       |                 | 572        |      |       | — |   |   | 267 |   |   | 4,416 |   |
| Prior periods                          |       |                             | 2,958      |                                      |       |                                                     | 1,953      |        |       |                 | 21,384     |      |       | 3,185 |   |   | 597 |   |   | 30,077 |   |
| Total                                  |       |                             | 6,535      |                                      |       |                                                     | 1,953      |        |       |                 | 21,956     |      |       | 3,185 |   |   | 864 |   |   | 34,493 |   |
| **Balance at March 31, 2006**     |       |                             | $          | (2,982                                    | )          |                                                     |       | $           | (16,111    | )                    |       |      | $          | (65,698 | ) |   | $ | (19,366 | ) |   | $ | (679 | ) |   | $ | (104,836 | ) |

 

*Stock-Based Compensation—*EffectiveJanuary 1, 2006, we adopted the provisions of SFAS 123(R), whichresulted in changes to our financial statements as detailed in Note 4 to thefinancial statements. Determining the amount and distribution of expense forstock-based compensation, as well as the associated impact to the balancesheets and statements of cash flows, requires us to develop estimates of thefair value of stock-based compensation expenses.

We estimate the fair valueof stock options using the Black-Scholes valuation model. This valuation modeltakes into account the exercise price of the award, as well as a variety ofassumptions. These assumptions used to estimate the fair value of stock optionsinclude the expected term, the expected volatility of our stock over theexpected term, the risk-free interest rate over the expected term, and ourexpected annual dividend yield. As required by SFAS 123(R), management has alsomade an estimate of expected forfeitures in determining the amount of expenseto be recorded, and is recognizing compensation expense only for those equityawards expected to vest. We believe that the valuation technique and theapproach utilized to develop the underlying assumptions are appropriate incalculating the fair value of stock-based compensation expenses. Theseestimates are not intended to predict actual future events or the valueultimately realized by persons who receive equity awards.

**Three Month Periods ended March 31, 2006 and 2005(Restated)**

*Revenues*

Product sales were$277,505,000 and $106,648,000 for the three months ended March 31, 2006and 2005, respectively, an increase of approximately 160%. This increase isprimarily a result of the commercial introduction of LUNESTA in April 2005,a significant increase in XOPENEX Inhalation Solution revenue and thecommercial introduction of XOPENEX HFAin December 2005.

Sales of LUNESTA were$138,085,000 for the three months ended March 31, 2006 as compared to $0for the same period in 2005. LUNESTA was commercially introduced in April 2005.

Sales of XOPENEXInhalation Solution were $134,065,000 for the three months ended March 31,2006 as compared to $106,648,000 for the same period in 2005, an increase ofapproximately 26%. The 

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salesincrease for XOPENEX Inhalation Solution for the three months ended March 31,2006 as compared with the same period in 2005 is due to a 16% increase in thenumber of units sold and an 8% increase in the net selling price per unit,which is due to a gross unit price increase of approximately 8%. Adjustmentsrecorded to gross sales remained relatively unchanged as disclosed in the tablebelow.

Sales of XOPENEX HFA were$5,355,000 for the three months ended March 31, 2006, as compared to $0 for thesame period in 2005. XOPENEX HFA was commercially introduced in December 2005.

*Analysisof gross sales to net sales*—The following table presents theadjustments deducted from gross sales to arrive at a net sales figure:

| ** **                                    | ** ** | **For the three months ended March 31,** | ** ** |
|-----------------------------------------------|------------|------------------------------------------------------------------------|------------|
| ** **                                    | ** ** | **2006**                                                               | ** ** | **% of  sales** | ** ** | **2005** | ** ** | **% of  sales** | ** ** | **Change** | ** ** | **%  Change** | ** ** |
| ** **                                    | ** ** | **(dollars in thousands)**                                   | ** ** |
| Gross sales                                   |       | $                                                                      | 340,415    |   | 100 | % | $ | 129,030 |   | 100 | % | $ | 211,385 |   |   | 164 | % |   |
| Adjustments to gross  sales:                  |       |                                                                   |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Payment term discounts                        |       | 6,885                                                                  |       | 2.0 | % | 2,750 |   | 2.1 | % | 4,135 |   |   | 150 | % |   |
| Wholesaler fee for  service                   |       | 8,561                                                                  |       | 2.5 | % | — |   | 0.0 | % | 8,561 |   |   | 100 | % |   |
| Government rebates and  contractual discounts |       | 40,192                                                                 |       | 11.8 | % | 16,284 |   | 12.6 | % | 23,908 |   |   | 147 | % |   |
| Returns                                       |       | 6,282                                                                  |       | 1.9 | % | 3,276 |   | 2.5 | % | 3,006 |   |   | 92 | % |   |
| Other (includes product  launch discounts)    |       | 990                                                                    |       | 0.3 | % | 72 |   | 0.1 | % | 918 |   |   | 1,275 | % |   |
| Sub-total adjustments                         |       | 62,910                                                                 |       | 18.5 | % | 22,382 |   | 17.3 | % | 40,528 |   |   | 181 | % |   |
| Net sales                                     |       | $                                                                      | 277,505    |   | 81.5 | % | $ | 106,648 |   | 82.7 | % | $ | 170,857 |   |   | 160 | % |   |

 

Increases in theadjustments to gross sales as a percentage of gross sales from the quarter endedMarch 31, 2005 to the quarter ended March 31, 2006 primarily reflectthe establishment of wholesaler fee for service discount arrangements in 2006to provide for fees consistent with the terms of the wholesaler serviceagreements we executed in the second quarter of 2005, offset by, lower returnsreserve as a percentage of gross sales due to LUNESTA being accrued at a lowerrate than XOPENEX Inhalation Solution and an overall decrease in governmentrebates and contractual discounts as a percentage of gross  sales. Part of the decrease is associatedwith lower Medicare Part B discounts resulting from favorable Medicarereimbursement rates for XOPENEX Inhalation Solution. We cannot be certain thesefavorable rates will continue. In March2006, the Medicare Durable Medical Equipment Program Safeguard Contractors, orDME-PSCs, issued a draft local coverage determination under which Medicarereimbursement for XOPENEX Inhalation Solution would be reduced to the level ofreimbursement for generic albuterol. If this local coverage determination isimplemented, our sales of XOPENEX Inhalation Solutions would be materialadversely affected.

Royalties were $8,173,000and $12,397,000 for the three months ended March 31, 2006 and 2005,respectively, a decrease of approximately 34%. The decrease is primarily due tothe decrease in royalties earned on the sales of ALLEGRA under our agreementwith sanofi-aventis, which were $5,439,000 for the three months ended March 31,2006 compared to $9,277,000 for the same period in 2005, with the majority ofthe decrease occurring in the United States. Pursuant to the terms of our U.S.agreement with sanofi-aventis, our royalties on the sale of ALLEGRA in theUnited States, which have historically been $15 to $20 million per year, terminatedbased on the introduction of a generic equivalent of this product in September 2005.We are still entitled to receive royalties on the sale of ALLEGRA outside ofthe United States in countries where we hold patents covering ALLEGRA and nogeneric equivalent product has been introduced. Royalties earned on sales ofCLARINEX®, under our agreement with Schering-Plough Corporation, decreased to$1,981,000 from $2,340,000 for the three months ended March 31, 2006versus the same period in 2005.

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*Costs of Revenues*

Cost of product sold was$25,533,000 and $10,037,000 for the three months ended March 31, 2006 and2005, respectively.

Cost of LUNESTA sold as apercentage of LUNESTA sales was approximately 6% for the three months ended March 31,2006, with the largest portion being the royalty paid on net sales of LUNESTAto a third party. In accordance with our accounting policies, we did not beginto capitalize product manufacturing costs associated with LUNESTA inventoryuntil the FDA approved the new drug application, or NDA, for LUNESTA.Therefore, we expect costs of LUNESTA sold as a percentage of LUNESTA sales toincrease after we have sold all of our product for which we have notcapitalized manufacturing costs. We expect this to occur around mid to late 2006.

Cost of XOPENEX InhalationSolution sold as a percentage of XOPENEX Inhalation Solution sales wasapproximately 9% for the three months ended March 31, 2006 and for thesame period in 2005.

Cost of XOPENEX HFA soldas a percentage of XOPENEX HFA sales was approximately 14% for the three monthsended March 31, 2006. Included in the costs of XOPENEX HFA sold is aroyalty paid on net sales of XOPENEX HFA to 3M Company, or 3M, our third-partyfinished goods manufacturer of the product.

Cost of royalties earnedwas $159,000 and $203,000 for the three months ended March 31, 2006 and2005, respectively. The cost of royalties in both periods relates to anobligation to a third party as a result of royalties we earn from Schering-PloughCorporation based upon its sales of CLARINEX. This decrease in third-partyobligations is due to the decrease in royalties earned in the three monthsended March 31, 2006 as compared with the same period in 2005.

*Research and Development*

Research and developmentexpenses were $49,269,000 and $28,569,000 for the three months ended March 31,2006 and 2005, respectively, an increase of approximately 72%. The increase isprimarily due to our increased spending on our LUNESTA Phase IIIB/IV program aswell as drug discovery efforts. We also incurred increased spending on one ofour early-stage programs, SEP-225289, targeted for the treatment ofdepression. In addition, stock compensation expense resulting from the January 1,2006 implementation of FAS123(R) was$2,425,000 for the period ended March 31, 2006 as compared to $0 for theperiod ended March 31, 2005.

Drug development andapproval in the United States is a multi-step process regulated by the FDA. Theprocess begins with the filing of an investigational new drug application, orIND, which, if successful, allows the opportunity for study in humans, orclinical study, of the potential new drug. Clinical development typicallyinvolves three phases of study: Phase I, II and III. The most significantcosts in clinical development are in Phase III clinical trials, as they tend tobe the longest and largest studies in the drug development process. Followingsuccessful completion of Phase III clinical trials, an NDA must be submittedto, and accepted by, the FDA, and the FDA must approve the NDA prior tocommercialization of the drug. We may elect either on our own, or at therequest of the FDA, to conduct further studies that are referred to as PhaseIIIB and IV studies. Phase IIIB studies are initiated and either completed orsubstantially completed while the NDA is under FDA review. These studies areconducted under an IND. Phase IV studies, also referred to as post-marketingstudies, are studies that are initiated and conducted after the FDA hasapproved a product for marketing. Phase IV studies may be requested by the FDAeither before or after the FDA has approved an NDA. These studies may also beindependently initiated by the company whose NDA has been approved. The FDAuses post-marketing studies to gather additional information about a product’ssafety, efficacy or optimal use.

