**SECURITIES AND EXCHANGE COMMISSION**

**Washington,D.C. 20549**

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FORM 10-Q

**(Mark One)**

**x**                              QUARTERLYREPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACTOF 1934

**Forthe Quarterly Period Ended June 30, 2005**

**or**

**o**                                 TRANSITIONREPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACTOF 1934

**Forthe transition period from                  to                  **

**Commissionfile number 0-19410**

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Sepracor Inc.

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

 

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

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

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

Thenumber of shares outstanding of the registrant’s class of Common Stock as of July 29,2005 was: 105,367,989 shares.

 

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**SEPRACOR INC.INDEX**
| **Part I—Financial Information** |   |                                                                                                                    |
|--------------------------------------------|--------|-------------------------------------------------------------------------------------------------------------------------|
| Item 1.                                    |   | Condensed Consolidated Financial Statements  (Unaudited)                                                                |   |   |
|                                       |   | Consolidated Balance  Sheets as of June 30, 2005 and December 31, 2004 (Unaudited)                            |   | 3 |
|                                       |   | Consolidated  Statements of Operations for the Three and Six Months Ended June 30,  2005 and 2004 (Unaudited) |   | 4 |
|                                       |   | Consolidated  Statements of Cash Flows for the Six Months Ended June 30, 2005 and 2004 (Unaudited)            |   | 5 |
|                                       |   | Notes  to Condensed Consolidated Interim Financial Statements                                                           |   | 6 |
| Item  2.                                   |   | Management’s  Discussion and Analysis of Financial Condition and Results of Operations                             |   | 12 |
| Item 3.                                    |   | Quantitative and Qualitative  Disclosures About Market Risk                                                             |   | 36 |
| Item 4.                                    |   | Controls and Procedures                                                                                                 |   | 36 |
| **Part II—Other  Information**   |   |                                                                                                                    |
| Item 1.                                    |   | Legal  Proceedings                                                                                                      |   | 38 |
| Item  4.                                   |   | Submission  of Matters to a Vote of Security Holders                                                                    |   | 38 |
| Item 6.                                    |   | Exhibits                                                                                                                |   | 39 |
|                                       |   | Signatures                                                                                                              |   | 40 |
|                                       |   | Exhibit Index                                                                                                      |   | 41 |

 

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**SEPRACOR INC.CONSOLIDATED BALANCESHEETS(Unaudited)(In Thousands)**
| ** **                                                                                                                                                                                                        | ** ** | **June 30, 2005** | ** ** | **December 31, 2004** | ** ** |
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------------------|------------|---------------------------------|------------|
| **Assets**                                                                                                                                                                                                        |       |                        |       |                            |       |   |   |
| Current assets:                                                                                                                                                                                                   |       |                        |       |                            |       |   |   |
| Cash and cash equivalents                                                                                                                                                                                         |       | $                           | 209,447    |                            |       | $ | 435,905 |   |   |
| Short-term investments                                                                                                                                                                                            |       | 565,388                     |       |                            | 303,303    |   |   |
| Accounts receivable, net                                                                                                                                                                                          |       | 111,220                     |       |                            | 68,914     |   |   |
| Inventories                                                                                                                                                                                                       |       | 18,969                      |       |                            | 13,086     |   |   |
| Other assets                                                                                                                                                                                                      |       | 23,328                      |       |                            | 18,722     |   |   |
| Total current  assets                                                                                                                                                                                             |       | 928,352                     |       |                            | 839,930    |   |   |
| Long-term investments                                                                                                                                                                                             |       | 145,532                     |       |                            | 94,704     |   |   |
| Property and equipment, net                                                                                                                                                                                       |       | 70,966                      |       |                            | 70,860     |   |   |
| Investment in affiliate                                                                                                                                                                                           |       | 5,067                       |       |                            | 5,535      |   |   |
| Patents and deferred financing costs, net                                                                                                                                                                         |       | 24,571                      |       |                            | 27,035     |   |   |
| Other assets                                                                                                                                                                                                      |       | 356                         |       |                            | 1,054      |   |   |
| Total assets                                                                                                                                                                                                      |       | $                           | 1,174,844  |                            |       | $ | 1,039,118 |   |   |
| **Liabilities  and Stockholders’ Equity (Deficit)**                                                                                                                                                          |       |                        |       |                            |       |   |   |
| Current liabilities:                                                                                                                                                                                              |       |                        |       |                            |       |   |   |
| Accounts payable                                                                                                                                                                                                  |       | $                           | 6,337      |                            |       | $ | 5,772 |   |   |
| Accrued expenses                                                                                                                                                                                                  |       | 108,052                     |       |                            | 126,701    |   |   |
| Current portion of notes payable and capital lease  obligation                                                                                                                                                    |       | 1,926                       |       |                            | 1,926      |   |   |
| Other current liabilities                                                                                                                                                                                         |       | 94,655                      |       |                            | 69,711     |   |   |
| Total current  liabilities                                                                                                                                                                                        |       | 210,970                     |       |                            | 204,110    |   |   |
| Notes payable and capital lease obligation                                                                                                                                                                        |       | 1,512                       |       |                            | 2,529      |   |   |
| Other long-term liabilities                                                                                                                                                                                       |       | 2,830                       |       |                            | 2,774      |   |   |
| Convertible subordinated debt                                                                                                                                                                                     |       | 1,160,820                   |       |                            | 1,160,820  |   |   |
| Total liabilities                                                                                                                                                                                                 |       | 1,376,132                   |       |                            | 1,370,233  |   |   |
| Stockholders’  equity (deficit):                                                                                                                                                                             |       |                        |       |                            |       |   |   |
| Preferred stock, $1.00 par value, 1,000 shares  authorized; none outstanding at June 30, 2005 and December 31, 2004                                                                                     |       | —                      |       |                            | —     |   |   |
| Common stock, $.10 par value, 240,000 and 240,000  shares authorized; 107,254 and 105,309 shares issued, 105,320 and 103,376  shares outstanding, at June 30, 2005 and December 31, 2004,  respectively |       | 10,725                      |       |                            | 10,531     |   |   |
| Treasury stock, at cost (1,934 and 1,933 shares at  June 30, 2005 and December 31, 2004, respectively)                                                                                                  |       | (100,400                    | )          |                            | (100,321   | ) |   |
| Additional paid-in capital                                                                                                                                                                                        |       | 1,521,772                   |       |                            | 1,370,372  |   |   |
| Accumulated deficit                                                                                                                                                                                               |       | (1,655,458                  | )          |                            | (1,625,486 | ) |   |
| Accumulated other comprehensive income                                                                                                                                                                            |       | 22,073                      |       |                            | 13,789     |   |   |
| Total  stockholders’ equity (deficit)                                                                                                                                                                        |       | (201,288                    | )          |                            | (331,115   | ) |   |
| Total liabilities and  stockholders’ equity (deficit)                                                                                                                                                        |       | $                           | 1,174,844  |                            |       | $ | 1,039,118 |   |   |

 

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

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**SEPRACOR INC.CONSOLIDATED STATEMENTS OF OPERATIONS(Unaudited)(In Thousands, Except Per Share Amounts)**
| ** **                                                             | ** ** | **Three Months Ended** | ** ** | **Six Months Ended** | ** ** |
|------------------------------------------------------------------------|------------|----------------------------------|------------|--------------------------------|------------|
| ** **                                                             | ** ** | **June 30, 2005**      | ** ** | **June 30, 2004**    | ** ** | **June 30, 2005** | ** ** | **June 30, 2004** | ** ** |
| Revenues:                                                              |       |                             |       |                           |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Product sales                                                          |       |                             | $          | 166,743                        |       |   |   | $ | 57,450 |   |   |   | $ | 273,391 |   |   |   | $ | 142,506 |   |   |
| Royalties and other                                                    |       |                             | 18,321     |                           |       |   | 12,517 |   |   |   | 30,718 |   |   |   | 26,939 |   |   |
| Total revenues                                                         |       |                             | 185,064    |                           |       |   | 69,967 |   |   |   | 304,109 |   |   |   | 169,445 |   |   |
| Costs and expenses:                                                    |       |                             |       |                           |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Cost of product sold                                                   |       |                             | 14,453     |                           |       |   | 6,821 |   |   |   | 24,490 |   |   |   | 15,681 |   |   |
| Cost of royalties and other                                            |       |                             | 202        |                           |       |   | 109 |   |   |   | 405 |   |   |   | 349 |   |   |
| Research and development                                               |       |                             | 37,132     |                           |       |   | 45,077 |   |   |   | 65,701 |   |   |   | 82,373 |   |   |
| Selling, marketing and distribution                                    |       |                             | 130,148    |                           |       |   | 86,355 |   |   |   | 223,320 |   |   |   | 170,789 |   |   |
| General and administrative                                             |       |                             | 9,848      |                           |       |   | 7,899 |   |   |   | 18,329 |   |   |   | 14,933 |   |   |
| Total costs and expenses                                               |       |                             | 191,783    |                           |       |   | 146,261 |   |   |   | 332,245 |   |   |   | 284,125 |   |   |
| Loss from operations                                                   |       |                             | (6,719     | )                              |       |   | (76,294 | ) |   |   | (28,136 | ) |   |   | (114,680 | ) |   |
| Other income (expense):                                                |       |                             |       |                           |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Interest income                                                        |       |                             | 5,422      |                           |       |   | 1,424 |   |   |   | 10,670 |   |   |   | 2,679 |   |   |
| Interest expense                                                       |       |                             | (5,839     | )                              |       |   | (5,830 | ) |   |   | (11,681 | ) |   |   | (11,954 | ) |   |
| Loss on redemption of debt                                             |       |                             | —     |                           |       |   | — |   |   |   | — |   |   |   | (7,022 | ) |   |
| Equity in investee (losses)                                            |       |                             | (300       | )                              |       |   | (358 | ) |   |   | (468 | ) |   |   | (505 | ) |   |
| Other income (expense), net                                            |       |                             | 36         |                           |       |   | (71 | ) |   |   | (357 | ) |   |   | (88 | ) |   |
| Net loss                                                               |       |                             | $          | (7,400                         | )          |   |   | $ | (81,129 | ) |   |   | $ | (29,972 | ) |   |   | $ | (131,570 | ) |   |
| Basic and diluted net loss per common share                            |       |                             | $          | (0.07                          | )          |   |   | $ | (0.93 | ) |   |   | $ | (0.29 | ) |   |   | $ | (1.53 | ) |   |
| Shares used in computing  basic and diluted net loss per common share: |       |                             |       |                           |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Basic and diluted                                                      |       |                             | 104,686    |                           |       |   | 86,797 |   |   |   | 104,118 |   |   |   | 86,006 |   |   |

