Table of Contents



SECURITIES AND EXCHANGE COMMISSIONWashington, D.C. 20549



FORM 10-Q

(Mark One)ý

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934For the Quarterly Period Ended June 30, 2008oro

TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934For the transition period
from                        to


Commission file number 0-19410



Sepracor Inc.(Exact name of registrant as specified in its charter)

Delaware(State or Other Jurisdiction of
Incorporation or Organization)

22-2536587(IRS Employer
Identification No.)84 Waterford Drive
Marlborough, Massachusetts(Address of principal executive offices)

01752(Zip Code)Registrant's telephone number, including area code: (508) 481-6700




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

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

Large accelerated filer ý

Accelerated filer o

Non-accelerated filer o (Do not check if a smaller
reporting company)

Smaller reporting company o


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

The number of shares outstanding of the registrant's class of Common Stock as of July 31, 2008 was 108,848,178 shares.



---



Table of Contents

SEPRACOR INC.
INDEX



Part IFinancial InformationItem 1.

Condensed Consolidated Interim Financial Statements (unaudited)Condensed Consolidated Balance Sheets as of June 30, 2008 (unaudited) and December 31, 2007


2Condensed Consolidated Statements of Operations for the Three and Six Months Ended June 30, 2008 and 2007 (unaudited)


3Condensed Consolidated Statements of Cash Flows for the Six Months Ended June 30, 2008 and 2007 (unaudited)


4Notes to Condensed Consolidated Interim Financial Statements (unaudited)


5Item 2.

Management's Discussion and Analysis of Financial Condition and Results of Operations


24Item 3.

Quantitative and Qualitative Disclosures About Market Risk


47Item 4.

Controls and Procedures


47Part IIOther InformationItem 1.

Legal Proceedings


50Item 1A.

Risk Factors


55Item 4.

Submission of Matters to a Vote of Security Holders


82Item 6.

Exhibits


83Signatures


84Exhibit Index


85


---





Table of Contents

PART 1FINANCIAL INFORMATION

Item 1.    Financial Statements

SEPRACOR INC.

CONDENSED CONSOLIDATED BALANCE SHEETS

(In Thousands)

June 30,
2008

December 31,
2007(Unaudited)AssetsCurrent assets:Cash and cash equivalents

$
515,554

$
598,929Short-term investments


234,920


292,659Accounts receivable, net


166,711


159,644Inventories


71,135


53,125Deferred tax asset


154,589


Other current assets


30,778


26,948Total current assets


1,173,687


1,131,305Long-term investments


102,873


174,031Property and equipment, net


100,004


87,308Investment in affiliate


3,612


4,313Deferred financing costs, net


5,152


7,071Intangible assets, net


168,393


501Goodwill


25,016


Deferred tax asset


312,417


Other assets


197


197Total assets

$
1,891,351

$
1,404,726Liabilities and Stockholders' EquityCurrent liabilities:Accounts payable

$
17,601

$
17,317Accrued expenses


142,342


210,109Current portion of notes payable and capital lease obligation


1,112


1,162Current portion of convertible subordinated debt


72,800


72,800Deferred tax liabilities


1,814


Product sales allowances and reserves


285,151


245,839Other current liabilities


129


6,887Total current liabilities


520,949


554,114Notes payable and capital lease obligation


900


1,443Convertible subordinated debt


648,020


648,020Deferred tax liabilities


8,816


Other liabilities


115,308


24,736Total liabilities


1,293,993


1,228,313Stockholders' equity:Preferred stock, $1.00 par value, 1,000 shares authorized; none outstanding at June 30, 2008 and December 31, 2007





Common stock, $.10 par value, 240,000 shares authorized at June 30, 2008 and December 31, 2007; 113,094 and 111,955 shares issued, 108,833 and 107,694 shares
outstanding, at June 30, 2008 and December 31, 2007, respectively


11,309


11,195Treasury stock, at cost (4,261 shares at June 30, 2008 and December 31, 2007)


(232,028
)

(232,028
)Additional paid-in capital


1,882,365


1,858,775Accumulated deficit


(1,064,444
)

(1,471,716
)Accumulated other comprehensive income


156


10,187Total stockholders' equity


597,358


176,413Total liabilities and stockholders' equity

$
1,891,351

$
1,404,726


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

2

---





Table of Contents

SEPRACOR INC.        CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS        (Unaudited)        (In Thousands, Except Per Share Amounts)

Three Months Ended

Six Months EndedJune 30,
2008

June 30,
2007

June 30,
2008

June 30,
2007Revenues:Product sales, net

$
269,946

$
264,326

$
575,490

$
581,889Royalties and license fees


24,199


12,466


39,434


22,603Total revenues


294,145


276,792


614,924


604,492Costs and expenses:Cost of product sold


27,301


25,141


56,636


56,493Cost of royalties


580


389


1,069


655Research and development


58,299


45,457


124,528


86,159Research and developmentin process upon acquisition


50,758





89,995


Selling, marketing and distribution


179,308


191,516


334,635


383,634General and administrative


28,461


19,263


51,960


38,104Amortization of intangible assets


1,918


34


4,183


85Litigation settlement, net











34,000Restructuring


(266
)




(566
)

Total costs and expenses


346,359


281,800


662,440


599,130(Loss) income from operations


(52,214
)

(5,008
)

(47,516
)

5,362Other income (expense):Interest income


5,865


11,107


14,598


23,709Interest expense


(2,115
)

(113
)

(2,170
)

(2,870
)Equity in investee losses


(272
)

(132
)

(475
)

(404
)Other expense


(9,354
)

(558
)

(9,432
)

(286
)(Loss) income before income taxes


(58,090
)

5,296


(44,995
)

25,511(Benefit from) provision for income taxes


(453,170
)

485


(452,267
)

1,885Net income

$
395,080

$
4,811

$
407,272

$
23,626Basic net income per common share

$
3.66

$
0.05

$
3.78

$
0.22Diluted net income per common share

$
3.41

$
0.04

$
3.52

$
0.20Shares used in computing basic and diluted net income per common share:Basic


107,834


106,567


107,797


106,275Diluted


115,764


116,635


115,747


116,839


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

3

---





Table of Contents

SEPRACOR INC.        CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS        (Unaudited)        (In Thousands)

Six Months EndedJune 30,
2008

June 30,
2007Cash flows from operating activities:Net income

$
407,272

$
23,626Adjustments to reconcile net income to net cash provided by operating activities:Depreciation and amortization


16,306


10,585Research and developmentin process upon acquisition


89,995


Interest accretion on license fee liabilities


2,066


Impairment on investments


9,106


Equity in investee losses


475


404Stock compensation


19,509


17,589Changes in deferred income taxesrelease of valuation allowance


(451,997
)

Loss on asset disposal


37


200Changes in operating assets and liabilities, net of acquisitions:Accounts receivable


(5,084
)

69,139Inventories


(13,661
)

(4,887
)Other assets


(12,979
)

(24,867
)Accounts payable


(167
)

12,233Accrued expenses


(69,219
)

12,293Product sales allowances and reserves


39,311


(6,549
)Other liabilities


(3,322
)

(26
)Net cash provided by operating activities


27,648


109,740Cash flows from investing activities:Purchases of short and long term investments


(293,583
)

(577,314
)Sales and maturities of short and long term investments


403,104


659,456Additions to property and equipment


(21,305
)

(14,252
)Payments for purchased intangibles


(151,000
)

Business acquisition, net of cash acquired


(49,812
)

Net cash (used in) provided by investing activities


(112,596
)

67,890Cash flows from financing activities:Net proceeds from issuance of common stock


4,195


30,696Repayments of long-term debt and capital leases


(593
)

(440,597
)Net cash provided by (used in) financing activities


3,602


(409,901
)Effect of exchange rate changes on cash and cash equivalents


(2,029
)

285Net decrease in cash and cash equivalents


(83,375
)

(231,986
)Cash and cash equivalents at beginning of period

$
598,929

$
415,411Cash and cash equivalents at end of period

$
515,554

$
183,425Supplemental schedule of cash flow information:Cash paid during the period for interest

$
104

$
22,084Cash paid during the period for income taxes

$
5,702

$
3,873Non cash activities:Additions to capital leases

$


$
3,260Fair value of intangible assets acquired under license and development agreement

$
78,996

$
Liabilities assumed under the license and development agreement

$
77,996

$
Cash paid upon execution of license and development agreement

$
(1,000
)
$



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

4

---





Table of Contents

NOTES TO CONDENSED CONSOLIDATED INTERIM FINANCIAL STATEMENTS (UNAUDITED)

1. Basis of Presentation

The accompanying condensed consolidated interim financial statements are unaudited and have been prepared on a basis substantially consistent with the audited financial statements.
Certain information and footnote disclosures normally included in our annual financial statements have been condensed or omitted. The condensed consolidated interim financial statements, in the
opinion of our management, reflect all adjustments (consisting of normal recurring accruals) necessary for a fair presentation of the results for the interim periods ended June 30, 2008 and
2007. Certain prior period amounts have been reclassified to conform to the current period presentation.

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

The
condensed consolidated results of operations for the interim periods are not necessarily indicative of the results of operations to be expected for the full fiscal year. These
condensed consolidated interim financial statements should be read in conjunction with the audited financial statements for the year ended December 31, 2007, which are contained in our annual
report on Form 10-K for the year ended December 31, 2007, filed with the Securities and Exchange Commission, or SEC.

The
preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the following:
(i) the reported amounts of assets and liabilities, (ii) the disclosure of contingent assets and liabilities at the dates of the financial statements and (iii) the reported
amounts of revenues and expenses during the reporting periods. Actual results could differ from those estimates.

2. Recent Accounting Pronouncements

In May 2008, the Financial Accounting Standards Board, or FASB, issued Statement of Financial Accounting Standards, or SFAS, No. 162,The Hierarchy of
Generally Accepted Accounting Principles,or SFAS 162. SFAS 162 identifies the sources of accounting principles and the framework for selecting the principles to
be used in the preparation of financial statements that are presented in conformity with generally accepted accounting principles. This statement will become effective 60 days following the
SEC's approval of the Public Company Accounting Oversight Board amendments to AU Section 411,The Meaning of Present Fairly in Comformity with Generally Accepted
Accounting Principles. We do not expect the adoption of SFAS 162 to have a material impact on our consolidated financial statements.

In
May 2008, the FASB issued FASB Staff Position, or FSP, No. APB 14-1,Accounting for Convertible Debt Instruments That May Be Settled in Cash
upon Conversion (Including Partial Cash Settlement), which clarifies the accounting for convertible debt instruments that may be settled in cash (including partial cash
settlement) upon conversion. The FSP requires issuers to account separately for the liability and equity components of certain convertible debt instruments in a manner that reflects the issuer's
nonconvertible debt (unsecured debt) borrowing rate when interest cost is recognized. The FSP requires bifurcation of a component of the debt, classification of that component in equity and the
accretion of the resulting discount on the debt to be recognized as part of interest expense in our consolidated statement of operations. The FSP requires retrospective application to the terms of
instruments as they existed for all periods presented. Accordingly, prior periods will be restated as if the new rule had been in effect in these prior periods. This statement is effective for
financial statements issued for fiscal years and interim periods beginning after December 15, 2008 and early adoption is not permitted. While cash payments for interest will not be affected,
the adoption of this

5

---



Table of Contents

NOTES TO CONDENSED CONSOLIDATED INTERIM FINANCIAL STATEMENTS (UNAUDITED) (Continued)

2. Recent Accounting Pronouncements (Continued)

FSP
could increase reported interest expense in a manner that reflects interest rates of similar non-convertible debt. We are evaluating the impact this standard will have on our
consolidated financial statements but expect it to result in greater interest expense and therefore lower earnings per share.

In
March 2008, the FASB issued SFAS No. 161,Disclosures about Derivative Instruments and Hedging Activitiesan amendment of FASB Statement
No. 133, or SFAS 161. SFAS 161 requires enhanced disclosures about an entity's derivative and hedging activities to make transparent the effect of those
activities on the entity's financial position, financial performance and cash flows This statement is effective for financial statements issued for fiscal years and interim periods beginning after
November 15, 2008, with early application encouraged. This statement encourages, but does not require, comparative disclosures for earlier periods at initial adoption. We do not expect the
adoption of SFAS 161 to have a material impact on our consolidated financial statements.

In
December 2007, the FASB issued SFAS No. 160,Noncontrolling Interests in Consolidated Financial Statementsan amendment of ARB
No. 51, or SFAS 160. SFAS 160 establishes accounting and reporting standards for the noncontrolling interest in a subsidiary and for the deconsolidation of
a subsidiary. It clarifies that a noncontrolling interest in a subsidiary is an ownership interest in the consolidated entity that should be reported as equity in the consolidated financial
statements. This pronouncement will be effective for fiscal years beginning on or after December 15, 2008. SFAS 160 requires retroactive adoption of the presentation and disclosure
requirements for existing minority interests. All other requirements of SFAS 160 shall be applied prospectively. We do not expect the adoption of SFAS 160 to have a material impact on
our consolidated financial statements.

In
December 2007, the FASB issued SFAS No. 141(R),Business Combinations, or SFAS 141(R), which will require an acquiring
company to measure all assets acquired and liabilities assumed, including contingent considerations and all contractual contingencies, at fair value as of the acquisition date. In addition, an
acquiring company is required to capitalize in-process research and development and either amortize it over the life of the product, or write it off if the project is abandoned or
impaired. This statement is effective for transactions occurring on or after January 1, 2009. We are evaluating the impact this standard will have on our consolidated financial statements.

In
November 2007, the Emerging Issues Task Force of the FASB, or EITF, reached a final consensus on Issue No. 07-1,Accounting for
Collaborative Arrangements Related to the Development and Commercialization of Intellectual Property,or EITF 07-1. This statement is effective for financial
statements issued for fiscal years beginning after December 15, 2008, and interim periods within those fiscal years, and is to be applied retrospectively to all periods presented for all
collaborative arrangements existing as of the effective date. We do not expect the adoption of EITF 07-1 to have a material impact on our consolidated financial statements.

In
June 2007, the EITF, reached a final consensus on Issue No. 07-3,Accounting for Nonrefundable Advance Payments for Goods or Services to Be
Used in Future Research and Development Activities,or EITF 07-3. This statement is effective beginning January 1, 2009. EITF 07-3
requires nonrefundable advance payments for future research and development activities to be capitalized until the goods have been delivered or related services have been performed. Adoption will be
on a prospective basis and could impact the timing of expense recognition for agreements entered into after January 1, 2008. We do not expect the adoption of EITF 07-3 to
have a material impact on our consolidated financial statements.

6

---



Table of Contents

NOTES TO CONDENSED CONSOLIDATED INTERIM FINANCIAL STATEMENTS (UNAUDITED) (Continued)

2. Recent Accounting Pronouncements (Continued)

In
June 2008, the FASB issued FSP No. EITF 03-6-1,Determining Whether Instruments Granted in Share-Based Payment Transactions are
Participating Securities,which states that unvested share-based payment awards that contain nonforfeitable rights to dividends or dividend equivalents (whether paid or unpaid)
are participating securities and shall be included in the computation of earnings per share under the two-class method. This statement is effective for financial statements issued for
fiscal years and interim periods beginning after December 15, 2008. We are currently evaluating the impact this standard will have on our consolidated financial statements.

In
February 2007, the FASB issued SFAS No. 159,The Fair Value Option for Financial Assets and Financial Liabilitiesincluding an amendment of
FASB Statement No. 115,or SFAS 159. SFAS 159 expands the use of fair value accounting but does not affect existing standards which require assets or
liabilities to be carried at fair value. The objective of SFAS 159 is to improve financial reporting by providing companies with the opportunity to mitigate volatility in reported earnings
caused by measuring related assets and liabilities differently without having to apply complex hedge accounting provisions. Under SFAS 159, a company may elect to use fair value to measure
eligible items at specified election dates and report unrealized gains and losses on items for which the fair value option has been elected in earnings at each subsequent reporting date. This election
is irrevocable. Eligible items include, but are not limited to, accounts and loans receivable, available-for-sale and held-to-maturity securities,
equity method investments, accounts payable, guarantees, issued debt and firm commitments. This Statement is effective beginning January 1, 2008. Currently, we have not expanded our eligible
items subject to the fair value option under SFAS 159. Accordingly, adoption of this statement has had no impact on our financial results.

3. Acquisitions

In June 2008, in order to establish a Canadian commercial presence, we acquired the outstanding capital stock of Oryx, a specialty pharmaceutical company that markets branded
prescription pharmaceutical products to physician specialists and hospitals within Canada and is focused in the cardiovascular, central nervous system disorder, pain and infectious diseases
therapeutic areas, for approximately $49.8 million, including $3.0 million of acquisition-related transaction costs. In addition, the selling shareholders are entitled to receive
milestone payments of up to an aggregate of $20.0 million upon the accomplishment of various regulatory milestones. This acquisition was accounted for under the purchase method of accounting
and the results of operations of Oryx have been included in our consolidated results from the acquisition date. The purchase price of the acquisition was allocated to tangible and intangible assets
and assumed liabilities based on their estimated fair values. We have allocated $34.1 million of the purchase price to intangible assets primarily comprised of acquired technology. We are
amortizing the acquired technology over estimated average useful lives of 3 to 13 years. The excess purchase price of $25.0 million after this allocation has been accounted for as
goodwill. The goodwill is not deductible for tax purposes.

7

---



Table of Contents

NOTES TO CONDENSED CONSOLIDATED INTERIM FINANCIAL STATEMENTS (UNAUDITED) (Continued)

3. Acquisitions (Continued)

The
following table presents the fair values of assets and liabilities recorded in connection with the Oryx acquisition:

Total(in thousands)Accounts receivable

$
1,982Inventory


4,568Other current assets


3,450Goodwill


25,016Intangible assets


34,070Fixed assets


40Total assets acquired


69,126Accrued expenses and other current liabilities


8,994Deferred tax liability


10,320Cash consideration paid, net of cash acquired

$
49,812


The
Oryx acquisition is not material to our condensed consolidated statements of operations, and therefore pro forma information is not presented.

4. Earnings Per Share

Basic earnings per share, or EPS, excludes dilution and is computed by dividing net income by the weighted-average number of common shares outstanding for the period. Unvested restricted
shares, although legally issued and outstanding, are not considered outstanding for purposes of calculating basic EPS. Diluted EPS is calculated by dividing net income by the weighted-average number
of common shares outstanding plus the dilutive effect, if any, of outstanding stock options, restricted shares and restricted stock units. Potential common shares result from the assumed conversion of
convertible subordinated debt and the assumed exercise of outstanding stock options, the proceeds of which are then assumed to have been used to repurchase outstanding stock options using the treasury
stock method. Potential common shares are not included in the per share calculation when the effect of their inclusion would be anti-dilutive.

For
the three and six months ended June 30, 2008 and 2007, the following options to purchase shares of common stock were excluded from the computation of diluted EPS because they
would have had an anti-dilutive effect:

Three Months
Ended
June 30,
2008

Three Months
Ended
June 30,
2007

Six Months
Ended
June 30,
2008

Six Months
Ended
June 30,
2007(in thousands, except price per share data)Number of options


9,309


6,645


9,034


6,618Price range per share

$
18.45 to $87.50

$
44.78 to $87.50

$
21.26 to $87.50

$
44.78 to $87.50


We have issued 0% convertible subordinated notes due 2024, which were not convertible into equity as of June 30, 2008 or 2007, or at any
time during the six months ended June 30, 2008 or 2007. Once these notes become convertible into equity, shares of common stock will be reserved under the conversion formula for issuance upon
conversion if and when our common stock price exceeds $67.20

8

---



Table of Contents

NOTES TO CONDENSED CONSOLIDATED INTERIM FINANCIAL STATEMENTS (UNAUDITED) (Continued)

4. Earnings Per Share (Continued)

per
share on the NASDAQ Global Select Market. Prior to such occurrence, the notes are only convertible into cash.

5. Inventories

Inventories consist of the following:

June 30,
2008

December 31,
2007(in thousands)Raw materials

$
32,414

$
26,811Finished goods


38,721


26,314Total

$
71,135

$
53,125


6. Business Investments

In January 2005, we entered into a collaboration agreement with ACADIA Pharmaceuticals, Inc., or ACADIA, for the development of new drug candidates targeted toward the treatment
of central nervous system disorders. This agreement expired pursuant to its terms in January 2008, and we are no longer pursuing the development of the drug candidates subject to this agreement.

In
2005 and 2006, under the terms of the collaboration agreement with ACADIA, we purchased a total of 1,890,422 shares of ACADIA's common stock for $16.1 million. These publicly
traded securities, which are classified as available-for-sale, are accounted for under SFAS 115,Accounting for Certain Investments in Debt and
Equity Securities.We adjust the carrying value of our available-for-sale securities to fair value and report the related temporary unrealized gains and
losses as a separate component in other comprehensive income. Declines in the fair value of an available-for-sale security that are estimated to be "other-than-temporary" are
recognized as other expense in the condensed consolidated
statements of operations, thus establishing a new cost basis for such investments. We evaluate our investment securities portfolio on a quarterly basis to determine whether declines in the fair value
of these securities are other-than-temporary. This quarterly evaluation consists of reviewing, among other things, the fair value of our investment securities compared to their carrying amount, the
historical volatility of the price of each security and any market and company-specific factors related to each security.

Based
on a significant decline in the value of ACADIA's common stock, which we believe is the result of adverse clinical results announced in June 2008, we recorded an
other-than-temporary impairment charge of $9.1 million related to this security. As of June 30, 2008, this investment was recorded at its fair value of
approximately $7.0 million on our condensed consolidated balance sheet.

7. Goodwill and Intangible Assets

In accordance with SFAS No. 142,Goodwill and Other Intangible Assets, goodwill is tested for impairment at least annually, or on
an interim basis if an event occurs or circumstances change that would, more likely than not, reduce the fair value of the reporting unit below its carrying value.

Intangible
assets subject to amortization are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable in
accordance with SFAS No. 144,Accounting for the Impairment or Disposal of Long-Lived Assets. Recoverability of

9

---



Table of Contents

NOTES TO CONDENSED CONSOLIDATED INTERIM FINANCIAL STATEMENTS (UNAUDITED) (Continued)

7. Goodwill and Intangible Assets (Continued)

assets
to be held and used is measured by a comparison of the carrying amount of an asset group to the estimated undiscounted future cash flows expected to be generated by the asset group. If the
carrying amount of an asset group exceeds its estimated future cash flows, an impairment charge is recognized in the amount by which the carrying amount of the asset group exceeds the fair value of
the asset group.

During
the six months ended June 30, 2008, we entered into a worldwide license and development agreement with Arrow International Limited, or Arrow, for the development,
commercialization, marketing, sale and distribution of Arrow's Levalbuterol/ipratropium combination inhalation solution product, which we refer to as the Levalbuterol/ipratropium Product, in current
and all future formulations and delivery modes. We refer to this agreement as the Levalbuterol/ipratropium Product Agreement. The Levalbuterol/ipratropium Product is currently ready to enter
Phase III clinical development. Arrow received $500,000 upon execution of this agreement and we are also required to pay Arrow $70.0 million as further consideration under the agreement,
provided Arrow is not in material breach of certain of its obligations under the agreement. Although these future payments are subject to Arrow's continued compliance with the agreement, they have
been recorded because we believe it is probable that Arrow will be entitled to these future payments. Arrow will also receive single-digit royalties based on our sales of the Levalbuterol/ipratropium
Product, subject to Arrow's one-time option in the fourth quarter of 2009 to receive a lump sum discounted amount of $23.5 million in lieu of ongoing royalty payments.

During
the six months ended June 30, 2008, we also entered into a worldwide license and development agreement with Arrow, which we refer to as the Ciclesonide Agreement, for
know-how and intellectual property rights related to stable sterile suspension formulations, for use in the development, commercialization, marketing, sale and distribution of an
inhalation solution pharmaceutical product containing ciclesonide as its only active ingredient, or the Nebule Ciclesonide Product, and an inhalation solution pharmaceutical product containing both
ciclesonide and arformoterol as its active ingredients, or the Ciclesonide/arformoterol Combination Product. The agreement also includes rights to Arrow's "U-Bend" packaging technology,
which allows increased accuracy in dosing through a novel U-Bend ampule design. Arrow received $500,000 upon execution of this agreement and we are also required to pay Arrow
$47.5 million as further consideration under the agreement, provided Arrow is not in material breach of certain of its obligations under the agreement. Although these future payments are
subject to Arrow's continued compliance with the agreement, they have been recorded because we believe it is probable that Arrow will be entitled to these future payments. Arrow will also receive
single-digit royalties based on our sales of the Nebule Ciclesonide Product and Ciclesonide/arformoterol Combination Product, subject to Arrow's one-time options in the fourth quarter of
2009 to receive an aggregate lump sum discounted amount of up to $37.9 million in lieu of ongoing royalty payments.

The
total of $117.5 million of future payments due to Arrow, pursuant to the Levalbuterol/ipratropium Product Agreement ($70 million) and the Ciclesonide Agreement
($47.5 million), which we refer to collectively as the Future Payments to Arrow, were recorded at their present value of $78.0 million on our condensed consolidated balance sheet as of
June 30, 2008. We imputed interest expense associated with these liabilities using a 13% interest rate, which will be amortized over the expected term of the payments and recorded as interest
expense in our condensed consolidated statement of operations.

10

---



Table of Contents

NOTES TO CONDENSED CONSOLIDATED INTERIM FINANCIAL STATEMENTS (UNAUDITED) (Continued)

7. Goodwill and Intangible Assets (Continued)

Of
the $78.0 million of Future Payments to Arrow currently recorded, and the $1.0 million previously paid to Arrow pursuant to the two agreements, $50.8 million was
assigned to in-process research and development, or IPR&D. IPR&D is defined by FASB Interpretation No. 4,Applicability of SFAS Statement No. 2 to
Business Combinations Accounted for by the Purchase Method, or FIN 4, as being a development project that has been initiated and achieved material progress but:
(i) has not yet reached technological feasibility or has not yet reached the appropriate regulatory approval; (ii) has no alternative future use; and (iii) the fair value is
estimable with reasonable certainty. As required by FIN 4, the portion of the purchase price under the Levalbuterol/ipratropium Product Agreement and the Ciclesonide Agreement allocated to
IPR&D was immediately charged to operations following the consummation of the transaction and is reflected in our condensed consolidated statement of operations.