Successful development of our productcandidates is highly uncertain. Completion dates and completion costs can varysignificantly for each product candidate and are difficult to predict. Thelengthy 

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process of seeking FDAapprovals, and subsequent compliance with applicable statutes and regulations,require the expenditure of substantial resources. Any failure by us to obtain,or delay in obtaining, regulatory approvals could materially adversely affectour business. We cannot assure you that we will obtain any approval required bythe FDA on a timely basis, if at all.

For additional discussionof the risks and uncertainties associated with completing development ofpotential product candidates, see “Risk Factors”.

Belowis a summary of development of our products and product candidates thatrepresent 10% or more of our direct project research and development spendingfor the three months ended March 31, 2006. The “Estimate of Completion ofStage” column contains forward-looking statements regarding expectedtiming of completion of product development phases. Completion of productdevelopment, if successful, culminates in the submission of an NDA to the FDA.The actual timing of completion of phases could differ materially from theestimates provided in the table. The table is sorted by highest to lowestspending amounts, and the three product candidates listed accounted forapproximately 89% of our direct project research and development spending forthe three months ended March 31, 2006. No other product candidateaccounted for more than 6% of our direct research and development spending inthis period.

| **Product or Product Candidate** | ** ** | ** **              | ** ** | **Indication** | ** ** | **Phase of  Development** | ** ** | **Estimate of  Completion of Phase** | ** ** |
|-------------------------------------------------|------------|-------------------------|------------|----------------|------------|--------------------------------|------------|-----------------------------------------------------|------------|
| LUNESTA (eszopiclone)                           |       | Insomnia                |       |           | *          |                           |       |                                                | *          |   |   |
| XOPENEX HFA  (levalbuterol tartrate)            |       | Respiratory—Asthma |       |           | **         |                           |       |                                                | **         |   |   |
| Arformoterol                                    |       | Respiratory—COPD   |       |           | ***        |                           |       |                                                | ***        |   |   |
| SEP-225289                                      |       | Depression              |       |           | Phase I    |                           |       |                                                | 2007       |   |   |

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*                    Wecommercially launched LUNESTA in April 2005.

**             Wecommercially launched XOPENEX HFA in December 2005.

***      Wesubmitted an NDA to the FDA in December 2005. The Prescription Drug UserFee Act, or PDUFA, date is October 12, 2006.

Belowis a summary of expenditure information related to our product candidatesrepresenting 10% or more of our direct project research and developmentspending during the three months ended March 31, 2006, and 2005, as wellas the costs incurred to date on these projects. The costs in this analysisinclude only direct costs and do not include certain indirect labor, overhead,stock based compensation, or other costs which benefit multiple projects. As aresult, fully loaded research and development cost summaries by project are notpresented.

| ** **                           | ** ** | **Project costs for  the three  months ended  March 31, 2006** | ** ** | **Project costs to  date through  March 31,  2006** | ** ** | **Project costs for  the three  months ended  March 31, 2005** | ** ** | **Project costs to  date through  March 31,  2005** | ** ** |
|--------------------------------------|------------|----------------------------------------------------------------------------------------------|------------|-------------------------------------------------------------------------|------------|----------------------------------------------------------------------------------------------|------------|-------------------------------------------------------------------------|------------|
| ** **                           | ** ** | **(in thousands)**                                                                      | ** ** |
| LUNESTA (eszopiclone)                |       |                                                                                         | $          | 7,981                                                                   |       |                                                                                         |       | $                                                                       | 207,703    |   |   |   | $ | — |   |   |   | $ | 183,369 |   |   |
| XOPENEX HFA  (levalbuterol tartrate) |       |                                                                                         | $          | 5,287                                                                   |       |                                                                                         |       | $                                                                       | 162,078    |   |   |   | $ | 5,246 |   |   |   | $ | 137,943 |   |   |
| Arformoterol                         |       |                                                                                         | $          | 3,643                                                                   |       |                                                                                         |       | $                                                                       | 165,221    |   |   |   | $ | 3,796 |   |   |   | $ | 147,315 |   |   |
| SEP-225289                           |       |                                                                                         | $          | 2,799                                                                   |       |                                                                                         |       | $                                                                       | 6,750      |   |   |   | $ | 493 |   |   |   | $ | 493 |   |   |

 

Due to the length of timenecessary to develop a product, uncertainties related to the ability to obtaingovernmental approval for commercialization, and difficulty in estimating costsof projects, it is difficult to make accurate and meaningful estimates of theultimate cost to bring our product candidates to FDA approved status. We do notbelieve it is possible to estimate, with any degree of accuracy, the costs ofproduct candidates that are in stages earlier than Phase III.

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*Selling, Marketing and Distribution*

Selling, marketing anddistribution expenses were $189,991,000 and $93,207,000 for the three months endedMarch 31, 2006 and 2005, respectively, an increase of approximately 104%.Of this increase, approximately 65% is due to an increase in marketing,advertising and promotion costs in support of the commercial launch of LUNESTA,which took place in April 2005. Additionally, we incurred increasedpayroll and related expense as a result of hiring additional sales representativesand management to support the commercialization of LUNESTA and XOPENEX HFA. Wealso experienced increased sales training costs for the three months endedMarch 31, 2006 compared to the same period last year as a result of salestraining for our sales force expansion in 2006. In addition, stock-based compensation expense was$3,304,000for the period ended March 31, 2006, whichincluded $3,274,000 resulting from our January 1, 2006implementation of SFAS 123(R) as compared to $35,000 ofstock-based compensation expense for the period ended March 31, 2005.

*General and Administrative*

General and administrativecosts were $14,508,000 and $8,707,000for the three months ended March 31, 2006 and 2005, respectively, anincrease of approximately 67%. Of this increase, stock-based compensation expense was approximately $4,185,000 or 72%,  which included $3,992,000resulting from the January 1, 2006 implementation of SFAS 123(R) ascompared to $226,000  of stock-basedcompensation  expensefor the same period in 2005.

*Other Income (Expense)*

Interest income was$9,794,000 and $5,248,000 for the three months ended March 31, 2006 and2005, respectively, an increase of approximately 87%. The increase is due tohigher average balances of cash and short- and long-term investmentscombined with an increase in the interest rates earned on investments in 2006.Our monthly average cash and investment balance was approximately $978,657,000and $813,591,000 for the three months ended March 31, 2006 and 2005,respectively. For the three months ended March 31, 2006 and 2005 theaverage annualized interest rate that we earned on our investments was 4.00%and 2.58%, respectively.

Interest expense was$5,551,000 and $5,842,000 for the three months ended March 31, 2006 and2005, respectively. The expense in both periods is primarily related to theinterest we paid on our 5% convertible subordinated debentures.

Equity in investee losseswere $258,000 and $168,000 for the three months ended March 31, 2006 and2005, respectively, an increase of approximately 54%. The loss represents ourportion of BioSphere losses.

**Liquidity and Capital Resources (Restated)**

Our liquidity requirementshave historically consisted of research and development expenses, sales andmarketing expenses, capital expenditures, working capital, debt service andgeneral corporate expenses. We have funded these requirements and the growth ofour business primarily through convertible subordinated debt offerings, theissuance of common stock, including the exercise of stock options, and sales ofproduct and license agreements for our drug compounds. We now expect to fund ourliquidity requirements primarily through the generation of positive cash flowfrom our operations. We also believe we have the ability to meet our short-termliquidity needs through the use of our cash and short-term investments on handat March 31, 2006.

Cash, cash equivalents andshort- and long-term investments totaled $960,201,000, or 75% of totalassests at March 31, 2006, compared to $976,201,000, or 77% of totalassets at December 31, 2005.

Net cash used in operatingactivities for the three months ended March 31, 2006 was $27,567,000 whichincludes net income of $10,036,000, which includes non-cash chargesof $15,274,000, consisting 

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primarilyof stock compensation and depreciation and amortization expense. Accountsreceivable and inventory increased by $10,137,000 and $3,836,000, respectivelydue primarily to LUNESTA and XOPENEX Inhalation Solution sales. Other currentassets increased by $10,976,000, which is primarily attributable to an increasein prepaid expenses as well as an increase in interest receivable on ourinvestments. Accounts payable increased by $15,138,000 primarily due to timingof vendor payments. Accrued expenses decreased by $71,196,000 primarily due tothe timing of payments relating to commissions, interest and sales andmarketing accruals as well as a decrease in manufacturing accruals due to theproduction timing of LUNESTA and XOPENEX HFA. Other current liabilitiesincreased by $28,130,000 primarily due to an increase in accruals for productrevenue rebates related to LUNESTA and XOPENEX HFA product sales.

Net cash used in investingactivities for the three months ended March 31, 2006 was $37,621,000. Cashused in net purchases of short- and long-term investments was$22,849,000. We made purchases of property and equipment of $5,833,000. We alsomade an investment in ACADIA of $8,939,000.

Net cash provided byfinancing activities for the three months ended March 31, 2006 was$6,399,000. We received proceeds of $6,987,000 from issuing common stock uponthe exercise of stock options issued under our stock option plans. We also used$588,000 to repay capital lease obligations and long-term debt.

Webelieve our existing cash and the anticipated cash flow from operations andcurrent strategic alliances will be sufficient to support existing operationsthrough 2007. In the longer term, we expect to continue to fund our operationswith revenue generated from product sales. Our actual future cash requirementsand our ability to generate revenue, however, will depend on many factors,including:

·       LUNESTAsales;

·       XOPENEXInhalation Solution sales;

·       successfulcommercialization of XOPENEX HFA;

·       FDAapproval of our arformoterol NDA;

·       acquisitionsof technologies, product candidates, approved products and/or businesses;

·       ourability to establish and maintain additional strategic alliances and licensingarrangements;

·       achievementof milestones under our strategic alliance arrangements;

·       progressof our preclinical, clinical and research programs and the number and breadthof these programs; and

·       progressof our development efforts and the development efforts of our strategicpartners.