 

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

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**SEPRACOR INC.CONSOLIDATED STATEMENTS OF CASHFLOWS(Unaudited)(In Thousands)**
| ** **                                                                   | ** ** | **Six Months Ended** | ** ** |
|------------------------------------------------------------------------------|------------|--------------------------------|------------|
| ** **                                                                   | ** ** | **June 30, 2005**    | ** ** | **June 30, 2004** | ** ** |
| Cash flows from  operating activities:                                       |       |                           |       |   |   |   |   |   |   |
| Net loss                                                                     |       |                           | $          | (29,972 | ) |   |   | $ | (131,570 | ) |   |
| Adjustments to reconcile  net loss to net cash used in operating activities: |       |                           |       |   |   |   |   |   |   |
| Depreciation and amortization                                                |       |                           | 8,280      |   |   |   | 8,961 |   |   |
| Equity in investee losses                                                    |       |                           | 468        |   |   |   | 505 |   |   |
| Loss on patent impairment                                                    |       |                           | —     |   |   |   | 374 |   |   |
| Loss on redemption of debt                                                   |       |                           | —     |   |   |   | 7,022 |   |   |
| Loss on asset disposal                                                       |       |                           | 377        |   |   |   | — |   |   |
| Changes in operating  assets and liabilities:                                |       |                           |       |   |   |   |   |   |   |
| Accounts receivable                                                          |       |                           | (42,306    | ) |   |   | 5,689 |   |   |
| Inventories                                                                  |       |                           | (6,066     | ) |   |   | (9,030 | ) |   |
| Other current assets                                                         |       |                           | (4,610     | ) |   |   | (618 | ) |   |
| Accounts payable                                                             |       |                           | 533        |   |   |   | 5,919 |   |   |
| Accrued expenses                                                             |       |                           | (18,610    | ) |   |   | (13,393 | ) |   |
| Other current liabilities                                                    |       |                           | 25,001     |   |   |   | 3,316 |   |   |
| Other liabilities                                                            |       |                           | —     |   |   |   | 30,768 |   |   |
| Net cash used in  operating activities                                       |       |                           | (66,905    | ) |   |   | (92,057 | ) |   |
| Cash flows from  investing activities:                                       |       |                           |       |   |   |   |   |   |   |
| Purchases of short and long-term investments                                 |       |                           | (624,443   | ) |   |   | (192,410 | ) |   |
| Sales and maturities of short and long-term  investments                     |       |                           | 327,155    |   |   |   | 106,291 |   |   |
| Additions to property and equipment                                          |       |                           | (6,431     | ) |   |   | (5,415 | ) |   |
| Investment in ACADIA                                                         |       |                           | (7,143     | ) |   |   | — |   |   |
| Change in other assets                                                       |       |                           | 697        |   |   |   | 53 |   |   |
| Net cash used in  investing activities                                       |       |                           | (310,165   | ) |   |   | (91,481 | ) |   |
| Cash flows from  financing activities:                                       |       |                           |       |   |   |   |   |   |   |
| Redemption of convertible subordinated notes                                 |       |                           | —     |   |   |   | (433,709 | ) |   |
| Net proceeds from issuance of common stock                                   |       |                           | 27,718     |   |   |   | 34,198 |   |   |
| Proceeds from sale of convertible subordinated debt                          |       |                           | —     |   |   |   | 150,000 |   |   |
| Costs associated with sale of convertible  subordinated debt                 |       |                           | —     |   |   |   | (4,125 | ) |   |
| Settlement of call spread options                                            |       |                           | 123,798    |   |   |   | 50,006 |   |   |
| Repayments of long-term debt and capital  leases                             |       |                           | (930       | ) |   |   | (356 | ) |   |
| Net cash provided  by (used in) financing activities                         |       |                           | 150,586    |   |   |   | (203,986 | ) |   |
| Effect of  exchange rate changes on cash and cash equivalents                |       |                           | 26         |   |   |   | 162 |   |   |
| Net decrease in  cash and cash equivalents                                   |       |                           | (226,458   | ) |   |   | (387,362 | ) |   |
| Cash and cash  equivalents at beginning of period                            |       |                           | $          | 435,905 |   |   |   | $ | 705,802 |   |   |
| Cash and cash  equivalents at end of period                                  |       |                           | $          | 209,447 |   |   |   | $ | 318,440 |   |   |
| Non cash activities:                                                         |       |                           |       |   |   |   |   |   |   |
| Additions to  capital leases                                                 |       |                           | —     |   |   |   | $ | 4,707 |   |   |

 

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

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**NOTESTO CONDENSED CONSOLIDATED INTERIM FINANCIAL STATEMENTS**

**1.   Basis of Presentation**

The accompanying condensed consolidated interimfinancial statements are unaudited and have been prepared on a basissubstantially consistent with the audited financial statements. Certaininformation and footnote disclosures normally included in our annual financialstatements have been condensed or omitted. The year-end consolidated balancesheet data was derived from audited financial statements but does not include alldisclosures required by generally accepted accounting principles. Theconsolidated interim financial statements, in the opinion of our management,reflect all adjustments (consisting of normal recurring accruals) necessary fora fair presentation of the results for the interim periods ended June 30,2005 and 2004.

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

The consolidated results of operations for the interimperiods are not necessarily indicative of the results of operations to beexpected for the fiscal year. These condensed consolidated interim financialstatements should be read in conjunction with the audited financial statementsfor the year ended December 31, 2004, which are contained in our annualreport on Form 10-K for the year ended December 31, 2004, filed withthe Securities and Exchange Commission, or SEC.

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

**2.   RecentAccounting Pronouncements**

In November 2004, the Financial AccountingStandards Board, or FASB, issued Statement of Financial Accounting Standards,or SFAS, No. 151, “Inventory Costs—an amendment of ARB No. 43,Chapter 4,” or SFAS No. 151, in an effort to conform U.S. accountingstandards for inventories to International Accounting Standards. SFAS No. 151requires idle facility expenses, freight, handling costs and wasted material(spoilage) costs to be recognized as current-period charges. It alsorequires that the allocation of fixed production overheads to the costs ofconversion be based on the normal capacity of the relevant productionfacilities. SFAS No. 151 will be effective for inventory costs incurredduring fiscal years beginning after June 15, 2005. We do not expect theadoption of SFAS No. 151 to have a material impact on our financialcondition or our results of operations.

In December 2004, the FASB issued SFAS No. 123(R),“Share-Based Payment”, which replaces SFAS No. 123, “Accounting forStock-Based Compensation,” and supersedes Accounting Principles BoardOpinion No. 25, “Accounting for Stock Issued to Employees”, or APB 25.SFAS No. 123(R) requires compensation costs relating to share-basedpayment transactions be recognized in financial statements, as well as moreextensive disclosures concerning stock options than required under currentguidance. The new rule applies to option grants made after adoption aswell as options that are not vested at the date of adoption. The pro formadisclosure previously permitted under SFAS No. 123 will no longer be anacceptable alternative to recognition of expenses in the financial statements.The SEC recently approved a rule delaying the implementations of SFAS No. 123(R) untilthe first annual reporting period that begins after June 15, 2005. Wecurrently measure compensation costs related to share-based paymentsunder APB 25, as allowed by SFAS No. 123, and provide disclosure in notesto financial statements as required 

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by SFAS No. 123. Weare required to adopt SFAS No. 123(R) starting in the first fiscalquarter of 2006. We expect the adoption of SFAS No. 123(R) to have amaterial adverse impact on our results of operations and net income per share.We are currently in the process of evaluating the extent of such impact. We donot anticipate adopting SFAS No. 123(R) early and are currentlyevaluating whether we will implement SFAS No. 123(R) prospectively orwhether we will restate prior periods.

In December 2004, the FASB issued SFAS No. 153**,** “Exchanges of Nonmonetary Assets—anamendment of APB Opinion No. 29.” The amendments made by SFAS No. 153are based on the principle that exchanges of nonmonetary assets should bemeasured based on the fair value of the assets exchanged. The amendment alsoeliminates the narrow exception for nonmonetary exchanges of similar productiveassets and replaces it with a broader exception for exchanges of nonmonetaryassets that do not have commercial substance. The provisions of SFAS No. 153are effective for nonmonetary asset exchanges occurring in fiscal periodsbeginning after June 15, 2005. We do not expect the adoption of SFAS No. 153to have a material impact on our financial condition or our results ofoperations.