A
project-by-project valuation using the guidance in SFAS No. 141Business Combinations, or
SFAS 141, has been conducted to determine the fair value of our research and development projects that were in-process, but not yet completed, as of the date we entered into the
Levalbuterol/ipratropium Product Agreement and the Ciclesonide Agreement. The Levalbuterol/ipratropium Product candidate, an inhalation solution with the potential to treat chronic obstructive
pulmonary disease, or COPD, was the only project in development under the Levalbuterol/ipratropium Product Agreement as of the valuation date. We have targeted commercial introduction of this product
for 2011. The two projects in development pursuant to the Ciclesonide Agreement as of the valuation date were the (i) Nebule Ciclesonide Product candidate and
(ii) Ciclesonide/arformoterol Combination Product candidate. The Nebule Ciclesonide Product candidate is an inhalation solution formulation of ciclesonide, which is an inhaled corticosteroid
that is intended for the treatment of asthma symptoms, regardless of asthma severity. We have targeted commercial introduction of this product for 2013 or early 2014. The Ciclesonide/arformoterol
Combination Product candidate will be comprised of a nebulized version of ciclesonide with the arformoterol inhalation solution, which is a long-acting maintenance treatment of
bronchoconstriction in patients suffering from COPD. The Ciclesonide/arformoterol Combination Product is targeted for commercial introduction in 2014. Successful development of our products is highly
uncertain. Completion costs can be significant, vary for each product and are difficult to predict.

The
fair value of IPR&D has been determined by the income approach using the excess cash flow method. The value of the projects has been based on the present value of probability
adjusted
incremental cash flows, after the deduction of contributory asset charges for other assets employed (including working capital, trade names and acquired workforce). The probability weightings used to
determine IPR&D cash flows ranged from 25% to 80%. The discount rates used to determine the present value of IPR&D cash flows ranged from 15% to 25%.

The
remaining $28.2 million of acquired intangible assets represent core technology product rights.

During
the three months ended March 31, 2008, we entered into an agreement with Nycomed GmbH, or Nycomed, for the exclusive distribution, development and commercialization
in the United States, its territories and possessions of Nycomed's compound ciclesonide, and products incorporating such compound, including ALVESCO® HFA (ciclesonide) Inhalation Aerosol
metered-dose inhaler, or MDI, for use in the treatment of asthma, OMNARIS (ciclesonide) Nasal Spray for use in the treatment of allergic rhinitis and three development
projects for line extensions. Under the agreement, we paid Nycomed an upfront payment of $150.0 million in February 2008 and may be required to make subsequent payments of up to
$280.0 million over the life of the agreement upon accomplishment of various development and sales milestones. The transaction was accounted for under the purchase method of accounting and the
purchase price was allocated to identifiable intangible assets based on their estimated fair values.

11

---



Table of Contents

NOTES TO CONDENSED CONSOLIDATED INTERIM FINANCIAL STATEMENTS (UNAUDITED) (Continued)

7. Goodwill and Intangible Assets (Continued)

Of the $150.0 million of intangible assets related to the Nycomed transaction, $39.2 million was assigned to IPR&D. As required by FIN 4, the portion of the purchase
price allocated to IPR&D was immediately charged to operations following the consummation of the transaction and is reflected in our condensed consolidated statement of operations.

A
project-by-project valuation using the guidance in SFAS No. 141 has been conducted to determine the fair value of Nycomed's research and development
projects that were in-process, but not yet completed, as of the completion of the consummation of the Nycomed transaction. The three projects in development as of the valuation date were a
hydrofluoroalkane, or HFA, MDI and two other respiratory-related candidates. We have targeted commercial introduction of the HFA MDI for 2012. One of the respiratory candidates is a combination
therapy that is comprised of ciclesonide and a long-acting beta-agonist, which we have targeted for commercial introduction for 2014. The second respiratory candidate is an
inhalation solution for which we have targeted commercial introduction at the end of 2013 or early 2014.

The
fair value of IPR&D has been determined by the income approach using the excess cash flow method. The value of the Nycomed projects has been based on the present value of probability
adjusted incremental cash flows, after the deduction of contributory asset charges for other assets employed (including working capital, trade names and acquired workforce). The probability weightings
used to determine IPR&D cash flows ranged from 65% to 86%. The discount rate used to determine the present value of IPR&D cash flows was approximately 25%.

The
remaining $110.8 million of acquired intangible assets related to the Nycomed transaction include: OMNARIS Nasal Spray product rights for $21.2 million, ALVESCO HFA
Inhalation Aerosol product rights for $30.0 million, and core technology product rights for $59.6 million.

Our
intangible assets included in the condensed consolidated balance sheets are detailed as follows:

June 30, 2008

December 31, 2007(in thousands)Gross
Carrying
Amount

Accumulated
Amortization

Net
Carrying
Amounts

Gross
Carrying
Amount

Accumulated
Amortization

Net
Carrying
AmountsGoodwill (not amortized)

$
25,016

$


$
25,016

$


$


$
Oryx's intangible assets

$
34,070

$
(336
)
$
33,734

$


$


$
Arrow's intangible assets


28,238


(313
)

27,925








Nycomed's intangible assets


110,763


(4,463
)

106,300








Patents and other intangible assets


2,259


(1,825
)

434


2,259


(1,758
)

501Total intangible assets

$
175,330

$
(6,937
)
$
168,393

$
2,259

$
(1,758
)
$
501


Oryx intangible assets are being amortized over 3-13 years; Arrow intangible assets are being amortized over 15 years;
Nycomed intangible assets are being amortized over 8 - 15 years; and patents are being amortized over 10 years.

The
estimated aggregate amortization expense for each of the next five years is as follows: 2008, $16.5 million; 2009, $17.7 million; 2010, $15.5 million; 2011,
$14.3 million; and 2012, $13.5 million.

12

---



Table of Contents

NOTES TO CONDENSED CONSOLIDATED INTERIM FINANCIAL STATEMENTS (UNAUDITED) (Continued)

8. Convertible Subordinated Debt

Convertible subordinated debt consists of the following:

June 30,
2008

December 31,
2007(in thousands)0% Series A convertible senior subordinated notes due December 2008

$
72,800

$
72,8000% Series B convertible senior subordinated notes due December 2010


148,020


148,0200% convertible senior subordinated notes due October 2024


500,000


500,000Total

$
720,820

$
720,820


Our
0% notes due 2024 are convertible into cash and, if applicable, shares of our common stock at a conversion price of approximately $67.20, at the option of the holders in October
2009, 2014, 2019 and 2024, as well as under certain circumstances.

In
August 2008, we repurchased, at our option, $21.3 million principal amount of our 0% notes due 2024.

9. Comprehensive Income

Total comprehensive income consists of net income, net foreign currency translation adjustments and net unrealized (loss) gain on available-for-sale securities.

Three Months Ended

Six Months EndedJune 30,
2008

June 30,
2007

June 30,
2008

June 30,
2007(in thousands)Comprehensive income:Net income

$
395,080

$
4,811

$
407,272

$
23,626Net foreign currency translation adjustment


448


1,791


(495
)

1,844Net unrealized (loss) gain on available-for-sale securities


(2,089
)

(2,646
)

(9,536
)

8,866Total comprehensive income

$
393,439

$
3,956

$
397,241

$
34,336


10. Legal Proceedings

Litigation Related to Generic Competition and Patent Infringement

Patent litigation involves complex legal and factual questions. We can provide no assurance concerning the outcome or the duration of
any patent related lawsuits. If we, third parties from whom we receive royalties, or third parties from whom we have licensed products or received other rights to commercialize products, are not
successful in enforcing our respective patents, the companies seeking to market generic versions of our marketed drugs and the drugs of our licensees will not be excluded, for the full term of the
respective patents, from marketing their generic versions of our marketed products or third-party products for which we have licensed rights to our patents. Introduction of generic copies of any of
our marketed products or third-party products for which we have licensed

13

---



Table of Contents

NOTES TO CONDENSED CONSOLIDATED INTERIM FINANCIAL STATEMENTS (UNAUDITED) (Continued)

10. Legal Proceedings (Continued)

rights
to our patents before the expiration of our patents would have a material adverse effect on our business, financial condition and results of operations.



In September 2005, we received notification that the United States Food and Drug Administration, or FDA, had received an Abbreviated
New Drug Application, or ANDA,
from Breath Limited, or Breath, seeking approval of a generic version of our 1.25 mg/3 mL, 0.63 mg/3 mL and 0.31 mg/3 mL XOPENEX brand levalbuterol HCl Inhalation Solution. Breath's submission
includes a Paragraph IV certification alleging that our patents listed in the FDA publication entitledApproved Drug Products With Therapeutic Equivalence
Evaluations, commonly referred to as the "Orange Book," for these three dosages of XOPENEX Inhalation Solution are invalid, unenforceable or not infringed by the generic
version for which Breath is seeking approval. In October 2005, we filed a civil action against Breath for patent infringement in the United States District Court for the District of Massachusetts,
No. CV:06-10043.

In
April 2008, we entered into a settlement and license agreement with Breath to resolve this litigation. The agreement permits Breath to sell its generic versions of these XOPENEX
Inhalation Solution products in the United States under the terms of an exclusive 180-day license commencing on August 20, 2012 and a non-exclusive license thereafter.
Upon launch, Breath would pay us a double-digit royalty on gross profits generated from the sales of generic versions of these XOPENEX Inhalation Solution products. Under the agreement, Breath agrees
not to sell any of the products covered by our patents that are the subject of the license before the date on which the license commences. On May 1, 2008, the parties submitted to the court an
agreed order of dismissal without prejudice, which the court approved. The litigation is now concluded.

In
April 2008, we also entered into a supply agreement with Breath whereby, effective August 20, 2012, we will exclusively supply levalbuterol products (1.25 mg/3 mL, 0.63 mg/3 mL
and 0.31 mg/3 mL)to Breath, under our New Drug Application, or NDA, for a period of 180 days, which we refer to as the Initial Term, and on a
non-exclusive basis for two and one-half years thereafter. In addition to the royalties described above, Breath will pay us on a cost plus margin basis for supply of these
levalbuterol products. The supply agreement contains provisions regarding termination for cause and convenience, including either party's right to terminate the agreement at any time after the Initial
Term upon nine months written notice. Both the exclusive license under the settlement and license agreement and the exclusive supply obligations under the supply agreement could become effective prior
to August 20, 2012 if a third party launches a generic version of these dosages of XOPENEX Inhalation Solution or if the parties otherwise mutually agree.

On
May 9, 2008, we provided to the Federal Trade Commission and Department of Justice Antitrust Division the notifications of the settlement with Breath as required under
Section 1112(a) of the Medicare Prescription Drug, Improvement and Modernization Act of 2003, or MMA. The settlement with Breath and the other agreements with Breath and its affiliates,
including the supply agreement, the agreement for the acquisition of Oryx, and license agreements with Arrow, may be reviewed by antitrust enforcement agencies, such as the Federal Trade Commission
and Department of Justice Antitrust Division. There can be no assurances that governmental authorities will not seek to challenge the settlement with Breath or that a competitor, customer or other
third party will not initiate a private action under antitrust or other laws challenging the settlement with Breath. We may

14

---



Table of Contents

NOTES TO CONDENSED CONSOLIDATED INTERIM FINANCIAL STATEMENTS (UNAUDITED) (Continued)

10. Legal Proceedings (Continued)

not
prevail in any such challenges or litigation and, in any event, may incur significant costs in the event of an investigation or in defending any action under antitrust laws.

In
January 2006, we received notification that the FDA had received an ANDA from Dey, L.P., seeking approval of a generic version of our 1.25 mg/3 mL, 0.63 mg/3 mL, and 0.31 mg/3
mL XOPENEX Inhalation Solution. Dey, L.P.'s submission includes a Paragraph IV certification alleging that our patents listed in the Orange Book for these three dosages of XOPENEX
Inhalation Solution are invalid, unenforceable, or not infringed by the generic version for which Dey, L.P. is seeking approval. In February 2006, we filed a civil action against
Dey, L.P. for patent infringement and the case is pending in the United States District Court for the District of Delaware, C.A. No. 06-113.

In
August 2006, we received notification that the FDA had received an ANDA from Dey, L.P. seeking approval of a generic version of our 1.25 mg/0.5 mL XOPENEX Inhalation Solution
concentrate. Dey, L.P.'s submission includes a Paragraph IV certification alleging that our patents listed in the Orange Book for 1.25 mg/0.5 mL XOPENEX Inhalation Solution concentrate
are invalid, unenforceable, or not infringed by the generic version for which Dey, L.P. is seeking approval. In September 2006, we filed a civil action against Dey, L.P. for patent
infringement in the United States District Court for the District of Delaware, C.A. No. 06-604. In September 2006, both civil actions we filed against Dey, L.P. were
consolidated into a single suit.

In
May 2007, we received notification that the FDA had received an ANDA from Barr Laboratories, Inc., or Barr, seeking approval of a generic version of our 1.25 mg/3 mL, 0.63 mg/3
mL and 0.31 mg/3 mL XOPENEX Inhalation Solution. Barr's submission includes a Paragraph IV certification alleging that our patents listed in the Orange Book for these three dosages of XOPENEX
Inhalation Solution are invalid, unenforceable or not infringed by the generic version for which Barr is seeking approval. In July 2007, we filed a civil action against Barr for patent infringement
and the case is pending in the United States District Court for the District of Delaware, C.A. No. 07-438.

In
March 2008, the trial judge consolidated the Dey L.P. and Barr cases for all purposes, including discovery and trial. The court held a Markman hearing on July 18, 2008,
to address the parties' disputed issues of patent claim interpretation. The court has not yet issued its decision regarding the disputed issues of patent claim interpretation nor has it formally set a
trial date.

In
June 2008, Dey L.P. filed a Complaint against us in the United States District Court for the District of Delaware, C.A. 08-372. The Complaint is a declaratory
judgment action in which Dey L.P. seeks a declaration of non-infringement and invalidity of United States Patent 6,451,289 owned by us. Dey L.P. had previously sent us notice
that its ANDA contained a Paragraph IV certification against the 6,451,289 patent, and we did not commence litigation in response.

The
filing of an action for patent infringement under the Drug Price Competition and Patent Term Restoration Act of 1984, also known as the "Hatch-Waxman Act results in an automatic
30-month stay of the FDA's authority to grant final marketing approval to those companies that filed an ANDA containing a Paragraph IV certification against one or more of our
XOPENEX Inhalation Solution patents. The first filer of an ANDA with a Paragraph IV certification is potentially entitled to a 180 day period of semi-exclusivity during which
the FDA cannot
approve subsequently filed ANDAs. The 180 day semi-exclusivity period would begin to run only upon first commercial marketing by the first filer. There are, however, also certain
events that could cause the first filer to forfeit the 180 day semi-exclusivity period, which we refer to as a forfeiture event.

15

---



Table of Contents

NOTES TO CONDENSED CONSOLIDATED INTERIM FINANCIAL STATEMENTS (UNAUDITED) (Continued)

10. Legal Proceedings (Continued)

For
our 1.25 mg/3 mL, 0.63 mg/3 mL, and 0.31 mg/3 mL dosages of XOPENEX Inhalation Solution, we believe that Breath is the sole first filer and potentially entitled to 180 days of
semi-exclusivity against subsequent ANDA filers for those three dosages. The 30-month stay against Breath's ANDA expired on March 7, 2008. On April 9, 2008, the
FDA granted final approval to Breath's ANDA for all three dosages. However, if a forfeiture event occurs and the FDA determines that Breath has forfeited the 180 day
semi-exclusivity period for those three dosages, other ANDA filers who have been granted final approval by the FDA could commence an "at risk" launch upon expiration of the
30-month stay. For those three dosages, the 30-month stay against Dey, L.P. expired on July 9, 2008 and the 30-month stay against Barr expires on or
about November 30, 2009.

For
our 1.25 mg/0.5 mL XOPENEX Inhalation Solution concentrate, we believe that Dey, L.P. is the sole first filer and potentially entitled to 180 days of
semi-exclusivity for that concentration. The 30-month stay against Dey, L.P.'s ANDA for that concentration expires on or about February 14, 2009.

Although
we could seek recovery of any damages sustained in connection with any activities conducted by a party that infringe a valid and enforceable claim in our patents, whether we are
ultimately entitled to such damages would be determined by the court in connection with our ongoing legal proceedings with each party desiring to launch generic levalbuterol hydrochloride products. If
any of these parties were to commence selling a generic alternative to our XOPENEX Inhalation Solution product prior to the resolution of these ongoing legal proceedings, or there is a court
determination that the products these companies wish to market do not infringe our patents, or that our patents are invalid or unenforceable, it would have a material adverse effect on our business,
financial condition and results of operations. In addition, our previously issued guidance regarding our projected financial results may no longer be accurate and we would have to revise such
guidance.



Certain of Schering-Plough Corporation's, or Schering-Plough's, CLARINEX® (desloratadine) products for which we receive
sales royalties are currently the subject of patent infringement litigation. Since June 2007, the FDA has received ANDAs relating to various dosage forms of CLARINEX from ten different generic
pharmaceutical companies. These ANDA submissions include Paragraph IV certifications alleging that our patents, which Schering-Plough (as exclusive licensee of such patents) listed in the
Orange Book for these products, are invalid, unenforceable or not infringed by the submitter's proposed product. We and the University of Massachusetts, co-owners of certain patents listed
in the Orange Book, filed civil actions against these parties for patent infringement in the United States District Court for the District of New Jersey. In April 2008, the trial judge consolidated
these cases for all purposes including discovery and trial. The court has not set a trial date. We believe that all of these ANDAs are subject to a statutory stay of approval until at least
December 21, 2009 based on previous litigation commenced by Schering-Plough against these parties in separate civil actions involving another patent.

In
March 2008, we entered into a consent agreement with Glenmark Pharmaceuticals, Inc., or Glenmark, one of the ten generic pharmaceutical companies that filed a
Paragraph IV certification against our patents, whereby Glenmark agreed not to pursue its case and to not market CLARINEX 5 mg tablets until the expiration of our patents listed by
Schering-Plough in the Orange Book or until these patents are found invalid or unenforceable.

16

---



Table of Contents

NOTES TO CONDENSED CONSOLIDATED INTERIM FINANCIAL STATEMENTS (UNAUDITED) (Continued)

10. Legal Proceedings (Continued)



Beginning in February 2008, we and UCB S.A., or UCB, received notices from Synthon Pharmaceuticals, Inc., or Synthon, Sun
Pharmaceutical Industries Limited of Andheri (East), or Sun, Sandoz Inc., or Sandoz and Pliva Hrvatska D.O.O., or Pliva, that each has filed an ANDA seeking approval to market a generic version
of XYZAL® 5 mg tablets, and that each ANDA contained a Paragraph IV certification alleging that United States Patent 5,698,558, owned by us and exclusively licensed to UCB, is
invalid, unenforceable or not infringed. Beginning in April 2008, UCB filed in its name and on our behalf civil actions in the United States District Court for the Eastern District of North Carolina
against Synthon, Sun, Sandoz, Pliva and Barr (Pliva's agent), an action against Synthon in the United States District Court for the District of Delaware, and actions against Sun and Pliva/Barr in the
United States District Court for the District of New Jersey. The action in Delaware has been voluntarily dismissed. We believe that all of these ANDAs are subject to a
30-month statutory stay of approval, the earliest of which, against Synthon, is scheduled to expire on or about August 29, 2010.

BROVANA Patent Infringement Claim

In April 2007, we were served with a Complaint filed in the United States District Court for the Southern District of New York, C.A.
No. 1:07-cv-2353, by Dey, L.P. and Dey, Inc., referred to collectively as Dey, alleging that manufacture and sale of BROVANA® (arformoterol
tartrate) Inhalation Solution infringes or will induce infringement of a single United States patent for which Dey owns all rights, title and interest. In April 2007, we filed an Answer and
Counterclaims to this Complaint seeking to invalidate the originally asserted patent and a second related patent. In May 2007, Dey filed a reply asserting infringement of the second patent. Under the
current trial scheduling order, trial will begin no earlier than January 12, 2009. It is too early to make a reasonable assessment as to the likely outcome or impact of this litigation. We are
unable to reasonably estimate any possible range of loss or liability related to this lawsuit due to its uncertain resolution.

In
March 2008, United States Patent 7,348,362, or the '362 patent, entitled "Bronchodilationb-agonist compositions and Methods" issued
and Dey, L.P. is the assignee of the patent. In May 2008, we filed a Motion to Amend our Answer and Counterclaims to seek declaratory judgment that the '362 patent is invalid and unenforceable
and to add Mylan Inc. as a party. Dey has opposed this motion and we await a decision from the court.

XOPENEX Inhalation Solution LCA Matter

In March 2006, the parties responsible for administrating the Medicare Part B prescription drug benefit for respiratory products
on behalf of Centers for Medicare and Medicaid Services, or CMS, which we refer to collectively as the Medicare Administration Subcontractors, announced their intention to implement a Least Costly
Alternative, or LCA, reimbursement action for XOPENEX Inhalation Solution. If implemented, the LCA would reduce the Medicare Part B reimbursement paid for XOPENEX Inhalation Solution to the
level of generic racemic albuterol. As a result, we would be unable to discount XOPENEX Inhalation Solution in the Medicare market, and we do not believe that providers would continue to dispense
XOPENEX Inhalation Solution to Medicare Part B beneficiaries at this payment rate.

The
LCA announced in March 2006 was subsequently stayed by the Medicare Administration Subcontractors pending a National Coverage Analysis by CMS. CMS ultimately deferred to the

17

---



Table of Contents

NOTES TO CONDENSED CONSOLIDATED INTERIM FINANCIAL STATEMENTS (UNAUDITED) (Continued)

10. Legal Proceedings (Continued)

Medicare
Administration Subcontractors the determination as to the criteria for when XOPENEX Inhalation Solution would be appropriate for use by the Medicare population. On April 10, 2008, the
Medicare Administration Subcontractors announced their intention to implement the previously announced LCA, effective July 1, 2008.

In
June 2008, a preliminary injunction motion seeking to block the implementation of the LCA policy in advance of its July 1, 2008 effective date was filed in the District Court
for the District of Columbia against certain of the Medicare Administration Subcontractors, among others, by four Medicare beneficiaries utilizing XOPENEX Inhalation Solution. These Medicare
beneficiaries, who rely on XOPENEX Inhalation Solution to treat their medical conditions, stated in the motion that they would be denied access to this drug if the LCA was implemented and as a result
would suffer irreparable injury. Shortly following the filing of the motion, the Medicare Administration Subcontractors announced they would suspend the LCA and not reinstate it at any time prior to
December 31, 2008. The Medicare Administration Subcontractors further agreed that they would provide a public notice and comment period, which is typically 90 days, should they decide to
reinstate the LCA. As a result of the LCA suspension, the court denied the Medicare beneficiaries' preliminary injunction motion. CMS filed a motion to dismiss the Medicare beneficiary lawsuit on the
grounds that the case is moot as no LCA is in effect or pending. If the court denies this motion the permanent injunction case will proceed and be heard on its merits. Otherwise, the beneficiaries
will not have a cause of action unless and until the LCA is reinstated by CMS.

Both
Sepracor and the Medicare beneficiaries believe that the LCA action by the Medicare Administration Subcontractors is outside the scope of their authority and is contrary to the
express intent of Congress which has been enumerated in statutes, such as the MMA, and establishes the method that CMS and the Medicare Administration Subcontractors must use to determine the payment
rate for Medicare Part B inhalation drugs such as XOPENEX Inhalation Solution that are administered through durable medical equipment. Although we are not a named party to the litigation, our
interest in the outcome is aligned with that of the Medicare beneficiaries. Accordingly, we have, and if the case proceeds, plan to continue to provide funding in support of the litigation and
assistance to legal counsel for the Medicare beneficiaries.

Class Action Litigation Settlement

Litigation settlement expense was $0 and $34.0 million for the six months ended June 30, 2008 and 2007, respectively. In
June 2007, we filed in the United States District Court for the District of Massachusetts, or the Court, a Stipulation of Settlement regarding two securities class action lawsuits, or class actions,
then pending in the Court naming Sepracor and certain of our
current and former officers and one director as defendants. The class actions, which were filed on behalf of certain purchasers of our equity and debt securities, or the plaintiffs, alleged that the
defendants violated the Federal securities laws by making false and misleading statements relating to the testing, safety and likelihood of approval of tecastemizole by the FDA. Under the terms of the
Stipulation of Settlement, in June 2007 we paid into escrow $52.5 million in settlement of the class actions and, in July 2007, received an $18.5 million reimbursement from our insurance
carriers. We recorded the litigation settlement expense of $34.0 million, relating to this matter, during the quarter ended March 31, 2007. In September 2007, the Court granted final
approval of the Stipulation of Settlement and entered a final judgment consistent with the Stipulation of Settlement. The settlement is now final and the total settlement amount has been released from
escrow.

18

---



Table of Contents

NOTES TO CONDENSED CONSOLIDATED INTERIM FINANCIAL STATEMENTS (UNAUDITED) (Continued)

10. Legal Proceedings (Continued)

Other Legal Proceedings

We have been named as a defendant in a lawsuit filed in the United States District Court for the Middle District of Florida (Sharp, et
al., filed July 17, 2008) claiming that our pharmaceutical sales representatives should have been categorized as "non-exempt"
rather than "exempt" employees, and claiming that we owe damages, overtime wages, interest, costs and attorneys' fees for up to the four-year period preceding the filing of the action. Other companies
in the pharmaceutical industry face substantially similar lawsuits. Based upon the facts as presently known, we do not believe that it is likely that the collective action will result in liability
which would be material to our financial position. We believe this lawsuit is without merit and are prepared to defend against it vigorously.

From
time to time we are party to other legal proceedings in the course of our business. We do not, however, expect such other legal proceedings to have a material adverse effect on our
business, financial condition or results of operations.

11. Commitments and Contingencies

See Note 5 "Acquisitions" regarding a commitment for potential future milestone payments relating to the purchase of Oryx. See Note 7 "Goodwill and Intangible Assets"
regarding commitments for future payments under the Arrow Levalbuterol/ipratoropium Product Agreement, Arrow Ciclesonide Agreement and the Nycomed distribution agreement.

We
have committed to make potential future milestone payments to third parties as part of licensing, distribution and development agreements. Payments under these agreements generally
become due and payable only upon achievement of certain development, regulatory and/or commercial milestones. We may also be required to make additional payments to Nycomed and
BialPortela & Ca, S.A., or Bial, of up to $280.0 million and $90.0 million, respectively, if all remaining milestones under the agreements with
these parties are met. Because the achievement of these milestones is neither probable nor reasonably estimable, such contingent payments have not been recorded on our condensed consolidated balance
sheet.