If our assumptionsunderlying our beliefs regarding future revenues and expenses change, or ifunexpected opportunities or needs arise, we may seek to raise additional cashby selling debt or equity securities or borrowing money from a bank. However,we may not be able to raise such funds on favorable terms, or at all.

Based on our currentoperating plan, we believe that we will not be required to raise additionalcapital to fund the repayment of our outstanding convertible debt when due. Ifwe are not able to successfully continue to grow our revenue and properlymanage our expenses, it is likely that our business would be materially andadversely affected and that we would be required to raise additional funds inorder to repay our outstanding convertible debt. We cannot assure that, ifrequired, we would be able to raise the additional funds on favorable terms, ifat all.

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**Off-Balance Sheet Arrangements**

We do not have anyoff-balance sheet arrangements, other than operating leases in the normalcourse of business, or variable interest entities or activities that includenon-exchange traded contracts accounted for at fair value.

**Contractual Obligations**

As of March 31, 2006, our contractualobligations disclosure in ourannual report on Form 10-K/Afor the year ended December 31, 2005 has not materially changed.

**ITEM 3.****                QUANTITATIVEAND QUALITATIVE DISCLOSURES ABOUT MARKET RISK**

**Market Risk**

We are exposed to marketrisk from changes in interest rates and equity prices, which could affect ourfuture results of operations and financial condition. These risks are describedin our annual report on Form 10-K/A for the year ended December 31,2005. As of May 9, 2006, there have been no material changes to the marketrisks described in our annual report on Form 10-K/Afor the year ended December 31, 2005. Additionally, we do not anticipateany near-term changes in the nature of our market risk exposures or in ourmanagement’s objectives and strategies with respect to managing such exposures.

**ITEM4.**                CONTROLS ANDPROCEDURES

**Disclosure Controls and Procedures**

In August2006, our management, with the participation of our chiefexecutive officer and chief financial officer, re-evaluatedthe effectiveness of our disclosure controls and procedures as of March 31,2006 taking into account theresults of the special committee’s stock option review. Theterm “disclosure controls and procedures,” as defined in Rules 13a-15(e) and15d-15(e) under the Exchange Act, means controls and otherprocedures of a company that are designed to ensure that information requiredto be disclosed by a company in the reports that it files or submits under theExchange Act is recorded, processed, summarized and reported, within the timeperiods specified in the SEC’s rules and forms. Disclosure controls andprocedures include, without limitation, controls and procedures designed toensure that information required to be disclosed by a company in the reportsthat it files or submits under the Exchange Act is accumulated and communicatedto the company’s management, including its principal executive and principalfinancial officers, as appropriate to allow timely decisions regarding requireddisclosure. Our management recognizes that any controls and procedures, nomatter how well designed and operated, can provide only reasonable assurance ofachieving their objectives and our management necessarily applies its judgmentin evaluating the cost-benefit relationship of possible controls andprocedures. Based on the re-evaluationof our disclosure controls and procedures as of March 31, 2006, our chiefexecutive officer and chief financial officer concluded that, as of such date,our disclosure controls and procedures were effective at the reasonableassurance level.

**Changes in Internal Control Over Financial Reporting**

There has been no change in our internalcontrol over financial reporting (as defined in Rules 13a-15(f) and15d-15(f) under the Exchange Act) during our quarter ended March 31,2006 that has materially affected, or is reasonably likely to materiallyaffect, our internal control over financial reporting.

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**PART II**

**OTHERINFORMATION**

**ITEM1.**                LEGAL PROCEEDINGS

**Legal Proceedings As of March 31, 2006**

The following legalproceedings were pending as of March 31, 2006:

**Levalbuterol Hydrochloride Inhalation Solution ANDAs.**   InSeptember 2005, we received notification that the FDA had received anANDA from Breath Limited seeking approval of a *g*enericversion of our 1.25 mg, 0.63 mg and 0.31 mg levalbuterol hydrochlorideinhalation solution. Breath Limited’s submission includes a Paragraph IVcertification alleging that our patents listed in the FDA publication entitled“Approved Drug Products With Therapeutic Equivalence Evaluations,” commonlyreferred to as the “Orange Book,” for XOPENEX Inhalation Solution are invalid,unenforceable or not infringed by Breath Limited’s proposed product. We havefiled a civil action against Breath Limited for patent infringement. We were notifiedin January 2006 of a second ANDA seeking approval of a genericversion of our 1.25 mg, 0.63 mg and 0.31 mg levalbuterol hydrochlorideinhalation solution including a Paragraph IV certification, which wassubmitted to the FDA by Dey, L.P. We have filed a civil actionagainst Dey, L.P. for patent infringement. In April 2006, we werenotified of a third ANDA seeking approval of a generic version of our 1.25 mg,0.63 mg and 0.31 mg levalbuterol hydrochloride inhalation solution including a Paragraph IVcertification, which was submitted to the FDA by Watson Laboratories, Inc.We have yet to decide whether we will file a civil action against WatsonLaboratories, Inc. for patent infringement.

Should we successfully enforce our patents,ANDA approval will not occur until the expiration of the applicablepatents. Otherwise, the FDA will stay its approval of the relevant ANDAuntil 30 months following the date we received notice of such ANDA oruntil a court decides that our patents are invalid, unenforceable or notinfringed, whichever is earlier. Patent litigation involves complex legal andfactual questions. We can provide no assurance concerning the outcome or theduration of the lawsuit. If we are not successful in enforcing our patents, wewill not be able to exclude the generic company, for the full term of ourpatents, from marketing their generic version of XOPENEX Inhalation Solution.Introduction of a generic copy of XOPENEX Inhalation Solution before theexpiration of our patents would have a material adverse effect on our business.

**Tecastemizole Class Action Complaints.**   Weand several of our current and former officers and a current director are namedas defendants in several class action complaints which have been filed onbehalf of certain persons who purchased our common stock and/or debt securitiesduring different time periods, beginning on various dates, the earliest being May 17,1999, and all ending on March 6, 2002. These complaints allege violationsof the Securities Exchange Act of 1934, as amended and the rules andregulations promulgated thereunder by the Securities and Exchange Commission.Primarily they allege that the defendants made certain materially false andmisleading statements relating to the testing, safety and likelihood of FDAapproval of tecastemizole. In both the debt purchasers’ action and equitypurchasers’ action, the court has granted the plaintiffs’ motion for classcertification. In late February 2006, two corrected and amended consolidated complaintswere filed, one on behalf of the purchasers of our common stock and the otheron behalf of the purchasers of our debt securities. These corrected and amendedconsolidated complaints reiterate the allegations contained in the previouslyfiled complaints and define the alleged class periods as May 17, 1999through March 6, 2002. The parties are currently engaged in discovery. Weare unable to reasonably estimate any possible range of loss related to thelawsuits due to their uncertain resolution. However, any conclusion of thesematters in a manner adverse to us would have a material adverse effect on ourfinancial position and results of operation.

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**Legal Proceedings Relating to Stock Option Review**

The following legalproceedings relating to the stock option review discussed in the ExplanatoryNote at the beginning of this Form 10-Q/A and Note 11 to theconsolidated financial statements set forth herein were initiated afterMarch 31, 2006:

**Stock Option Inquiry.****  **InJune 2006, we announced that we had received an informal letterof inquiry from the SEC requesting documents related to our stock option grantsand stock option practices. We appointed a special committee of outsidedirectors to conduct an internal review relating to our stock option grants andstock option practices. The special committee, with the assistance of outside legal counsel and outside accounting specialists, has reviewed stock optiongrants to our officers, directors and employees from 1996 to present under ourvarious stock option plans in effect during this period. We have beencooperating with the review and our finance department has also reviewed ourstock option grants and stock option practices. Although the special committee has completed itsreview, the committee will remain in place for the duration of the SEC'sinquiry. Should additional information become available to us in connectionwith the SEC inquiry, the special committee may be required to reopen itsreview and our current determination of stock-based compensation could change. See Note 11 to our financial statements foradditional information concerning these reviews.

**Derivative Stockholder Complaints.****  **We have accepted service of three stockholder derivative complaints that were filed in the Superior Court, Middlesex County,Commonwealth of Massachusetts, naming Sepracor as nominal defendant and alsonaming as defendants certain current members of our board of directors andcertain of our current and former employees. The complaints allege purportedbreaches of fiduciary duties and unjust enrichment in connection with certainstock option grants made by us between June 1998 and May 2001. Thecomplaints seek monetary damages in unspecified amounts, equitable andinjunctive relief, including disgorgement of profits obtained by certaindefendants and other relief as determined by the Court. On August 30, 2006, the parties in all threeactions moved to consolidate the actions and to transfer them to the BusinessLitigation Session of the Superior Court, Suffolk County.

**ITEM 1A.**        RISKFACTORS

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

**Risks Related to Our Financial Results**

**Wehave a history of net losses and we may not be able to generate revenuessufficient to achieve and maintain profitability on a quarterly and annualbasis.**

Except for our fiscalquarters ended December 31, 2005 and March 31, 2006, we have incurrednet losses each quarter since our inception. It is possible we will not be ableto achieve profitability again or maintain profitability on a quarterly orannual basis. We expect to continue to incur significant operating expendituresto further develop and commercialize our products and product candidates. As aresult, we will need to generate significant revenues in future periods toachieve and maintain profitability. We cannot assure you that we will achievesignificant revenues or that we will ever achieve profitability again. Even ifwe do achieve profitability again, we may not be able maintain profitabilityfor any substantial period of time. If revenues grow more slowly than weanticipate or if operating expenses exceed our expectations or cannot beadjusted accordingly, our business, results of operations and financialcondition will be materially and adversely affected. In addition, if we areunable to achieve or maintain profitability on a quarterly or annual basis, themarket price of our common stock may decline.