In May 2005, the FASBissued SFAS No. 154, “Accounting Changes and Error Corrections—areplacement of APB Opinion No. 20 and FASB Statement No. 3.” Thisstatement changes the requirements for the accounting for and reporting of achange in accounting principle and applies to all voluntary changes inaccounting principle. It also applies to changes required by an accountingpronouncement in the unusual instance that the pronouncement does not includespecific transition provisions. When a pronouncement includes specifictransition provisions, those provisions should be followed. APB No. 20required that most voluntary changes in accounting principle be recognized byincluding in net income of the period of the change the cumulative effect ofchanging to the new accounting principle. This statement requires retrospectiveapplication to prior period financial statements of changes in accountingprinciple, unless it is impracticable to determine either the period-specificeffects or the cumulative effect of the change. The provisions of SFAS 154 areeffective for fiscal years beginning after December 15, 2005. We do notexpect this statement to have a material impact on our financial condition orour results of operations.

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

Basic earnings (loss) per share, or EPS, excludesdilution and is computed by dividing net income by the weighted-averagenumber of common shares outstanding for the period. Diluted EPS is based uponthe weighted average number of common shares outstanding during the period plusthe additional weighted average common equivalent shares during the period.Common equivalent shares are not included in the per share calculation when theeffect of their inclusion would be anti-dilutive. Common equivalent sharesresult from the assumed conversion of preferred stock, convertible subordinateddebt and the assumed exercise of outstanding stock options, the proceeds ofwhich are then assumed to have been used to repurchase outstanding stockoptions using the treasury stock method. Purchased call options are also notincluded in the per share calculations because including them would beanti-dilutive.

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For the three andsix months ended June 30, 2005 and 2004, basic and diluted net loss percommon share is computed based on the weighted-average number of commonshares outstanding during the period because the effect of common stockequivalents would be anti-dilutive. Certain securities were not included in thecomputation of diluted earnings per share for the three and six months ended June 30,2005 and 2004 because they would have an anti-dilutive effect due to net lossesfor such periods. These excluded securities include the following:

a.                 Optionsto purchase shares of common stock:
| ** **            | ** ** | **June 30, 2005**                                                   | ** ** | **June 30, 2004** | ** ** |
|-----------------------|------------|-------------------------------------------------------------------------------|------------|-----------------------------|------------|
| ** **            | ** ** | **(in thousands, except price per share data)** | ** ** |
| Number of options     |       |                                                                          | 11,625     |                        |       |   | 12,189 |   |   |
| Price range per share |       |                                                                          | $          | 5.75 to $87.50              |       |   |   | $ | 2.63 to $87.50 |   |   |
|                       |            |                                                                               |            |                             |            |  |  |  |  |  |  |

 

b.                Sharesof common stock reserved for issuance upon conversion of convertiblesubordinated debt:
| ** **                                                            | ** ** | **June 30, 2005** | ** ** | **June 30, 2004** | ** ** |
|-----------------------------------------------------------------------|------------|-----------------------------|------------|-----------------------------|------------|
| ** **                                                            | ** ** | **(in thousands)**     | ** ** |
| 5% convertible  subordinated debentures due 2007                 |       |                        | 4,763      |                        |       |   | 4,763 |   |   |
| 0% Series A  convertible senior subordinated notes due 2008 |       |                        | 2,283      |                        |       |   | 7,839 |   |   |
| 0% Series B  convertible senior subordinated notes due 2010 |       |                        | 4,961      |                        |       |   | 16,756 |   |   |
| Total                                                                 |       |                        | 12,007     |                        |       |   | 29,358 |   |   |

 

We have issued 0%convertible subordinated notes due 2024, which were not convertible as of June 30,2005 or at any time during the three or six months ended June 30, 2005.Once these notes become convertible, shares of common stock will be reservedunder the conversion formula for issuance upon conversion if and when ourcommon stock price exceeds $67.20 per share on the Nasdaq National Market.Prior to such occurrence, the notes are only convertible into cash.

**4.   Accountingfor Stock-Based Compensation**

We have elected to follow APB 25, “Accounting forStock Issued to Employees”, and related interpretations, in accounting for ourstock-based compensation plans, rather than the alternative fair valueaccounting method provided for under SFAS No. 123, “Accounting for Stock-BasedCompensation”. Under APB 25, when the exercise price of options granted underthese plans equals the market price of the underlying stock on the date ofgrant, no compensation expense is recognized.

Thefollowing table illustrates the effect on net loss and loss per share if we hadapplied the fair value recognition provisions of SFAS No. 123 to stock-basedemployee compensation:
| ** **                                                                                                | ** ** | **Three Months Ended**                                   | ** ** | **Six Months Ended** | ** ** |
|-----------------------------------------------------------------------------------------------------------|------------|--------------------------------------------------------------------|------------|--------------------------------|------------|
| ** **                                                                                                | ** ** | **June 30,  2005**                                            | ** ** | **June 30,  2004**        | ** ** | **June 30,  2005** | ** ** | **June 30,  2004** | ** ** |
| ** **                                                                                                | ** ** | **(in thousands, except per share data)** | ** ** |
| Net loss  attributable to common stockholders                                                             |       | $                                                                  | (7,400     | )                              | $          | (81,129 | ) | $ | (29,972 | ) | $ | (131,570 | ) |
| Total stock-based  employee compensation expense determined under fair value based method for  all awards |       | (12,279                                                            | )          | (11,757                        | )          | (24,132 | ) | (22,795 | ) |
| Pro forma net  loss                                                                                       |       | $                                                                  | (19,679    | )                              | $          | (92,886 | ) | $ | (54,104 | ) | $ | (154,365 | ) |
| Net loss per common  share:                                                                               |       |                                                               |       |                           |       |   |   |   |   |
| Basic and  diluted—as reported                                                                       |       | $                                                                  | (0.07      | )                              | $          | (0.93 | ) | $ | (0.29 | ) | $ | (1.53 | ) |
| Basic and diluted—pro  forma                                                                         |       | $                                                                  | (0.19      | )                              | $          | (1.07 | ) | $ | (0.52 | ) | $ | (1.79 | ) |

 

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**5.   Inventories**

Inventoriesconsist of the following:
| ** **       | ** ** | **June 30,  2005** | ** ** | **December 31,  2004** | ** ** |
|------------------|------------|-------------------------|------------|-----------------------------|------------|
| ** **       | ** ** | **(in thousands)** | ** ** |
| Raw materials    |       | $                       | 7,568      |                        |       | $ | 3,905 |   |   |
| Work in progress |       | 618                     |       |                        | 292        |   |   |
| Finished goods   |       | 10,783                  |       |                        | 8,889      |   |   |
| Total            |       | $                       | 18,969     |                        |       | $ | 13,086 |   |   |

 

We expense costs relatingto inventory until such time as we receive an approval letter from the UnitedStates Food and Drug Administration, or FDA, for a new product, and then webegin to capitalize the inventory costs for subsequent purchases or production relatingto that product. As a result of this policy, we capitalized $1,394,000 of XOPENEXHFATM MDI raw material inventory purchased and produced during the secondquarter of 2005.

**6.   Patentsand Deferred Financing Costs**

Thefollowing schedule details the carrying value of our patents and deferredfinancing costs:
| ** **                     | ** ** | **June 30,  2005** | ** ** | **December 31,  2004** | ** ** |
|--------------------------------|------------|-------------------------|------------|-----------------------------|------------|
| ** **                     | ** ** | **(in thousands)** | ** ** |
| Deferred finance  costs, gross |       | $                       | 34,440     |                        |       | $ | 34,440 |   |   |
| Accumulated  amortization      |       | (13,006                 | )          |                        | (11,200    | ) |   |
| Deferred finance  costs, net   |       | $                       | 21,434     |                        |       | $ | 23,240 |   |   |
| Patents, gross                 |       | $                       | 5,807      |                        |       | $ | 6,439 |   |   |
| Accumulated  amortization      |       | (2,670                  | )          |                        | (2,644     | ) |   |
| Patents, net                   |       | $                       | 3,137      |                        |       | $ | 3,795 |   |   |

 

Thefollowing schedule details our amortization expense related to patents anddeferred financing costs:
| ** **                              | ** ** | **Three Months Ended** | ** ** | **Six Months Ended** | ** ** |
|-----------------------------------------|------------|----------------------------------|------------|--------------------------------|------------|
| ** **                              | ** ** | **June 30,  2005**          | ** ** | **June 30,  2004**        | ** ** | **June 30,  2005** | ** ** | **June 30,  2004** | ** ** |
| ** **                              | ** ** | **(in thousands)**          | ** ** |
| Amortization of  deferred finance costs |       |                             | $          | 903                            |       |   |   | $ | 1,326 |   |   |   | $ | 1,806 |   |   |   | $ | 2,706 |   |   |
| Amortization of  patents                |       |                             | 137        |                           |       |   | 174 |   |   |   | 290 |   |   |   | 348 |   |   |
| Total                                   |       |                             | $          | 1,040                          |       |   |   | $ | 1,500 |   |   |   | $ | 2,096 |   |   |   | $ | 3,054 |   |   |

 

We currently estimate thatour amortization expense will be $2,078,000, $4,201,000, $2,564,000, $2,208,000and $1,807,000 for the remainder of 2005 and for the years ending December 31,2006, 2007, 2008 and 2009, respectively.