12. Income Taxes

Deferred tax assets and liabilities are recognized for the estimated future tax consequences attributable to tax benefit carryforwards and for differences between the financial statement
amounts of assets and liabilities and their respective tax basis. Deferred tax assets and liabilities are measured using enacted tax rates in effect for the year in which the differences are expected
to reverse. A valuation allowance is established if, based on management's review of both positive and negative evidence, it is more likely than not that all or a portion of the deferred tax asset
will not be realized. Based upon our settlement with Breath during the second quarter of 2008, our operating results over recent years and through June 30, 2008 and an assessment of our
expected future results of operations, we determined that it is more likely than not that we will realize a substantial portion of our deferred tax assets in the United States and a foreign
jurisdiction. As a result, during the second quarter, we released a total of $452.0 million of our valuation allowance, which was recorded as an income tax benefit.

As
of June 30, 2008, we had a remaining valuation allowance recorded against United States net deferred tax assets of $215.4 million which consists of $145.9 million
for stock based compensation deductions and $6.9 million of stock based compensation research and development credits that will be credited to additional paid-in-capital
when realized; $6.1 million for certain state operating loss

19

---



Table of Contents

NOTES TO CONDENSED CONSOLIDATED INTERIM FINANCIAL STATEMENTS (UNAUDITED) (Continued)

12. Income Taxes (Continued)

carryforwards,
and $19.4 million of research and development credits that will likely expire without being utilized; and an aggregate of $37.1 million which will be released in the third
and fourth quarters of 2008 to offset our expected tax expense for the remainder of 2008. Additionally, there is a non-U.S. valuation allowance of $2.0 million for
non-U.S. operating loss and tax credit carryforwards that will likely expire without being utilized.

Our
income tax provisions for the three and six months ended June 30, 2008 include a tax benefit of $452.0 million recorded upon our decision in the second quarter of 2008
to release a substantial portion of the valuation allowance recorded against net deferred tax assets in the United States and a foreign jurisdiction. Excluding the effect of this tax benefit, our
income tax provisions in the three and six
months ended June 30, 2008 consisted primarily of income taxes owed on income generated by a foreign subsidiary and certain state income taxes in the United States. The tax provisions for these
periods included only insignificant amounts in relation to the income that we generated in the United States, due to our utilization of available net operating loss carryforwards that previously had
been recorded in our balance sheet with a full valuation allowance.

We
account for uncertain tax positions in accordance with FIN 48,Accounting for Uncertainty in Income Taxes,which prescribes a
recognition threshold and measurement attribute for financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return and also provides guidance on
various related matters such as derecognition, interest, penalties, and disclosure. At December 31, 2007, approximately $18.4 million of unrecognized tax benefits were identified related
to certain temporary differences, which have been reduced to $11.3 million at June 30, 2008 for certain temporary differences that meet the recognition threshold. An additional
$10.7 million of unrecognized tax benefits have been identified and recorded as of March 31, 2008 related to certain tax credit carryforwards, which resulted in a reduction of the
related deferred tax asset.

We
file tax returns in the United States Federal jurisdiction and in various state, local and foreign jurisdictions. We are no longer subject to Internal Revenue Service, or IRS,
examination for years prior to 2004, although carryforward attributes that were generated prior to 2004 may still be adjusted upon examination by the IRS if they either have been or will be used in a
future period. We receive inquiries from various states during the year, some of which include an audit of state returns previously filed. With limited exceptions, we are no longer subject to state or
local examinations for years prior to 2004, however, carryforward attributes that were generated prior to 2004 may still be adjusted upon examination by state or local tax authorities if they either
have been or will be used in a future period.

The
foreign jurisdictions where we currently file income tax returns are Canada and the Netherlands Antilles. We are currently under examination by Canada Revenue Agency, or CRA, for our
Scientific Research and Experimental Development claims for the years ended December 31, 2005, 2004 and 2003. There are currently no examinations being conducted by the tax authorities in the
Netherlands Antilles. With limited exceptions, we are no longer subject to examination in Canada and the Netherlands Antilles for years prior to 2003 and 1999, respectively, although carryforward
attributes that were generated prior to these respective periods may still be adjusted upon examination if they either have been or will be used in a future period.

We
recognize accrued interest and penalties related to unrecognized tax benefits as a component of tax expense. For the three and six months ended June 30, 2008, the amount of
accrued interest related to unrecognized tax benefits was not significant and no amount has been accrued for penalties.

20

---



Table of Contents

NOTES TO CONDENSED CONSOLIDATED INTERIM FINANCIAL STATEMENTS (UNAUDITED) (Continued)

13. Fair Value Measurements

In September 2006, the FASB issued SFAS 157,Fair Value Measurements, or SFAS 157. SFAS 157 defines fair value,
establishes a framework and gives guidance regarding the methods used for measuring fair value and expands disclosures about fair value measurements. We partially adopted this statement effective
January 1, 2008. In February 2008, the FASB released FSP No. 157-2,Effective Date of FASB Statement No. 157,or FSP
157-2 which delays the effective date of SFAS 157 for all nonfinancial assets and nonfinancial liabilities, except those that are recognized or disclosed at fair value in the
financial statements on a recurring basis (at least annually).

In
accordance with FSP 157-2, we have not applied the provisions of SFAS 157 to the following nonfinancial assets and nonfinancial
liabilities:



We
have not yet determined the impact on our financial statements from our expected adoption of SFAS 157 as it pertains to non-financial assets and liabilities in the
first quarter of 2009. The partial adoption of SFAS 157 for financial assets and liabilities did not have a material impact on our condensed consolidated financial position, results of
operations or cash flows.

Fair
value is defined as the price that would be received to sell an asset or paid to transfer a liability, in an orderly transaction between market participants at the measurement date.
Fair value is based upon quoted market prices, where available. Where quoted market prices or other observable inputs are not available, we apply valuation techniques to estimate fair value.
SFAS 157 establishes a three-level valuation hierarchy for disclosure of fair value measurements. The three levels of the hierarchy are defined as follows:

Level 1Inputs
to the valuation methodology are quoted market prices for identical assets or liabilities in active markets. The types of assets measured at fair value
using Level 1 inputs include our publicly traded equity investments with quoted market prices and money market funds.

Level 2Inputs
include quoted prices for similar assets and liabilities in active markets, quoted prices for identical or similar assets or liabilities in markets that
are not active, inputs other than quoted prices that are observable for the asset or liability (i.e., interest rates, yield curves, etc.) and inputs that are derived principally from or
corroborated by observable market data by correlation or other means (market corroborated inputs). The types of assets measured at fair value using Level 2 inputs include our publicly traded
debt securities and other marketable securities with quoted market prices, which are in markets that are considered less active.

Level 3Inputs
to the valuation methodology are unobservable inputs based on management's best estimate of inputs market participants would use in pricing the asset or
liability at the measurement date, including assumptions about risk. The types of assets measured at fair value using Level 3 inputs include auction-rate securities where the
auctions have failed.

21

---



Table of Contents

NOTES TO CONDENSED CONSOLIDATED INTERIM FINANCIAL STATEMENTS (UNAUDITED) (Continued)

13. Fair Value Measurements (Continued)

In
accordance with the fair value hierarchy described above, the following table shows the fair value of our financial assets and liabilities that are measured at fair value on a
recurring basis as of June 30, 2008:

Quoted Prices
in Active
Markets

Significant
Other
Observable
Inputs

Significant
Unobservable
Inputs

Carrying
Value at
June 30, 2008Level 1

Level 2

Level 3

Total(in thousands)Money market funds

$
437,130

$


$


$
437,130US treasury securities


42,299








42,299Asset-backed securities





1,501





1,501Corporate bonds





696





696Equity securities(1)


10,442








10,442Other available-for-sale investments





250





250Auction-rate securities








78,194


78,194Total

$
489,871

$
2,447

$
78,194

$
570,512


---

Auction-rate
securities are long-term variable rate bonds tied to short-term interest rates. After the initial issuance of the securities, the
interest rate on the securities is reset periodically, at intervals established at the time of issuance (primarily every twenty-eight days), based on market demand for a reset period.
Auction-rate securities are bought and sold in the marketplace through a competitive bidding process referred to as an auction. If there is insufficient interest in the securities at the
time of an auction, the auction may not be completed and the rates may be reset to predetermined "penalty" or "maximum" rates.

Substantially
all of our auction-rate investments, approximately $78.2 million at June 30, 2008, are backed by pools of student loans guaranteed by the Federal
Family Education Loan Program, or FFELP, and we continue to believe that the credit quality of these securities is high based on this guarantee and other collateral. Auctions for these securities
began failing in the first quarter of 2008 and continued to fail throughout the second quarter, which we believe is a result of the recent uncertainties in the credit markets. Consequently, the
investments are not currently liquid, and we will not be able to access these funds until a future auction of these investments is successful, a buyer is found outside of the auction process, the
security is called, or the underlying securities have matured. At the time of the initial investment and through the date of this report, all of these auction-rate securities remain AAA
rated. We believe we have the ability to hold these investments until the lack of liquidity in these markets is resolved. As a result, we continue to classify the entire balance of our
auction-rate securities as non-current available-for-sale investments at fair value on our condensed consolidated balance sheet.

Because
of the temporary declines in fair value for the auction-rate securities, which we attribute to liquidity matters rather than credit issues as discussed above, we have
recorded an unrealized loss of $4.0 million to accumulated other comprehensive income. Any future fluctuation in fair value related to these instruments that we deem to be temporary, including
any recoveries of previous write-downs,

22

---



Table of Contents

NOTES TO CONDENSED CONSOLIDATED INTERIM FINANCIAL STATEMENTS (UNAUDITED) (Continued)

13. Fair Value Measurements (Continued)

would
be recorded to accumulated other comprehensive income. If current market conditions deteriorate further, we may be required to record additional unrealized losses in other comprehensive income.
If the credit ratings of the security issuers deteriorate, the anticipated recovery in market values does not occur or we need funds from the auction-rate securities to meet working
capital needs, we may be required to adjust the carrying value of these investments through impairment charges recorded to earnings, as appropriate.

The
fair values of these auction-rate securities are estimated utilizing a trinomial discounted cash flow valuation model as of June 30, 2008. This analysis considers,
among other items, the maximum interest rate, the probability of passing, failing or default at each auction, the severity of default and the discount rate. These securities were also compared, when
possible, to other observable market data or inputs with similar characteristics to the securities that we held, including credit default swaps spreads on securities with similar credit, implied
volatility rates on exchange traded options and spreads on corporate credit. The analysis assumes that a successful auction would occur, at par, at some point in time for each security.

All
of our assets measured at fair value on a recurring basis using significant Level 3 inputs as of June 30, 2008 were auction-rate securities. The following
table summarizes the change in balances for the six month period ended June 30, 2008:

Level 3
Auction-Rate
Securities(in thousands)Balance at December 31, 2007

$
99,900Unrealized loss included in other comprehensive income


(3,509
)Net settlements


(16,150
)Balance at March 31, 2008

$
80,241Unrealized loss included in other comprehensive income


(447
)Net settlements


(1,600
)Balance at June 30, 2008

$
78,194


14. Restructuring Charges

During the year ended December 31, 2007, we completed an evaluation of our sales force structure, size and allocation in an attempt to maximize efficiency of our sales force. This
evaluation resulted in a decision to restructure and re-align our sales force. The restructuring program was completed by December 31, 2007, approximately 300 positions were
eliminated and we recorded a charge of $6.9 million. This charge was primarily comprised of severance costs for terminated employees and contract termination costs for excess leased computer
equipment and company cars. At June 30, 2008 and December 31, 2007, the remaining accrual was $0 and $6.7 million, respectively.

In
the six months ended June 30, 2008, we reversed $566,000 of our restructure reserve as the result of a change in estimate associated with employee severance costs and contract
terminations that were not realized. We do not expect to incur any additional charges in connection with this restructuring.

23

---





Table of Contents

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

Cautionary Statement Regarding Forward-Looking Statements

This report contains forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995 concerning
our business, operations and financial condition, including statements with respect to the safety, efficacy and potential benefits of our products and products under development, expectations with
respect to the timing and success of the development and commercialization of our products and product candidates, expectations with respect to acquisitions of technologies, product candidates,
approved products and/or businesses, the timing and success of the submission, acceptance and approval of regulatory filings, the scope of patent protection
with respect to our products and product candidates, our review of government pricing and the related restatement of certain historical financial statements and information with respect to the other
plans and strategies for our business and the business of our subsidiaries. All statements other than statements of historical facts included in this report regarding our strategy, future operations,
timetables for product testing, development, regulatory approvals and commercialization, acquisitions, financial position, costs, prospects, plans and objectives of management are forward-looking
statements. When used in this report the words "expect," "anticipate," "intend," "plan," "believe," "seek," "will," "estimate," and similar expressions are intended to identify forward-looking
statements, although not all forward-looking statements contain these identifying words. Because these forward-looking statements involve risks and uncertainties, actual results could differ
materially from those expressed or implied by these forward-looking statements for a number of important reasons, including those discussed under "Risk Factors", "Management's Discussion and Analysis
of Financial Condition and Results of Operations" and elsewhere in this report.

You
should read these forward-looking statements carefully because they discuss our expectations about our future performance, contain projections of our future operating results or our
future financial condition or state other "forward-looking" information. You should be aware that the occurrence of any of the events described under "Risk Factors" and elsewhere in this report could
substantially harm our business, results of operations and financial condition and that upon the occurrence of any of these events, the trading price of our common stock could decline.

We
cannot guarantee any future results, levels of activity, performance or achievements. The forward-looking statements contained in this quarterly report on Form 10-Q
represent our expectations as of the date of this quarterly report on Form 10-Q and should not be relied upon as representing our expectations as of any other date. Subsequent
events and developments will cause our expectations to change. However, while we may elect to update these forward-looking statements, we specifically disclaim any obligation to do so, even if our
expectations change.

Executive Overview

We are a research-based pharmaceutical company dedicated to discovering, developing and commercializing innovative pharmaceutical
products targeted to address large and growing markets and unmet medical needs.

Our
currently marketed products are:



24

---



Table of Contents



In
January 2008, we obtained from Nycomed GmbH, or Nycomed, the exclusive United States distribution rights to OMNARIS Nasal Spray and ALVESCO® HFA (ciclesonide)
Inhalation Aerosol, which has been approved by the United States Food and Drug Administration, or FDA.

We
commercially launched OMNARIS Nasal Spray in April 2008 and expect to commercially launch ALVESCO HFA Inhalation Aerosol during the second half of 2008. We market our products in the
United States to primary care physicians, allergists, pulmonologists, pediatricians, hospitals, psychiatrists
and sleep specialists, as appropriate, primarily through our sales organization currently comprised of approximately 1,700 sales professionals. In May 2008, in an effort to maximize the commercial
opportunity of OMNARIS Nasal Spray and ALVESCO HFA Inhalation Aerosol, we entered into an agreement with a contract sales organization for the services of additional sales professionals. We anticipate
that approximately 400 sales professionals will commence selling certain of our products pursuant to this agreement during the end of the third quarter or early in the fourth quarter of 2008. In
addition, we have entered into out-licensing arrangements with respect to the sale of eszopiclone outside of the United States, Canada and Mexico and with respect to several other
compounds. We expect to commercialize any additional products that we may successfully develop or acquire through our sales force, co-promotion agreements and/or out-licensing
partnerships. Factors that will be critical for us in achieving near-term success include our ability to:



We
believe that success in each of these areas should allow us to continue to be profitable in the near term and provide us the ability to repay our outstanding convertible debt of
$720.8 million. If not

25

---



Table of Contents

converted,
repurchased at the noteholders' or our option, or otherwise refinanced earlier, the principal amount of this debt becomes due as follows:

Principal Amount of Convertible Debt

Maturity Date$72,800,000

December 2008$148,020,000

December 2010$500,000,000(1)

2024
(2)






Our
long-term success depends in part on our ability to build upon our current business, our ability to successfully develop or acquire and commercialize new products and
product candidates, and our ability to successfully launch ALVESCO HFA Inhalation Aerosol and commercialize OMNARIS Nasal Spray and ALVESCO HFA Inhalation Aerosol.

We
expect that sales of LUNESTA and XOPENEX Inhalation Solution will represent the majority of our total revenues in 2008. We do not have long-term sales contracts with our
customers, and we rely on purchase orders for sales of our products. Reductions, delays or cancellations of orders for our marketed products could adversely affect our operating results. If sales of
our marketed products do not meet our expectations, we may not have sufficient revenue to achieve our business plan and our business will not be successful.

In
2008, we expect to be profitable for the year on an operating and net income basis. We expect sales and marketing expenses to continue to decrease as compared to 2007 as we have
reduced marketing programs related to LUNESTA, which will be offset by costs incurred related to the second quarter 2008 commercial introduction of OMNARIS Nasal Spray and costs we expect to incur
related to the planned commercial introduction of ALVESCO HFA Inhalation Aerosol. Research and development expenses for 2008 are expected to increase as compared to 2007 as we continue to invest in
research and development activities relating to LUNESTA and our earlier-stage drug candidates, as well as
increased drug discovery efforts and development activities for ciclesonide and eslicarbazepine acetate, an anti-epileptic compound that we licensed from BialPortela &
Ca, S.A., or Bial, in late 2007. As part of our business strategy, in 2008, and in the future, we expect to consider and, as appropriate, consummate acquisitions of other
technologies, product candidates, approved products and/or businesses. We can provide no assurance that we will be successful in completing any such acquisitions.

Significant 2008 Developments and Recent Corporate Development and Licensing Transactions



26

---



Table of Contents



27

---



Table of Contents



28

---



Table of Contents



Three Month Periods ended June 30, 2008 and 2007

Revenues

Product sales were $269.9 million and $264.3 million for the three months ended June 30, 2008 and 2007,
respectively, an increase of approximately 2%.

Sales
of LUNESTA were $148.1 million and $142.9 million for the three months ended June 30, 2008 and 2007, respectively, an increase of approximately 4%. The
increase is primarily the result of an increase in gross selling price of approximately 20%, which resulted in a net selling price increase of
approximately 3%. The number of units sold increased by less than 1%. Adjustments recorded to gross sales are disclosed below under the heading "Analysis of gross sales to net sales."

Sales
of XOPENEX Inhalation Solution were $85.4 million and $103.5 million for the three months ended June 30, 2008 and 2007, respectively, a decrease of
approximately 18%. The decrease is in part the result of a decrease in net selling price of approximately 5%, which was related to the decision made by CMS during the second quarter 2007 to institute
a new bundled payment amount for XOPENEX Inhalation Solution and generic albuterol inhalation solution products. Partially offsetting the decrease in net selling price is a gross selling price
increase of approximately 20%. The decrease in sales was also due in part to a decrease in number of units sold of approximately 13%, which was primarily the result of a decrease in market share. We
believe that the re-allocation of sales resources in an effort to support the second quarter launch of OMNARIS Nasal Spray may have contributed to this decrease in market share. Adjustments recorded
to gross sales are disclosed below under the heading "Analysis of gross sales to net sales."

29

---



Table of Contents

Sales of XOPENEX HFA were $14.1 million and $12.4 million for the three months ended June 30, 2008 and 2007, respectively, an increase of
approximately 14%. The increase is primarily the result of a gross selling price increase of approximately 10%, which resulted in a net selling price increase of approximately 5%, and an increase in
the number of units sold of approximately 8%. Adjustments recorded to gross sales are disclosed below under the heading "Analysis of gross sales to net sales."

Sales
of BROVANA were $13.3 million and $5.5 million for the three months ended June 30, 2008 and 2007, respectively. We introduced BROVANA commercially in April
2007. The increase is primarily the result of an increase in the number of units sold of approximately 118%, and a gross selling price increase of approximately 14% including discounts given at the
commencement of the commercialization in the three months ended June 30, 2007, which resulted in a net selling price increase of approximately 11%. Adjustments recorded to gross sales are
disclosed below under the heading "Analysis of gross sales to net sales."

Sales
of OMNARIS Nasal Spray were $7.4 million and $0 for the three months ended June 30, 2008 and 2007, respectively. We introduced OMNARIS Nasal Spray commercially in
April 2008. Adjustments recorded to gross sales are disclosed below under the heading "Analysis of gross sales to net sales."

Analysis of gross sales to net salesWe record product sales net of the following significant categories of product sales allowances: payment term discounts,
wholesaler fee-for-service discounts, government rebates and contractual discounts, returns and other discounts. We recompute these amounts each quarter and, with the exception
of the Medicaid best price matters described in more detail in Item 4, Controls and Procedures, of this Form 10-Q, historically our estimates have not materially differed
from actual results. Calculating each of these items involves significant estimates and judgments and requires us to use information from external sources. The following table presents the adjustments
deducted from gross sales to arrive at total net sales:

For the Three Months Ended June 30,2008

% of
Sales

2007

% of
Sales

$ Change

% Change(dollars in thousands)Gross sales

$
402,942


100
%
$
336,960


100.0
%
$
65,982


20
%Adjustments to gross sales:Payment term discounts


7,995


2.0
%

6,741


2.0
%

1,254


19
%Wholesaler fee-for-service


1,123


0.3
%

3,712


1.1
%

(2,589
)

(70
)%Government rebates and contractual discounts


115,488


28.7
%

53,083


15.8
%

62,405


118
%Returns


4,178


1.0
%

3,831


1.1
%

347


9
%Other (includes product introduction discounts)


4,212


1.0
%

5,267


1.6
%

(1,055
)

(20
)%Sub-total adjustments


132,996


33.0
%

72,634


21.6
%

60,362


83
%Net sales

$
269,946


67.0
%
$
264,326


78.4
%
$
5,620


2
%


The
increase in adjustments to gross sales as a percentage of gross sales for the three months ended June 30, 2008, as compared to the three months ended June 30, 2007,
primarily reflects an increase in government rebates and contractual discounts as a result of an increase in:



30

---



Table of Contents



Partially
offsetting the increase in government rebates and contractual discounts was a net decrease in wholesaler fee-for-service discounts given primarily on the sales of
XOPENEX Inhalation Solution.

Royalties
and license fees were $24.2 million and $12.5 million for the three months ended June 30, 2008 and 2007, respectively.

Royalties
earned on the sales of ALLEGRA® (fexofenadine HCl) under our agreement with sanofi-aventis were $7.8 million and $6.3 million for the three months
ended June 30, 2008 and 2007, respectively, an increase of approximately 25%. The increase is primarily the result of increased sales in Japan.

Royalties
earned on sales of CLARINEX® (desloratadine) under our agreement with Schering-Plough Corporation, or Schering-Plough, were $7.3 million and
$4.8 million for the three months ended June 30, 2008 and 2007, respectively, an increase of approximately 52%. The increase is primarily the result of a contractual royalty rate
increase that took effect in October 2007.

Royalties
received on sales of XYZAL®/XUSAL (levocetirizine) under our agreements with UCB S.A. and UCB Farchim S.A., which we refer to
collectively as the UCB entities, were $6.7 million and $1.4 million for the three months ended June 30, 2008 and 2007, respectively, an increase of approximately 369%. The
increase is the result of the commencement of commercialization of XYZAL in the United States during the fourth quarter of 2007.

A
number of the patents we own and license to third parties and for which we receive these royalties are the subject of patent invalidation or revocation claims by companies seeking to
introduce generic equivalents of the products covered by such patents. We can provide no assurance concerning the outcome or the duration of any patent related lawsuits. If we, or third parties from
whom we receive royalties, are not successful in enforcing our respective patents, the companies seeking to market generic versions will not be excluded from marketing their generic versions of these
products. Introduction of generic copies of any of these products before the expiration of our patents or the patents of our licensees could have a material adverse effect on our business.

Costs of Revenues

Cost of products sold was $27.3 million and $25.1 million for the three months ended June 30, 2008 and 2007,
respectively.

Cost
of LUNESTA sold as a percentage of LUNESTA gross sales was approximately 5% and 6% for the three months ended June 30, 2008 and 2007, respectively. The decrease in the cost
as a percentage of gross sales is primarily due to an increase in our gross selling price.

Cost
of XOPENEX Inhalation Solution sold as a percentage of XOPENEX Inhalation Solution gross sales was approximately 6% and 7% for the three months ended June 30, 2008 and 2007,

31

---



Table of Contents

respectively.
The decrease in the cost as a percentage of gross sales is primarily due to an increase in our gross selling price.

Cost
of XOPENEX HFA sold as a percentage of XOPENEX HFA gross sales was approximately 12% and 15% for the three months ended June 30, 2008 and 2007, respectively. Included in the
costs of XOPENEX HFA sold is a royalty paid on net sales of XOPENEX HFA to 3M Company, or 3M, our third party finished goods manufacturer of the product. The decrease in the cost as a percentage of
gross sales is primarily due to an increase in our gross selling price in addition to lower manufacturing cost per-unit as a result of an increase in the number of units manufactured
during the three months ended June 30, 2008 as compared to the same period in 2007.

Cost
of BROVANA sold as a percentage of BROVANA gross sales was approximately 11% and 20% for the three months ended June 30, 2008 and 2007, respectively. The decrease in the cost
as a percentage of gross sales is primarily due to lower manufacturing costs during the three months ended
June 30, 2008 as compared to the same period in 2007. The decrease in the cost to manufacture BROVANA is the result of increased production of the 60-count package, which has a
lower manufacturing cost, as compared to the 30-count package, during the three months ended June 30, 2008 as compared to the same period in 2007.

Cost
of OMNARIS Nasal Spray sold as a percentage of OMNARIS Nasal Spray gross sales was approximately 23% for the three months ended June 30, 2008. We commercially introduced
OMNARIS Nasal Spray in April 2008.

Cost
of royalties earned was $580,000 and $389,000 for the three months ended June 30, 2008 and 2007, respectively, an increase of approximately 49%. The cost of royalties in both
periods relates to an obligation to a third party as a result of royalties we earn from Schering-Plough based on its sales of CLARINEX. This increase in third party obligations is due to the increase
in royalties earned in the three months ended June 30, 2008 as compared with the same period in 2007.

Research and Development

Research and development expenses were $58.3 million and $45.5 million for the three months ended June 30, 2008
and 2007, respectively, an increase of approximately 28%. The increase is primarily due to increased spending on early-stage programs (SEP-225441, SEP-228432,
SEP-227900) and increased drug discovery efforts, as well as increased salary and other compensation related expenses for research and development personnel.

Research
and development in-process upon acquisition expenses were $50.8 million and $0 for the three months ended June 30, 2008 and 2007, respectively. These
expenses represent the cost of acquiring rights to branded pharmaceutical products in development from third parties, which we expense at the time of acquisition. For the three months ended
June 30, 2008, research and development-in process upon acquisition expenses included costs associated with our agreements with Arrow.