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**Almostall of our revenues are derived from sales of LUNESTA and XOPENEX InhalationSolution and our future success depends on the continued commercial success ofthese products.**

Approximately 95% of ourrevenues for the three months ended March 31, 2006 resulted from sales ofLUNESTA and XOPENEX Inhalation Solution and we expect sales from these twoproducts to represent substantially all of our revenues for the foreseeablefuture. In April 2005, we commercially launched LUNESTA as a new productin a highly and increasingly competitive market and we cannot be certain thatit will achieve continued commercial success. In addition, we do not havelong-term sales contracts with our customers, and we rely on purchase ordersfor sales of LUNESTA and XOPENEX Inhalation Solution. Reductions, delays orcancellations of orders for LUNESTA or XOPENEX Inhalation Solution couldadversely affect our operating results. If sales of LUNESTA and XOPENEXInhalation Solution do not continue to increase, we may not have sufficientrevenues to achieve our business plan or repay our outstanding debt, and ourbusiness will not be successful. In December 2005, we commerciallylaunched XOPENEX HFA and we cannot be certain that it will achieve commercialsuccess.

With respect to XOPENEXInhalation Solution, three generic companies have filed ANDAs with the FDAseeking to market a generic version of levalbuterol hydrochloride inhalationsolution. We have commenced patent litigation against two of these genericcompanies and we have yet to decide whether to commence litigation against thethird. A finding that the products these companies wish to market do notinfringe our patents or that our patents are invalid or unenforceable willlikely lead to introduction of generic levalbuterol inhalation solution. Ifthis occurs, sales of XOPENEX Inhalation Solution will be adversely affected.

Wecannot be certain that we will be able to continue to successfullycommercialize our products or that any of our products will continue to beaccepted in their markets. Specifically, the following factors, among others,could affect the level of success and market acceptance of LUNESTA, XOPENEXInhalation Solution and/or XOPENEX HFA:

·       achange in the perception of the health care community of their safety and/orefficacy, both in an absolute sense and relative to that of competing products;

·       theintroduction of new products into the sleep or respiratory markets;

·       thelevel and effectiveness of our sales and marketing efforts;

·       anyunfavorable publicity regarding these products or similar products;

·       litigationor threats of litigation with respect to these products;

·       theprice of the product relative to other competing drugs or treatments;

·       anychanges in government and other third-party payor reimbursement policiesand practices; and

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

Any adverse developmentswith respect to the sale of LUNESTA or XOPENEX Inhalation Solution couldsignificantly reduce revenues and have a material adverse effect on our abilityto maintain profitability and achieve our business plan.

**Wehave significant long-term debt and we may not be able to make principalpayments when due.**

As of March 31, 2006,our total long-term debt was approximately $1.2 billion and ourstockholders’ equity (deficit) was ($127.7) million. None of our 5% debenturesdue 2007, our 0% Series A notes due 2008, our 0% Series B notes due2010 nor our 0% notes due 2024 restricts us or our subsidiaries’ ability to incuradditional indebtedness, including debt that ranks senior to the notes. The 0%notes due 2024 are senior to the Series A notes due 2008 and Series Bnotes due 2010, which are senior to the 5% debentures due 2007. Additionalindebtedness that we incur may in certain circumstances rank senior to or onparity 

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withthis debt. Our ability to satisfy our obligations will depend upon our futureperformance, which is subject to many factors, including factors beyond ourcontrol. The conversion prices for the 5% debentures due 2007, 0% Series Anotes due 2008 and 0% Series B notes due 2010 are $92.38, $31.89 and$29.84, respectively. On May 1, 2006, the closing sale price of our commonstock was $43.76. If the market price for our common stock does not exceed theconversion price, the holders of our outstanding convertible debt may notconvert their securities into common stock. Our 0% notes due 2024 areconvertible into cash and, if applicable, shares of our common stock at aconversion price of approximately $67.20, at the option of the holders undercertain circumstances. We may not be able to make the required cash paymentsupon conversion of the 0% notes due 2024.

Historically, we have hadnegative cash flow from operations. For the three months ended March 31,2006, net cash used in operating activities was approximately$27.6 million. Our annual debt service through 2006, assuming noadditional interest-bearing debt is incurred and no additional 5%debentures due 2007 are converted, redeemed, repurchased or exchanged, isapproximately $22.0 million. Unless we have sufficient cash or are able togenerate sufficient operating cash flow to pay off the principal of ouroutstanding debt, we will be required to raise additional funds or default onour obligations under the debentures and notes. If revenue generated from salesof LUNESTA and XOPENEX Inhalation Solution do not meet expected levels, it isunlikely that we would have sufficient cash flow to repay our outstandingconvertible debt and/or make cash payments upon conversion of the 0% notes due2024. There can be no assurance that, if required, we would be able to raisethe additional funds on favorable terms, if at all.

**If weexchange debt for shares of common stock, there will be additional dilution toholders of our common stock.**

As of March 31, 2006,we had approximately $1.2 billion of outstanding long-term debt. In orderto reduce future cash interest payments, as well as future payments due atmaturity, we may, from time to time, depending on market conditions, repurchaseadditional outstanding convertible debt for cash; exchange debt for shares ofour common stock, warrants, preferred stock, debt or other consideration; or acombination of any of the foregoing. If we exchange shares of our capital stock,or securities convertible into or exercisable for our capital stock, foroutstanding convertible debt or use proceeds from the issuance of convertibledebt to fund redemption of outstanding convertible debt with a higherconversion ratio, the number of shares that we might issue as a result of suchexchanges would significantly exceed the number of shares originally issuableupon conversion of such debt and, accordingly, such exchanges would result inmaterial dilution to holders of our common stock. We cannot assure you that wewill repurchase or exchange any additional outstanding convertible debt.

**Ifthe estimates we make, or the assumptions on which we rely, in preparing ourfinancial statements prove inaccurate, our actual results may vary from these reflectedin our projections and accruals.**

Our financial statementshave been prepared in accordance with accounting principles generally acceptedin the United States. The preparation of these financial statements requires usto make estimates and judgments that affect the reported amounts of our assets,liabilities, revenues and expenses, the amounts of charges accrued by us andrelated disclosure of contingent assets and liabilities. We base our estimateson historical experience and on various other assumptions that we believe to bereasonable under the circumstances. We cannot assure you, however, that ourestimates, or the assumptions underlying them will not be materially different fromactual results. For example, our royalty revenue is recognized based upon ourestimates of our collaboration partners’ sales during the period and, if thesesales estimates are greater than the actual sales that occur during the period,our net income would be reduced. This, in turn, could adversely affect ourstock price.

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**Ifsufficient funds to finance our business are not available to us when needed oron acceptable terms, then we may be required to delay, scale back, eliminate oralter our strategy for our programs.**

We mayrequire additional funds for our research and product development programs,operating expenses, repayment of debt, the pursuit of regulatory approvals,license or acquisition opportunities and the expansion of our production, salesand marketing capabilities. Historically, we have satisfied our funding needsthrough collaboration arrangements with corporate partners, sales of product,and equity and debt financings. These funding sources may not be available tous when needed in the future, and, if available, they may not be on termsacceptable to us. Insufficient funds could require us to delay, scale back oreliminate certain of our research and product development programs or to enterinto license agreements with third parties to commercialize products ortechnologies that we would otherwise develop or commercialize ourselves. Ourcash requirements may vary materially from those now planned because of factorsincluding:

·       patentdevelopments;

·       licensingor acquisition opportunities;

·       relationshipswith collaboration partners;

·       theFDA regulatory process;

·       litigation;

·       ourcapital requirements; and

·       selling, marketing andmanufacturing expenses in connection with commercialization of products.

**Severalclass action lawsuits have been filed against us which may result in litigationthat is costly to defend and the outcome of which is uncertain and may harm ourbusiness.**

We and several of ourcurrent and former officers and a current director are named as defendants inseveral class action complaints which have been filed on behalf of certainpersons who purchased our common stock and/or debt securities during differenttime periods, beginning on various dates, the earliest being May 17, 1999,and all ending on March 6, 2002. These complaints allege violations of theExchange Act and the rules and regulations promulgated thereunder by theSEC. Primarily they allege that the defendants made certain materially falseand misleading statements relating to the testing, safety and likelihood of FDAapproval of tecastemizole. On September 8, 2005, in both the debtpurchasers’ action and the equity purchasers’ action, the district courtgranted the plaintiff’s motion for class certification. In late February 2006,two corrected and amended consolidated complaints were filed, one on behalf ofthe purchasers of our equity securities and the other on behalf the purchasersof our debt securities. These corrected and amended consolidated complaintsreiterate the allegations contained in the previously filed complaints anddefine the alleged class periods as May 17, 1999 through March 6,2002. The parties are currently engaged in discovery.

We can provide noassurance as to the outcome of these lawsuits. Any conclusion of these mattersin a manner adverse to us would have a material adverse effect on our financialcondition and business. In addition, the costs to us of defending anylitigation or other proceeding, even if resolved in our favor, could besubstantial. Such litigation could also substantially divert the attention ofour management and our resources in general. Uncertainties resulting from theinitiation and continuation of any litigation or other proceedings could harmour ability to compete in the marketplace.

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**Fluctuationsin the demand for products, the success and timing of clinical trials,regulatory approvals, product launches, collaboration arrangements and anytermination of development efforts will cause fluctuations in our quarterlyoperating results, which could cause volatility in our stock price.**

Ourquarterly operating results are likely to fluctuate significantly, which couldcause our stock price to be volatile. These fluctuations will depend on manyfactors, including:

·       timingand extent of product sales and market penetration;

·       timingand extent of operating expenses, including selling and marketing expenses andthe costs of expanding and maintaining a direct sales force;

·       successand timing of regulatory filings and approvals for products developed by us orour licensing partners or for collaborative agreements;

·       timingand success of product launches;

·       introductionof competitive products into the market;

·       resultsof clinical trials with respect to products under development;

·       theinitiation of litigation against us, or adverse developments in any judicialproceedings in which we are involved;

·       achange in the perception of the health care and/or investor communities withrespect to our products;

·       successand timing of collaboration agreements for development of our pharmaceuticalcandidates and development costs for those pharmaceuticals;

·       timingof receipt of upfront, milestone or royalty payments under collaborationagreements;

·       terminationof development efforts of any product under development or any collaborationagreement; and

·       timing of expenses we mayincur with respect to any license or acquisitions of products or technologies.