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**7.   ConvertibleSubordinated Debt**

Convertiblesubordinated debt consists of the following:
| ** **                                                  | ** ** | **June 30,  2005** | ** ** | **December 31,  2004** | ** ** |
|-------------------------------------------------------------|------------|-------------------------|------------|-----------------------------|------------|
| ** **                                                  | ** ** | **(in thousands)** | ** ** |
| 5% convertible subordinated  debentures due 2007            |       | $                       | 440,000    |                        | $          | 440,000 |   |
| 0% Series A  convertible senior subordinated notes due 2008 |       | 72,800                  |       | 72,800                      |       |
| 0% Series B  convertible senior subordinated notes due 2010 |       | 148,020                 |       | 148,020                     |       |
| 0% convertible  senior subordinated notes due 2024          |       | 500,000                 |       | 500,000                     |       |
| Total                                                       |       | $                       | 1,160,820  |                        | $          | 1,160,820 |   |

 

**8.   Equity**

In December 2003, we used approximately$94,820,000 of the proceeds from the issuance of 0% Series A convertiblesenior subordinated notes due 2008 and 0% Series B convertible seniorsubordinated notes due 2010 to purchase call spread options on our commonstock. The first series of settled options expired at various dates beginningon May 12, 2004 and ending on June 9, 2004, the second series ofoptions expired at various dates beginning on November 11, 2004 and endingon December 9, 2004, and the third series of options expired at variousdates beginning on May 12, 2005 and ending on June 9, 2005. Wereceived proceeds on these series of settled options of $50,006,000, $74,327,000and $123,798,000, respectively, which were recorded as an increase toadditional paid-in capital. Our remaining outstanding call spread optionsexpire at various dates beginning November 11, 2005 and ending on December 9,2005, and we have the option to settle them in either net shares or in cash. Wecurrently expect to settle these call spread options for cash, although theamount we receive upon settlement, if any, will vary based on the price of ourcommon stock on the option expiration dates. Proceeds from a cash settlement ofthese options are calculated based on the difference between our stock priceand the option price if our stock price is below the cap price or thedifference between the cap price and the option price if our stock priceexceeds the cap price. Any cash received in settlement of the remaining callspread options will be recorded as additional paid-in capital.

Thefollowing table sets forth the potential proceeds from our remaining callspread options if settled in cash using the closing price of our common stockon July 29, 2005 of $52.35:
| **Expiration period**                            | ** ** | ** ** | ** ** | **Number of  Options** | ** ** | **Option  Price** | ** ** | **Cap  Price** | ** ** | **Proceeds** | ** **  |
|-------------------------------------------------------|------------|------------|------------|-----------------------------|------------|-------------------|------------|----------------|------------|--------------|-------------|
| November 11,  2005 through December 9, 2005 |       | 4,919,496  |       | $                           | 29.84      |              | $          | 65.00          |       | $            | 110,738,000 |   |
|                                                       |            |            |            |                             |            |                   |            |                |            |              |             |  |  |  |

 

**9.   Comprehensive**Income (Loss)

Totalcomprehensive income (loss) consists of net loss, net foreign currencytranslation adjustments and net unrealized gain (loss) on available-for-salesecurities.
| ** **                                                   | ** ** | **Three Months Ended** | ** ** | **Six Months Ended** | ** ** |
|--------------------------------------------------------------|------------|----------------------------------|------------|--------------------------------|------------|
| ** **                                                   | ** ** | **June 30,  2005**          | ** ** | **June 30,  2004**        | ** ** | **June 30,  2005** | ** ** | **June 30,  2004** | ** ** |
| ** **                                                   | ** ** | **(in thousands)**          | ** ** |
| Comprehensive income  (loss):                                |       |                             |       |                           |       |   |   |   |   |
| Net loss                                                     |       | $                                | (7,400     | )                              | $          | (81,129 | ) | $ | (29,972 | ) | $ | (131,570 | ) |
| Net foreign  currency translation adjustment                 |       | (186                             | )          | 5                              |       | (268 | ) | 825 |   |
| Net unrealized gain  (loss) on available-for-sale securities |       | 10,037                           |       | (7,182                         | )          | 8,552 |   | (3,413 | ) |
| Total comprehensive income  (loss)                           |       | $                                | 2,451      |                           | $          | (88,306 | ) | $ | (21,688 | ) | $ | (134,158 | ) |

 

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**10.   Commitments and Contingencies**

We enter into standard indemnification agreements inour ordinary course of business, under which we indemnify and hold harmlesscertain parties, including customers such as wholesalers, against claims,liabilities and losses brought by third parties to the extent that the claimsarise out of (1) injury or death to person or property caused by defectsin our products, (2) negligence in the manufacture or distribution of theproducts or (3) a material breach by us. We have no liabilities recordedfor these guarantees at June 30, 2005 and, if liabilities were incurred,we have insurance policies covering product liabilities, which would mitigateany losses.

We have agreements whereby we indemnify our officersand directors for certain events or occurrences while the officer or directoris, or was, serving at our request in such capacity. The term of theindemnification period is for the officer’s or director’s lifetime. The maximumpotential amount of future payments we could be required to make under theseindemnification agreements is unlimited; however, we believe the fair value ofthese indemnification agreements is minimal.

We and several of ourcurrent and former officers and a current director are named as defendants inseveral class action complaints which have been filed on behalf of certainpersons who purchased our common stock and/or debt securities during differenttime periods, beginning on various dates, the earliest being May 17, 1999,and all ending on March 6, 2002. These complaints allege violations of theSecurities Exchange Act of 1934, as amended, and the rules and regulationspromulgated thereunder by the SEC. Primarily they allege that the defendantsmade certain materially false and misleading statements relating to thetesting, safety and likelihood of FDA approval of tecastemizole. On April 11,2003, two consolidated amended complaints were filed, one on behalf of thepurchasers of our common stock and the other on behalf of the purchasers of ourdebt securities. These consolidated amended complaints reiterate theallegations contained in the previously filed complaints and define the allegedclass periods as May 17, 1999 through March 6, 2002. We filed amotion to dismiss both consolidated amended complaints on May 27, 2003. OnMarch 11, 2004, the court, while granting in part the motion to dismiss,did allow much of the case to proceed. The parties are currently engaged indiscovery. We are unable to reasonably estimate any possible range of lossrelated to these lawsuits due to their uncertain resolution. However, anyconclusion of these matters in a manner adverse to us would have a materialadverse effect on our financial condition and business.

**11.   Investments**

On January 10, 2005, we entered into a license,option and collaboration agreement, or collaboration, with ACADIAPharmaceuticals Inc., or ACADIA, for the development of new drugcandidates targeted toward the treatment of central nervous system disorders.The collaboration has been established to investigate potential clinicalcandidates resulting from screening ACADIA’s medicinal chemistry compoundlibrary against a broad array of selective muscarinic receptors, which arereceptors that respond to acetylcholine, a neurotransmitter in the centralnervous system. The collaboration includes ACADIA’s m1 agonistprogram, which is designed to target neuropsychiatric/neurologic conditions andneuropathic pain. We have agreed to collaborate with each other to research anddevelop certain compounds that interact with these muscarinic receptors. We arepermitted to develop and commercialize these compounds in any field outside ofthe prevention or treatment of ocular disease. The agreement also includes anoption to select a preclinical program from ACADIA’s 5-HT2aprogram for use in combination with LUNESTA. 5-HT2aantagonists have been shown in clinical studies to affect sleep architecture inhumans. We will have exclusive worldwide rights to develop and commercializecompounds developed under our collaboration with ACADIA.

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During the three-year research term of the ACADIAcollaboration agreement, we will provide ACADIA with $2,000,000 of researchfunding each year, which will be recorded as research and development expense.In addition, we have agreed to make milestone payments to ACADIA upon theachievement by ACADIA of specified development and regulatory milestones foreach product developed under the collaboration, including any product to beused in combination with LUNESTA that is developed under the collaboration. Wehave also agreed to pay royalties to ACADIA on net worldwide sales of productsdeveloped under the collaboration.

In connection with the ACADIA collaboration, wepurchased 1,077,029 shares of ACADIA common stock for an aggregate purchaseprice of $10,000,000 based on a per share price of approximately $9.2848, whichrepresents a 40 percent premium to the average closing price for the 30trading days prior to the signing of the agreement. We recorded the premiumamount of $2,857,000 as research and development expense and the remainingamount of $7,143,000 as an investment in ACADIA, which we have classified as anavailable-for-sale security. We will adjust this investment to its fair valueat each reporting date with unrealized gains and losses recorded as a componentof accumulated other comprehensive income (loss). Subject to certainconditions, we also agreed to purchase up to an additional $10,000,000 ofACADIA common stock at a 25 percent premium to the trailing 30-dayaverage closing price per share as of the one-year anniversary of thesigning of the agreement.

On June 15, 2005,Vicuron Pharmaceuticals, Inc. entered into an agreement and plan ofmerger, or agreement, with Pfizer, Inc. Under the agreement, Pfizer agreedto purchase all outstanding shares of Vicuron for a purchase price of $29.10per share in cash. We own 687,766 shares of Vicuron common stock which we carryat fair market value. As of June 30, 2005, the fair market value of ourinvestment in Vicuron is approximately $19,189,000 which is included inshort-term investments on the consolidated balance sheet. The merger is subjectto certain closing conditions. Upon the closing of the merger, we will receiveapproximately $20,014,000 in cash from Pfizer, of which, approximately $18,345,000will be recorded as a gain on sale of investment and will be included in otherincome on the consolidated statements of operations.