Drug
development and approval in the United States is a multi-step process regulated by the FDA. The process begins with the filing of an investigational new drug
application, or IND, which, if successful, allows the opportunity for study in humans, or clinical study, of the potential new drug. Clinical development typically involves three phases of study:
Phase I, II and III. The most significant costs in clinical development are in Phase III clinical trials, as they tend to be the longest and largest studies in the drug development
process. Following successful completion of Phase III clinical trials, an NDA must be submitted to, and accepted by, the FDA, and the FDA must approve the NDA, prior to commercialization of the
drug. We may elect either on our own, or at the request of the FDA, to conduct further studies that are referred to as Phase IIIB and IV studies, which if conducted, could cause us to incur
substantial costs. Phase IIIB studies are initiated and either completed or substantially

32

---



Table of Contents

completed
while the NDA is under FDA review. These studies are conducted under an IND. Phase IV studies, also referred to as post-marketing studies, are studies that are initiated
and conducted after the FDA has approved a product for marketing. Phase IV studies may be requested by the FDA either before or after the FDA has approved an NDA. These studies may also be
independently initiated by the company for which an NDA has been approved. The FDA and the companies conducting post-marketing studies use them to gather additional information about a
product's safety, efficacy or optimal use.

Successful
development of our product candidates is highly uncertain. Completion dates and completion costs can vary significantly for each product candidate and are difficult to
predict. The lengthy process of seeking FDA approvals, 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 affect our business. We cannot provide assurance that we will obtain any approval required by the FDA on a timely basis,
if at all.

For
additional discussion of the risks and uncertainties associated with completing development of potential product candidates, see "Risk Factors."

Below
is a summary of development of our products and product candidates that represent approximately 10% or more of our direct project research and development spending for the three
months ended June 30, 2008. The "Estimate of Completion of Phase" column contains forward-looking statements regarding expected timing of completion of product development phases. Completion of
product development, if successful, culminates in the submission of an NDA to the FDA; however, there can be no assurance that the FDA will accept for filing, or approve, any NDA. The actual timing of
completion of phases could differ materially from the estimates provided in the table. In the table below, the FDA approved product and the three product candidates listed accounted for approximately
56% of our direct project research and development spending for the three months ended June 30, 2008. No other product candidate accounted for more than 8% of our direct research and
development spending in this period.

Product or Product Candidate

Indication

Phase of Development

Estimate of Completion of PhaseLUNESTA (eszopiclone)

Insomnia

*

*SEP-225441

Anxiety

Phase II

2009SEP-227162

Depression

Phase I

2009SEP-228432

Depression

Phase I

2009


---

Below
is a summary of expenditure information related to our products and product candidates representing approximately 10% or more of our direct project research and development
spending during the three months ended June 30, 2008 and 2007, as well as the costs incurred to date on these projects. The costs in this analysis include only direct costs and do not include
certain indirect labor,

33

---



Table of Contents

overhead,
share-based compensation or other costs that benefit multiple projects. As a result, fully-loaded research and development cost summaries by project are not presented.

Project costs
for the
three months ended
June 30, 2008

Project costs to
date through
June 30, 2008

Project costs
for the
three months ended
June 30, 2007

Project costs to
date through
June 30, 2007(in thousands)LUNESTA (eszopiclone)

$
3,926

$
259,739

$
5,921

$
231,549BROVANA (arformoterol tartrate)

$
1,636

$
192,600

$
3,886

$
181,343XOPENEX HFA (levalbuterol tartrate)

$
1,829

$
178,250

$
1,961

$
172,219SEP-225289

$
1,748

$
28,465

$
2,596

$
17,565SEP-225441

$
4,376

$
14,640

$
1,118

$
1,725SEP-227162

$
2,488

$
25,476

$
3,071

$
12,151SEP-228432

$
2,966

$
6,410

$
712

$
831


Due
to the length of time necessary to develop a product, uncertainties related to the ability to obtain governmental approval for commercialization, and difficulty in estimating costs
of projects, we do not believe it is possible to make accurate and meaningful estimates, with any degree of accuracy, of the ultimate cost to bring our product candidates that have not entered into
Phase III clinical trials to FDA approved status.

Selling, Marketing and Distribution

Selling, marketing and distribution expenses were $179.3 million and $191.5 million for the three months ended
June 30, 2008 and 2007, respectively, a decrease of approximately 6%. The decrease was largely due to a $19.6 million decrease in marketing, advertising and promotional expenses
primarily related to LUNESTA, partially offset by increased expenses associated with our commercialization of OMNARIS Nasal Spray.

General and Administrative

General and administrative costs were $28.5 million and $19.3 million for the three months ended June 30, 2008 and
2007, respectively, an increase of approximately 48%. The increase primarily relates to a $4.8 million increase in salary and other compensation related expenses, a $1.8 million increase
in legal fees largely related to patent litigation, and a $1.8 million increase in fees associated with outside consulting services.

Amortization of Intangible Assets

Amortization of intangible assets were $1.9 million and $34,000 for the three months ended June 30, 2008 and 2007,
respectively. The increase primarily relates to the amortization of the intangible assets acquired from Nycomed during the first quarter of 2008 and Arrow during the second quarter of 2008. We
recorded $997,000 and $0 of amortization of the intangible assets to cost of product sold in the three months ended June 30, 2008 and 2007, respectively.

Other Income (Expense)

Interest income was $5.9 million and $11.1 million for the three months ended June 30, 2008 and 2007,
respectively, a decrease of approximately 47%. The decrease is primarily due to lower interest rates earned on investments in the three months ended June 30, 2008 as compared to the same period
in 2007. For the three months ended June 30, 2008 and 2007, the average annualized interest rate that we earned on our investments was 2.68% and 5.23%, respectively.

34

---



Table of Contents

Interest
expense was $2.1 million and $113,000 for the three months ended June 30, 2008 and 2007, respectively. The expense in the three months ended June 30, 2008
is primarily related to imputed interest associated with the intangible assets licensed from Arrow.

Equity
in investee losses were $272,000 and $132,000 for the three months ended June 30, 2008 and 2007, respectively. The loss represents our portion of BioSphere
Medical, Inc., or BioSphere, losses.

Other
expense was $9.4 million and $558,000 for the three months ended June 30, 2008 and 2007, respectively. The expense in the three months ended June 30, 2008
primarily represents an impairment loss recorded related to our investment in ACADIA Pharmaceuticals Inc., or ACADIA.

Income Taxes

For the three months ended June 30, 2008, our effective tax rate was a benefit of 780% on pre-tax losses of
$58.1 million compared to an income tax expense of 9.2% for the three months ended June 30, 2007, on pre-tax income of $5.3 million. The net tax benefit recorded for
the three months ended June 30, 2008 was principally due to a tax benefit of $452.0 million recorded upon our decision in the second quarter of 2008 to release a valuation allowance
recorded against net deferred tax assets in the United States and a foreign jurisdiction. Excluding the effect of these tax benefits, our income tax provisions in the three months ended
June 30, 2008 consisted primarily of income taxes owed on income generated by a foreign subsidiary and certain state income taxes in the United States. The tax provisions of those periods
included only insignificant amounts in the United States, due to our utilization of available net operating loss carryforwards that previously had been recorded in our balance sheet with a full
valuation allowance.

As
of the end of the first quarter of 2008, a full valuation allowance was recorded against our net deferred tax assets in the United States and foreign jurisdictions. Based upon our
settlement with Breath during the second quarter of 2008, our operating results over recent years and through June 30, 2008 and an assessment of our expected future results of operations, we
determined that it is more likely than not that we will realize a substantial portion of our deferred tax assets in the United States and a foreign jurisdiction. As a result, during the second
quarter, we released a total of $452.0 million of our valuation allowance, which was recorded as an income tax benefit.

As
of the end of the second quarter, we have a remaining valuation allowance recorded against United States net deferred tax assets of $215.4 million which consists of
$145.9 million for stock-based compensation deductions and $6.9 million of stock-based compensation research and development credits that will be credited to additional
paid-in-capital when realized; $6.1 million for certain state operating loss carryforwards, and $19.4 million of research and development credits that will likely
expire without being utilized; and $37.1 million which will be released in the third and fourth quarters of 2008 to offset our expected tax expense for the remainder of 2008. Additionally,
there is a non-U.S. valuation allowance of $2.0 million for non-U.S. operating loss and tax credit carryforwards that will likely expire without being utilized.

We
account for uncertain tax positions in accordance with the Financial Accounting Standards Board, or FASB, Interpretation No. 48,Accounting for
Uncertainty in Income Taxes,or FIN 48, which prescribes a recognition threshold and measurement attribute for financial statement recognition and measurement of a tax
position taken or expected to be taken in a tax return and also provides guidance on various related matters such as derecognition, interest, penalties and disclosure. At December 31, 2007,
approximately $18.4 million of unrecognized tax benefits were identified related to certain temporary differences, which have been reduced to $11.3 million at June 30, 2008 for
certain temporary differences that meet the recognition threshold. In the first quarter of 2008, an additional $10.7 million of unrecognized tax benefits have been identified and recorded as of
March 31, 2008 related to certain tax credit carryforwards, which resulted in a reduction of the related deferred tax asset.

35

---



Table of Contents

Six Month Periods ended June 30, 2008 and 2007

Revenues

Product sales were $575.5 million and $581.9 million for the six months ended June 30, 2008 and 2007,
respectively, a decrease of approximately 1%.

Sales
of LUNESTA were $283.7 million and $290.4 million for the six months ended June 30, 2008 and 2007, respectively, a decrease of approximately 2%. The decrease
is primarily the result of a decrease in the number of units sold of approximately 6%, which is primarily the result of a decline in our market share after the launch of zolpidem tartrate, the generic
equivalent to AMBIEN®, in April of 2007, and a reduction in selling and marketing resources. The reduction in units sold was partially offset by a gross selling price increase of
approximately 19%, which resulted in a net selling
price increase of approximately 4%. Adjustments recorded to gross sales are disclosed below under the heading "Analysis of gross sales to net sales."

Sales
of XOPENEX Inhalation Solution were $225.4 million for the six months ended June 30, 2008 as compared to $253.1 million for the same period in 2007, a decrease
of approximately 11%. The decrease is in part the result of a decrease in net selling price of approximately 2%, which was related to the decision made by CMS during the second quarter 2007 to
institute a new bundled payment amount for XOPENEX Inhalation Solution and generic albuterol inhalation solution products. Partially offsetting the decrease in net selling price is a gross selling
price increase of approximately 19%. The decrease in sales was also due in part to a decrease in number of units sold of approximately 9%, which was primarily the result of a decrease in market share.
We believe that the re-allocation of sales resources in an effort to support the second quarter launch of OMNARIS Nasal Spray may have contributed to this decrease in market share. Adjustments
recorded to gross sales are disclosed below under the heading "Analysis of gross sales to net sales."

Sales
of XOPENEX HFA were $34.2 million for the six months ended June 30, 2008, as compared to $32.9 million for the same period in 2007, an increase of
approximately 4%. The increase is primarily the result of a net selling price increase of approximately 13%, which was impacted by a gross selling price increase of approximately 10%, partially offset
by a decrease in the number of units sold of approximately 8%. Adjustments recorded to gross sales are disclosed below under the heading "Analysis of gross sales to net sales."

Sales
of BROVANA were $23.2 million for the six months ended June 30, 2008, as compared to $5.5 million for the same period in 2007. We commercially introduced
BROVANA in April 2007. Adjustments recorded to gross sales are disclosed below under the heading "Analysis of gross sales to net sales."

Sales
of OMNARIS Nasal Spray were $7.4 million for the six months ended June 30, 2008 and $0 for the same period in 2007, respectively. We commercially introduced OMNARIS
Nasal Spray in April 2008. Adjustments recorded to gross sales are disclosed below under the heading "Analysis of gross sales to net sales."

36

---



Table of Contents

Analysis of gross sales to net salesThe following table presents the adjustments deducted from gross sales to arrive at net sales:

For the Six Months Ended June 30,2008

% of
sales

2007

% of
sales

$
Change

%
Change(dollars in thousands)
(as restated)Gross sales

$
848,622


100.0
%
$
748,746


100.0
%
$
99,876


13
%Adjustments to gross sales:Payment term discounts


16,961


2.0
%

14,966


2.0
%

1,995


13
%Wholesaler fee for service


4,607


0.5
%

13,862


1.9
%

(9,255
)

(67
)%Government and commercial rebates and discounts


235,510


27.8
%

122,704


16.4
%

112,806


92
%Returns


10,640


1.3
%

8,950


1.2
%

1,690


19
%Other (includes product introduction discounts)


5,414


0.6
%

6,375


0.8
%

(961
)

(15
)%Sub-total adjustments


273,132


32.2
%

166,857


22.3
%

106,275


64
%Net sales

$
575,490


67.8
%
$
581,889


77.7
%
$
(6,399
)

(1
)%


The increase in adjustments to gross sales as a percentage of gross sales for the six months ended June 30, 2008, as compared to the six
months ended June 30, 2007, primarily reflects an increase in
government rebates and contractual discounts as a result of:



Partially
offsetting this increase in government rebates and contractual discounts was a net decrease in wholesaler fee-for-service discounts given primarily on the sales of
XOPENEX Inhalation Solution, LUNESTA and XOPENEX HFA.

Royalties
and license fees were $39.4 million and $22.6 million for the six months ended June 30, 2008 and 2007, respectively, an increase of approximately 74%.

Royalties
earned on the sales of ALLEGRA under our agreement with sanofi-aventis increased to $15.6 million for the six months ended June 30, 2008 compared to
$12.1 million for the same period in 2007, an increase of approximately 28%. The increase is primarily the result of increased sales in Japan.

Royalties
earned on sales of CLARINEX under our agreement with Schering-Plough were $13.4 million for the six months ended June 30, 2008 compared to $8.1 million for
the same period in 2007, an increase of approximately 65%. The increase is primarily the result of a contractual royalty rate increase that took effect in October 2007.

37

---



Table of Contents

Royalties
received on sales of XYZAL/XUSAL under our agreements with the UCB entities were $8.0 million for the six months ended June 30, 2008 compared to
$2.4 million for the same period in 2007, an increase of approximately 238%. The increase is the result of the commencement of commercialization of XYZAL in the United States during the fourth
quarter of 2007.

A
number of the patents we own and license to third parties for which we receive these royalties are the subject of patent invalidation or revocation claims by companies seeking to
introduce generic equivalents of the products covered by such patents. We can provide no assurance concerning the outcome or the duration of any patent related lawsuits. If we, or third parties from
whom we receive royalties, are not successful in enforcing our respective patents, the companies seeking to market generic versions will not be excluded from marketing their generic versions of these
products. Introduction of generic copies of any of these products before the expiration of our patents or the patents of our licensees could have a material adverse effect on our business.

Costs of Revenues

Cost of products sold was $56.6 million and $56.5 million for the six months ended June 30, 2008 and 2007,
respectively.

Cost
of LUNESTA sold as a percentage of LUNESTA gross sales was approximately 5% and 6% for the six months ended June 30, 2008 and 2007, respectively. The decrease in the cost as
a percentage of gross sales is primarily due to an increase in our gross selling price.

Cost
of XOPENEX Inhalation Solution sold as a percentage of XOPENEX Inhalation Solution gross sales was approximately 6% and 7% for the six months ended June 30, 2008 and 2007,
respectively. The decrease in the cost as a percentage of gross sales is primarily due to lower manufacturing costs during the six months ended June 30, 2008 as compared to the same period in
2007, in addition to an increase in our gross selling price.

Cost
of XOPENEX HFA sold as a percentage of XOPENEX HFA gross sales was approximately 13% and 15% for the six months ended June 30, 2008 and 2007, respectively. Included in the
costs of XOPENEX HFA sold is a royalty paid on net sales of XOPENEX HFA to 3M our third party finished goods manufacturer of the product. The decrease in the cost as a percentage of gross sales is
primarily due to an increase in our gross selling price in addition to lower manufacturing cost per-unit as a result of an increase in the number of units manufactured during the six
months ended June 30, 2008 as compared to the same period in 2007.

Cost
of BROVANA sold as a percentage of BROVANA gross sales was approximately 13% and 20% for the six months ended June 30, 2008 and 2007, respectively. The decrease in the cost
as a percentage of gross sales is primarily due to lower manufacturing costs during the six months ended June 30, 2008 as compared to the same period in 2007. The decrease in the cost to
manufacture BROVANA is the result of increased production of the 60-count package, which has a lower manufacturing cost, as compared to the 30-count package, during the six
months ended June 30, 2008 as compared to the same period in 2007.

Cost
of OMNARIS Nasal Spray sold as a percentage of OMNARIS Nasal Spray gross sales was approximately 26% for the six months ended June 30, 2008. We commercially introduced
OMNARIS Nasal Spray in April 2008.

Cost
of royalties earned was $1.1 million and $655,000 for the six months ended June 30, 2008 and 2007, respectively, an increase of approximately 63%. The cost of
royalties in both periods relates to an obligation to a third party as a result of royalties we earn from Schering-Plough based upon its sales of CLARINEX. This increase in third party obligations is
due to the increase in royalties earned during the six months ended June 30, 2008 as compared with the same period in 2007.

38

---



Table of Contents

Research and Development

Research and development expenses were $124.5 million and $86.2 million for the six months ended June 30, 2008 and
2007, respectively, an increase of approximately 45%. The increase is primarily due to the $10.0 million milestone payment to Bial pursuant to the license agreement for SEP-0002093,
referred to by Bial as BIA-2093, as a result of the outcome of a pre-NDA meeting with the FDA, increased spending on LUNESTA Phase IV and pediatric programs, increased
spending on drug discovery efforts and early-stage programs (SEP-225441, SEP-228425, SEP-228432, SEP-227900), as well as an increase in salary and other
compensation related expenses. These increases were offset by a decrease in research and development spending on BROVANA.

Research
and development in-process upon acquisition expenses were $90.0 million and $0 for the six months ended June 30, 2008 and 2007, respectively. These
expenses represent the cost of acquiring rights to branded pharmaceutical products in development from third parties, which we expense at the time of acquisition. For the six months ended
June 30, 2008, research and development-in process upon acquisition expenses included costs associated with our Nycomed and Arrow transactions.

Below
is a summary of development of our products and product candidates that represent approximately 10% or more of our direct project research and development spending for the six
months ended June 30, 2008. The "Estimate of Completion of Phase" column contains forward-looking statements regarding expected timing of completion of product development phases. Completion of
product development, if successful, culminates in the submission of an NDA to the FDA; however, there can be no assurance that the FDA will accept for filing, or approve, any NDA. The actual timing of
completion of phases could differ materially from the estimates provided in the table. In the table below, the FDA approved product and product candidate listed accounted for approximately 44% of our
direct project research and development spending for the six months ended June 30, 2008. No other product candidate accounted for more than 9% of our direct research and development spending in
this period.

Product or Product Candidate

Indication

Phase of
Development

Estimate of
Completion of PhaseLUNESTA (eszopiclone)

Insomnia

*


*SEP-225441

Anxiety

Phase II


2009


---

Below
is a summary of expenditure information related to our product candidates representing approximately 10% or more of our direct project research and development spending during the
six months ended June 30, 2008 or 2007, as well as the costs incurred to date on these projects. The costs in this analysis include only direct costs and do not include certain indirect labor,
overhead, share-based compensation or other costs which benefit multiple projects. As a result, fully loaded research and development cost summaries by project are not presented.

Project costs for
the six months
ended
June 30,
2008

Project costs
to date through
June 30,
2008

Project costs for
the six months
ended
June 30,
2007

Project costs
to date through
June 30,
2007(in thousands)LUNESTA (eszopiclone)

$
14,642

$
259,739

$
11,526

$
231,549BROVANA (arformoterol tartrate)

$
3,832

$
192,600

$
7,412

$
181,343SEP-225289

$
4,272

$
28,465

$
4,455

$
17,565SEP-227162

$
4,492

$
25,476

$
4,010

$
12,151SEP-225441

$
7,407

$
14,640

$
1,725

$
1,725


39

---



Table of Contents

Selling, Marketing and Distribution

Selling, marketing and distribution expenses were $334.6 million and $383.6 million for the six months ended
June 30, 2008 and 2007, respectively, a decrease of approximately 13%. The decrease was largely due to a $45.0 million decrease in marketing, advertising and promotional expenses
primarily related to LUNESTA, in addition to a decrease in salary and other compensation related expenses resulting from our sales force restructuring, which occurred in the quarter ended
December 31, 2007.

General and Administrative

General and administrative costs were $52.0 million and $38.2 million for the six months ended June 30, 2008 and
2007, respectively, an increase of approximately 36%. The increase is primarily the result of an $8.3 million increase in salary and other compensation related expenses, a $3.0 million
increase in legal fees largely related to patent litigation, and a $1.9 million increase in fees associated with outside consulting services.

Amortization of Intangible Assets

Amortization of intangible assets were $4.2 million and $85,000 for the six months ended June 30, 2008 and 2007,
respectively. The increase primarily relates to the amortization of the intangible assets acquired from Nycomed and Arrow in January 2008 and April 2008, respectively.
We recorded $997,000 and $0 of amortization of the intangible assets to cost of product sold in the six months ended June 30, 2008 and 2007, respectively.

Litigation Settlement

Litigation settlement expense was $0 and $34.0 million for the six months ended March 31, 2008 and 2007, respectively. In
June 2007, we filed in the United States District Court for the District of Massachusetts, or the Court, a Stipulation of Settlement regarding two securities class action lawsuits, or class actions,
then pending in the Court naming Sepracor and certain of our current and former officers and one director as defendants. The class actions, which were filed on behalf of certain purchasers of our
equity and debt securities, or the plaintiffs, alleged that the defendants violated the Federal securities laws by making false and misleading statements relating to the testing, safety and likelihood
of approval of tecastemizole by the FDA. Under the terms of the Stipulation of Settlement, in June 2007 we paid into escrow $52.5 million in settlement of the class actions and, in July 2007,
received an $18.5 million reimbursement from our insurance carriers. We recorded the litigation settlement expense of $34.0 million, relating to this matter, during the quarter ended
March 31, 2007. In September 2007, the Court granted final approval of the Stipulation of Settlement and entered a final judgment consistent with the Stipulation of Settlement. The settlement
is now final and the total settlement amount has been released from escrow.

Other Income (Expense)

Interest income was $14.6 million and $23.7 million for the six months ended June 30, 2008 and 2007, respectively,
a decrease of approximately 38%. The decrease is primarily due to lower average balances of cash and short- and long-term investments and lower interest rates earned on investments in the
six months ended June 30, 2008 compared to the same period in 2007. For the six months ended June 30, 2008 and 2007, the average annualized interest rate that we earned on our
investments was 3.32% and 5.25%, respectively.

Interest
expense was $2.2 million and $2.9 million for the six months ended June 30, 2008 and 2007, respectively. The expense for the six months ended 2008 is
primarily related to imputed interest associated with the intangible assets licensed from Arrow. The expense for the six months ended 2007

40

---



Table of Contents

is
primarily related to the interest we paid on our 5% convertible subordinated debentures, which we repaid in full upon their maturity on February 15, 2007.

Equity
in investee losses were $475,000 and $404,000 for the six months ended June 30, 2008 and 2007, respectively, an increase of approximately 18%. The loss represents our
portion of BioSphere losses.

Other
expense was $9.4 million and $286,000 for the six months ended June 30, 2008 and 2007, respectively. The expense in the six months ended June 30, 2008
primarily represents an impairment loss recorded related to our investment in ACADIA.

Income Taxes

For the six months ended June 30, 2008, our effective tax rate was a benefit of 1,005% on pre-tax losses of
$45.0 million compared to an income tax expense of 7.4% for the six months ended June 30, 2007, on pre-tax income of $25.5 million. The net tax benefit recorded for
the six months ended June 30, 2008 was principally due to a tax benefit of $452.0 million recorded upon our decision in the second quarter of 2008 to release a valuation allowance
recorded against net deferred tax assets in the United States and a foreign jurisdiction. Excluding the effect of these tax benefits, our income tax provisions for the six months ended June 30,
2008 consisted primarily of income taxes owed on income generated by a foreign subsidiary and certain state income taxes in the United States The tax provisions of those periods included only
insignificant amounts due to our utilization of available net operating loss carryforwards that previously had been recorded in our balance sheet with a full valuation allowance.

As
of the end of the first quarter of 2008, a full valuation allowance was recorded against our net deferred tax assets in the United States and foreign jurisdictions. Based upon our
settlement with Breath during the second quarter of 2008, our operating results over recent years and through June 30, 2008 and an assessment of our expected future results of operations, we
determined that it is more likely than not that we will realize a substantial portion of our deferred tax assets in the United States and a foreign jurisdiction. As a result, during the second
quarter, we released a total of $452.0 million of our valuation allowance, which was recorded as an income tax benefit.

As
of the end of the second quarter, we have a remaining valuation allowance recorded against United States net deferred tax assets of $215.4 million, which consists of
$145.9 million for stock-based compensation deductions and $6.9 million of stock-based compensation research and development credits that will be credited to additional
paid-in-capital when realized; $6.1 million for certain state operating loss carryforwards, and $19.4 million of research and development credits that will likely
expire without being utilized; and $37.1 million, which will be released in the third and fourth quarters of 2008 to offset our expected tax expense for the remainder of 2008. Additionally,
there is a non-U.S. valuation allowance of $2.0 million for non-U.S. operating loss and tax credit carryforwards that will likely expire without being utilized.

Liquidity and Capital Resources

Our liquidity requirements have historically consisted of research and development expenses, sales and marketing expenses, capital
expenditures, working capital, debt service and general corporate expenses. Historically, we have funded these requirements and the growth of our business primarily through convertible subordinated
debt offerings, the issuance of common stock, including the exercise of stock options, sales of our products and license agreements for our drug compounds. We now expect to fund our liquidity
requirements primarily with revenue generated from product sales. We also believe we have the ability to meet our short-term liquidity needs through the use of our cash and
short-term investments on hand at June 30, 2008.

41

---



Table of Contents

At
June 30, 2008, $78.2 million of our investment portfolio was invested in AAA rated investments in auction-rate securities. Auction-rate
securities are long-term variable rate bonds tied to short-term interest rates. After the initial issuance of the securities, the interest rate on the securities is reset
periodically, at intervals established at the time of issuance (primarily every 28 days), based on market demand for a reset period. Auction-rate securities are bought and sold in
the marketplace through a competitive bidding process often referred to as an auction. If there is insufficient interest in the securities at the time of an auction, the auction may not be completed
and the rates may be reset to predetermined "penalty" or "maximum" rates.

Substantially
all of our auction-rate securities are backed by pools of student loans guaranteed by the Federal Family Education Loan Program, or FFELP, and we continue to
believe that the credit quality of these securities is high based on this guarantee and other collateral. Auctions for these securities began failing in the first quarter of 2008 and continued to fail
throughout the second quarter, which we believe is a result of the recent uncertainties in the credit markets. Consequently, the investments are not currently liquid, and we will not be able to access
these funds until a future auction of these investments is successful, a buyer is found outside of the auction process, the security is called, or the underlying securities have matured. At the time
of our initial investment and through the date of this report, all of our auction-rate securities remain AAA rated. We believe we have the ability to hold these investments until the lack
of liquidity in these markets is resolved. As a result, we continue to classify the entire balance of auction-rate securities as non-current
available-for-sale investments at fair value on our condensed consolidated balance sheet.