**Wehave various mechanisms in place to discourage takeover attempts, which mayreduce or eliminate our stockholders’ ability to sell their shares for apremium in a change of control transaction.**

Variousprovisions of our certificate of incorporation and by-laws and of Delawarecorporate law may discourage, delay or prevent a change in control or takeoverattempt of our company by a third party that is opposed by our management andboard of directors. Public stockholders who might desire to participate in sucha transaction may not have the opportunity to do so. These anti-takeoverprovisions could substantially impede the ability of public stockholders tobenefit from a change of control or change in our management and board ofdirectors. These provisions include:

·       preferredstock that could be issued by our board of directors to make it more difficultfor a third party to acquire, or to discourage a third party from acquiring, amajority of our outstanding voting stock;

·       classificationof our directors into three classes with respect to the time for which theyhold office;

·       non-cumulativevoting for directors;

·       controlby our board of directors of the size of our board of directors;

·       limitationson the ability of stockholders to call special meetings of stockholders;

·       inabilityof our stockholders to take any action by written consent; and

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·       advancenotice requirements for nominations of candidates for election to our board ofdirectors or for proposing matters that can be acted upon by our stockholdersat stockholder meetings.

In addition, in June 2002,our board of directors adopted a shareholder rights plan, the provisions ofwhich could make it more difficult for a potential acquirer of Sepracor toconsummate an acquisition transaction.

**Theprice of our common stock historically has been volatile, which could cause youto lose part or all of your investment.**

The market price of ourcommon stock, like that of the common stock of many other pharmaceutical andbiotechnology companies, may be highly volatile. In addition, the stock markethas experienced extreme price and volume fluctuations. This volatility hassignificantly affected the market prices of securities of many pharmaceuticaland biotechnology companies for reasons frequently unrelated to ordisproportionate to the operating performance of the specific companies. Thesebroad market fluctuations may adversely affect the market price of our commonstock. Prices for our common stock will be determined in the marketplace andmay be influenced by many factors, including variations in our financialresults and investors’ perceptions of us, and changes in recommendations bysecurities analysts as well as their perceptions of general economic, industryand market conditions.

**Risks Related to Commercialization**

**Weface intense competition and our competitors have greater resources andcapabilities than we have.**

We face intensecompetition in the sale of our current products, and expect to face intensecompetition in the sale of any future products we sell. If we are unable tocompete effectively, our financial condition and results of operations could bematerially adversely affected because we may not achieve our product revenueobjectives and because we may use our financial resources to seek todifferentiate ourselves from our competition. Large and small companies,academic institutions, governmental agencies and other public and privateorganizations conduct research, seek patent protection, develop products,establish collaborative arrangements for product development and sell productsin competition with us. Many of our competitors and potential competitors havesubstantially greater resources, manufacturing and sales and marketingcapabilities, research and development staff and production facilities than wehave. The fields in which we compete are subject to rapid and substantialtechnological change. Our competitors may be able to respond more quickly tonew or emerging technologies or to devote greater resources to the development,manufacture and marketing of new products and/or technologies than we can. As aresult, any products and/or technologies that we develop may become obsolete ornoncompetitive before we can recover expenses incurred in connection with theirdevelopment.

In the respiratory market,we compete primarily against albuterol. XOPENEX Inhalation Solution and genericalbuterol inhalation solution currently account for the majority ofbeta-agonist inhalation solution prescriptions in the market. Albuterol hasbeen marketed for many years, is well established and sells at pricessubstantially lower than XOPENEX Inhalation Solution. To continue successfullymarketing XOPENEX Inhalation Solution, we must continue to demonstrate that theefficacy and safety features of our drug outweigh its higher cost. In the sleepdisorder market, we face intense competition from established products, such asAMBIEN® and SONATA®. We also face competition from the newly approved sleepagents ROZEREMÔ and AMBIEN CRÔ.There are also other potentially competitive therapies that are in late-stagedevelopment for the treatment of insomnia. For all of our products, we need todemonstrate to physicians, patients and third-party payors that the costof our product is reasonable and appropriate in light of its safety andefficacy, its price and the health care benefits, each as compared to othercompeting products.

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**We may be unable to commercialize products for whichwe receive approval from the FDA.**

Commercialization of a product for which we havereceived an approval letter from the FDA could be delayed for a number ofreasons, some of which are outside of our control, including delays in deliveryof the product due to importation regulations and/or problems with ourdistribution channels or delays in the issuance of approvals from, or thecompletion of required procedures by, agencies other than the FDA, such as theUnited States Drug Enforcement Administration. In addition, commercializationof FDA-approved products may be delayed by our failure to timely finalizedistribution arrangements, manufacturing processes and arrangements, producesufficient inventory and/or properly prepare our sales force. If we are unableto commercialize a product promptly after receipt of an approval letter, ourbusiness and financial position may be materially adversely affected due toreduced revenue from product sales during the period or periods thatcommercialization is delayed and the shortening of any lead time to market wemay have had over our competitors. In addition, the exclusivity period, whichis the time during which the FDA will prevent generic pharmaceutical companiesfrom introducing a generic copy of the product, begins to run upon FDA approvaland, therefore, to the extent we are unable to commercialize a product promptlyafter receipt of an approval letter, our long-term product sales and revenuescould be adversely affected.

Even if the FDA or similarforeign agencies grant us regulatory approval of a product, if we fail tocomply with the applicable regulatory requirements, we may be subject to fines,suspension or withdrawal of regulatory approvals, product recalls, seizures ofproducts, operating restrictions and criminal prosecution. In any such event,our product sales and revenues could be adversely affected.

**We sell our products primarily through a direct salesforce and if we are not successful in attracting and retaining qualified salespersonnel, we may not be successful in commercializing our products.**

We have limited marketing and sales experience. Wehave established a sales force to market XOPENEX Inhalation Solution, LUNESTAand XOPENEX HFA. We have incurred significant expense in expanding our salesforce and expect to incur additional expense as we further expand. If wesuccessfully develop and obtain regulatory approval for the products we aredeveloping, we may (1) market and sell them through our sales force,(2) license some of them to large pharmaceutical companies or(3) market and sell them through other arrangements, includingco-promotion arrangements. We may incur significant costs in expanding oursales force before the products under development have been approved formarketing. For example, we expanded our sales force in 2004 in anticipation ofmarketing and selling LUNESTA and in 2005 in anticipation of marketing andselling XOPENEX HFA. In addition, if we enter into co-promotion arrangements ormarket and sell additional products directly, we may need to significantlyexpand our sales force.

Our ability to realizesignificant revenues from direct marketing and sales activities depends on ourability to attract and retain qualified sales personnel. Competition for thesepersons is intense. If we are unable to attract and retain qualified salespersonnel, we will not be able to successfully expand our marketing and directsales force on a timely or cost effective basis. We may also need to enter intoadditional co-promotion arrangements with third parties, for example where ourown direct sales force is not large enough or sufficiently well aligned toachieve maximum penetration in the market. We may not be successful in enteringinto any co-promotion arrangements, and the terms of any co-promotionarrangements may not be favorable to us.

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**If we or our third-party manufacturers do notcomply with current Good Manufacturing Practices regulations, then the FDAcould refuse to approve marketing applications or force us to recall orwithdraw our products.**

The FDA and other regulatory authorities require thatour products be manufactured according to their Good Manufacturing Practices,or GMP, regulations. The failure by us, our collaborative development partnersor third-party manufacturers to comply with current GMP regulations couldlead to delay in our development programs or refusal by the FDA to approvemarketing applications. Failure in either respect could also be the basis foraction by the FDA to withdraw approvals previously granted, to recall productsand for other regulatory action.

On October 22, 2004,we commenced notifying drug wholesalers, hospitals and pharmacies of amanufacturer-initiated voluntary Class III recall of one componentof our XOPENEX Inhalation Solution product line, XOPENEX Inhalation SolutionConcentrate (1.25mg/0.5mL), which we introduced in August 2004. Therecall, which affects only XOPENEX Inhalation Solution Concentrate and no othercomponents of our XOPENEX Inhalation Solution product line, was necessitated bypackaging process validation issues relating to the automated process ofplacing finished vials into a foil pouch. We have suspended manufacture andsale of XOPENEX Inhalation Solution Concentrate until the issues giving rise tothe recall have been fully addressed. We expect to re-introduce XOPENEXInhalation Solution Concentrate before the end of 2006. If our manufacturercannot remedy the GMP deficiencies giving rise to the recall of XOPENEXInhalation Solution Concentrate, or if these or similar deficiencies are foundto extend to other components or our XOPENEX Inhalation Solution product line,our ability to supply product to the market may be limited or interruptedindefinitely, which could have a material adverse effect on our business.

**We could be exposed to significant liability claimsthat could prevent or interfere with our product commercialization efforts.**

We may be subject toproduct liability claims that arise through testing, manufacturing, marketing,sale and use of pharmaceutical products. Product liability claims coulddistract our management and key personnel from our core business, require us tospend significant time and money in litigation or to pay significant damages,which could prevent or interfere with our product commercialization efforts andcould adversely affect our business. Claims of this nature could also adverselyaffect our reputation, which could damage our position in the market andsubject us to product recalls. Although we maintain product liability insurancecoverage for both the clinical trials and commercialization of our products, itis possible that we will not be able to obtain further product liabilityinsurance on acceptable terms, if at all, and that our insurance coverage maynot provide adequate coverage against all potential claims.

**Risks Related tothe Regulatory Environment**

**If our products do not receive government approval,then we will not be able to commercialize them.**

The FDA and similarforeign agencies must approve for commercialization any pharmaceutical productsdeveloped by us or our development partners. These agencies impose substantialrequirements on drug manufacturing and marketing. Any unanticipated preclinicaland clinical studies we are required to undertake could result in a significantincrease in the cost of advancing our products to commercialization. Inaddition, failure by us or our collaborative development partners to obtainregulatory approval on a timely basis, or at all, or the attempt by us or ourcollaborative development partners to receive regulatory approval to achievelabeling objectives, could prevent or adversely affect the timing of commercialintroduction of, or our ability to market and sell, our products.