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

**CautionaryStatement Regarding Forward-Looking Statements**

This quarterly report on Form 10-Qcontains, in addition to historical information, forward-lookingstatements within the meaning of Section 21E of the Securities ExchangeAct of 1934, as amended, which we refer to as the Exchange Act. These forward-lookingstatements involve risks and uncertainties and are not guarantees of futureperformance. Words such as “expect,” “anticipate,” “intend,” “plan,” “believe,”“seek,” “estimate” and variations of these words and similar expressions areintended to identify forward-looking statements. Our actual results coulddiffer significantly from the results we discuss in these forward-lookingstatements. These forward-looking statements represent our expectationsas of the date of this report. Subsequent events will cause our expectations tochange. However, while we may elect to update these forward-lookingstatements, we specifically disclaim any obligation to do so. See the sectionentitled “Factors Affecting Future Operating Results” below for a discussion ofimportant factors that could cause our actual results to differ materially fromthe results we discuss in our forward-looking statements.

**Executive Overview**

We are a research-based pharmaceutical companyfocused on the discovery, development and commercialization of differentiatedproducts that address large and growing markets and unmet medical needs, andcan be marketed to primary care physicians through our sales force.

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We currently manufacture and sell two products:XOPENEX® (levalbuterol HCl) Unit Dose Vial, or UDV, Inhalation Solution, ashort-acting bronchodilator, for the treatment or prevention ofbronchospasm in patients with reversible obstructive airway disease, such asasthma, and LUNESTATM (eszopiclone), for the treatment of insomnia. On March 11,2005, we received an approval letter from the United States Food and DrugAdministration, or FDA, for our New Drug Application, or NDA, for XOPENEX HFATM(levalbuterol tartrate) Inhalation Aerosol, a hydrofluoroalkane, or HFA,metered-dose inhaler, or MDI.

We market and sell XOPENEXUDV and LUNESTA directly through our sales force and we expect to market andsell XOPENEX HFA MDI, if commercialized, through our sales force. We haveentered into out-licensing arrangements with respect to several othercompounds. We expect to commercialize products that we successfully developthrough our sales force, through co-promotion agreements and throughout-licensing partnerships.

**Significant 2005 Developments**

During the second quarter of 2005, pursuant to callspread option agreements we entered into in December 2003, we settled4,919,496 call spread options for cash in the amount of $123,798,000. The settled options expired at various datesbeginning on May 12, 2005 and ending on June 9, 2005. We recorded thefull amount of the call spread option settlement as an increase to additionalpaid-in capital. Our remaining outstandingcall spread options expire at various dates beginning November 11, 2005and ending on December 9, 2005, and we have the option to settle them ineither net shares or in cash.

On April 4, 2005, we commercially launchedLUNESTA brand eszopiclone for the treatment of insomnia. On December 15,2004, we received approval from the FDA for our NDA for LUNESTA 1 mg, 2 mg and3 mg tablets for the treatment of insomnia. The recommended dosing to improvesleep onset and/or maintenance is 2 mg or 3 mg for adult patients (ages 18 to64). In older adult patients (ages 65 and older), 2 mg is recommended forimprovement in sleep onset and/or maintenance while the 1 mg dose isrecommended for sleep onset in older adult patients whose primary complaint isdifficulty falling asleep.

On March 11, 2005, we received approval from theFDA for our XOPENEX HFA MDI. On May 12, 2004, we submitted our NDA to theFDA for XOPENEX HFA MDI for the treatment or prevention of bronchospasm inadults, adolescents and children 4 years of age and older with reversibleobstructive airway disease. MDIs are hand-held, pressurized canisters that deliverinhaled medications directly to the lungs. We are working to resolveoutstanding manufacturing issues and to complete process validation work.Contingent upon successful resolution of these issues, we are targetingcommercial launch of the product by the end of 2005. If we are unable toresolve manufacturing issues or complete process validation for XOPENEX HFAMDI, then commercialization of this product candidate could be delayed orterminated, which would have a material adverse effect on our business. Wecapitalized $1,394,000 of XOPENEX HFA MDI raw material inventory purchased andproduced during the second quarter of 2005. Under our supply agreement withMinnesota Mining and Manufacture Company, or 3M, and 3M Innovative PropertiesCompany, we are obligated to pay to 3M a combination of a fixed price per unitof product purchased and a percentage royalty based on our net sales of XOPENEXHFA MDI.

On January 10, 2005, we entered into a license,option and collaboration agreement, or collaboration, with ACADIAPharmaceuticals Inc., or ACADIA, for the development of new drugcandidates targeted toward the treatment of central nervous system disorders.The collaboration has been established to investigate potential clinicalcandidates resulting from screening ACADIA’s medicinal chemistry compoundlibrary against a broad array of selective muscarinic receptors, which arereceptors that respond to acetylcholine, a neurotransmitter in the centralnervous system. The collaboration includes ACADIA’s m1 agonist program,which is designed to target neuropsychiatric/neurologic conditions andneuropathic pain. We have agreed to collaborate with each other to research anddevelop certain compounds that interact with these muscarinic receptors. We arepermitted to develop and commercialize these 

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compounds in any fieldoutside of the prevention or treatment of ocular disease. The agreement alsoincludes an option to select a preclinical program from ACADIA’s 5-HT2aprogram for use in combination with LUNESTA. 5-HT2a antagonists havebeen shown in clinical studies to affect sleep architecture in humans. We willhave exclusive worldwide rights to develop and commercialize compoundsdeveloped under our collaboration with ACADIA.

During the three-year research term of the collaborationagreement, we will provide ACADIA with $2,000,000 of research funding eachyear, which will be recorded as research and development expense. In addition,we have agreed to make milestone payments to ACADIA upon the achievement byACADIA of specified development and regulatory milestones for each productdeveloped under the collaboration, including any product to be used incombination with LUNESTA that is developed under the collaboration. We havealso agreed to pay royalties to ACADIA on net worldwide sales of productsdeveloped under the collaboration.

In connection with thecollaboration, we purchased 1,077,029 shares of ACADIA common stock for anaggregate purchase price of $10,000,000 based on a per share price ofapproximately $9.2848, which represents a 40 percent premium to theaverage closing price for the 30 trading days prior to the signing of theagreement. We recorded the premium amount of $2,857,000 as research anddevelopment expense and the remaining amount of $7,143,000 as an investment inACADIA, which we have classified as an available-for-sale security and willadjust to its fair value at each reporting date with unrealized gains andlosses recorded as a component of accumulated other comprehensive income(loss). Subject to certain conditions, we also agreed to purchase up to anadditional $10,000,000 of ACADIA common stock at a 25 percent premium tothe trailing 30-day average closing price per share as of the one-yearanniversary of the signing of the agreement.

**Critical Accounting Policies**

We identified criticalaccounting policies in our annual report on Form 10-K for the year ended December 31,2004. These critical accounting policies relate to product revenue recognition,royalty revenue recognition, rebate and return reserves, patents, intangiblesand other assets, accounts receivable and bad debt, income taxes, inducedconversion of debt and inventory write-downs. These policies require usto make estimates in the preparation of our financial statements as of a givendate. Because of the uncertainty inherent in these matters, our actual resultscould differ from the estimates we use in applying the critical accountingpolicies. No changes to these critical accounting policies have taken placesince December 31, 2004.

**ThreeMonth Periods ended June 30, 2005 and 2004**

*Revenues*

Product sales were $166,743,000 and $57,450,000 forthe three months ended June 30, 2005 and 2004, respectively, an increaseof approximately 190%, primarily because of the commercial introduction ofLUNESTA brand eszopiclone in April 2005.

Sales of LUNESTA were $83,459,000 for the three monthsended June 30, 2005 as compared to $0 for the same period in 2004. Weexpect that sales of LUNESTA will decrease in the third quarter of 2005 aspharmacies sell through their initial orders.

Sales of XOPENEX UDV were $83,284,000 as compared to$57,450,000 for the same period in 2004, an increase of approximately 45%. Thesales increase for XOPENEX UDV for the three months ended June 30, 2005 ascompared with the same period in 2004 is due to unit sales growth of 31% and an11% increase in the net selling price per unit. The 31% increase in unit salesis a result of increased market growth and higher market shares, particularlyin the hospital and home health care market sectors. The 

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11% increase in the netselling price per unit is due to a gross unit price increase of approximately7% and a decrease in sales rebates and allowances. The decrease in salesrebates and allowances is primarily attributable to favorable reimbursementrate changes, as mandated by the Medicare Prescription Drug Improvement andModernization Act of 2003, in the home health care market sector. FavorableMedicare reimbursement has resulted in a decrease in the rebates we pay to homehealth care providers. We cannot be certain whether, or for how long, thisfavorable reimbursement rate will remain in effect.

Royalties and otherrevenue were $18,321,000 and $12,517,000 for the three months ended June 30,2005 and 2004, respectively, an increase of approximately 46%. The increase forthe three months ended June 30, 2005 as compared with the same period in2004 is primarily due to an increase in royalties earned on sales of ALLEGRA®under our agreement with sanofi-aventis, which were $14,379,000 for the threemonths ended June 30, 2005 as compared with $7,537,000 for the threemonths ended June 30, 2004, with the majority of the increase occurring inJapan. Royalties earned on sales of CLARINEX®, under our agreement withSchering-Plough Corporation, and from sales of XYZAL®/XUSALTM, under ouragreement with UCB Farchim SA, also increased. These increases were offset bydecreases in other revenue earned from MedPointe related to our promotion ofASTELIN®, which were $0 for the three months ended June 30, 2005 comparedto $2,774,000 for the three months ended June 30, 2004. We terminated ouragreement with MedPointe in October 2004.