Typically,
the fair value of auction-rate securities investments approximates par value due to the frequent resets through the auction process. While we continue to earn
interest on our auction-rate securities investments at the contractual rate, these investments are not currently trading and therefore do not have a readily determinable market value.
Accordingly, the estimated fair value of the auction-rate securities no longer approximates par value.

At
June 30, 2008, because of the temporary declines in fair value for the auction-rate securities, which we attribute to liquidity matters rather than credit issues as
discussed above, we have classified our auction-rate securities at Level 3, as defined under the Statement of Financial Accounting Standards, or SFAS No. 157, Fair Value Measurement, or
SFAS 157, framework and described in Note 13, Fair Value Measurements, of our condensed consolidated financial
statements included in this quarterly report on Form 10-Q, with a fair value of $78.2 million. The fair value of these auction-rate securities are estimated
utilizing a trinomial discounted cash flow analysis, which was compared, when possible, to other observable market data or inputs with similar characteristics. The assumptions used in preparing the
discounted cash flow analysis include estimates for the maximum interest rate, the probability of passing, failing or default at each auction, the severity of default and the discount rate. Based on
this assessment of fair value, as of June 30, 2008, we determined there was a decline in fair value of our auction-rate securities investments of $4.0 million, which was
deemed temporary. If current market conditions deteriorate further, we may be required to record additional unrealized losses in other comprehensive income. If the credit ratings of the security
issuers deteriorate, the anticipated recovery in market values does not occur, or we need funds from the auction-rate securities to meet working capital needs, we may be required to adjust
the carrying value of these investments through impairment charges recorded to earnings, as appropriate, which could be material.

Cash,
cash equivalents and short- and long-term investments totaled $853.3 million, or 45% of total assets, at June 30, 2008, compared to $1.1 billion,
or 76% of total assets, at December 31, 2007.

Net
cash provided by operating activities for the six months ended June 30, 2008 was $27.6 million, which includes net income of $407.3 million. Our net income
includes non-cash adjustments of $314.5 million, consisting primarily of the release of the tax valuation allowance, research and development in process upon acquisition,
share-based compensation, impairment on investments and

42

---



Table of Contents

depreciation
and amortization expense. Accounts receivable increased by $5.1 million primarily due to the timing of our sales. Inventory on hand increased by $13.7 million primarily due
to timing of deliveries and replenishment of depleted stock. Other assets increased by $13.0 million, which is primarily a result of an increase in prepaid expenses and a change in our deferred
tax asset. Accrued expenses decreased by $69.2 million primarily due to the $75.0 million upfront payment we paid to Bial in January 2008. Product sales allowances and reserves increased
by $39.3 million primarily due to product revenue rebates related to LUNESTA and XOPENEX Inhalation Solution product sales.

Net
cash used in investing activities for the six months ended June 30, 2008 was $112.6 million, which is primarily attributable to the purchase of intangible assets from
Nycomed for $150.0 million, the acquisition of Oryx for $49.8 million net of cash acquired, and the purchases of property and equipment of $21.3 million, partially offset by the
cash provided by net sales of short- and long-term investments of $109.5 million.

Net
cash provided by financing activities for the six months ended June 30, 2008 was $3.6 million. We received proceeds of $4.2 million from issuing common stock
upon the exercise of stock options issued under our stock option plans, and we used $593,000 to repay capital lease obligations.

We
believe our existing cash and the cash flow that we anticipate from operations and current strategic alliances will be sufficient to support existing operations through at least 2009.
However, if some or all of our significant contingent payments become due and payable under our collaboration agreements and the holders of our 0% notes due 2024 exercise their right to require us to
convert their notes into cash in October 2009, we may need to raise additional capital to meet these obligations. In the longer term, we expect to continue to fund our operations with revenue
generated from product sales. Our actual future cash requirements and our ability to generate revenue, however, will depend on many factors, including:



43

---







Table of Contents

If our assumptions underlying our beliefs regarding future revenues and expenses change, or if opportunities or needs arise, we may seek to raise additional cash
by selling debt or equity securities or otherwise borrowing money. However, we may not be able to raise such funds on favorable terms, if at all.

Based
on our current operating plan, we believe that we will not be required to raise additional capital to fund the repayment of our outstanding convertible debt when due, although we
may choose to do so. However, if some or all of our significant contingent payments become due and payable under our collaboration agreements and the holders of our 0% notes due 2024 exercise their
right to require us to convert their notes into cash in October 2009, we may need to raise additional capital to meet these obligations. If we are not able to successfully continue to grow our revenue
and properly manage our expenses, it is likely that our business would be materially and adversely affected and that we would be required to raise additional funds in order to repay our outstanding
convertible debt. We cannot assure that, if required, we would be able to raise the additional funds on favorable terms, if at all.

Critical Accounting Policies and Estimates

We identified critical accounting policies and estimates in our annual report on Form 10-K for the year ended
December 31, 2007. These critical accounting policies relate to product revenue recognition, revenue recognition related to multiple element arrangements, royalty revenue recognition, product
sales allowance and reserves, cash and cash equivalents, short- and long-term investments, accounts receivable and bad debt, amortization, depreciation and certain long lived assets,
income taxes, inventory write-downs, stock based compensation, and research and development expense. These policies require us to make estimates in the preparation of our financial statements as of a
given date. Because of the uncertainty inherent in these matters, our actual results could differ from the estimates we use in applying the critical accounting policies.

A
summary of accounting policies that are considered critical may be found in Part II, Item 7 of our annual report on Form 10-K for the year ended
December 31, 2007 in the "Critical Accounting Policies" section. Other than as described below, our critical accounting policies and estimates are as set forth in the
Form 10-K.

Product sales allowances and reservesThe following table summarizes activity in each of our product sales allowances and reserve categories for the six months
ended June 30, 2008:

Payment
Term
Discount

Wholesaler
Fee
for Service

Government
Rebates and
Contractual
Discounts

Returns

Other
Discounts

Total(in thousands)Balance at December 31, 2007

$
(4,139
)
$
(12,112
)
$
(206,733
)
$
(24,351
)
$
(2,643
)
$
(249,978
)Current provision:Current year


(16,961
)

(4,607
)

(226,066
)

(10,640
)

(5,414
)

(263,688
)Prior year








(9,444
)







(9,444
)Total


(16,961
)

(4,607
)

(235,510
)

(10,640
)

(5,414
)

(273,132
)Actual:Current year


13,426


3,751


66,577


17


3,373


87,144Prior year


3,912


11,046


116,557


13,369


2,169


147,053Total


17,338


14,797


183,134


13,386


5,542


234,197Balance at June 30, 2008

$
(3,762
)
$
(1,922
)
$
(259,109
)
$
(21,605
)
$
(2,515
)
$
(288,913
)


Calculating each of these product sales allowances and reserves involves significant estimates and judgments and requires us to use information
from external sources. Based on known market events

44

---



Table of Contents

and
trends, internal and external historical trends, third party data, customer buying patterns and current knowledge of contractual and statutory requirements, we believe that we are able to make
reasonable estimates of sales discounts.

Fair Value MeasurementsEffective January 1, 2008, we partially adopted SFAS 157. SFAS 157 defines fair value, establishes a framework and
gives guidance regarding the methods used for measuring fair value and expands disclosures about fair value measurements. In February 2008, the FASB released a FASB Staff Position, or FSP,
No. 157-2,Effective Date of FASB Statement No. 157, or FSP 157-2, which delays the effective date of
SFAS 157 for all nonfinancial assets and nonfinancial liabilities, except those that are recognized or disclosed at fair value in the financial statements on a recurring basis (at least
annually).

In
accordance with FSP 157-2, we have not applied the provisions of SFAS 157 to the following nonfinancial assets and nonfinancial
liabilities:



We
have not yet determined the impact on our financial statements from adoption of SFAS 157 as it pertains to non-financial assets and liabilities for our first
quarter of 2009. The partial adoption of SFAS 157 for financial assets and liabilities did not have a material impact on our condensed consolidated financial position, results of operations or
cash flows.

Fair
value is defined as the price that would be received to sell an asset or paid to transfer a liability, in an orderly transaction between market participants at the measurement date.
Fair value is based upon quoted market prices, where available. Where quoted market prices or other observable inputs are not available, we apply valuation techniques to estimate fair value.
SFAS 157 establishes a three-level valuation hierarchy for disclosure of fair value measurements. The three levels of the hierarchy are defined as follows:

Level 1Inputs
to the valuation methodology are quoted market prices for identical assets or liabilities in active markets. The types of assets measured at fair value
using Level 1 inputs include our publicly traded equity investments with quoted market prices and money market funds.

Level 2Inputs
include quoted prices for similar assets and liabilities in active markets, quoted prices for identical or similar assets or liabilities in markets that
are not active, inputs other than quoted prices that are observable for the asset or liability (i.e., interest rates, yield curves, etc.) and inputs that are derived principally from or
corroborated by observable market data by correlation or other means (market corroborated inputs). The types of assets measured at fair value using Level 2 inputs include our publicly traded
debt securities and other marketable securities with quoted market prices, which are in markets that are considered less active.

Level 3Inputs
to the valuation methodology are unobservable inputs based on management's best estimate of inputs market participants would use in pricing the asset or
liability at the measurement date, including assumptions about risk. The types of assets measured at fair value using Level 3 inputs include auction-rate securities where the
auctions have failed.

Short- and Long-Term Investments:We estimated the fair values of our auction-rate securities utilizing a trinomial discounted cash flow
valuation model. This analysis considers, among other items, the maximum interest rate, the probability of passing, failing or default at each auction, the severity of default and the discount rate.
These securities were also compared, when possible, to other observable

45

---



Table of Contents

market
data or inputs with similar characteristics to the securities that we held including credit default swaps spreads on securities with similar credit, implied volatility rates on exchange traded
options and spreads on corporate credit. The analysis assumes that a successful auction would occur, at par, at some point in time for each security.

Contractual Obligations

Contractual obligations represent future cash commitments and liabilities under agreements with third parties and exclude contingent
liabilities for which we cannot reasonably predict future payment, including contingencies related to potential future development, financing and/or commercial milestone payments on collaboration
agreements. The following chart summarizes our material contractual obligations as of June 30, 2008:

Contractual Obligations

Total

2008

2009

2010

2011

2012

2013 and
beyond(In Thousands)Convertible subordinated debtprincipal(1)

$
720,820

$
72,800

$


$
148,020

$


$


$
500,000ArrowLevalbuterol/ipratropium(2)


70,000





25,000


25,000





20,000


ArrowCiclesonide(3)


47,500





12,500


15,000








20,000Capital lease obligations


2,174


621


1,242


311








Operating leases(4)


5,399


919


1,471


1,312


1,208


489Purchase obligations(5)


354,011


319,864


28,814


3,476


1,857





Total material contractual cash obligations(6)

$
1,199,904

$
394,204

$
69,027

$
193,119

$
3,065

$
20,489

$
520,000


---

This table also excludes any liabilities pertaining to uncertain tax positions as we cannot make a reliable estimate of the period of cash
settlement with the respective taxing authorities.

46

---



Table of Contents

ITEM 3.    QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Market Risk

We are exposed to market risk from changes in interest rates and equity prices, which could affect our future results of operations and
financial condition. These risks are described in Part II, Item 7A of our annual report on Form 10-K for the year ended December 31, 2007. As of
August 8, 2008, there have been no material changes to the market risks described in our annual report on Form 10-K for the year ended December 31, 2007. Additionally,
we do not anticipate any near-term changes in the nature of our market risk exposures or in our management's objectives and strategies with respect to managing such exposures.

We
hold auction-rate security investments which are AAA rated and the underlying assets are backed by pools of student loans guaranteed by FFELP. Due to the recent
uncertainties in the credit market, these securities have been rendered temporarily illiquid, and the fair value of those investments as of June 30, 2008, is estimated to be $4.0 million
below par value. We continue to classify our entire balance of auction-rate securities as non-current available-for-sale investments at fair value on
our unaudited condensed consolidated balance sheet. We believe we have the ability to hold these investments until the lack of liquidity in these markets is resolved. If current market conditions
deteriorate further, we may be required to record additional unrealized losses in other comprehensive income. If the credit ratings of the security issuers deteriorate, the anticipated recovery in
market values does not occur, or we need
funds from the auction-rate securities to meet working capital needs, we may be required to adjust the carrying value of these investments through impairment charges recorded to earnings,
as appropriate, which could be material.

ITEM 4.    CONTROLS AND PROCEDURES

Disclosure Controls and Procedures

Our management has carried out an evaluation, under the supervision and with the participation of our Chief Executive Officer and Chief
Financial Officer of the effectiveness of the design and operation of our disclosure controls and procedures as of June 30, 2008. The term "disclosure controls and procedures," as defined in
Rule 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, or Exchange Act, means controls and other procedures of a company that are designed to ensure
that information required to be disclosed in the reports that the company files or submits under the Exchange Act is recorded, processed, summarized and reported, within the time periods specified in
the SEC's rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by a company in the
reports that it files or submits under the Exchange Act is accumulated and communicated to the company's management, including its principal financial officers, as appropriate, to allow timely
decisions regarding required disclosure. There are inherent limitations to the effectiveness of any system of disclosure controls and procedures, including the possibility of human error and the
circumvention or overriding of the controls and procedures. Accordingly, even effective disclosure controls and procedures can only provide reasonable assurance of achieving their control objectives
and management necessarily applies its judgment in evaluating the cost-benefit relationship of possible controls and procedures. Based on the evaluation and the identification of the
material weakness in internal control over financial reporting described below, our Chief Executive Officer and Chief Financial Officer have concluded that, as of June 30, 2008, our disclosure
controls and procedures were not effective.

A
material weakness is a deficiency, or a combination of deficiencies, in internal control over financial reporting, such that there is a reasonable possibility that a material
misstatement of the company's annual or interim financial statements will not be prevented or detected on a timely basis.

47

---



Table of Contents

Our
management has identified the following material weakness in our internal control over financial reporting:

We
did not establish and/or maintain effective controls over the process to identify transactions with the potential to establish a new Medicaid best price which affected the accuracy of
the net revenue and product sales allowances and reserve accounts. Specifically, our controls over the calculation of Medicaid rebates were not designed to effectively monitor whether certain entities
were appropriately exempt from the Medicaid best price calculation. This control deficiency resulted in the restatement of our consolidated financial statements for the years ended December 31,
2006 and 2005 and each quarter in 2006 and the first three quarters of 2007. Additionally, this control deficiency, if not addressed, could result in misstatements of Medicaid rebate liability and
corresponding revenues that would result in a material misstatement of the consolidated financial statements that would not be prevented or detected.

In
light of the material weakness referred to above, we performed additional analyses and procedures in order to conclude that our condensed consolidated financial statements included in
this quarterly report on Form 10-Q are fairly presented, in all material respects, in accordance with generally accepted accounting principles in the United States.

Changes in Internal Control Over Financial Reporting

There has been no change in our internal control over financial reporting during our quarter ended June 30, 2008 that has
materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

Remediation Plan

The material weakness noted above was identified by year end 2007. During the first and second quarters of 2008, we have engaged in
substantial efforts to address this material weakness and will continue to do so throughout 2008. All of these efforts were commenced in either the first or second quarter of 2008 or will be commenced
in the third quarter of 2008 and
concluded thereafter in a timely fashion as early in 2008 as is reasonably possible. Our ongoing improvements to the internal controls designed to address this material weakness will include the
following, which will be undertaken with the assistance of qualified outside legal counsel:

I)     Measures
are and will continue to be taken to identify the cause of the material weakness in internal controls over financial reporting, through the following
procedures:



48

---



Table of Contents



II)   The
following remediation efforts were and will continue to be implemented by management to remediate the material weakness of internal control over financial
reporting:



We
anticipate that these remediation actions represent ongoing improvement measures and we expect that they will be fully implemented by year end 2008. Although we have devoted, and
intend to continue to devote, significant resources to remediating the material weakness, the effectiveness of our remediation efforts will not be known until management next performs its test of
internal controls.

49

---





Table of Contents

PART II        OTHER INFORMATION

ITEM 1.    LEGAL PROCEEDINGS

Litigation Related to Generic Competition and Patent Infringement

Patent litigation involves complex legal and factual questions. We can provide no assurance concerning the outcome or the duration of
any patent related lawsuits. If we, third parties from whom we receive royalties, or third parties from whom we have licensed products or received other rights to commercialize products, are not
successful in enforcing our respective patents, the companies seeking to market generic versions of our marketed drugs and the drugs of our licensees will not be excluded, for the full term of the
respective patents, from marketing their generic versions of our marketed products or third party products for which we have licensed rights to our patents. Introduction of generic copies of any of
our marketed products or third party products for which we have licensed rights to our patents before the expiration of our patents would have a material adverse effect on our business, financial
condition and results of operations.



In September 2005, we received notification that the FDA had received an ANDA from Breath, seeking approval of a generic version of our
1.25 mg/3 mL, 0.63 mg/3 mL and 0.31 mg/3 mL XOPENEX Inhalation Solution. Breath's submission includes a Paragraph IV certification alleging that our patents listed in the FDA publication
entitledApproved Drug Products With Therapeutic Equivalence Evaluations, commonly referred to as the "Orange Book," for these three dosages of XOPENEX
Inhalation Solution are invalid, unenforceable or not infringed by the generic version for which Breath is seeking approval. In October 2005, we filed a civil action against Breath for patent
infringement in the United States District Court for the District of Massachusetts, No. CV:06-10043.

In
April 2008, we entered into a settlement and license agreement with Breath to resolve this litigation. The agreement permits Breath to sell its generic versions of these XOPENEX
Inhalation Solution products in the United States under the terms of an exclusive 180-day license commencing on August 20, 2012 and a non-exclusive license thereafter.
Upon launch, Breath would pay us a double-digit royalty on gross profits generated from the sales of generic versions of these XOPENEX Inhalation Solution products. Under the agreement, Breath agrees
not to sell any of the products covered by our patents that are the subject of the license before the date on which the license commences. On May 1, 2008, the parties submitted to the court an
agreed order of dismissal without prejudice, which the court approved. The litigation is now concluded.

In
April 2008, we also entered into a supply agreement with Breath whereby, effective August 20, 2012, we will exclusively supply levalbuterol products (1.25 mg/3 mL, 0.63 mg/3 mL
and 0.31 mg/3 mL)to Breath, under our NDA for a period of 180 days, which we refer to as the Initial Term, and on a non-exclusive
basis for two and one-half years thereafter. In addition to
the royalties described above, Breath will pay us on a cost plus margin basis for supply of these levalbuterol products. The supply agreement contains provisions regarding termination for cause and
convenience, including either party's right to terminate the agreement at any time after the Initial Term upon nine months written notice. Both the exclusive license under the settlement and license
agreement and the exclusive supply obligations under the supply agreement could become effective prior to August 20, 2012 if a third party launches a generic version of those dosages of XOPENEX
Inhalation Solution or if the parties otherwise mutually agree.

On
May 9, 2008, we provided to the Federal Trade Commission and Department of Justice Antitrust Division the notifications of the settlement with Breath as required under
Section 1112(a) of the Medicare Prescription Drug, Improvement and Modernization Act of 2003, or MMA. The

50

---



Table of Contents

settlement
with Breath and the other agreements with Breath and its affiliates, including the supply agreement, the agreement for the acquisition of Oryx and license agreements with Arrow, may be
reviewed by antitrust enforcement agencies, such as the Federal Trade Commission and Department of Justice Antitrust Division. There can be no assurances that governmental authorities will not seek to
challenge the settlement with Breath or that a competitor, customer or other third party will not initiate a private action under antitrust or other laws challenging the settlement with Breath. We may
not prevail in any such challenges or litigation and, in any event, may incur significant costs in the event of an investigation or in defending any action under antitrust laws.

In
January 2006, we received notification that the FDA had received an ANDA from Dey, L.P., seeking approval of a generic version of our 1.25 mg/3 mL, 0.63 mg/3 mL, and 0.31 mg/3
mL XOPENEX Inhalation Solution. Dey, L.P.'s submission includes a Paragraph IV certification alleging that our patents listed in the Orange Book for these three dosages of XOPENEX
Inhalation Solution are invalid, unenforceable, or not infringed by the generic version for which Dey, L.P. is seeking approval. In February 2006, we filed a civil action against
Dey, L.P. for patent infringement and the case is pending in the United States District Court for the District of Delaware, C.A. No. 06-113.

In
August 2006, we received notification that the FDA had received an ANDA from Dey, L.P. seeking approval of a generic version of our 1.25 mg/0.5 mL XOPENEX Inhalation Solution
concentrate. Dey, L.P.'s submission includes a Paragraph IV certification alleging that our patents listed in the Orange Book for 1.25 mg/0.5 mL XOPENEX Inhalation Solution concentrate
are invalid, unenforceable, or not infringed by the generic version for which Dey, L.P. is seeking approval. In September 2006, we filed a civil action against Dey, L.P. for patent
infringement in the United States District Court for the District of Delaware, C.A. No. 06-604. In September 2006, both civil actions we filed against Dey, L.P. were
consolidated into a single suit.

In
May 2007, we received notification that the FDA had received an ANDA from Barr Laboratories, Inc., or Barr, seeking approval of a generic version of our 1.25 mg/3 mL, 0.63 mg/3
mL and 0.31 mg/3 mL XOPENEX Inhalation Solution. Barr's submission includes a Paragraph IV certification alleging that our patents listed in the Orange Book for these three dosages of XOPENEX
Inhalation Solution are invalid, unenforceable or not infringed by the generic version for which Barr is seeking approval. In July 2007, we filed a civil action against Barr for patent infringement
and the case is pending in the United States District Court for the District of Delaware, C.A. No. 07-438.

In
March 2008, the trial judge consolidated the Dey L.P. and Barr cases for all purposes, including discovery and trial. The court held a Markman hearing on July 18, 2008,
to address the parties' disputed issues of patent claim interpretation. The court has not yet issued its decision regarding the disputed issues of patent claim interpretation nor has it formally set a
trial date.

In
June 2008, Dey L.P. filed a Complaint against us in the United States District Court for the District of Delaware, C.A. 08-372. The Complaint is a declaratory
judgment action in which Dey L.P. seeks a declaration of non-infringement and invalidity of United States Patent 6,451,289 owned by us. Dey L.P. had previously sent us notice
that its ANDA contained a Paragraph IV certification against the 6,451,289 patent, and we did not commence litigation in response.

The
filing of an action for patent infringement under the Drug Price Competition and Patent Term Restoration Act of 1984, also known as the "Hatch-Waxman Act" results in an automatic
30-month stay of the FDA's authority to grant final marketing approval to those companies that filed an ANDA containing a Paragraph IV certification against one or more of our
XOPENEX Inhalation Solution patents. The first filer of an ANDA with a Paragraph IV certification is potentially entitled to a 180 day period of semi-exclusivity during which
the FDA cannot approve subsequently filed ANDAs. The 180 day semi-exclusivity period would begin to run only upon first commercial marketing by the first filer. There are, however,
also certain events that could cause the first filer to forfeit the 180 day semi-exclusivity period, which we refer to as a forfeiture event.

51

---



Table of Contents

For
our 1.25 mg/3 mL, 0.63 mg/3 mL, and 0.31 mg/3 mL dosages of XOPENEX Inhalation Solution, we believe that Breath is the sole first filer and potentially entitled to 180 days of
semi-exclusivity against subsequent ANDA filers for those three dosages. The 30-month stay against Breath's ANDA expired on March 7, 2008. On April 9, 2008, the
FDA granted final approval to Breath's ANDA for all three dosages. However, if a forfeiture event occurs and the FDA determines that Breath has forfeited the 180 day
semi-exclusivity period for those three dosages, other ANDA filers who have been granted final approval by the FDA could commence an "at risk" launch upon expiration of the
30-month stay. For those three dosages, the 30-month stay against Dey, L.P. expired on July 9, 2008 and the 30-month stay against Barr expires on or
about November 30, 2009.

For
our 1.25 mg/0.5 mL XOPENEX Inhalation Solution concentrate, we believe that Dey, L.P. is the sole first filer and potentially entitled to 180 days of
semi-exclusivity for that concentration. The 30-month stay against Dey, L.P.'s ANDA for that concentration expires on or about February 14, 2009.

Although
we could seek recovery of any damages sustained in connection with any activities conducted by a party that infringe a valid and enforceable claim in our patents, whether we are
ultimately entitled to such damages would be determined by the court in connection with our ongoing legal proceedings with each party desiring to launch generic levalbuterol hydrochloride products. If
any of these parties were to commence selling a generic alternative to our XOPENEX Inhalation Solution product prior to the resolution of these ongoing legal proceedings, or there is a court
determination that the products these companies wish to market do not infringe our patents, or that our patents are invalid or unenforceable, it would have a material adverse effect on our business,
financial condition and results of operations. In addition, our previously issued guidance regarding our projected financial results may no longer be accurate, and we would have to revise such
guidance.



Certain of Schering-Plough's CLARINEX products for which we receive sales royalties are currently the subject of patent infringement
litigation. Since June 2007, the FDA has received ANDAs relating to various dosage forms of CLARINEX from ten different generic pharmaceutical companies. These ANDA submissions include
Paragraph IV certifications alleging that our patents, which Schering-Plough (as exclusive licensee of such patents) listed in the Orange Book for these products, are invalid, unenforceable or
not infringed by the submitter's proposed product. We and the University of Massachusetts, co-owners of certain patents listed in the Orange Book, filed civil actions against these parties
for patent infringement in the United States District Court for the District of New Jersey. In April 2008, the trial judge consolidated these cases for all purposes including discovery and trial. The
court has not set a trial date. We believe that all of these ANDAs are subject to a statutory stay of approval until at least December 21, 2009 based on previous litigation commenced by
Schering-Plough against these parties in separate civil actions involving another patent.

In
March 2008, we entered into a consent agreement with Glenmark Pharmaceuticals, Inc., or Glenmark, one of the ten generic pharmaceutical companies that filed a
Paragraph IV certification against or patents, whereby Glenmark agreed not to pursue its case and to not market CLARINEX 5mg tablets until the expiration of our patents listed by
Schering-Plough in the Orange Book or until these patents are found invalid or unenforceable.