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**If we fail to successfully develop and receiveregulatory approval for arformoterol or other product candidates, we will beunable to commercialize the product candidates and future sales and earningsgrowth will be substantially hampered.**

Our ability to maintain profitability will depend inlarge part on successful development and commercialization of additionalproducts, including arformoterol. In February 2006, the FDA accepted ourarformoterol NDA for filing. The PDUFA date for the arformoterol NDA isOctober 12, 2006. We cannot assure you that the FDA will approve our NDAfor arformoterol on a timely basis, or at all. If the FDA does not approve ourNDA for arformoterol, we will not be able to commercialize the productcandidate and, therefore, will not receive any revenues from sales of theproduct.

Other than arformoterol, our product candidates are inthe early stages of development. We cannot assure you that we will be able todevelop or acquire and commercially introduce new products in a timely manneror that new products, if developed, will be approved for the indications,and/or with the labeling, we expect or that they will achieve marketacceptance. Before we commercialize any other product candidate, we will needto successfully develop the product candidate by completing successful clinicaltrials, submitting an NDA for the product candidate that is accepted by the FDAand receiving FDA approval to market the candidate. If we fail to successfullydevelop a product candidate and/or the FDA delays or denies approval of anysubmitted NDA or any NDA that we submit in the future, then commercializationof our products under development may be delayed or terminated, which couldhave a material adverse effect on our business.

A number ofproblems may arise during the development of our product candidates:

·       resultsof clinical trials may not be consistent with preclinical study results;

·       resultsfrom later phases of clinical trials may not be consistent with results fromearlier phases;

·       resultsfrom clinical trials may not demonstrate that the product candidate is safe andefficacious;

·       wemay not receive regulatory approval for our product candidates;

·       theproduct candidate may not offer therapeutic or other improvements overcomparable drugs;

·       wemay elect not to continue funding the development of our product candidates; or

·       fundsmay not be available to develop all of our product candidates.

In addition, our growth isdependent on our continued ability to penetrate new markets where we havelimited experience and competition is intense. We cannot assure you that themarkets we serve will grow in the future, that our existing and new productswill meet the requirements of these markets, that our products will achievecustomer acceptance in these markets, that competitors will not force prices toan unacceptably low level or take market share from us, or that we can achieveor maintain profits in these markets.

**If the FDA delays or denies approval of any NDA thatwe file in the future, then commercialization of the product subject to the NDAwill be delayed or terminated, which could have a material adverse effect onour business.**

The regulatoryprocess to obtain marketing approval requires clinical trials of a product toestablish its safety and efficacy. Problems that may arise during clinicaltrials include:

·       resultsof clinical trials may not be consistent with preclinical study results;

·       resultsfrom later phases of clinical trials may not be consistent with results fromearlier phases; and

·       productsmay not be shown to be safe and efficacious.

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Even if the FDA or similarforeign agencies grant us regulatory approval of a product, the approval maytake longer than we anticipate and may be subject to limitations on theindicated uses for which the product may be marketed or contain requirementsfor costly post-marketing follow-up studies. Moreover, if we fail to complywith applicable regulatory requirements, we may be subject to fines, suspensionor withdrawal of regulatory approvals, product recalls, seizure of products,operating restrictions and criminal prosecution.

**Our sales depend on payment and reimbursement fromthird-party payors, and a reduction in payment rate or reimbursementcould result in decreased use or sales of our products.**

Sales of our products are dependent, in part, on theavailability of reimbursement from third-party payors such as state andFederal governments under programs such as Medicare and Medicaid, and privateinsurance plans. Third-party payors continually attempt to contain orreduce the cost of health care by challenging the prices charged for medicalproducts and services. We may not be able to sell our products profitably ifreimbursement is unavailable or limited in scope or amount.

There have been, there are, and we expect there willcontinue to be, state and Federal legislative and/or administrative proposalsthat could limit the amount that state or Federal governments will pay toreimburse the cost of pharmaceutical products. The Medicare Prescription DrugImprovement and Modernization Act of 2003, or the MMA, which was signed intolaw in December 2003, contains provisions that permit reductions ingovernment reimbursement for drugs. We are not able to predict the full impactof the MMA and its regulatory requirements on our business. However, we believethat legislative or administrative acts that reduce reimbursement for ourproducts could adversely affect our business. In addition, private insurers,such as managed care organizations, may adopt their own reimbursement reductionsin response to legislation. Reduction in reimbursement for our products couldhave a material adverse effect on our results of operations. Also, theincreasing emphasis on managed care in the U.S. may put increasing pressure onthe price and usage of our products, which may adversely affect product sales.Further, when a new drug product is approved, governmental and/or privatereimbursement for that product is uncertain, as is the amount for which thatproduct will be reimbursed. We cannot predict availability or amount ofreimbursement for our approved products or product candidates, including thoseat a late stage of development, and current reimbursement policies for marketedproducts may change at any time.

The MMA also establishes a prescription drug benefitbeginning in 2006 for all Medicare beneficiaries. We cannot be assured that ourproducts will be included in the Medicare prescription drug benefit. Even ifour products are included, we may be required to provide significant discountsor rebates to drug plans participating in the Medicare drug benefit. Moreover,the Federal government may acquire the ability to negotiate price and demanddiscounts on pharmaceutical products that may implicitly create price controlson prescription drugs. On the other hand, the drug benefit may increase thevolume of pharmaceutical drug purchases, offsetting at least in part thesepotential price discounts. In addition, Managed Care Organizations, or MCOs,Health Maintenance Organizations, or HMOs, Preferred Provider Organizations, orPPOs, health care institutions and other government agencies continue to seekprice discounts. MCOs, HMOs, PPOs and private health plans will administer theMedicare drug benefit, leading to managed care and private health plans influencingprescription decisions for a larger segment of the population. In addition,certain states have proposed and certain other states have adopted variousprograms to control prices for their seniors’ and low-income drug programs,including price or patient reimbursement constraints, restrictions on access tocertain products, importation from other countries, such as Canada, and bulkpurchasing of drugs.

Some states have adopted preferred drug lists, orPDLs, for their Medicaid programs and more states may adopt this practice.Medicaid PDLs indicate which drugs a provider is permitted under the Medicaidprogram to prescribe without first seeking prior authorization from the stateMedicaid agency. If our drugs 

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are not included onMedicaid PDLs, use of our drugs in the Medicaid program may be adverselyaffected. In some states that have adopted PDLs, we have been, and may continueto be, required to provide substantial supplemental rebates to state Medicaidauthorities in order for our drugs to be included on the PDL.

On March 24, 2006, the Medicare Durable MedicalEquipment Program Safeguard Contractors, or DME-PSCs issued a draft localcoverage determination under which Medicare reimbursement for XOPENEXInhalation Solutions would be reduced to the level of reimbursement for genericalbuterol. We oppose the DME-PSCs’ proposal and are seeking its withdrawal. However,if this local coverage determination is implemented, our sales of XOPENEXInhalation Solution would be material adversely affected.

If reimbursement for our marketedproducts changes adversely or if we fail to obtain adequate reimbursement forour other current or future products, health care providers may limit how muchor under what circumstances they will prescribe or administer them, which couldreduce use of our products or cause us to reduce the price of our products.

**We will spend considerable time and money complyingwith Federal and state laws and regulations and, if we are unable to fullycomply with such laws and regulations, we could face substantial penalties.**

We are subject toextensive regulation by Federal and state governments. The laws that directlyor indirectly affect our business include, but are not limited to, thefollowing:

·       FederalMedicare and Medicaid Anti-Kickback laws, which prohibit persons from knowinglyand willfully soliciting, offering, receiving or providing remuneration,directly or indirectly, in cash or in kind, to induce either referral of anindividual, or furnishing or arranging for a good or service, for which paymentmay be made under Federal health care programs such as the Medicare andMedicaid programs;

·       otherMedicare laws and regulations that establish requirements for coverage andpayment for our products, including the amount of such payments;

·       theFederal False Claims Act, which imposes civil and criminal liability onindividuals and entities who submit, or cause to be submitted, false orfraudulent claims for payment to the government;

·       theFederal Health Insurance Portability and Accountability Act of 1996, or HIPAA,which prohibits executing a scheme to defraud any health care benefit program,including private payors and, further, requires us to comply with standardsregarding privacy and security of individually identifiable health informationand conduct certain electronic transactions using standardized code sets;

·       theFederal False Statements Statute, which prohibits knowingly and willfullyfalsifying, concealing or covering up a material fact or making any materiallyfalse statement in connection with the delivery of or payment for health carebenefits, items or services;

·       theFederal Food, Drug and Cosmetic Act, which regulates manufacturing, labeling,marketing, distribution and sale of prescription drugs and medical devices;

·       theControlled Substances Act, which regulates handling of controlled substancessuch as LUNESTA;

·       stateand foreign law equivalents of the foregoing;

·       statefood and drug laws, pharmacy acts and state pharmacy board regulations, whichgovern sale, distribution, use, administration and prescribing of prescriptiondrugs; and

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·       statelaws that prohibit practice of medicine by non-physicians and fee-splittingarrangements between physicians and non-physicians, as well as state lawequivalents to the Federal Medicare and Medicaid Anti-Kickback Laws, which maynot be limited to government reimbursed items or services.

If our past or presentoperations are found to be in violation of any of the laws described above orother governmental regulations to which we or our customers are subject, we maybe subject to the applicable penalty associated with the violation, includingcivil and criminal penalties, damages, fines, exclusion from Medicare andMedicaid programs and curtailment or restructuring of our operations. Similarly,if our customers are found non-compliant with applicable laws, they may besubject to sanctions, which could also have a negative impact on us. Inaddition, if we are required to obtain permits or licenses under these lawsthat we do not already possess, we may become subject to substantial additionalregulation or incur significant expense. Any penalties, damages, fines,curtailment or restructuring of our operations would adversely affect ourability to operate our business and our financial results. The risk of ourbeing found in violation of these laws is increased by the fact that many ofthem have not been fully interpreted by the regulatory authorities or thecourts and their provisions are open to a variety of interpretations. Anyaction against us for violation of these laws, even if we successfully defendagainst it, could cause us to incur significant legal expenses, divert ourmanagement’s attention from operating our business and damage our reputation.