*Costs of Revenues*

Cost of products sold was $14,453,000 and $6,821,000for the three months ended June 30, 2005 and 2004, respectively.

Cost of LUNESTA sold as a percentage of LUNESTA saleswas approximately 7%, with the largest portion being the royalty paid on netsales of LUNESTA to a third party. In accordance with our accounting policies,we do not begin to capitalize product manufacturing costs as inventory untilthe NDA receives approval by the FDA. Therefore, we expect costs of LUNESTAsold as a percentage of LUNESTA sales to increase after we have sold throughall of our product for which we have not capitalized manufacturing costs. Weexpect this to occur around the beginning of 2006.

Cost of XOPENEX UDV sold as a percentage of XOPENEXUDVsales was approximately 10% for the three months ended June 30, 2005 ascompared to 12% for the same period in 2004. This decrease was due to a lowermanufacturing cost per unit which resulted from an increase in the number ofunits of XOPENEX UDV produced.

Cost of royalties earnedwas $202,000 and $109,000 for the three months ended June 30, 2005 and2004, respectively. The cost of royalties in both periods relates to anobligation to a third-party as a result of royalties we received fromSchering-Plough Corporation based upon its sales of CLARINEX and isdirectly related to the increase in royalties received in the three monthsended June 30, 2005.

*Research andDevelopment*

Research and development expenses were $37,132,000 and$45,077,000 for the three months ended June 30, 2005 and 2004,respectively, a decrease of approximately 18%. The decrease in the three monthsended June 30, 2005 as compared with the same period in 2004 is primarilydue to our decreased spending on two of our late-stage programs, LUNESTA andarformoterol. We commercially launched LUNESTA on April 4, 2005, however,we continue to spend on Phase IIIB/IV studies under our LUNESTA program. Wehave completed Phase III clinical trials for arformoterol, targeted as amaintenance treatment for Chronic Obstructive Pulmonary Disease, or COPD, andare currently preparing an NDA that we anticipate submitting to the FDA by theend of 2005. Our decreased spending in these programs was partially offset byour increased spending on two of our early-stage programs, SEP-226330,targeted for the treatment of restless leg syndrome, and SEP-225289, targetedfor the treatment of depression.

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Drug development and approval in the United States isa multi-step process regulated by the FDA. The process begins with the filingof an Investigational New Drug Application, or IND, which, if successful,allows the opportunity for study in humans, or clinical study, of the potentialnew drug. Clinical development typically involves three phases of study: PhaseI, II and III. The most significant costs in clinical development are inthe Phase III clinical trials, as they tend to be the longest and largeststudies in the drug development process. Following successful completion ofPhase III clinical trials, an NDA must be submitted to, and accepted by, theFDA, and the FDA must approve the NDA prior to commercialization of the drug.As further discussed below, we currently have one product candidate in NDApreparation stage. Successful development of our product candidates is highlyuncertain. Completion dates and completion costs can vary significantly foreach product candidate and are difficult to predict. The lengthy process ofseeking FDA approvals, and subsequent compliance with applicable statutes andregulations, require expenditure of substantial resources. Any failure by us toobtain, or delay in obtaining, regulatory approvals could materially adverselyaffect our business. We cannot assure you that we will obtain any approvalrequired by the FDA on a timely basis, if at all.

For additional discussion of the risks anduncertainties associated with completing development of potential productcandidates, see “Factors Affecting Future Operating Results”.

Belowis a summary of development of our product and product candidates thatrepresent 10% or more of our direct project research and development spendingfor the three months ended June 30, 2005. The “Estimate of Completion ofPhase” column contains forward-looking statements regarding expectedtiming of completion of product development phases. Completion of productdevelopment, if successful, culminates in the submission of an NDA to the FDA.The actual timing of completion of phases could differ materially from theestimates provided in the table. The table is sorted by highest to lowestspending amounts, and the three product candidates listed accounted forapproximately 71% of our direct project research and development spending forthe three months ended June 30, 2005. No other product candidate accountedfor more than 6% of our direct research and development spending in thisperiod.
| **Product Candidate** | ** ** | ** **              | ** ** | **Indication**           | ** ** | **Stage of Development** | ** ** | **Estimate of  Completion of  Stage** | ** ** |
|----------------------------|------------|-------------------------|------------|--------------------------|------------|-------------------------------|------------|-------------------------------------------------|------------|
| XOPENEX HFA MDI            |       | Respiratory—Asthma |       | NDA  Approved            |       |                          | *          |                                            |       |
| LUNESTA                    |       | Insomnia                |       | NDA  Approved / Launched |       |                          | N/A        |                                            |       |
| Arformoterol               |       | Respiratory—COPD   |       | NDA Preparation          |       |                          | 2005       |                                            |       |

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*                    TheFDA approved XOPENEX HFA MDI on March 11, 2005. Contingent upon successfulresolution of outstanding manufacturing issues and completion of processvalidation work, we are targeting commercial launch of the product by the endof 2005.

Belowis a summary of expenditure information related to our product candidatesrepresenting 10% or more of our direct project research and developmentspending during the three months ended June 30, 2005, and 2004, as well asthe costs incurred to date on these projects. The costs in this analysisinclude only direct costs and do not include certain indirect labor, overheador other costs which benefit multiple projects. As a result, fully loadedresearch and development cost summaries by project are not presented.
| ** **      | ** ** | **Project costs for  the three  months ended  June 30, 2005** | ** ** | **Project costs to  date through  June 30, 2005** | ** ** | **Project costs for  the three  months ended  June 30, 2004** | ** ** | **Project costs to  date through  June 30, 2004** | ** ** |
|-----------------|------------|---------------------------------------------------------------------------------------------|------------|----------------------------------------------------------------------------|------------|---------------------------------------------------------------------------------------------|------------|----------------------------------------------------------------------------|------------|
| ** **      | ** ** | **(in thousands)**                                                                     | ** ** |
| XOPENEX HFA MDI |       |                                                                                        | $          | 8,049                                                                      |       |                                                                                        |       | $                                                                          | 145,992    |   |   |   | $ | 4,181 |   |   |   | $ | 123,214 |   |   |
| LUNESTA         |       |                                                                                        | $          | 6,152                                                                      |       |                                                                                        |       | $                                                                          | 189,715    |   |   |   | $ | 14,113 |   |   |   | $ | 155,380 |   |   |
| Arformoterol    |       |                                                                                        | $          | 4,641                                                                      |       |                                                                                        |       | $                                                                          | 151,956    |   |   |   | $ | 8,161 |   |   |   | $ | 134,821 |   |   |

 

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Due to the length of timenecessary to develop a product, uncertainties related to the ability to obtaingovernmental approval for commercialization and difficulty in estimating costsof projects, it is difficult to make accurate and meaningful estimates of theultimate cost to bring our product candidates to FDA approved status. We do notbelieve it is possible to estimate, with any degree of accuracy, the costs ofproduct candidates that are in stages earlier than Phase III. We estimate thatthe cost range to bring arformoterol from its current state to an NDA submissionis $5,000,000 to $10,000,000 based on a targeted NDA submission by the end of2005, provided that no significant delays are imposed by internal resourceconstraints or unanticipated FDA requirements.

*Selling, Marketingand Distribution*

Selling, marketing and distribution expenses were$130,148,000 and $86,355,000 for the three months ended June 30, 2005 and2004, respectively, an increase of approximately 51%. Of this increase,approximately 98% is due to an increase in marketing, advertising and promotioncosts in support of the commercial launch of LUNESTA, which took place in April 2005.Additionally, we incurred increased sales commission expense paid to internalsales representatives as a result of the 45% increase in XOPENEX UDV productsales for the three months ended June 30, 2005 as compared with the sameperiod in 2004. Partially offsetting these increases was a decrease in salescommission expense paid to Ross for the co-promotion of XOPENEX UDV, since weterminated our co-promotion agreement with Ross effective December 31,2004. These increases are partially off-set by decreases in travel expensesfrom the same period in 2004 which were related to hiring and training ourincreased sales force.

We expect selling,marketing and distribution expenses to continue to increase in connection withincreased sales of LUNESTA and in anticipation of commercial launch of XOPENEXHFA MDI, including a proposed sales force increase of approximately 175employees, commencement of marketing programs and an increase in salescommissions and distribution costs.

*General andAdministrative*

General and administrativecosts were $9,848,000 and $7,899,000 for the three months ended June 30,2005 and 2004, respectively, an increase of approximately 25%. The increase isprimarily due to payroll and related expenses resulting from an increase inpermanent and temporary employees and contracted service providers hired tosupport the commercialization of LUNESTA as well as increased legal feesrelated to two class action complaints pending against us.

*Other Income(Expense)*

Interest income was $5,422,000 and $1,424,000 for thethree months ended June 30, 2005 and 2004, respectively, an increase ofapproximately 281%. The increase is due to higher average balances of cash andshort- and long-term investments combined with an increase in theinterest rates earned on investments in 2005. Our monthly average cash andinvestment balance was approximately $835,537,000 and $517,705,000 for thethree months ended June 30, 2005 and 2004, respectively.

Interest expense was $5,839,000 and $5,830,000 for thethree months ended June 30, 2005 and 2004, respectively, an increase ofless than 1%. The slight increase is due to interest on capital leaseobligations, which were not in place for the full three-month period ended June 30,2004.

Equity in investee(losses) were ($300,000) and ($358,000) for the three months ended June 30,2005 and 2004, respectively, a decrease of approximately 16%. The lossrepresents our portion of BioSphere losses.