Beginning in February 2008, we and UCB, S.A., or UCB, received notices from Synthon Pharmaceuticals, Inc., or Synthon,
Sun Pharmaceutical Industries Limited of Andheri (East), or Sun, Sandoz Inc., or Sandoz and Pliva Hrvatska D.O.O., or Pliva, that each has filed an ANDA seeking approval to market a generic
version of XYZAL 5 mg tablets, and that each ANDA contained a Paragraph IV certification alleging that United States Patent 5,698,558, owned by us and exclusively

52

---



Table of Contents

licensed
to UCB, is invalid, unenforceable or not infringed. Beginning in April 2008, UCB filed in its name and on our behalf civil actions in the United States District Court for the Eastern District
of North Carolina against Synthon, Sun Sandoz, Pliva and Barr (Pliva's agent), an action against Synthon in the United States District Court for the District of Delaware, and an action against Sun and
Pliva/Barr in the United States District Court for the District of New Jersey. The action in Delaware has been voluntarily dismissed. We believe that all of these ANDAs are subject to a
30-month statutory stay of approval, the earliest of which, against Synthon, is scheduled to expire on or about August 29, 2010.

BROVANA Patent Infringement Claim

In April 2007, we were served with a Complaint filed in the United States District Court for the Southern District of New York, C.A.
No. 1:07-cv-2353, by Dey, L.P. and Dey, Inc., referred to collectively as Dey, alleging that manufacture and sale of BROVANA infringes or will induce
infringement of a single United States patent for which Dey owns all rights, title and interest. In April 2007, we filed an Answer and Counterclaims to this Complaint seeking to invalidate the
originally asserted patent and a second related patent. In May 2007, Dey filed a reply asserting infringement of the second patent. Under the current trial scheduling order, trial will begin no
earlier than January 12, 2009. It is too early to make a reasonable assessment as to the likely outcome or impact of this litigation. We are unable to reasonably estimate any possible range of
loss or liability related to this lawsuit due to its uncertain resolution.

In
March 2008, United States Patent 7,348,362, or '362 patent, entitled "Bronchodilationb-agonist compositions and Methods" issued and
Dey, L.P. is the assignee of the patent. In May 2008, we filed a Motion to Amend our Answer and Counterclaims to seek declaratory judgment that the '362 patent is invalid and unenforceable and
to add Mylan Inc. as a party. Dey has opposed this motion and we await a decision from the court.

XOPENEX Inhalation Solution LCA Matter

In March 2006, the parties responsible for administrating the Medicare Part B prescription drug benefit for respiratory products
on behalf of CMS, which we refer to collectively as the Medicare Administration Subcontractors, announced their intention to implement a Least Costly Alternative, or LCA, reimbursement action for
XOPENEX Inhalation Solution. If implemented, the LCA would reduce the Medicare Part B reimbursement paid for XOPENEX Inhalation Solution to the level of generic racemic albuterol. As a result,
we would be unable to discount XOPENEX Inhalation Solution in the Medicare market, and we do not believe that providers would continue to dispense XOPENEX Inhalation Solution to Medicare Part B
beneficiaries at this payment rate.

The
LCA announced in March 2006 was subsequently stayed by the Medicare Administration Subcontractors pending a National Coverage Analysis by CMS. CMS ultimately deferred to the Medicare
Administration Subcontractors the determination as to the criteria for when XOPENEX Inhalation Solution would be appropriate for use by the Medicare population. On April 10, 2008, the Medicare
Administration Subcontractors announced their intention to implement the previously announced LCA, effective July 1, 2008.

53

---





Table of Contents

In June 2008, a preliminary injunction motion seeking to block the implementation of the LCA policy in advance of its July 1, 2008 effective date was filed
in the District Court for the District of Columbia against certain of the Medicare Administration Subcontractors, among others, by four Medicare beneficiaries utilizing XOPENEX Inhalation Solution.
These Medicare beneficiaries, who rely on XOPENEX Inhalation Solution to treat their medical conditions, stated in the motion that they would be denied access to this drug if the LCA was implemented
and as a result would suffer irreparable injury. Shortly following the filing of the motion, the Medicare Administration Subcontractors announced they would suspend the LCA and not reinstate it at any
time prior to December 31, 2008. The Medicare Administration Subcontractors further agreed that they would provide a public notice and comment period, which is typically 90 days, should
they decide to reinstate the LCA. As a result of the LCA suspension, the court denied the Medicare beneficiaries' preliminary injunction motion. CMS filed a motion to dismiss the Medicare beneficiary
lawsuit on the grounds that the case is moot as no LCA is in effect or pending. If the court denies this motion the permanent injunction case will proceed and be heard on its merits. Otherwise, the
beneficiaries will not have a cause of action unless and until the LCA is reinstated by CMS.

Both
Sepracor and the Medicare beneficiaries believe that the LCA action by the Medicare Administration Subcontractors is outside the scope of their authority and is contrary to the
express intent of Congress which has been enumerated in statutes, such as the MMA, and establishes the method that CMS and the Medicare Administration Subcontractors must use to determine the payment
rate for Medicare Part B inhalation drugs such as XOPENEX Inhalation Solution that are administered through durable medical equipment. Although we are not a named party to the litigation, our
interest in the outcome is aligned with that of the Medicare beneficiaries. Accordingly, we have, and if the case
proceeds, plan to continue to provide funding in support of the litigation and assistance to legal counsel for the Medicare beneficiaries.

Class Action Litigation Settlement

In June 2007, we filed in the United States District Court for the District of Massachusetts, or the Court, a Stipulation of Settlement
regarding two securities class action lawsuits, or class actions, then pending in the Court naming Sepracor and certain of our current and former officers and one director as defendants. The class
actions, which were filed on behalf of certain purchasers of our equity and debt securities, or the plaintiffs, alleged that the defendants violated the Federal securities laws by making false and
misleading statements relating to the testing, safety and likelihood of approval of tecastemizole by the FDA. Under the terms of the Stipulation of Settlement, in June 2007 we paid into escrow
$52.5 million in settlement of the class actions and, in July 2007, received an $18.5 million reimbursement from our insurance carriers. We recorded the litigation settlement expense of
$34.0 million, relating to this matter, during the quarter ended March 31, 2007. In September 2007, the Court granted final approval of the Stipulation of Settlement and entered a final
judgment consistent with the Stipulation of Settlement. The settlement is now final and the total settlement amount has been released from escrow.

Other Legal Proceedings

We have been named as a defendant in a lawsuit filed in the United States District Court for the Middle District of Florida (Sharp, et
al., filed July 17, 2008) claiming that our pharmaceutical sales representatives should have been categorized as "non-exempt" rather than "exempt" employees, and claiming that we
owe damages, overtime wages, interest, costs and attorneys' fees for up to the four-year period preceding the filing of the action. Other companies in the pharmaceutical industry face substantially
similar lawsuits. Based upon the facts as presently known, we do not believe that it is likely that the collective action will result in liability which would be material to our financial position. We
believe this lawsuit is without merit and are prepared to defend against it vigorously.

From
time to time we are party to other legal proceedings in the course of our business. We do not, however, expect such other legal proceedings to have a material adverse effect on our
business, financial condition or results of operations.

54

---



Table of Contents

ITEM 1A.    RISK FACTORS

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

Risks Related to Our Financial Results and Our Common Stock

We have a history of net losses and we may not be able to generate revenues sufficient to achieve and maintain profitability on a quarterly and annual basis.

Until the year ended December 31, 2006, we had incurred net losses each year since our inception. It is possible we will not be
able to achieve profitability again or maintain profitability on a quarterly or annual basis. We expect to continue to incur significant operating expenditures to further develop and commercialize our
products and product candidates and in order to allow us to otherwise expand our product portfolio through drug discovery and business development efforts. As a result, we will need to generate
significant revenues in future periods to achieve and maintain profitability. We cannot provide assurance that we will be able to maintain profitability for any substantial period of time. If revenues
grow more slowly than we anticipate or if operating expenses exceed our expectations or cannot be adjusted accordingly, our business, results of operations and financial condition will be materially
and adversely affected. In addition, if we are unable to achieve or maintain profitability on a quarterly or annual basis, the market price of our common stock may decline.

Almost all of our revenues are derived from sales of LUNESTA and XOPENEX Inhalation Solution, and our future success depends on the continued commercial success of these
products as well as our other products.

Approximately 86% of our total revenues for the six months ended June 30, 2008 and approximately 89% of our total revenues for
the year ended December 31, 2007 resulted from sales of LUNESTA and XOPENEX Inhalation Solution, and we expect that sales from these two products will continue to represent a significant
majority of our revenues for the coming year. However, unit sales for both LUNESTA and XOPENEX have decreased during the first half of 2008 and may continue to decrease. As a result of the
introduction of zolpidem tartrate, the generic equivalent to AMBIEN, and other competitive products being marketed or developed by others, LUNESTA's market share and unit sales may continue to
decrease. In addition to the decrease in XOPENEX Inhalation Solution unit sales, revenues from the sale of XOPENEX Inhalation Solution have been, and we expect will continue to be, adversely affected
on a comparable basis as a result of changes in the Medicare Part B reimbursement rate. Moreover, the growth of the overall non-generic pharmaceutical market, which includes branded
drugs such as LUNESTA and XOPENEX Inhalation Solution, has been declining, and may continue to decline, as a result of economic conditions and managed care trends. If sales of LUNESTA do not increase
and if sales of XOPENEX Inhalation Solution in other markets do not offset the reduction in revenues resulting from the changes in Medicare Part B reimbursement for the product, we may not have
sufficient revenues to achieve our business plan or repay our outstanding debt, and our business will not be successful.

We
do not have long-term sales contracts with our customers, and we rely primarily on purchase orders for sales of LUNESTA, XOPENEX Inhalation Solution and our other marketed
products. Reductions, delays or cancellations of orders for LUNESTA, XOPENEX Inhalation Solution or our other marketed products could adversely affect our operating results. Any other adverse
developments with respect to the sale of LUNESTA or XOPENEX Inhalation Solution could significantly reduce

55

---



Table of Contents

revenues
and have a material adverse effect on our ability to maintain profitability and achieve our business plan.

We
cannot be certain that we will be able to continue to successfully commercialize LUNESTA and/or XOPENEX Inhalation Solution, that we will be able to successfully commercialize
BROVANA, XOPENEX HFA, OMNARIS Nasal Spray or launch ALVESCO HFA Inhalation Aerosol, or that any of our products will be accepted in their markets. Specifically, the following factors, among others,
could affect the level of success and market acceptance of our products:



In
addition, a number of the patents we own and/or license to third parties and for which we receive sales revenue or royalties are the subject of patent invalidation or revocation
claims by companies seeking to introduce generic equivalents of the products covered by such patents. We can provide no assurance concerning the outcome or the duration of any patent related lawsuits.
If we, or third parties from whom we receive royalties, are not successful in enforcing our respective patents, the companies seeking to market generic versions will not be excluded from marketing
their generic versions of these products. Introduction of generic copies of any of these products before the expiration of our patents or the patents of our licensees could have a material adverse
effect on our business.

Sales of XOPENEX Inhalation Solution have been adversely affected as a result of the changes in the Medicare Part B reimbursement rate, and if our strategy for
responding to such changes is not successful, our revenue will be further adversely affected.

In May 2007, CMS announced that based on its interpretation of the statutory language of the MMA, it was required to discontinue the
stand-alone reimbursement for XOPENEX Inhalation Solution and generic albuterol, which had been in place since January 2005, and instead calculate the reimbursement for XOPENEX Inhalation Solution and
generic albuterol based on the blended weighted average selling price, or ASP, for the two products. This new reimbursement became effective on July 1, 2007. Using a blended weighted ASP for
XOPENEX Inhalation Solution results in reimbursement for the product that is considerably lower than the published selling price for the product in the wholesaler distribution channel. The new
reimbursement rate is subject to change quarterly based upon the respective contribution of commercial sales of XOPENEX Inhalation Solution

56

---



Table of Contents

and
generic albuterol to the quarterly blended weighted ASP calculation. This quarterly ASP calculation is mandated by the MMA. Revenues from the sale of XOPENEX Inhalation Solution have been, and we
expect will continue to be, adversely affected on a comparable basis as a result of this change.

On
December 29, 2007, President Bush signed into law legislation, the effect of which is two-fold with respect to XOPENEX Inhalation Solution. First, the legislation
mandates that XOPENEX Inhalation Solution and generic albuterol be reimbursed at the lower of their stand-alone weighted ASP and the blended weighted ASP for XOPENEX Inhalation Solution and generic
albuterol. Since the bundling action described above resulted in an unintended increase in Medicare
Part B reimbursement for generic albuterol, significantly higher than the product's ASP (as publicly reported by the Medicare Part B program), the legislation eliminated the potential
for inappropriate reimbursement incentives to influence the dispensing decisions of providers. Second, the legislation passed by Congress, and signed into law by President Bush, included a change in
the methodology CMS uses to calculate quarterly ASP. This change has resulted in further downward pressure on the Medicare Part B reimbursement for XOPENEX Inhalation Solution, particularly
when applied to the blended albuterol/XOPENEX Inhalation Solution ASP calculation.

We
estimate that as much as 20% of our XOPENEX Inhalation Solution units sold are subject to reimbursement under Medicare Part B. We have been actively contracting with home
health care and retail pharmacy providers in an effort to ensure the continued availability of XOPENEX Inhalation Solution to Medicare Part B beneficiaries with reversible obstructive airway
disease. If the contracting strategy for XOPENEX Inhalation Solution is not successful in maintaining as much of the current unit sales levels for the product in Medicare as commercially possible, if
the blended Medicare Part B reimbursement rate for XOPENEX Inhalation Solution and generic albuterol falls to an amount where it is no longer financially feasible to market XOPENEX Inhalation
Solution to Medicare Part B participants and/or if the parties responsible for administrating the Medicare Part B prescription drug benefit for respiratory products on behalf of CMS,
which we refer to collectively as the Medicare Administration Subcontractors, impose restrictive coverage policies on, or take action intended to further reduce the payment level for XOPENEX
Inhalation Solution, revenue from sales of XOPENEX Inhalation Solution will be adversely affected and our financial condition and results from operations will be impaired.

In
March 2006, the Medicare Administration Subcontractors announced their intention to implement an LCA reimbursement action for XOPENEX Inhalation Solution. If implemented, the LCA
would reduce the Medicare Part B reimbursement paid for XOPENEX Inhalation Solution to the level of generic racemic albuterol. As a result, we would be unable to discount XOPENEX Inhalation
Solution in the Medicare market, and we do not believe that providers will continue to dispense XOPENEX Inhalation Solution to Medicare Part B beneficiaries at this payment rate.

The
LCA announced in March 2006 was subsequently stayed by the Medicare Administration Subcontractors pending a National Coverage Analysis by CMS. CMS ultimately deferred to the Medicare
Administration Subcontractors the determination as to the criteria for when XOPENEX Inhalation Solution would be appropriate for use by the Medicare population. On April 10, 2008, the Medicare
Administration Subcontractors announced their intention to implement the previously announced LCA, effective July 1, 2008.

57

---



Table of Contents

In June 2008, a preliminary injunction motion seeking to block the implementation of the LCA policy in advance of its July 1, 2008 effective date was filed
in the District Court for the District of Columbia against certain of the Medicare Administration Subcontractors, among others, by four Medicare beneficiaries utilizing XOPENEX Inhalation Solution.
These Medicare beneficiaries, who rely on XOPENEX Inhalation Solution to treat their medical conditions, stated in the motion that they would be denied access to this drug if the LCA was implemented
and as a result would suffer irreparable injury. Shortly following the filing of the motion, the Medicare Administration Subcontractors announced they would suspend the LCA and not reinstate it at any
time prior to December 31, 2008. The Medicare Administration Subcontractors further agreed that they would provide a public notice and comment period, which is typically 90 days, should
they decide to reinstate the LCA. As a result of the LCA suspension, the court denied the Medicare beneficiaries' preliminary injunction motion. CMS filed a motion to dismiss the Medicare beneficiary
lawsuit on the grounds that the case is moot as no LCA is in effect or pending. If the court denies this motion the permanent injunction case will proceed and be heard on its merits. Otherwise, the
beneficiaries will not have a cause of action unless and until the LCA is reinstated by CMS.

Both
Sepracor and the Medicare beneficiaries believe that the LCA action by the Medicare Administration Subcontractors is outside the scope of their authority and is contrary to the
express intent of Congress which has been enumerated in statutes, such as the MMA, and establishes the method that CMS and the Medicare Administration Subcontractors must use to determine the payment
rate for Medicare Part B inhalation drugs such as XOPENEX Inhalation Solution that are administered through durable medical equipment. Although we are not a named party to the litigation, our
interest in the outcome is aligned with that of the Medicare beneficiaries. Accordingly, we plan to provide funding in support of the litigation and assistance to legal counsel for the Medicare
beneficiaries.

We have significant debt and we may not be able to make principal payments when due.

As of June 30, 2008, our total debt was approximately $720.8 million. None of our 0% Series A notes due December
2008, our 0% Series B notes due December 2010 nor our 0% notes due October 2024 restricts us or our subsidiaries' ability to incur additional 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 B notes due 2010. Additional indebtedness that we incur may in certain circumstances rank senior to
or on parity with this debt. Our ability to satisfy our obligations will depend upon our future performance, which is subject to many factors, including factors beyond our control. The conversion
prices for the 0% Series A notes due 2008 and 0% Series B notes due 2010 are $31.89 and $29.84, respectively. In December 2008, $72.8 million will be due on our 0% Series A
notes. On July 31, 2008, the closing sale price of our common stock was $17.48. If the market price for our common stock does not exceed the conversion price, the holders of our outstanding
convertible debt may decide not to convert their securities into common stock. For example, the holders of our 5% debentures did not convert such debentures into common stock, and on
February 15, 2007, the maturity date for the 5% debentures, we repaid in cash the entire principal amount of $440.0 million, plus $11.0 million of accrued interest. Our 0% notes
due 2024 are convertible into cash and, if applicable, shares of our common stock at a conversion price of approximately $67.20, at the option of the holders in October 2009, 2014, 2019 and 2024, as
well as under certain circumstances. We may not be able to make the required cash payments upon maturity of 0% Series B notes due 2010 or upon conversion of the 0% notes due 2024.

Historically,
we have had negative cash flow from operations, and in 2006, we experienced our first full year of positive cash flow from operating activities. Unless we have sufficient
cash or are able to generate sufficient operating cash flow to pay off the principal of our outstanding debt, we will be required to raise additional funds or default on our obligations under the
debentures and notes. If revenue generated from sales of our products do not meet expected levels, it is unlikely that we would have sufficient cash flow to repay our outstanding convertible debt
and/or make cash payments upon

58

---



Table of Contents

maturity
of the 0% Series B notes due 2010 or upon conversion of the 0% notes due 2024. There can be no assurance that, if required, we would be able to raise the additional funds on favorable
terms, if at all.

If we exchange debt for shares of common stock, there will be additional dilution to holders of our common stock.

As of June 30, 2008, we had approximately $220.8 million of outstanding debt that could be converted into common stock
and $500.0 million that could be converted into cash. In order to reduce future payments due at maturity, we may, from time to time, depending on market conditions, repurchase additional outstanding
convertible debt for cash; exchange debt for shares of our common stock, warrants, preferred stock, debt or other consideration; or a combination of any of the foregoing. The amounts involved in any
such transactions, individually or in the aggregate, could be material. If we exchange shares of our capital stock, or securities convertible into or exercisable for our capital stock, for outstanding
convertible debt or use proceeds from the issuance of convertible debt to fund redemption of outstanding convertible debt with a higher conversion ratio, the number of shares that we might issue as a
result of such exchanges would significantly exceed the number of shares originally issuable upon conversion of such debt and, accordingly, such exchanges would result in material dilution to holders
of our common stock. Repurchase of the notes could also adversely affect the trading market for such notes if the public float in such notes is materially reduced. We cannot provide assurance that we
will repurchase or exchange any additional outstanding convertible debt.

We have identified a material weakness in our internal control over financial reporting that could adversely affect our ability to meet reporting obligations and negatively
affect the trading price of our stock.

A material weakness is a deficiency, or a combination of deficiencies, in internal control over financial reporting, such that there is
a reasonable possibility that a material misstatement of the company's annual or interim financial statements will not be prevented or detected on a timely basis. Accordingly, a material weakness
increases the risk that the financial information we report contains material errors. As more fully described in Item 4 of this quarterly report on Form 10-Q, Controls and
Procedures, we have determined that we did not establish and/or maintain effective controls over the process to identify transactions with the potential to establish a new Medicaid best price, which
affected the accuracy of the net revenue and product sales allowance and return accounts. Specifically, our controls over the calculation of Medicaid rebates were not designed to effectively monitor
whether certain entities were appropriately exempt from the Medicaid best price calculation. Our management has determined that this control deficiency constitutes a material weakness, which resulted
in the restatement of our consolidated financial statements as of and for the years ended December 31, 2006 and 2005 and selected financial data as of and for the years ended
December 31, 2006, 2005, 2004 and 2003, as set forth in our Form 10-K filed on February 29, 2008, and the restatement of our unaudited quarterly information for the
fiscal quarters ended March 31, June 30 and September 30, 2007 and 2006, as set forth in our amended and restated quarterly reports for these periods filed on
Form 10-Q/A on May 7, 2008.

While
we have taken, and will continue to take, steps to remediate the identified material weakness, these steps may not be adequate to fully remediate the material weakness. In
addition, we may identify additional control deficiencies in the future that individually or in the aggregate constitute a material weakness. If we fail to adequately remediate the identified material
weakness or there are other undetected or uncorrected deficiencies in our internal controls, we could fail to meet our reporting obligations, we could have material misstatements in our financial
statements and, under certain circumstances, could be subject to legal liability. In addition, inferior controls could cause investors to lose confidence in our reported financial information, which
could have a negative effect on the trading price of our common stock.

59

---



Table of Contents

If the estimates we make, or the assumptions on which we rely, in preparing our financial statements prove inaccurate, our actual results may vary from those reflected in
our projections and accruals.

Our financial statements have been prepared in accordance with accounting principles generally accepted in the United States. The
preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of our assets, liabilities, net revenues and expenses, the amounts of charges
accrued by us and related disclosure of contingent assets and liabilities. We base our estimates on historical experience and on various other assumptions that we believe to be reasonable under the
circumstances. We cannot provide assurance, however, that our estimates, or the assumptions underlying them, will not be materially different from actual results. For example, our royalty revenue is
recognized based upon our estimates of our collaboration partners' sales during the period and, if these sales estimates are greater than the actual sales that occur during the period, our net income
would be reduced. In addition, we estimate product sales allowances, including payment term discounts, government and commercial rebates and returns and other discounts. If actual amounts differ from
these estimates, net income could be adversely affected. Each, in turn, could adversely affect our financial condition, results from operations and stock price.

If sufficient funds to finance our business are not available to us when needed or on acceptable terms, then we may be required to delay, scale back, eliminate or alter our
strategy for our programs.

We may require 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, sales and marketing capabilities. Historically, we have satisfied our funding needs through collaboration arrangements with
corporate partners, sales of products, and equity and debt financings. These funding sources may not be available to us when needed in the future, and, if available, they may not be on terms
acceptable to us. Insufficient funds could require us to delay, scale back, eliminate or alter certain of our research and product development programs and/or commercialization efforts or to enter
into license agreements with third parties to commercialize products or technologies that we would otherwise develop or commercialize ourselves. Our cash requirements may vary materially from those
now planned because of factors including:



60

---



Table of Contents



Our long-term investments include auction-rate securities that may not be accessible within the next 12 months and may experience a decline in
value, which may adversely affect our liquidity and income.

At June 30, 2008, $78.2 million of our investment portfolio was invested in AAA rated investments in
auction-rate securities. Auction-rate securities are long-term variable rate bonds tied to short-term interest rates. After the initial issuance of the
securities, the interest rate on the securities is reset periodically, at intervals established at the time of issuance (primarily every 28 days), based on market demand for a reset period.
Auction-rate securities are bought and sold in the marketplace through a competitive bidding process often referred to as an auction. If there is insufficient interest in the securities at
the time of an auction, the auction may not be completed and the rates may be reset to predetermined "penalty" or "maximum" rates.

Substantially
all of our auction-rate securities are backed by pools of student loans guaranteed by FFELP, and we continue to believe that the credit quality of these
securities is high based on this guarantee and other collateral. Auctions for these securities began failing in the first quarter of 2008 and continued to fail throughout the second quarter, which we
believe is a result of the recent uncertainties in the credit markets. Consequently, the investments are not currently liquid, and we will not be able to access these funds until a future auction of
these investments is successful, a buyer is found outside of the auction process, the security is called or the underlying securities have matured. At the time of our initial investment and through
the date of this report, all of our auction-rate securities remain AAA rated. We believe we have the ability to hold these investments until the lack of liquidity in these markets is
resolved. As a result, we continue to classify the entire balance of auction-rate securities as non-current available-for-sale investments at fair value
on our unaudited condensed consolidated balance sheet.

Typically,
the fair value of auction-rate securities investments approximates par value due to the frequent resets through the auction process. While we continue to earn
interest on our auction-rate securities investments at the contractual rate, these investments are not currently trading and therefore do not have a readily determinable market value.
Accordingly, the estimated fair value of the auction-rate securities no longer approximates par value.

At
June 30, 2008, because of the temporary declines in fair value for the auction-rate securities, which we attribute to liquidity matters rather than credit issues as
discussed above, we have classified our auction-rate securities at Level 3, as defined under SFAS 157 framework and described in Note 13,Fair
Value Measurements, of our condensed consolidated financial statements included in this quarterly report on Form 10-Q, with a fair value of
$78.2 million. The fair value of these auction-rate securities are estimated utilizing a trinomial discounted cash flow analysis, which was compared, when possible, to other
observable market data or inputs with similar characteristics. The assumptions used in preparing the discounted cash flow analysis include estimates for the maximum interest rate, the probability of
passing, failing or default at each auction, the severity of default and the discount rate. Based on this assessment of fair value, as of June 30, 2008, we determined there was a decline in
fair value of our auction-rate securities investments of $4.0 million, which we deem temporary. If current market conditions deteriorate further, we may be required to record
additional unrealized losses in other comprehensive income. If the credit ratings of the security issuers deteriorate, the anticipated recovery in market values does not occur, or we need funds from
the auction-rate securities to meet working capital needs, we may be required to adjust the carrying value of these investments through impairment charges recorded to earnings, as
appropriate, which could be material.

61

---



Table of Contents

Fluctuations in the demand for our products, the success and timing of clinical trials, regulatory approvals, product introductions, collaboration and licensing
arrangements, any termination of development efforts and other material events will cause fluctuations in our quarterly operating results, which could cause volatility in our stock price.

Our quarterly operating results are likely to fluctuate significantly, which could cause our stock price to be volatile. These
fluctuations will depend on many factors, including:



We have various mechanisms in place to discourage takeover attempts, which may reduce or eliminate our stockholders' ability to sell their shares for a premium in a change
of control transaction.