**If our Medicaid rebate program practices areinvestigated, the costs could be substantial and could divert the attention ofmanagement.**

We are a participant inthe Medicaid rebate program established by the Omnibus Budget ReconciliationAct of 1990. Under the Medicaid rebate program, we pay a rebate for each unitof our product reimbursed by Medicaid. The amount of the rebate for eachproduct is set by law. We are also required to pay certain statutorily definedrebates on Medicaid purchases for reimbursement on prescription drugs understate Medicaid plans. Both the Federal government and state governments haveinitiated investigations into the rebate practices of many pharmaceuticalcompanies to ensure compliance with these rebate programs. Any investigation ofour rebate practices could be costly, could divert the attention of ourmanagement from our core business and could damage our reputation.

**The approval of sale of certain medications without aprescription may adversely affect our business.**

In May 2001, anadvisory panel to the FDA recommended that the FDA allow certain popularallergy medications to be sold without a prescription. In November 2002,the FDA approved CLARITIN®, an allergy medication, to be sold without aprescription. In the future, the FDA may also allow sale of other allergymedications without a prescription. The sale of CLARITIN and /or, if allowed,the sale of other allergy medications without a prescription, may have amaterial adverse effect on our business because the market for prescriptiondrugs, including CLARINEX, for which we receive royalties on sales, has beenand may continue to be adversely affected.

**Risks Related toOur Intellectual Property**

**If we fail to adequately protect or enforce ourintellectual property rights, then we could lose revenue under our licensingagreements or lose sales to generic copies of our products.**

Our success depends in part on our ability to obtain,maintain and enforce patents, and protect trade secrets. Our ability tocommercialize any drug successfully will largely depend upon our ability toobtain and maintain patents of sufficient scope to prevent third parties fromdeveloping substantially equivalent products. In the absence of patent andtrade secret protection, competitors may adversely affect our business byindependently developing and marketing substantially equivalent products. It isalso possible 

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that we could incursubstantial costs if we are required to initiate litigation against others toprotect or enforce our intellectual property rights.

We have filed patent applications covering compositionof, methods of making, and/or methods of using our drugs and drug candidates.Our revenues under collaboration agreements with pharmaceutical companiesdepend in part on the existence and scope of issued patents. We may not be issuedpatents based on patent applications already filed or that we file in thefuture and if patents are issued, they may be insufficient in scope to coverthe products licensed under these collaboration agreements. Generally, we donot receive royalty revenue from sales of products licensed under collaborationagreements in countries where we do not have a patent for such products. Theissuance of a patent in one country does not ensure the issuance of a patent inany other country. Furthermore, the patent position of companies in thepharmaceutical industry generally involves complex legal and factual questions,and has been and remains the subject of much litigation. Legal standardsrelating to scope and validity of patent claims are evolving. Any patents wehave obtained, or obtain in the future, may be challenged, invalidated orcircumvented. Moreover, the United States Patent and Trademark Office maycommence interference proceedings involving our patents or patent applications.Any challenge to, or invalidation or circumvention of, our patents or patentapplications would be costly, would require significant time and attention ofour management and could have a material adverse effect on our business.

On September 7, 2005, we announced that the FDAreceived an abbreviated new drug application, or ANDA from Breath Limitedseeking marketing approval for generic copies of our 1.25 mg, 0.63 mg and 0.31mg XOPENEX brand levalbuterol HCl Inhalation Solution unit-dose vial products.XOPENEX Inhalation Solution Concentrate is not subject to the ANDA. On January 12,2006, we announced that we received notice that the FDA had received an ANDAfrom Dey, L.P. for a generic version of our 1.25 mg, 0.63 mg and 0.31 mg levalbuterolhydrochloride inhalation solution. Both submissions include a Paragraph IVcertification alleging that our patents listed in the Orange Book for XOPENEXInhalation Solution are invalid, unenforceable or not infringed by thesubmitter’s proposed product. We have filed civil actions against BreathLimited and Dey, L.P. for patent infringement. In April 2006, we were notified of a third ANDA seeking approval of ageneric version of our 1.25 mg, 0.63 mg and 0.31 mg levalbuterol hydrochlorideinhalation solution including a Paragraph IV certification, which wassubmitted to the FDA by Watson Laboratories, Inc. We have yet to decide whetherwe will file a civil action against Watson Laboratories, Inc. for patentinfringement.

Should we successfully enforce our patents, the FDA will not approve the ANDAuntil expiration of the applicable patents. Otherwise, the FDA will stay itsapproval of the relevant ANDA until 30 months following the date wereceived notice of such ANDA or until a court decides that our patents areinvalid, unenforceable or not infringed, whichever is earlier. Patentlitigation involves complex legal and factual questions. We can provide noassurance concerning the outcome or the duration of the lawsuits. Anyconclusion of these matters in a manner adverse to us would have a material adverseeffect on our financial condition and business. If we are not successful inenforcing our patents, we will not be able to prevent the generic company, forthe full term of our patents, from marketing their generic version of XOPENEXInhalation Solution. Introduction of a generic copy of XOPENEX InhalationSolution before the expiration of our patents would have a material adverseeffect on our business. In addition, the costs to us of conducting theseproceedings, even if resolved in our favor, could be substantial. Suchlitigation could also substantially divert the attention of our management andother key personnel from our core business and our resources in general.Uncertainties resulting from the initiation and continuation of any litigation orother proceedings could harm our ability to compete in the marketplace.

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**If we face a claim of intellectual propertyinfringement by a third party, then we could be liable for significant damagesor be prevented from commercializing our products.**

Our success depends inpart on our ability to operate without infringing upon proprietary rights ofothers, including patent and trademark rights. Third parties, typically drugcompanies, hold patents or patent applications covering compositions, methodsof making and uses, covering the composition of matter for some of the drugcandidates for which we have patents or patent applications. Third parties alsohold patents relating to drug delivery technology that may be necessary fordevelopment or commercialization of some of our drug candidates. In each ofthese cases, unless we have or obtain a license agreement, we generally may notcommercialize the drug candidates until these third-party patents expireor are declared invalid or unenforceable by the courts. Licenses may not beavailable to us on acceptable terms, if at all. In addition, it would be costlyfor us to contest validity of a third-party patent or defend any claimthat we infringe a third-party patent. Moreover, litigation involvingthird-party patents may not be resolved in our favor. Such contests andlitigation would be costly, would require significant time and attention of ourmanagement, could prevent us from commercializing our products, could requireus to pay significant damages and could have a material adverse effect on ourbusiness. If any of our trademarks, or our use of any of our trademarks on ourproducts, is challenged, we may be forced to rename the affected product orproduct candidate, which could be costly and time consuming, and would resultin the loss of any brand equity associated with the product name.

**Risks Related toOur Dependence on Third Parties**

***If any third-partycollaborator is not successful in development of our product candidates, we maynot realize the potential commercial benefits of the arrangement and ourresults of operations could be adversely affected.***

We have entered into acollaboration agreement with 3M for the scale-up and manufacturing of XOPENEXHFA and we may enter into additional collaboration agreements in the future.Under our agreement with 3M, 3M is responsible for manufacturing an MDIformulation of XOPENEX. We commercially launched XOPENEX HFA in December 2005.If 3M, or any future development or commercialization collaborator, does notdevote sufficient time and resources to its collaboration arrangement with us,breaches or terminates its agreement with us, fails to perform its obligationto us in a timely manner or is unsuccessful in its development and/orcommercialization efforts, we may not realize the potential commercial benefitsof the arrangement and our results of operations may be adversely affected. Inaddition, if regulatory approval or commercialization of any product candidateunder development by or in collaboration with a partner is delayed or limited,we may not realize, or may be delayed in realizing, the potential commercialbenefits of the arrangement.

**The royalties we receive under licensing arrangementscould be delayed, reduced or terminated if our licensing partners terminate, orfail to perform their obligations under, their agreements with us, or if ourlicensing partners are unsuccessful in their sales efforts.**

We have entered intolicensing arrangements pursuant to which we license patents to pharmaceuticalcompanies and our revenues under these licensing arrangements consist primarilyof royalties on sales of products. Payments and royalties under thesearrangements depend in large part on the commercialization efforts of ourlicensing partners in countries where we hold patents, including sales effortsand enforcement of patents, which we cannot control. If any of our licensingpartners does not devote sufficient time and resources to its licensingarrangement with us or focuses its efforts in countries where we do not hold patents,we may not realize the potential commercial benefits of the arrangement, ourrevenues under these arrangements may be less than anticipated and our resultsof operations may be adversely affected. If any of our licensing partners wasto breach or terminate its agreement with us or fail to perform its obligationsto us in a timely manner, the royalties we receive under the licensingagreement could decrease 

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orcease. If we are unable or fail to perform, or breach in our performance of,our obligations under a licensing agreement, the royalties and benefits towhich we are otherwise entitled under the agreement could be reduced oreliminated. Any delay or termination of this type could have a material adverseeffect on our financial condition and results of operations because we may losetechnology rights and milestone or royalty payments from licensing partnersand/or revenues from product sales, if any, could be delayed, reduced orterminated.