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**SixMonth Periods ended June 30, 2005 and 2004**

*Revenues*

Product sales were $273,391,000 and $142,506,000 forthe six months ended June 30, 2005 and 2004, respectively, an increase ofapproximately 92%, primarily as a result of the commercial introduction ofLUNESTA in April 2005.

Sales of LUNESTA were $83,459,000 for the six monthsended June 30, 2005 as compared to $0 for the same period in 2004. Weexpect that sales of LUNESTA will decrease in the third quarter of 2005 aspharmacies sell through their initial orders.

Sales of XOPENEX UDV were $189,932,000 as compared to$142,506,000 for the same period in 2004, an increase of 33%. The salesincrease for XOPENEX UDV for the six months ended June 30, 2005 ascompared with the same period in 2004 is due to unit volume sales growth of 19%and a 12% increase in the net selling price per unit. The 19% increase in unitsales is a result of increased market growth and higher market shares,particularly in the hospital and home health care market sector. The 12%increase in the net selling price per unit is due to a gross unit priceincrease of approximately 7% and a decrease in sales rebates and allowances.The decrease in sales rebates and allowances is primarily attributable tofavorable reimbursement rate changes, as mandated by the Medicare PrescriptionDrug Improvement and Modernization Act of 2003, in the home health care sectorof our business. Favorable Medicare reimbursement has resulted in a decrease inthe rebates we pay to home health care providers. We cannot be certain whether,or for how long, this favorable reimbursement rate will remain in effect.

Royalties and otherrevenue were $30,718,000 and $26,939,000 for the six months ended June 30,2005 and 2004, respectively, an increase of approximately 14%. The increase forthe six months ended June 30, 2005 as compared with the same period in2004 is primarily due to an increase in royalties earned on sales of ALLEGRAunder our agreement with sanofi-aventis, which were $23,657,000 for the sixmonths ended June 30, 2005 as compared with $17,914,000 for the six monthsended June 30, 2004, with the majority of the increase occurring in Japan.Royalties earned on sales of CLARINEX, under our agreement with Schering-PloughCorporation, and from sales of XYZAL/XUSAL, under our agreement with UCBFarchim SA, also increased. These increases were offset by a decrease in otherrevenue earned from MedPointe related to our promotion of ASTELIN, which were$0 for the six months ended June 30, 2005 compared to $3,895,000 for thesix months ended June 30, 2004. We terminated our agreement with MedPointein October 2004.

*Costs of Revenues*

Cost of products sold was $24,490,000 and $15,681,000for the six months ended June 30, 2005 and 2004, respectively.

Cost of LUNESTA sold as a percentage of LUNESTA saleswas approximately 7%, with the largest portion being the royalty paid on netsales of LUNESTA to a third party. In accordance with our accounting policies,we do not begin to capitalize product manufacturing costs as inventory untilthe NDA receives approval by the FDA. Therefore, we expect costs of LUNESTAsold as a percentage of LUNESTA sales to increase after we have sold throughall of our product for which we have not capitalized manufacturing costs. Weexpect this to occur around the beginning of 2006.

Cost of XOPENEX UDV sold as a percentage of XOPENEXUDV sales was approximately 10% for the six months ended June 30, 2005 ascompared to 11% for the same period in 2004. This decrease was due to a lowermanufacturing cost per unit which resulted from an increase in the number ofunits of XOPENEX UDV produced.

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Cost of royalties earnedwas $405,000 and $349,000 for the six months ended June 30, 2005 and 2004,respectively, an increase of approximately 16%. The cost of royalties in bothperiods relates to an obligation to a third-party as a result ofroyalties we received from Schering-Plough Corporation based upon itssales of CLARINEX.

*Research andDevelopment*

Research and development expenses were $65,701,000 and$82,373,000 for the six months ended June 30, 2005 and 2004, respectively,a decrease of approximately 20%. The decrease in the six months ended June 30,2005 as compared with the same period in 2004 is primarily due to our decreasedspending on two of our late-stage programs, LUNESTA and arformoterol. Wecommercially launched LUNESTA on April 4, 2005. However, we continue tospend on Phase IIIB/IV studies under our LUNESTA program. We have completedPhase III clinical trials for arformoterol, targeted as a maintenance treatmentfor Chronic Obstructive Pulmonary Disease, or COPD, and are currently preparingan NDA that we anticipate submitting to the FDA by the end of 2005. Ourdecreased spending in these programs was partially offset by our increasedspending on two of our early-stage programs, SEP-226330, targeted for thetreatment of restless leg syndrome, and SEP-225289, targeted for the treatmentof depression.

Belowis a summary of development of our products and product candidates thatrepresent 10% or more of our direct project research and development spendingfor the six months ended June 30, 2005 and 2004. The “Estimate ofCompletion of Phase” column contains forward-looking statements regardingexpected timing of completion of product development phases. Completion ofproduct development, if successful, culminates in the submission of an NDA tothe FDA. The actual timing of completion of phases could differ materially fromthe estimates provided in the table. The table is sorted by highest to lowestspending amounts, and the two product candidates listed accounted forapproximately 70% of our direct project research and development spending forthe six months ended June 30, 2005. No other product candidate accountedfor more than 6% of our direct research and development spending in thisperiod.
| **Product Candidate** | ** ** | ** **              | ** ** | **Indication**          | ** ** | **Stage of Development** | ** ** | **Estimate of  Completion of  Stage** | ** ** |
|----------------------------|------------|-------------------------|------------|-------------------------|------------|-------------------------------|------------|-------------------------------------------------|------------|
| XOPENEX HFA MDI            |       | Respiratory—Asthma |       | NDA  Approved           |       |                          | *          |                                            |       |
| Arformoterol               |       | Respiratory—COPD   |       | NDA  Preparation        |       |                          | 2005       |                                            |       |
| LUNESTA                    |       | Insomnia                |       | NDA Approved / Launched |       |                          | N/A        |                                            |       |

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*                    TheFDA approved XOPENEX HFA MDI on March 11, 2005. Contingent upon successfulresolution of outstanding manufacturing issues and completion of processvalidation work, we are targeting commercial launch of the product by the endof 2005.

Belowis a summary of expenditure information related to our product candidatesrepresenting 10% or more of our direct project research and developmentspending during the six months ended June 30, 2005, as well as the costsincurred to date on these projects. The costs in this analysis include onlydirect costs and do not include certain indirect labor, overhead or other costswhich benefit multiple projects. As a result, fully loaded research anddevelopment cost summaries by project are not presented.
| ** **      | ** ** | **Project costs for  the six  months ended  June 30, 2005** | ** ** | **Project costs to  date through  June 30, 2005** | ** ** | **Project costs for  the six  months ended  June 30, 2004** | ** ** | **Project costs to  date through  June 30, 2004** | ** ** |
|-----------------|------------|-------------------------------------------------------------------------------------------|------------|----------------------------------------------------------------------------|------------|-------------------------------------------------------------------------------------------|------------|----------------------------------------------------------------------------|------------|
| ** **      | ** ** | **(in thousands)**                                                                   | ** ** |
| XOPENEX HFA MDI |       |                                                                                      | $          | 13,295                                                                     |       |                                                                                      |       | $                                                                          | 145,992    |   |   |   | $ | 12,451 |   |   |   | $ | 123,214 |   |   |
| Arformoterol    |       |                                                                                      | $          | 8,437                                                                      |       |                                                                                      |       | $                                                                          | 151,956    |   |   |   | $ | 16,697 |   |   |   | $ | 134,821 |   |   |
| LUNESTA         |       |                                                                                      | $          | 6,152                                                                      |       |                                                                                      |       | $                                                                          | 189,715    |   |   |   | $ | 19,650 |   |   |   | $ | 155,380 |   |   |

 

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*Selling, Marketing and Distribution*

Selling, marketing anddistribution expenses were $223,320,000 and $170,789,000 for the six monthsended June 30, 2005 and 2004, respectively, an increase of approximately31%. Included in the six months ended June 30, 2004 is an accrual for$30,671,000, which represents the then-current value of termination paymentstotaling $33,000,000 that we will make to the Ross Products Division of AbbottLaboratories, or Ross. Approximately 73% of the increase, excluding the currentvalue of the Ross termination payments, is due to an increase in marketing andpromotion expenses in support of the commercial launch of LUNESTA, which tookplace in April 2005. Additionally, 32% of the increase is a result ofincreased salary, commission and benefit costs as a result of havingapproximately 800 more sales representatives whom we hired in the secondquarter of 2004. We also incurred increased sales commission expense paid tointernal sales representatives as a result of the 33% increase in XOPENEX UDVproduct sales for the six months ended June 30, 2005 as compared with thesame period in 2004. Offsetting these increases was a decrease in salescommission expense paid to Ross for the co-promotion of XOPENEX UDV, as aresult of termination of our co-promotion agreement with Ross effective December 31,2004 and decreases in travel expenses from the same period in 2004 which wererelated to hiring and training our increased sales force.

We expect selling,marketing and distribution expenses to continue to increase in connection withincreased sales of LUNESTA and in anticipation of commercial launch of XOPENEXHFA MDI, including a proposed sales force increase of approximately 175employees, commencement of marketing programs and an increase in salescommissions and distribution costs.

*General and Administrative*

General and administrativecosts were $18,329,000 and $14,933,000 for the six months ended June 30,2005 and 2004, respectively, an increase of approximately 23%. The increase isprimarily due to payroll and related expenses resulting from an increase inpermanent and temporary employees and contracted service providers hired tosupport the commercialization of LUNESTA as well as increased legal feesrelated to two class action complaints pending against us.