Various provisions of our certificate of incorporation and by-laws and of Delaware corporate law may discourage, delay or
prevent a change of control or takeover attempt of our company by a third party that is opposed by our management and board of directors. Public stockholders who might desire to participate in such a
transaction may not have the opportunity to do so. These anti-takeover

62

---



Table of Contents

provisions
could substantially impede the ability of public stockholders to benefit from a change of control or change in our management and board of directors. These provisions
include:



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

The price of our common stock historically has been volatile, which could cause the loss of part or all of an investment in Sepracor.

The market price of our common stock, like that of the common stock of many other pharmaceutical and biotechnology companies, has been
highly volatile. In addition, the stock market has experienced extreme price and volume fluctuations. The volatility and market prices of securities of many pharmaceutical and biotechnology companies
have been significantly affected for reasons frequently unrelated to or disproportionate to the operating performance of the specific companies. These broad market fluctuations may adversely affect
the market price of our common stock. Prices for our common stock are determined in the marketplace and may be influenced by many factors, including variations in our financial results and investors'
perceptions of us, and changes in recommendations by securities analysts as well as their perceptions of general economic, industry and market conditions.

Risks Related to Commercialization

We face intense competition and many of our competitors have greater resources and capabilities than we have.

We face intense competition in the sale of our current products, and expect to face intense competition in the sale of any future
products we sell. If we are unable to compete effectively, our financial condition and results of operations could be materially adversely affected because we may not achieve our product revenue
objectives and because we may use our financial resources to seek to differentiate ourselves from our competition. Large and small companies, academic institutions, governmental agencies and other
public and private organizations conduct research, seek patent protection, develop and acquire products, establish collaborative arrangements for product development and sell or license products in
competition with us. Many of our competitors and potential competitors have substantially greater resources, manufacturing and sales and marketing capabilities, research and development staff and
production facilities than we have. The fields in which we compete are subject to rapid and substantial technological change. Our competitors may be able to respond more quickly to new or emerging
technologies or to devote greater resources to the development, manufacture and

63

---



Table of Contents

marketing
of new products and/or technologies than we can. As a result, any products and/or technologies that we develop may become obsolete or noncompetitive before we can recover expenses incurred
in connection with their development.



For insomnia treatments, LUNESTA faces intense competition from established branded and generic products in several drug classes
including benzodiazepines, non-benzodiazepines, melatonin agonists, select antidepressants, and others. We estimate that our existing LUNESTA prescriptions account for less than 10% of the
total, annual prescriptions currently being written in the United States for insomnia pharmaceutical therapies. Furthermore, LUNESTA faces substantial competition from non-prescription,
over-the-counter and dietary supplement insomnia product options. During the first half of 2008, partially as a result of increasing competition, LUNESTA unit sales and market
share have been decreasing. We expect that LUNESTA will face increasing competition from a generic version of AMBIEN, which was introduced in April 2007, a generic version of AMBIEN CR®
(zolpidem tartrate extended release), which could be introduced as early as March 2009, and therapies in clinical development and under FDA review for the treatment of insomnia. We may also face
additional competition in the event of commercial introduction of a generic version of LUNESTA. To continue to be successful with LUNESTA, we must continue to demonstrate that LUNESTA's safety and
efficacy features are superior to those of competing branded and generic products, some of which may be less expensive than LUNESTA.



For asthma and COPD treatments, XOPENEX Inhalation Solution and XOPENEX HFA face intense competition from a variety of products.
Patients with asthma and COPD turn to numerous classes of drugs, including corticosteroids, long-acting beta-agonists, short-acting beta-agonists, leukotriene
modifiers, anticholingerics, and others, as well as certain combinations thereof. XOPENEX Inhalation Solution and XOPENEX HFA together account for approximately 3% of the total annual prescriptions
currently being written in the United States for asthma and COPD pharmaceutical therapies. XOPENEX Inhalation Solution and XOPENEX HFA also face intense competition specifically within the
beta-agonist classes of asthma and COPD treatments. We estimate that our existing XOPENEX prescriptions account for approximately 11% of the total annual prescriptions currently being
written in the United States for beta-agonist asthma and COPD pharmaceutical therapies.

Both
monotherapy and combination therapy beta-agonist treatments compete directly with our XOPENEX products for the treatment of asthma and COPD. Albuterol, a short-acting
beta-agonist, has been available generically for many years. Products containing albuterol as an active ingredient are well established and sell at prices substantially lower than XOPENEX
Inhalation Solution and XOPENEX HFA. XOPENEX HFA also faces direct competition from chlorofluorocarbon, or CFC, containing albuterol MDIs and branded HFA albuterol MDIs. With the phase-out
of CFC albuterol MDI products required by the end of December 2008, we expect that competition from branded HFA MDIs will increase substantially. Furthermore, as a consequence of the ongoing
commercialization of BROVANA, prescription levels for XOPENEX Inhalation Solution may be adversely affected to the extent that a significant number of physicians prescribe BROVANA, which could reduce
the need for concomitant XOPENEX products. We may also face additional competition in the event of the commercial introduction of generic versions of our XOPENEX products.

To
be successful with our XOPENEX products, we must demonstrate that the efficacy and safety features of these drugs outweigh the higher price as compared to generic albuterol and other
competing products and that these attributes differentiate these products from other asthma and COPD treatments, including beta-agonist asthma and COPD treatments.

64

---



Table of Contents



For COPD treatments solely, BROVANA faces competition from a variety of products. Competitive products include all products used in the
treatment of COPD. Patients with COPD turn to numerous classes of drugs including anticholingerics, corticosteroids, mukolytics, long-acting beta-agonists, short-acting
beta-agonists, theophyllines, and others to treat their condition. We estimate that our existing BROVANA prescriptions account for less than 1% of the total annual prescriptions currently
being written in the United States for COPD pharmaceutical therapies, and less than 1% of beta-agonist COPD pharmaceutical therapies specifically. Even though BROVANA is a nebulized
product, it also faces competition from long-acting beta-agonists and anticholinergics delivered by MDI and dry-powder inhaler. BROVANA also competes with
combination therapy products used for COPD. In the fourth quarter of 2007, PERFOROMIST (formoterol fumarate) Inhalation Solution, a direct competitor with BROVANA, was launched, which we
anticipate may impact adversely BROVANA's prescription levels. To be successful with BROVANA, we must demonstrate that patients with COPD will benefit by using BROVANA.



OMNARIS Nasal Spray, a corticosteroid nasal spray, competes with perennial and seasonal allergic rhinitis treatments, and faces
competition from oral antihistamines, intranasal antihistamines, intranasal decongestants, other intranasal corticosteroids, intranasal mast cell stabilizers, and antileukotrienes. To be successful
with OMNARIS Nasal Spray, we must demonstrate that OMNARIS Nasal Spray's safety and efficacy features are superior to those of competing branded and generic products, some of which may be less
expensive than OMNARIS Nasal Spray and may be available without a prescription. We may also face additional competition in the event of commercial introduction of a generic version of OMNARIS Nasal
Spray.



If and when commercialized, ALVESCO HFA Inhalation Aerosol, an inhaled corticosteroid in a MDI, will compete with other asthma
therapies, including asthma controller therapies, and face competition from leukotriene receptor antagonists, inhaled corticosteroid/long-acting beta-agonist combinations,
monotherapy long-acting beta-agonists and other monotherapy inhaled corticosteroids. In addition, several of the aforementioned categories will have generic product entries in
the future, which will likely result in competitive products that are less expensive than ALVESCO HFA Inhalation Aerosol. To be successful with ALVESCO HFA Inhalation Aerosol when commercialized, we
must
demonstrate that its safety and efficacy features are superior to that of competing branded products and, upon the entry of generic competition, these features outweigh the higher price compared to
such generic competition.

For
all of our products, we need to demonstrate to physicians, patients, and third party payors that the cost of our product is reasonable and appropriate in light of its safety,
efficacy, and health care benefits, each as compared to other competing products. The growth of the overall market for branded pharmaceutical products, such as ours, has been decreasing, and we expect
it will continue to decrease, due to increased generic competition, economic conditions and managed care trends. In addition, if competitors introduce new products or develop new processes or new
information about existing products, then our products, even those protected by patents, may be replaced in the marketplace or we may be required to lower our prices.

65

---



Table of Contents

We may be unable to successfully commercialize products for which we receive approval from the FDA or similar foreign agencies.

Commercialization of a product for which we have received an approval letter from the FDA or similar foreign agency could be delayed
for a number of reasons, some of which are outside of our control, including delays in delivery of the product due to importation regulations and/or problems with our distribution channels or delays
in the issuance of approvals from, or the completion of, required procedures by agencies other than the FDA, such as the United States Drug Enforcement Administration. In addition, commercialization
of approved products may be delayed by our failure to timely finalize distribution arrangements, manufacturing processes and arrangements, produce sufficient inventory and/or properly prepare our
sales force. If we are unable to successfully commercialize a product promptly after receipt of an approval letter, our business and financial position may be materially adversely affected due to
reduced revenue from product sales during the period or periods that commercialization is delayed and the shortening of any lead time to market we may have had over our competitors. In addition, the
exclusivity period, which is the time during which the FDA or similar foreign agency will prevent generic pharmaceutical companies from introducing a generic copy of the product, begins to run upon
approval and, therefore, to the extent we are unable to successfully commercialize a product promptly after receipt of an approval letter, our long-term product sales and revenues could be
adversely affected.

Even
if the FDA or similar foreign agencies grant us regulatory approval of a product, if we fail to comply with the applicable regulatory requirements, we may be forced to suspend
and/or cease commercialization of the product due to suspension or withdrawal of regulatory approvals, product recalls, seizures of products and/or operating restrictions and may be subject to fines
and criminal
prosecution. In any such event, our ability to successfully commercialize the product would be impaired and sales and revenues could be materially adversely affected.

We may increase or decrease the size of our sales force in the future based on factors such as inaccurate assumptions. Such increases may be done in anticipation of
approvals and/or expected sales growth that are not realized. If such approvals and/or growth are not realized, we will have incurred unnecessary expense and may also be forced to reduce our sales
force. Future reductions in our sales force could prevent us from achieving anticipated revenues and attracting and retaining qualified sales personnel and could negatively impact our financial
condition and results of operations.

We sell our products primarily through our direct sales force. During the fourth quarter of 2007, we reduced our direct sales force by
approximately 300 positions. We recently announced that we plan to increase our sales force capacity in order to accommodate the commercialization of OMNARIS Nasal Spray and ALVESCO HFA Inhalation
Aerosol. The costs of the increase in sales force capacity will offset the decrease in sales and marketing expenses we expected to realize as a result of the December 2007 sales force reduction. Any
future expansion of the direct sales force will also require us to incur significant expenses. To the extent we expand our direct sales force in anticipation of receiving marketing approval for
products under development, commercially introducing newly developed or acquired products and/or expected sales growth, we may again be forced to reduce our sales force if our expectations are not
realized. In addition, our recent sales force reduction, and any future sales force reduction, may make it more difficult for us to attract the qualified sales people necessary to implement necessary
sales force expansion, attract and retain qualified sales people necessary to maintain sales levels and/or to support potential sales growth and sales of additional products we may commercialize in
the future.

66

---



Table of Contents

We sell our products primarily through a direct sales force, and if we are not successful in attracting and retaining qualified sales personnel, we may not be successful in
commercializing our products.

We have established a sales force to market our products. Our ability to realize significant revenues from direct marketing and sales
activities depends on our ability to attract and retain qualified sales personnel. Competition for qualified sales personnel is intense. Our recent sales force reduction could harm our ability to
attract and retain qualified sales personnel, which would prevent us from successfully expanding our marketing and direct sales force on a timely or cost effective basis and from successfully
commercializing our newly acquired products. In addition, any failure to attract and retain qualified sales personnel in the future, could impair our ability to maintain sales levels, successfully
commercialize new products and/or support expected future sales growth. Our recent sales force reduction, and any future sales force reduction, could also result in temporary lack of focus and reduced
productivity among our sales personnel. If our sales organization does not devote the time and resources necessary to attain sales projections, we may not be able to achieve anticipated revenues and
our financial condition and operating results could be harmed.

We
recently announced that we planned to increase our sales force capacity in order to accommodate the commercialization of OMNARIS Nasal Spray and ALVESCO HFA Inhalation Aerosol. This
increase is being effectuated through the services of a contract sales organization. We may also need to
enter into additional co-promotion, contract sales force or other such arrangements with third parties, for example, where our own direct sales force is not large enough or sufficiently
well aligned to achieve maximum penetration in the market. We may not be successful in entering into any co-promotion, contract sales force or other such arrangements, and the terms of any
co-promotion, contract sales force or other such arrangements may not be favorable to us.

We may not be able to meet the unique operational, legal and financial challenges that we will encounter in our international operations, which may limit the growth of our
business.

Our success will depend in part on our ability to obtain approval for and market and sell our products in foreign markets. We undertake
these activities both on our own and in conjunction with strategic partners. Expanding sales of our products and operations internationally could impose substantial burdens on our resources, divert
management's attention from domestic operations and otherwise adversely affect our business. Furthermore, international operations are subject to several inherent risks
including:



67

---



Table of Contents



If
we are unable to meet and overcome these challenges, our international operations may not be successful, which would limit the growth of our business and could adversely impact our
results of operations.

If we, our collaboration partners or our third party manufacturers do not comply with current GMP regulations, then the FDA could refuse to approve marketing applications or
force us to recall or withdraw our marketed products.

The FDA and other regulatory authorities require that our products be manufactured according to their GMP regulations. The failure by
us, our collaborative partners or our third party manufacturers to comply with current GMP regulations could lead to delay in our development programs or refusal by the FDA or other regulatory
authorities to approve marketing applications. Following marketing approval of a product, failure in either respect could also impede commercial introduction or ongoing distribution of the product
and/or be the basis for action by the FDA or other regulatory authorities to withdraw approvals previously granted, to recall products and for other regulatory action.

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

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

Buying patterns of our wholesalers may vary from time to time, which could have a material impact on our financial condition, cash flows and results of operations.

Sales of our products to wholesalers represent a substantial portion of our total sales. Buying patterns of our wholesalers may vary
from time to time, in part as a result of pricing or seasonality. Wholesalers, or direct customers of wholesalers, may accumulate inventory in one quarter and limit product purchases in subsequent
quarters, which could have a material impact on our financial condition, cash flows and results of operations.

We
have entered into wholesaler fee-for-service agreements, or FFSAs, with our three largest customers and two smaller customers. Under the FFSAs, we pay the
wholesalers a fee to maintain certain minimum inventory levels. We believe it is beneficial to enter into FFSAs to establish specified levels of product inventory to be maintained by our wholesalers
and to obtain more precise information as to the level of our product inventory available throughout the product distribution channel. We record the cost associated with the FFSAs as revenue
deductions. We cannot be certain that the FFSAs will be effective in limiting speculative purchasing activity, that there will not be a future drawdown of inventory as a result of minimum inventory
requirements, or otherwise, or that the inventory level data provided through our FFSAs are accurate. If speculative purchasing does occur, if our wholesalers significantly decrease their inventory
levels, or if inventory level data provided through FFSAs is inaccurate, our business, financial condition, cash flows and results of operations may also be adversely affected.

68

---



Table of Contents

Risks Related to the Regulatory Environment

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

The FDA and similar foreign agencies must approve for commercialization in the relevant jurisdiction any pharmaceutical products
developed by us or our development partners. These agencies impose substantial requirements on drug manufacturing and marketing. Any unanticipated preclinical and clinical studies we or our
collaboration development partners are required to undertake, could result in a significant increase in the cost of advancing our products to commercialization. In addition, failure by us or our
collaborative development partners to obtain regulatory approval on a timely basis, or at all, or the attempt by us or our collaborative development partners to receive regulatory approval to achieve
labeling objectives, could prevent or adversely affect the timing of commercial introduction of, or our ability to market and sell, our products.

If we fail to successfully develop and receive regulatory approval for product candidates, we will be unable to commercialize the product candidates and future sales and
earnings growth will be substantially hampered.

Our ability to maintain profitability will depend in large part on successful development and commercialization of additional products.
Most of our product candidates are in the early stages of development. We cannot be assured that we will be able to develop or acquire and commercially introduce new products in a timely manner or
that new products, if developed or acquired, will be approved for the indications and/or with the labeling we expect, or that they will achieve market acceptance. Before we commercialize any other
product candidate in the United States, we will need to successfully develop the product candidate by completing successful clinical trials, submitting an NDA for the product candidate that is
accepted for filing by the FDA and receiving FDA approval to market the candidate. We must comply with similar requirements in foreign jurisdictions before commercializing any products in the
jurisdiction. If we fail to successfully develop a product candidate and/or the FDA or similar foreign agency delays or denies approval of any NDA, or foreign equivalent, that we have submitted or
submit in the future, then commercialization of our products under development may be delayed or terminated, which could have a material adverse effect on our business.

A
number of problems may arise during the development of our product candidates, including the following:



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

69

---



Table of Contents

In
addition, our growth is dependent on our continued ability to penetrate new markets where we have limited experience and competition is intense. We cannot be certain that the markets
we serve will grow in the future, that our existing and new products will meet the requirements of these markets, that our products will achieve customer acceptance in these markets, that competitors
or regulators will not force prices to an unacceptably low level or take market share from us, or that we can achieve or maintain profits in these markets.

Our sales depend on payment and reimbursement from third party payors, and a reduction in payment rate or reimbursement could result in decreased use or sales of our
products.

Sales of our products are dependent, in part, on the availability of reimbursement from third party payors such as Federal and state
government agencies under programs
such as Medicare and Medicaid, and private insurance plans. Third party payors continually attempt to contain or reduce the cost of health care by challenging the prices charged for medical products
and services. We may not be able to sell our products profitably if reimbursement is unavailable or coverage is limited in scope or amount.

There
have been, there are, and we expect there will continue to be, state and Federal legislative and/or administrative proposals that could limit the amount that state or Federal
governments will pay to reimburse the cost of pharmaceutical products. Legislative or administrative acts including, but not limited to, bundling multiple products into the same reimbursement code,
imposing LCAs that reference the reimbursement for our products to that of lower priced alternative therapies, and changing the manner in which reimbursement is calculated for prescription drugs, can
reduce reimbursement for our products and could adversely affect our business. In addition, private insurers, such as MCOs, may adopt their own coverage restrictions or demand price concessions in
response to legislation or administrative action. Reduction in reimbursement for our products could have a material adverse effect on our results of operations. Also, the increasing emphasis on
managed care in the United States may put increasing pressure on the price and usage of our products, which may adversely affect product sales. Further, when a new drug product is approved,
governmental and/or private reimbursement for that product is uncertain, as is the amount for which that product will be reimbursed and the extent of coverage for the product. We cannot predict
availability or amount of reimbursement for our approved products or product candidates and current reimbursement policies for marketed products may change at any time.

The
MMA established a prescription drug benefit beginning in 2006 for all Medicare beneficiaries. We do not know the extent to which our products will continue to be included in the
Medicare prescription drug benefit, and we may be required to provide significant discounts or rebates to drug plans participating in the Medicare drug benefit. Moreover, Congress may enact
legislation that permits the Federal government to directly negotiate price and demand discounts on pharmaceutical products that may implicitly create price controls on prescription drugs. In
addition, MCOs, Health Maintenance Organizations, or HMOs, Preferred Provider Organizations, or PPOs, health care institutions and other government agencies continue to seek price discounts. MCOs,
HMOs, PPOs and private health plans administer the Medicare drug benefit, leading to managed care and private health plans influencing prescription decisions for a larger segment of the population. In
addition, certain states have proposed, and certain other states have adopted, various programs to control prices for their seniors' and low-income drug programs, including price or
patient reimbursement constraints, restrictions on access to certain products, importation from other countries, such as Canada, and bulk purchasing of drugs.

As
we enter into agreements to license our products for commercialization outside of the United States, we may be subject to pricing decisions made by regulatory bodies and private
insurers around the world. Such pricing decisions may affect royalty rates and payments made to us under those agreements, or decisions whether or not to commercialize our products in the applicable
jurisdiction. Efforts to obtain pricing decisions are often the responsibility of the third party licensee and we cannot predict the success of any third party in obtaining desirable pricing, or how
the actions of such third

70

---



Table of Contents

party
or any regulatory body or private insurer will affect the ultimate commercial benefits of those transactions.

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

We will spend considerable time and money complying with Federal, state and foreign laws and regulations and, if we are unable to fully comply with such laws and
regulations, we could face substantial penalties.

We are subject to extensive regulation by Federal and state governments. The laws that directly or indirectly affect our business
include, but are not limited to, the following:



71

---



Table of Contents



If
our past, present or future operations are found to be in violation of any of the laws described above or other governmental regulations to which we or our customers are subject, we
may be subject to the applicable penalty associated with the violation, including civil and criminal penalties, damages, fines, exclusion from Medicare and Medicaid programs and curtailment or
restructuring of our operations. Similarly, if our customers are found non-compliant with applicable laws, they may be subject to sanctions, which could also have a negative impact on us.
In addition, if we are required to obtain permits or licenses under these laws that we do not already possess, we may become subject to substantial additional regulation or incur significant expense.
Any penalties, damages, fines, exclusion from Medicare and Medicaid programs or curtailment or restructuring of our operations would adversely affect our ability to operate our business and our
financial results. The risk of our being found in violation of these laws is increased by the fact that many of them have not been fully interpreted by the regulatory authorities or the courts and
their provisions are open to a variety of interpretations. Any action against us for violation of these laws, even if we successfully defend against it, could cause us to incur significant legal
expenses, divert our management's attention from operating our business and damage our reputation.

Federal
and state government agencies also continue to promote efforts to reduce health care costs, including those associated with the Medicare and Medicaid programs. These efforts may
include supplemental rebates and restrictions on the amounts that agencies will reimburse for the use of products. In addition, both the Federal and state governments have initiated investigations and
lawsuits concerning the Medicaid price reporting practices of many pharmaceutical companies to ensure compliance with the Medicaid rebate program. For example, in April 2007, we were sued by the
County of Orange, New York in the Southern District of New York, along with over 70 other pharmaceutical companies, for allegedly inflating published average wholesale prices allegedly resulting
in the overpayments by the state of New York's Medicaid program. Although this case was dismissed in May 2008 without prejudice and this matter is now closed, we could face similar lawsuits in the
future and be subject to damages and penalties if we are found liable.

The approval of sale of certain medications without a prescription may adversely affect our business.

In May 2001, an advisory panel to the FDA recommended that the FDA allow certain popular allergy medications to be sold without a
prescription. In November 2002 and November 2007, respectively, the FDA approved CLARITIN® and ZYRTEC®, both allergy medications, to be sold without a prescription. In the
future, the FDA may allow the sale of additional allergy medications without a prescription. The sale of CLARITIN, ZYRTEC and/or, if allowed, the sale of other allergy medications without a
prescription, may have a material adverse effect on our business because the market for prescription drugs, including CLARINEX and XYZAL/XUSAL for which we receive royalties on sales, has been and may
continue to be, adversely affected.

We recently determined that we provided PHS discounts to non-PHS covered entities. This circumstance creates uncertainty as to whether a new Medicaid
best price was set in prior periods. If a new best price was set, we will be required to pay additional Medicaid rebates. In addition, we may face an increased risk of investigation or litigation
concerning our Medicaid price reporting or other price reporting obligations.

Under
the Medicaid rebate program, we are obligated to pay a rebate to each participating State Medicaid program for each unit of product reimbursed by Medicaid. The amount of the rebate
for each product is set by law as the greater of (a) 15.1% of AMP or (b) the difference between AMP and the Medicaid best price, which is the lowest price available from us to any
customer not excluded by law from that determination. The rules related to determining AMP and best price are complicated. We compute best price and the required rebate payments each quarter based on
our knowledge of the statutory requirements, the current CMS guidance and our understanding of which customers are exempt from the best price calculation.

72

---



Table of Contents

In
January 2008, we notified CMS that we had identified potential errors in our determination of the best price used to calculate Medicaid rebate amounts in prior periods. As a follow up
to this disclosure to CMS, our management, with the oversight of our Audit Committee, is reviewing our government
pricing activities affected by the material weakness on our internal controls related to these potential errors. As a result of this matter, we restated our audited, consolidated financial statements
as of and for the years ended December 31, 2006 and 2005 and selected financial data as of and for the years ended December 31, 2006, 2005, 2004 and 2003, as set forth in our annual
report on Form 10-K filed on February 29, 2008, and our unaudited quarterly information for the fiscal quarters ended March 31, June 30 and September 30,
2007 and 2006, as set forth in our amended and restated quarterly reports for these periods filed on Form 10-Q/A on May 7, 2008. The amounts by which we have reduced revenues
for contingent rebates were based on management's best estimates and assumptions made prior to any concurrence by CMS. These amounts may change as a result of future communications with CMS, and we
cannot be certain that we have not overestimated the amount of additional rebates we may be required to pay, that the amount of any additional rebate payments or other payments we may owe will not
exceed our current estimates, or that we will not be subject to fines, penalties or interest.

Both
the federal government and state governments have initiated investigations and lawsuits concerning the Medicaid price reporting practices of many pharmaceutical companies to ensure
compliance with the Medicaid rebate program. As a result of the errors that we identified in our calculation of Medicaid rebate reserve amounts, we may face an increased risk of a government
investigation or lawsuits concerning our Medicaid or other price reporting. If any such investigation or lawsuit is initiated, we may be required to pay additional rebates or other amounts related to
sales made in prior periods, and we may be subject to fines, penalties or interest. In addition, an investigation or lawsuit concerning our Medicaid price reporting could be costly, could divert the
attention of our management from our core business and could damage our reputation.

If our drugs are not included on State Preferred Drug Lists, use of our drugs may be negatively affected.

Several state Medicaid programs have implemented Preferred Drug Lists, or PDLs, and more states may adopt this practice. Products
placed on a state Medicaid program's PDL are not subject to restrictions on their utilization by Medicaid patients, such as the need to obtain authorization prior to prescribing. If our drugs are not
included on Medicaid PDLs, use of our drugs in the Medicaid program may be adversely affected. In some states that have adopted PDLs, we have been, and may continue to be, required to provide
substantial supplemental rebates to state Medicaid authorities in order for our drugs to be included on the PDL.

Risks Related to Our Intellectual Property

If we fail to adequately protect or enforce our intellectual property rights, then we could lose revenue under our licensing agreements or lose sales to generic copies of
our products.

Our success depends in large part on our ability, and the ability of our collaboration partners, to obtain, maintain and successfully
enforce patents, and protect trade secrets. Our ability to commercialize any drug successfully will largely depend upon our ability to obtain and maintain patents, including successful enforcement of
those patents, of sufficient scope to prevent third parties from developing the same or substantially equivalent products. In the absence of patent and trade secret protection, competitors may
adversely affect our business by independently developing and marketing the same or substantially equivalent products. It is also possible that we could incur substantial costs if we are required to
initiate litigation against others to protect or enforce our intellectual property rights.