**We rely on third-party manufacturers, and thisreliance could adversely affect our ability to meet our customers’ demands.**

We currently operate a manufacturing plant that webelieve can meet our commercial requirements of the active pharmaceuticalingredient for XOPENEX Inhalation Solution and XOPENEX HFA, partially fulfillour commercial requirements of the active pharmaceutical ingredient forLUNESTA, and support production of our product candidates in amounts needed forour clinical trials. We do not, however, have the capability to manufacture atour manufacturing facility all of our requirements for the active ingredientsof our currently approved products, and we have no facilities for manufacturingpharmaceutical dosage forms or finished drug products. Developing and obtainingthis capability would be time consuming and expensive. Unless and until wedevelop this capability, we will rely substantially, and in some cases,entirely, on third-party manufacturers. Cardinal Health, Inc. iscurrently the sole finished goods manufacturer of our XOPENEX Inhalation Solution,Patheon Inc. is the sole manufacturer of LUNESTA brand eszopiclone and 3Mis the sole manufacturer and supplier of XOPENEX HFA. Certain components ofXOPENEX HFA are available from only a single source. If Cardinal Health,Patheon, 3M, or any of our sole-source component suppliers experiences delaysor difficulties in producing, packaging or delivering XOPENEX InhalationSolution, LUNESTA, or XOPENEX HFA, as the case may be, we could be unable tomeet our customers’ demands for such products, which could lead to customerdissatisfaction and damage to our reputation. Furthermore, if we are requiredto change manufacturers, we will be required to verify that the newmanufacturer maintains facilities and procedures that comply with qualitystandards and with all applicable regulations and guidelines, including FDAguidelines. The delays associated with the verification of a new manufacturerfor XOPENEX Inhalation Solution, LUNESTA or XOPENEX HFA could negatively affectour ability to produce such products in a timely manner or within budget.

3M owns certainproprietary technology required to manufacture our XOPENEX HFA. If 3M is unableor unwilling to fulfill its obligations to us under our agreement, we may beunable to manufacture XOPENEX HFA on terms that are acceptable to us, if atall. Our other current contract manufacturers, as well as any future contractmanufacturers, may also independently own technology related to manufacturingof our products. If so, we would be heavily dependent on such manufacturer andsuch manufacturer could require us to obtain a license in order to have anotherparty manufacture our products.

**Risks Related toGrowth of Our Business**

**If we fail to acquire and develop additional productcandidates or approved products, our ability to grow will be impaired.**

We are currently commercializing three products.However, other than arformoterol, for which we have filed an NDA, our productcandidates are in the early stages of development. In order to increase thelikelihood that we will be able to successfully develop and/or commercializeadditional drugs, we intend to acquire and develop additional productcandidates and /or approved products. The success of this growth strategydepends upon our ability to correctly establish criteria for such acquisitionsand successfully identify, select and acquire product candidates and/orproducts that meet such criteria. We will be required to integrate any acquiredproduct candidates into our research and development operations and any 

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acquired products into oursales and marketing operations. Managing the development and/orcommercialization of a new product involves numerous financial and operationalrisks, including difficulties allocating resources between existing andacquired assets and attracting and retaining qualified employees to developand/or sell the product.

Any product candidate we acquire may requireadditional research and development efforts prior to commercial sale, includingextensive pre-clinical and/or clinical testing and approval by the FDA andcorresponding foreign regulatory authorities. All product candidates are proneto the risks of failure inherent in pharmaceutical product development,including the possibility that the product candidate will be safe and effectiveor approved by regulatory authorities.

In addition, wecannot assure you that any products that we develop or acquire will be:

·       manufacturedor produced economically;

·       successfullycommercialized;

·       complementaryto our existing product portfolio; or

·       widelyaccepted in the marketplace.

Proposing, negotiating andimplementing an economically viable acquisition is a lengthy and complexprocess. Other companies, including those with substantially greater financial,marketing and sales resources, may compete with us for the acquisition ofproduct candidates and approved products. We may not be able to acquire therights to additional product candidates and approved products on terms that wefind acceptable, or at all.

**We may undertake strategic acquisitions in the futureand any difficulties from integrating such acquisitions could adversely affectour stock price, operating results and results of operations.**

We may acquire additional businesses and products thatcomplement or augment our existing business. We may not be able to integrateany acquired business or product successfully or operate any acquired businessprofitably. Integrating any newly acquired business or product could beexpensive and time-consuming. Integration efforts often take a significant amountof time, place a significant strain on managerial, operational and financialresources and could prove to be more difficult or expensive than we predict.The diversion of our management’s attention and any delay or difficultiesencountered in connection with any future acquisitions we may consummate couldresult in the disruption of our on-going business or inconsistencies instandards, controls, procedures and policies that could negatively affect ourability to maintain relationships with customers, suppliers, collaborators,employees and others with whom we have business dealings. Moreover, we may needto raise additional funds through public or private debt or equity financing toacquire any businesses or products, which may result in dilution for stockholdersor the incurrence of indebtedness.

As part of our efforts to acquire businesses orproduct candidates or to enter into other significant transactions, we conductbusiness, legal and financial due diligence with the goal of identifying andevaluating material risks involved in the transaction. Despite our efforts, weultimately may be unsuccessful in ascertaining or evaluating all such risksand, as a result, might not realize the intended advantages of the transaction.If we fail to realize the expected benefits from acquisitions we may consummatein the future, whether as a result of unidentified risks, integrationdifficulties, regulatory setbacks and other events, our business, results ofoperations and financial condition could be adversely affected. If we acquireproduct candidates, we will also need to make certain assumptions about, amongother things, development costs, the likelihood of receiving regulatoryapproval and the market for such product candidates. Our assumptions may proveto be incorrect, which could cause us to fail to realize the anticipatedbenefits of these transactions.

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In addition, we willlikely experience significant charges to earnings in connection with ourefforts, if any, to consummate acquisitions. For transactions that areultimately not consummated, these charges may include fees and expenses forinvestment bankers, attorneys, accountants and other advisers in connectionwith our efforts. Even if our efforts are successful, we may incur as part of atransaction substantial charges for closure costs associated with eliminationof duplicate operations and facilities and acquired in-process research anddevelopment charges. In either case, the incurrence of these charges couldadversely affect our results of operations for particular quarterly or annualperiods.

**Development and commercialization of our productcandidates could be delayed or terminated if we are unable to enter intocollaboration agreements in the future or if any future collaboration agreementis subject to lengthy government review.**

Development andcommercialization of some of our product candidates may depend on our abilityto enter into additional collaboration agreements with pharmaceutical companiesto fund all or part of the costs of development and commercialization of theseproduct candidates. We may not be able to enter into collaboration agreementsand the terms of the collaboration agreements, if any, may not be favorable tous. Inability to enter into collaboration agreements could delay or precludedevelopment, manufacture and/or marketing of some of our drugs and could have amaterial adverse effect on our financial condition and results of operationsbecause:

·       wemay be required to expend additional funds to advance the drugs to commercialization;

·       revenuefrom product sales could be delayed; or

·       wemay elect not to commercialize the drugs.

We are required tofile a notice under the Hart-Scott-Rodino Antitrust Improvements Actof 1976, as amended, which we refer to as the HSR Act, for certain agreementscontaining exclusive license grants and to delay the effectiveness of any suchexclusive license until expiration or earlier termination of the notice andwaiting period under the HSR Act. If expiration or termination of the noticeand waiting period under the HSR Act is delayed because of lengthy governmentreview, or if the Federal Trade Commission or Department of Justicesuccessfully challenges such a license, development and commercialization couldbe delayed or precluded and our business could be adversely affected.

**ITEMS 2-5.**                              NONE

**ITEM6.**                EXHIBITS

| 10.1       | Summary of Executive Officer Compensation for 2006 (previously filed).                                                                                                                                                                                                                                  |
|------------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 10.2† | U.S. License Agreement for Levoceterizine, dated as  of February 17, 2006, by and between UCB S.A. and the Registrant (filed  as Exhibit 10.43 to the Registrant’s Form 10-K (File No. 000-19410)  for the annual period ended December 31, 2005 and incorporated herein by  reference). |
| 31.1       | Certification of Chief Executive Officer pursuant to  Rule 13a-14(a)/Rule 15d-14(a) of the Securities  Exchange Act of 1934, as amended.                                                                                                                                                 |
| 31.2       | Certification of Chief Financial Officer pursuant to  Rule 13a-14(a)/Rule 15d-14(a) of the Securities  Exchange Act of 1934, as amended.                                                                                                                                                 |
| 32.1       | Certification of Chief Executive Officer pursuant to  18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the  Sarbanes-Oxley Act of 2002.                                                                                                                                          |
| 32.2       | Certification of Chief Financial Officer pursuant to  18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the  Sarbanes-Oxley Act of 2002.                                                                                                                                          |

 

 

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**SIGNATURES**

Pursuantto the requirements of the Securities Exchange Act of 1934, the registrant hasduly caused this report to be signed on its behalf by the undersigned thereuntoduly authorized.
|                                | **SEPRACOR INC.** |
|--------------------------------|-------------------|
| Date: September 12, 2006  | By:               | /s/  TIMOTHY J. BARBERICH |
|                           | * *          | Timothy J.  Barberich |
|                           | * *          | *Chairman  and Chief Executive Officer  (Principal Executive Officer)* |
| Date: September 12,  2006 | By:               | /s/  ROBERT F. SCUMACI |
|                           | * *          | Robert F. Scumaci |
|                           | * *          | *Executive  Vice President, Finance and Administration, and Treasurer  (Principal Accounting Officer)* |

 

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**Exhibit Index**
| Exhibit No. | ** ** | **Description**                                                                                                                                                                                                                                                                                              |
|------------------|------------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 10.1             |       | Summary of Executive Officer Compensation for 2006 (previously filed).                                                                                                                                                                                                                                       |
| 10.2†       |       | U.S. License Agreement for Levoceterizine, dated as  of February 17, 2006, by and between UCB S.A. and the Registrant (filed  as Exhibit 10.43 to the Registrant’s Form 10-K (File No. 000-19410)  for the annual period ended December 31, 2005 and incorporated herein by  reference). |
| 31.1             |       | Certification of Chief Executive Officer pursuant to  Rule 13a-14(a)/Rule 15d-14(a) of the Securities  Exchange Act of 1934, as amended.                                                                                                                                                      |
| 31.2             |       | Certification of Chief Financial Officer pursuant to  Rule 13a-14(a)/Rule 15d-14(a) of the Securities  Exchange Act of 1934, as amended.                                                                                                                                                      |
| 32.1             |       | Certification of Chief Executive Officer pursuant to  18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the  Sarbanes-Oxley Act of 2002.                                                                                                                                               |
| 32.2             |       | Certification of Chief Financial Officer pursuant to  18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the  Sarbanes-Oxley Act of 2002.                                                                                                                                               |

 

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