We
have filed patent applications covering composition of, methods of making, and/or methods of using, our products and product candidates. Our revenues under collaboration agreements
with

73

---



Table of Contents

pharmaceutical
companies depend in part on the existence and scope of issued patents. In addition, we may not be issued patents based on patent applications already filed or that we file in the future
and if patents are issued, they may be insufficient in scope to cover the products licensed under these collaboration agreements. Generally, we do not receive royalty revenue from sales of products
licensed under collaboration agreements in countries where we do not have a patent for such products. The issuance of a patent in one country does not ensure the issuance of a patent in any other
country. Furthermore, the patent position of companies in the pharmaceutical industry generally involves complex legal and factual questions, and has been and remains the subject of much litigation.
Legal standards relating to scope and validity of patent claims are evolving. Any patents we have obtained, or obtain in the future, may be challenged, invalidated or circumvented. Moreover, the
United States Patent and Trademark Office may commence interference proceedings involving our patents or patent applications. Any challenge to, or invalidation or circumvention of, our patents or
patent applications would be costly, would require significant time and attention of our management and could have a material adverse effect on our business. In addition, if we are not successful in
obtaining patents of sufficient scope and enforcing our patents, we will not be able to prevent others from introducing generic versions of our products.

If we do not prevail against those parties seeking to market generic versions of our products, our business will be adversely affected and we may not have sufficient
revenues to achieve our business plan or repay our outstanding debt.

With respect to XOPENEX Inhalation Solution, Breath, Dey, L.P., Barr, Teva, Watson and Apotex have filed ANDAs including
Paragraph IV certifications with the FDA seeking to market a generic version of levalbuterol hydrochloride inhalation solution before our patents expire. Patent infringement litigation remains
outstanding against Dey, L.P., and Barr, but we have decided not to commence litigation against Watson and Teva as their respective Paragraph IV certifications are limited to a single
patent that expires in 2021. Apotex's Paragraph IV certification is likewise limited to the patent that expires in 2021 and we are still evaluating whether to commence litigation in response.

In
April 2008, we entered into a settlement and license agreement with Breath to resolve our patent infringement litigation against Breath. The agreement permits Breath to sell its
generic versions of these XOPENEX Inhalation Solution products (1.25 mg/3 mL, 0.63 mg/3 mL and 0.31 mg/3 mL) in the United States under terms of an exclusive 180 day license commencing on
August 20, 2012 and a non-exclusive license thereafter. Upon launch, Breath would pay us a double-digit royalty on gross profits generated from the sales of generic versions of
these XOPENEX Inhalation Solution products. Under the agreement, Breath agrees not to sell any of the products covered by our patents that are the subject of the license before the date on which the
license commences. On May 1, 2008, the parties submitted to the court an agreed order of dismissal without prejudice, which the court approved. The litigation is now concluded.

In
April 2008, we also entered into a supply agreement with Breath whereby, effective August 20, 2012, we will exclusively supply levalbuterol products (1.25 mg/3 mL, 0.63 mg/3 mL
and 0.31 mg/3 mL) to Breath, under our NDA for a period of 180 days, which we refer to as the Initial Term, and on a non-exclusive basis for two and one-half years
thereafter. In addition to the royalties described above, Breath will pay us on a cost plus margin basis for supply of these levalbuterol products. The supply agreement contains provisions regarding
termination for cause and convenience, including either party's right to terminate the agreement at any time after the Initial Term upon nine months written notice. Both the exclusive license under
the settlement and license agreement and the exclusive supply obligations under the supply agreement could become effective prior to August 20, 2012 if a third party launches a generic version
of those dosages of XOPENEX Inhalation Solution or if the parties otherwise mutually agree.

74

---



Table of Contents

On May 9, 2008, we provided to the Federal Trade Commission and Department of Justice Antitrust Division the notifications of the settlement with Breath as
required under Section 1112(a) of the MMA. The settlement with Breath and the other agreements with Breath and its affiliates, including the supply agreement, the agreement for the acquisition
of Oryx and license agreements with Arrow, may be reviewed by antitrust enforcement agencies, such as the Federal Trade Commission and Department of Justice Antitrust Division. There can be no
assurances that governmental authorities will not seek to challenge the settlement with Breath or that a competitor, customer or other third party will not initiate a private action under antitrust or
other laws challenging the settlement with Breath. We may not prevail in any such challenges or litigation and, in any event, may incur significant costs in the event of an investigation or in
defending any action under antitrust laws.

The
filing of a lawsuit for patent infringement under the Hatch-Waxman Act results in an automatic 30-month stay of the FDA's authority to grant marketing approval to these
companies. The 30-month stay against Breath's ANDA expired for our 1.25 mg/3 mL, 0.63 mg/3 mL and 0.31 mg/3 mL XOPENEX Inhalation Solution products on March 7, 2008. On
April 9, 2008, the FDA granted final approval to Breath's ANDA for all three dosages. If the FDA determines that Breath has forfeited the 180 day semi-exclusivity period for
those three dosages, other ANDA filers who have been granted final approval by the FDA could commence an "at risk" launch upon expiration of the 30-month stay. For those three dosages, the
30-month stay against Dey, L.P. expired on July 9, 2008 and the 30-month stay against Barr expires on or about November 30, 2009. If either of these
parties were to commence selling a generic alternative to our XOPENEX Inhalation Solution product prior to the resolution of these ongoing legal proceedings, or there is a court determination that the
products these companies wish to market do not infringe our patents, or that our patents are invalid or unenforceable, it would
have a material adverse effect on our business, financial condition and/or results of operations. In addition, our previously issued guidance regarding our projected financial results may no longer be
accurate and we would have to revise such guidance.

Certain
of Schering-Plough's CLARINEX products for which we receive sales royalties are currently the subject of patent infringement litigation. Since June 2007, the FDA has received
ANDAs relating to various dosage forms of CLARINEX from ten different generic pharmaceutical companies. These ANDA submissions include Paragraph IV certifications alleging that our patents,
which Schering-Plough (as exclusive licensee of such patents) listed in the Orange Book for these products, are invalid, unenforceable or not infringed by the submitter's proposed product. We and the
University of Massachusetts, co-owners of certain patents listed in the Orange Book, filed civil actions against these parties for patent infringement in the United States District Court
for the District of New Jersey. In April 2008, the trial judge consolidated these cases for all purposes including discovery and trial. The court has not set a trial date. We believe that all of these
ANDAs are subject to a statutory stay of approval until at least December 21, 2009 based on previous litigation commenced by Schering-Plough against these parties in separate civil actions
involving another patent.

UCB S.A.'s
XYZAL 5mg product, for which we receive royalties, is currently the subject of patent infringement litigation. The FDA has received ANDAs from four generic
pharmaceutical companies that include Paragraph IV certifications alleging that one of our patents which UCB (as NDA holder and licensee of the patent) listed in the Orange Book for this
product, is invalid and/or not infringed by the ANDA filer's product. UCB, on its own and on our behalf, commenced patent infringement litigation against all of these parties. We believe that these
ANDAs are subject to a statutory stay of approval until at least on or about August 29, 2010.

In
addition, a number of our foreign patents that we have out-licensed to Schering-Plough, sanofi-aventis and the UCB entities in connection with the sale of CLARINEX,
ALLEGRA and XYZAL/XUSAL, respectively, are subject to patent invalidity claims. If patent-based exclusivity is lost for one or more of these products in any foreign jurisdiction, our rights to receive
royalty revenue with respect to such product in the relevant jurisdiction will terminate, which may have a material adverse effect on

75

---



Table of Contents

our
business, financial condition and results of operations. Should the courts uphold our foreign patents, companies seeking to market generic versions of our drugs and the drugs of our licensees
should be deterred from market entry until the expiration of the applicable patent(s).

Patent
litigation involves complex legal and factual questions. We can provide no assurance concerning the outcome or the duration of any patent related lawsuits. If we, third parties
from whom we receive royalties, or third parties from whom we have licensed products or received other rights to commercialize products, are not successful in enforcing our respective patents, the
companies seeking to market generic versions of our market drugs and the drugs of our licensees will not be excluded, for the full term of our patents, from marketing their generic versions of our
marketed products or third
party products for which we have licensed rights to our patents. Introduction of generic copies of any of our marketed products or third party products for which we have licensed rights to our patents
before the expiration of our patents would have a material adverse effect on our business.

Additionally,
the costs to us of these proceedings, even if resolved in our favor, could be substantial. Such litigation could also substantially divert the attention of our management
and other key personnel from our core business and our resources in general. Uncertainties resulting from the initiation and continuation of this and any other litigation proceedings could harm our
ability to compete in the marketplace.

If we face a claim of intellectual property infringement by a third party, then we could be liable for significant damages or be prevented from commercializing our products.

Our success depends in part on our ability to operate without infringing the proprietary rights of others, including patent and
trademark rights. Third parties, typically pharmaceutical companies, may hold patents or patent applications covering compositions, methods of making and uses, covering the composition of matter for
some of the drug candidates for which we have patents or patent applications. Third parties may also hold patents relating to drug delivery technology that may be necessary for development or
commercialization of some of our drug candidates. In each of these cases, unless we have or obtain a license agreement, we generally may not commercialize the drug candidates until these third party
patents expire or are declared invalid or unenforceable by the courts. Licenses may not be available to us on acceptable terms, if at all.

Others
may file suit against us alleging that our marketed products or product candidates infringe patents they hold. Even if resolved in our favor, any patent infringement litigation
would be costly, would require significant time and attention of our management, could prevent us from commercializing our products for a period of time, could require us to pay significant damages
and could have a material adverse effect on our business. If the matter is not resolved in our favor, we could be required to pay significant damages and/or be prevented from commercializing our
product and our business could be materially adversely affected. In April 2007, we were served with a Complaint filed by Dey, alleging that the manufacture and sale of BROVANA infringes or will induce
infringement of a single United States patent for which Dey owns all rights, title and interest. In April 2007, we filed an Answer and Counterclaims to this Complaint seeking to invalidate the
originally asserted patent and a second related patent. In May 2007, Dey filed a reply asserting infringement of the second patent. Under the current trial scheduling order, trial will begin no
earlier than January 12, 2009. It is too early to make a reasonable assessment as to the likely outcome or impact of this litigation. We are unable to reasonably estimate any possible range of
loss or liability related to this lawsuit due to its uncertain resolution.

In
March 2008, United States Patent 7,348,362 entitled "Bronchodilationb-agonist compositions and Methods" issued and Dey, L.P. is
the assignee of the patent. In May 2008, we filed a Motion to Amend our Answer and Counterclaims to seek declaratory judgment that the '362 patent is invalid and

76

---



Table of Contents

unenforceable
and to add Mylan Inc. as a party. Dey has opposed this motion and we await a decision from the court.

If
any of our trademarks or the trademarks we license from our third party collaborators, or our use of any of these trademarks in connection with products we commercialize, is
challenged, we or our third party collaborators may be forced to rename the affected product or product candidate, which could be costly and time consuming, and would result in the loss of any brand
equity associated with the product name.

Risks Related to Our Dependence on Third Parties

If any third party collaborator is not successful in development or commercialization of our products and product candidates, we may not realize the potential commercial
benefits of the arrangement and our results of operations could be adversely affected.

We have entered into a collaboration agreement with 3M for the manufacturing of XOPENEX HFA. Under this agreement, we license certain
proprietary technology from 3M and it is responsible for manufacturing the MDI formulation of XOPENEX. We have also entered into agreements with Eisai and GSK for development and commercialization of
our eszopiclone product, marketed as LUNESTA in the United States. Under the Eisai agreement, Eisai will be responsible for completing remaining clinical trials necessary for attaining marketing
approval from the Japanese regulatory authorities and, contingent on regulatory approval, commercialization of the product in Japan. Under the GSK agreement, GSK is responsible for the development and
commercialization of the product for all markets worldwide, excluding the United States, Canada, Mexico and Japan. In addition, we have entered into a license agreement with Bial for the development
and commercialization in the United States and Canada of Bial's eslicarbazepine acetate anti-epileptic compound. Under this agreement, Bial is responsible for certain development
activities and prosecuting all patents and patent applications it licensed to us. We have also recently entered into a distribution and development agreement with Nycomed for the development,
commercialization and distribution in the United States, its territories and possessions of Nycomed's compound ciclesonide, and certain products incorporating such compound, including
ALVESCO HFA Inhalation Aerosol and OMNARIS Nasal Spray. Under this agreement, Nycomed is responsible for prosecuting all patents and patent applications with respect to these products. Most recently,
we entered into two license and development agreements with Arrow for the development and commercialization of Arrow's levalbuterol/ipratropium combination inhalation solution candidate and for the
development and commercialization of a ciclesonide standalone product and a ciclesonide/arformoterol combination product utilizing Arrow's know-how and intellectual property rights related
to stable sterile suspension formulations and other technology.

If
3M, Eisai, GSK, Bial, Nycomed, Arrow or any future development or commercialization collaborator does not devote sufficient time and resources to its collaboration arrangement with
us, breaches or terminates its agreement with us, fails to perform its obligations to us in a timely manner, is unsuccessful in its development and/or commercialization efforts, or is unsuccessful in
obtaining, maintaining or enforcing patents, and/or protecting trade secrets we license to or from such collaborator, we may not realize the potential commercial benefits of the arrangement and our
results of operations may be adversely affected. In addition, if regulatory approval or commercialization of any product candidate under development by or in collaboration with a partner is delayed or
limited, we may not realize, or may be delayed in realizing, the potential commercial benefits of the arrangement.

77

---



Table of Contents

The royalties and other payments we receive under licensing arrangements could be delayed, reduced or terminated if our licensing partners terminate, or fail to perform
their obligations under, their agreements with us, or if our licensing partners are unsuccessful in their sales efforts.

We have entered into licensing arrangements pursuant to which we license patents to pharmaceutical companies and our revenues under
these licensing arrangements consist primarily of milestone payments, royalties on sales of products and supply payments. Payments and royalties under these arrangements depend in large part on the
efforts of our licensing partners in countries where we hold patents, including development and sales efforts and enforcement of patents, which we cannot control. If any of our licensing partners do
not devote sufficient time and resources to its licensing arrangement 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, our revenues under these arrangements may be less than anticipated and our results of operations may be adversely affected. If any of our licensing partners was to breach or terminate
its agreement with us or fail to perform its obligations to us in a timely manner, the royalties and other payments we receive under the licensing agreement could decrease or cease. If we are unable
or fail to perform, or are in breach of our obligations under a licensing agreement, the royalties and other payments and benefits to which we are otherwise entitled under the agreement could be
reduced or eliminated. Any delay or termination of this type could have a material adverse effect on our financial condition and results of operations because we may lose technology rights and
milestone or royalty payments from licensing partners and/or revenues from product sales, if any, could be delayed, reduced or terminated.

We rely on third party manufacturers, and this reliance could adversely affect our ability to meet our customers' demands.

We currently operate a manufacturing plant that we believe can meet our commercial requirements of the active pharmaceutical ingredient
for XOPENEX Inhalation Solution, XOPENEX HFA and BROVANA, partially fulfill our commercial requirements of the active pharmaceutical ingredient for LUNESTA, and support production of our product
candidates in amounts needed for our clinical trials. We do not, however, have the capability to manufacture at our manufacturing facility all of our requirements for the active ingredients of our
currently approved products, and we have no facilities for manufacturing pharmaceutical dosage forms or finished drug products. Developing and obtaining this capability would be time consuming and
expensive. Unless and until we develop this capability, we will rely substantially, and in some cases, entirely, on third party manufacturers. Catalent Pharma Solutions, LLC, or Catalent,
formerly Cardinal Health, Inc., and Holopack International Corporation, or Holopack, are currently our only finished goods manufacturers of our XOPENEX Inhalation Solution, and Catalent is
currently the sole finished goods manufacturer of BROVANA. Patheon Inc., or Patheon, is the sole manufacturer of LUNESTA, and 3M is the sole manufacturer and supplier of XOPENEX HFA. Certain
components of XOPENEX HFA are available from only a single source. If Catalent, Holopack, Patheon, 3M, or any of our sole-source component suppliers experiences delays or difficulties in
producing, packaging or delivering XOPENEX Inhalation Solution, XOPENEX HFA or its components, BROVANA or LUNESTA, as the case may be, we could be unable to meet our customers' demands for such
products, which could lead to lost sales, customer dissatisfaction and damage to our reputation. Moreover, if we experience delays or difficulties meeting our supply obligations to GSK and Eisai as a
result of our third party suppliers and manufacturers not meeting our demands, or for any other reason, we may not realize the potential commercial benefits of our supply and/or licensing arrangements
with these parties and our results of operations may be adversely affected. If we are required to change manufacturers, we will be required to verify that the new manufacturer maintains facilities and
procedures that comply with quality standards and with all applicable regulations and guidelines, including FDA guidelines. The delays associated with the verification of a new manufacturer for
XOPENEX Inhalation Solution, XOPENEX HFA or its

78

---



Table of Contents

components,
BROVANA or LUNESTA could adversely affect our ability to produce such products in a timely manner or within budget.

Pursuant
to our distribution, development and commercialization agreement with Nycomed, Nycomed will be responsible for exclusively manufacturing and supplying us with our requirements
of ALVESCO HFA Inhalation Aerosol and OMNARIS Nasal Spray. Furthermore, in the event that we develop and commercialize any additional products containing the compound ciclesonide, including OMNARIS
HFA, Nycomed, upon request, will be our exclusive supplier of such additional products. If Nycomed experiences delays or difficulties in producing, packaging or delivering ALVESCO HFA Inhalation
Aerosol, OMNARIS Nasal Spray or other products containing the compound ciclesonide, we could be
unable to meet our customers' demands for such products, which could lead to lost sales, customer dissatisfaction and damage to our reputation.

We
license certain proprietary technology required to manufacture our XOPENEX HFA from 3M. If 3M is unable or unwilling to fulfill its obligations to us under our agreement, we may be
unable to manufacture XOPENEX HFA on terms that are acceptable to us, if at all. Our other current contract manufacturers, as well as any future contract manufacturers, may also independently own
technology related to manufacturing of our products. If so, we would be heavily dependent on such manufacturer and such manufacturer could require us to obtain a license in order to have another party
manufacture our products.

Risks Related to Growth of Our Business

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

We are currently commercializing five products and expect to launch a sixth product, ALVESCO HFA Inhalation Aerosol, in 2008. In
addition, we recently acquired from Nycomed the development rights to one late-stage product candidate, OMNARIS HFA, and recently licensed two late-stage product candidates,
eslicarbazepine acetate and a levalbuterol/ipratropium combination inhalation solution, from Bial and Arrow, respectively. However, all of our other product candidates are in the early stages of
development. In order to increase the likelihood that we will be able to successfully develop and/or commercialize additional drugs, we intend to acquire and develop additional product candidates
and/or approved products. The success of this growth strategy depends upon our ability to correctly establish criteria for such acquisitions and successfully identify, select and acquire product
candidates and/or products that meet such criteria. We will be required to integrate any acquired product candidates, including the product candidates we recently licensed from Bial and Arrow and
product candidates we are developing pursuant to our agreement with Nycomed, into our research and development operations and any acquired products, including ALVESCO HFA Inhalation Aerosol and
OMNARIS Nasal Spray into our sales and marketing operations. Managing the development and/or commercialization of a new product involves numerous other financial and operational risks, including
difficulties allocating resources between existing and acquired assets and attracting and retaining qualified employees to develop and/or sell the product.

Any
product candidate we acquire may require additional research and development efforts prior to commercial sale, including extensive preclinical and/or clinical testing and approval by
the FDA and
corresponding foreign regulatory authorities. All product candidates are prone to the risks of failure inherent in pharmaceutical product development, including the possibility that the product
candidate will not be safe and effective or approved by regulatory authorities.

In
addition, we cannot be assured that any products that we develop or acquire will be:



79

---



Table of Contents



Proposing,
negotiating and implementing an economically viable acquisition is a lengthy and complex process. Other companies, including those with substantially greater financial,
marketing and sales resources, may compete with us for the acquisition of product candidates and approved products. We may not be able to acquire the rights to additional product candidates and
approved products on terms that we find acceptable, or at all.

We may undertake strategic acquisitions in the future and any difficulties from integrating acquired businesses, products and product candidates could adversely affect our
stock price, business operations, financial condition or results from operations.

We may acquire additional businesses, products or product candidates that complement or augment our existing business. We have limited
acquisition experience and may not be able to integrate any acquired business, product or product candidate successfully or operate any acquired business profitably. Integrating any newly acquired
business, product or product candidate could be expensive and time-consuming. Integration efforts often place a significant strain on managerial, operational and financial resources and
could prove to be more difficult or expensive than we predict. The diversion of our management's attention and any delay or difficulties encountered in connection with any future acquisitions we may
consummate could result in the disruption of our on going business or inconsistencies in standards, controls, procedures and policies that could adversely affect our ability to maintain relationships
with customers, suppliers, collaborators, employees and others with whom we have business dealings. Moreover, we may need to raise additional funds through public or private debt or equity financing
to acquire any businesses, products or product candidates, which may result in dilution for stockholders or the incurrence of indebtedness.

As
part of our efforts to acquire businesses, products and product candidates or to enter into other significant transactions, we conduct business, legal and financial due diligence with
the goal of identifying and evaluating material risks involved in the transaction. Despite our efforts, we ultimately may be unsuccessful in ascertaining or evaluating all such risks and, as a result,
might not realize the intended advantages of the transaction. If we fail to realize the expected benefits from acquisitions we have consummated or may consummate in the future, whether as a result of
unidentified risks, integration difficulties, regulatory setbacks or other events, our business, results of operations and financial condition could be adversely affected. We will also need to make
certain assumptions regarding acquired product candidates, including, among other things, development costs, the likelihood of receiving regulatory approval and the market for such product candidates.
Our assumptions may prove to be incorrect, which could cause us to fail to realize the anticipated benefits of these transactions.

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

80

---



Table of Contents

Development and commercialization of our product candidates could be delayed or terminated if we are unable to enter into collaboration agreements in the future or if any
future collaboration agreement is subject to lengthy government review.

Development and commercialization of some of our product candidates may depend on our ability to enter into additional collaboration
agreements with pharmaceutical companies to fund all or part of the costs of development and commercialization of these product candidates. We may not be able to enter into collaboration agreements
and the terms of the collaboration agreements, if any, may not be favorable to us. Inability to enter into collaboration agreements could delay or preclude development, manufacture and/or
commercialization of some of our drugs and could have a material adverse effect on our financial condition and results of operations because:



We
are required to file a notice under the Hart-Scott-Rodino Antitrust Improvements Act of 1976, as amended, or the HSR Act, for certain agreements containing
exclusive license grants and to delay the effectiveness of any such exclusive license until expiration or earlier termination of the notice and waiting period under the HSR Act. If expiration or
termination of the notice and waiting period under the HSR Act is delayed because of lengthy government review, or if the Federal Trade Commission or Department of Justice successfully challenges such
a license, development and commercialization could be delayed or precluded and our business could be adversely affected.

81

---





Table of Contents

ITEMS 2-3.    NONE

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

Our annual meeting of stockholders was held on May 20, 2008. The following represents the results of the voting on proposals
submitted to a vote of stockholders at the annual meeting:



For

Withheld AuthorityAdrian Adams


93,299,120


2,772,129Timothy J. Barberich


76,057,651


20,013,598Timothy J. Rink


76,125,556


19,945,693


The
terms of office of the following directors continued after the annual meeting:



For

Against

Abstain

Broker Non-Votes68,899,438

17,893,190


27,823


9,250,799




For

Against

Abstain

Broker Non-Votes80,058,709

6,721,460


40,281


9,250,799




For

Against

Abstain

Broker Non-Votes85,486,965

1,290,147


43,338


9,250,799




For

Against

Abstain94,380,518

1,619,577


71,154


ITEM 5.    NONE

82

---





Table of Contents

ITEM 6.    EXHIBITS

10.1

Share Purchase Agreement dated April 30, 2008 between the Registrant, 1765800 Ontario Limited, Cobalt Pharmaceuticals Inc., Melville Holdings Limited, Oryx Pharmaceuticals, Inc. and Arrow
Group A.p.S.10.2

License and Development Agreement dated April 30, 2008 between the Registrant and Arrow International Limited for Levalbuterol/ipratropium Product.10.3

License and Development Agreement dated April 30, 2008 between the Registrant and Arrow International Limited for ciclesonide products.10.4

Settlement and License Agreement dated April 30, 2008 between the Registrant and Breath Limited.10.5

Supply Agreement dated April 30, 2008 between the Registrant and Breath Limited.10.6

Severance and Consulting Agreement by and between the Registrant and David Southwell dated May 14, 2008.10.7

Employment Agreement by and between the Registrant and Robert F. Scumaci dated May 14, 2008.10.8

Employment Agreement by and between the Registrant and Mark H. N. Corrigan dated May 14, 2008.10.9

2000 Stock Incentive Plan, as amended.10.10

2008 Director Stock Incentive Plan.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.


---

83

---





Table of Contents

SIGNATURES

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

SEPRACOR INC.Date: August 8, 2008

By:

/s/ADRIAN ADAMSAdrian Adams President and Chief Executive Officer
(Principal Executive Officer)Date: August 8, 2008

By:

/s/ROBERT F. SCUMACIRobert F. Scumaci Executive Vice President and Chief Financial Officer
(Principal Accounting Officer)


84

---





Table of Contents

Exhibit Index

Exhibit No.

Description10.1

Share Purchase Agreement dated April 30, 2008 between the Registrant, 1765800 Ontario Limited, Cobalt Pharmaceuticals Inc., Melville Holdings Limited, Oryx Pharmaceuticals, Inc. and Arrow
Group A.p.S.10.2

License and Development Agreement dated April 30, 2008 between the Registrant and Arrow International Limited for Levalbuterol/ipratropium Product.10.3

License and Development Agreement dated April 30, 2008 between the Registrant and Arrow International Limited for ciclesonide products.10.4

Settlement and License Agreement dated April 30, 2008 between the Registrant and Breath Limited.10.5

Supply Agreement dated April 30, 2008 between the Registrant and Breath Limited.10.6

Severance and Consulting Agreement by and between the Registrant and David Southwell dated May 14, 2008.10.7

Employment Agreement by and between the Registrant and Robert F. Scumaci dated May 14, 2008.10.8

Employment Agreement by and between the Registrant and Mark H. N. Corrigan dated May 14, 2008.10.9

2000 Stock Incentive Plan, as amended.10.10

2008 Director Stock Incentive Plan.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.


---

85

---