*Other Income (Expense)*

Interest income was$10,670,000 and $2,679,000 for the six months ended June 30, 2005 and2004, respectively, an increase of approximately 298%. The increase is dueprimarily to higher average balances of cash and short- and long-terminvestments combined with an increase in the interest rates earned oninvestments in 2005. Our monthly average cash and investment balance wasapproximately $824,564,000 and $529,182,000 for the six months ended June 30,2005 and 2004, respectively.

Interest expense was$11,681,000 and $11,954,000 for the six months ended June 30, 2005 and2004, respectively, a decrease of approximately 2%. The decrease is dueprimarily to not incurring interest on our 5.75% convertible subordinatednotes, which we redeemed on January 9, 2004.

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Loss on debt redemption was $0 and $7,022,000 for thesix months ended June 30, 2005 and 2004, respectively. The loss in the sixmonths ended June 30, 2004 resulted from our redemption of the remainingoutstanding $430,000,000 face value of our 5.75% convertible subordinated notesdue 2006 for aggregate cash consideration of $430,000,000, excluding accruedinterest. The loss represents the write-off of $7,022,000 of deferred financingcosts related to the notes.

Equity in investee(losses) were ($468,000) and ($505,000) for the six months ended June 30,2005 and 2004, respectively, a decrease of approximately 7%. The lossrepresents our portion of BioSphere losses.

**Liquidity and Capital Resources**

Cash, cash equivalents and short-and long-terminvestments totaled $920,367,000 at June 30, 2005, compared to$833,912,000 at December 31, 2004.

Net cash used in operating activities for the sixmonths ended June 30, 2005 was $66,905,000. Net cash used in operatingactivities includes a net loss of $29,972,000 adjusted by non-cash charges of$9,125,000, which consists primarily of depreciation and amortization expense.Accounts receivable increased by $42,306,000 due primarily to LUNESTA sales andextended payment terms that we offered to our customers in connection withLUNESTA launch promotions. Inventory increased by $5,883,000 due primarily tocapitalization of LUNESTA and XOPENEX HFA MDI inventory in the first half of2005 as well as higher XOPENEX UDV inventory balances in order to meetadditional demand. Accounts payable decreased by $565,000 primarily due totiming of vendor payments. Accrued expenses decreased by $18,649,000 primarilydue to decreases in sales and marketing and research and development relatedaccruals, which are the result of decreased spending in these areas in thesecond quarter of 2005 as compared to the fourth quarter of 2004. Other currentliabilities increased by $24,944,000 primarily due to an increase in accrualsfor product revenue rebates related to XOPENEX UDV and LUNESTA revenues.

Net cash used in investing activities for the sixmonths ended June 30, 2005 was $310,165,000. Cash used in net purchases ofshort-and long-term investments was $297,288,000. We made purchases ofproperty and equipment of $6,431,000. We also used $7,143,000 to purchase1,077,029 shares of ACADIA common stock in connection with our collaborationagreement with ACADIA.

Net cash provided by financing activities for the sixmonths ended June 30, 2005 was $150,586,000. We received proceeds of$27,718,000 from issuing common stock upon the exercise of stock options issuedunder our stock option plans and $123,798,000 from settlement of call spreadoptions. We also used $930,000 to repay capital lease obligations and long-termdebt.

We believe ourexisting cash and the anticipated cash flow from our current strategicalliances and operations will be sufficient to support existing operationsthrough 2006. In the longer term, we expect to fund our operations with revenuegenerated from product sales. Our actual future cash requirements and ourability to generate revenue, however, will depend on many factors, including:

·       XOPENEXUDV and LUNESTA sales;

·       successfulmanufacturing and commercialization of XOPENEX HFA MDI, for which we receivedapproval from the FDA on March 11, 2005;

·       approvalof our late-stage product candidates;

·       theprogress, number and breadth of our preclinical, clinical and researchprograms;

·       achievementof milestones under our strategic alliance arrangements;

·       acquisitions;

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

·       theprogress of our development efforts and the development efforts of ourstrategic partners.

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If our assumptions underlying our beliefs regardingfuture revenues and expenses change, or if unexpected opportunities or needsarise, we may seek to raise additional cash by selling debt or equitysecurities or borrowing money from a bank. However, we may not be able to raisesuch funds on favorable terms, if at all.

Based on our currentoperating plan, we believe that we will not be required to raise additionalcapital to fund the repayment of our outstanding convertible debt when due. Ifrevenue generated from sales of XOPENEX UDV and LUNESTA do not meet expectedlevels, it is likely that we would be required to raise additional funds inorder to repay our outstanding convertible debt. There can be no assurancethat, if required, we would be able to raise the additional funds on favorableterms, if at all.

**Off-Balance Sheet Arrangements**

We do not have anyoff-balance sheet arrangements, other than operating leases entered into in theordinary course of business, or variable interest entities or activities thatinclude non-exchange traded contracts accounted for at fair value.

**Contractual Obligations**

Our contractualobligations disclosure in our annual report on Form 10-K for theyear ended December 31, 2004 has not materially changed since we filedthat report.

**FactorsAffecting Future Operating Results**

Certain of the informationcontained in this report, including information with respect to the safety,efficacy and potential benefits of our drugs under development, expectationswith respect to the timing and success of development and commercialization ofour products and product candidates, the timing and success of submission,acceptance and approval of regulatory filings, the scope and duration of patentprotection with respect to our products and product candidates and informationwith respect to plans and strategies for our business and the business of oursubsidiaries and certain of our affiliates, consists of forward-lookingstatements. The forward-looking statements contained in this reportrepresent our expectations as of the date of this report. Subsequent eventswill cause our expectations to change. However, while we may elect to updatethese forward-looking statements, we specifically disclaim any intentionor obligation to do so. Important factors that could cause actual results todiffer materially from the forward-looking statements include thefollowing:

**Wehave never been profitable and we may not be able to generate revenuessufficient to achieve profitability.**

We have not beenprofitable since inception, and it is possible that we will not achieveprofitability. We incurred net losses on a consolidated basis of approximately$7.4 and $30.0 million for the three and six months ended June 30,2005, respectively, and $295.7 million for the year ended December 31,2004. We expect to continue to incur significant operating and capitalexpenditures. As a result, we will need to generate significant revenues toachieve and maintain profitability. We cannot assure you that we will achievesignificant revenues or that we will ever achieve profitability. Even if we doachieve profitability, we cannot assure you that we will be able to sustain orincrease profitability on a quarterly or annual basis in the future. Ifrevenues grow more slowly than we anticipate or if operating expenses exceedour expectations or cannot be adjusted accordingly, our business, results ofoperations and financial condition will be materially and adversely affected.

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**Salesof XOPENEX UDV and LUNESTA represent substantially all of our revenues; ifsales of XOPENEX UDV and LUNESTA do not continue to increase and we are unableto successfully commercialize other products, we may not have sufficientrevenues to achieve our business plan and our business will not be successful.**

All of our revenues from product sales for the threemonths ended June 30, 2005 resulted from sales of XOPENEX UDV and LUNESTA.In April 2005, we commercially launched LUNESTA as a new product in acompetitive market and we cannot be certain that it will achieve continuedcommercial success. In addition, we do not have long-term sales contracts withour customers, and we rely on purchase orders for sales of XOPENEX UDV andLUNESTA. Reductions, delays or cancellations of orders for XOPENEX UDV orLUNESTA could adversely affect our operating results. If sales of XOPENEX UDVand LUNESTA do not continue to increase, we may not have sufficient revenues toachieve our business plan and our business will not be successful. On March 11,2005, the FDA approved our NDA for XOPENEX HFA MDI. We expect to commercializeXOPENEX HFA MDI before the end of 2005. If we are unable to commercializeXOPENEX HFA MDI successfully, our revenues from XOPENEX UDV and LUNESTA salesmay not be sufficient for us to achieve our business plan and our business andfinancial position may be materially adversely affected.

XOPENEX UDV competesprimarily against generic albuterol in the asthma market. XOPENEX UDV is moreexpensive than generic albuterol. We must continue to demonstrate to physiciansand other healthcare professionals that the benefits of XOPENEX UDV justify thehigher price. In the sleep disorder market, we face intense competition fromestablished products, such as AMBIEN® and SONATA®. We will also facecompetition from a newly approved sleep agent, ROZEREMTM. There are also otherpotentially competitive therapies that are in late-stage clinical developmentfor the treatment of insomnia. If XOPENEX UDV and LUNESTA do not continue tocompete successfully against competitive products, our business will bematerially adversely affected.

**If wefail to successfully develop our principal product candidates, we will beunable to commercialize the product candidates and our ability to becomeprofitable will be adversely affected.**

Our ability to achieve profitability will depend inlarge part on successful development and commercialization of our principalproducts under development and successful commercialization of our existingproducts. If we fail to successfully commercialize any of our products orproducts under development, our business may be materially adversely affected.Before we commercialize any product candidate, we will need to successfullydevelop the product candidate by completing successful clinical trials, submitan NDA for the product candidate that is accepted by the FDA and receive FDAapproval to market the candidate. If we fail to successfully develop a productcandidate and/or the FDA delays or denies approval of any submitted NDA or anyNDA that we submit in the future, then commercialization of our products underdevelopment may be delayed or terminated, which could have a material adverseeffect on our business.

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

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

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

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

·       wemay not receive regulatory approval for our product candidates;

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

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

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Our success significantlydepends on our continued ability to develop and market new products. We cannotassure you that we will be able to develop and introduce new products in atimely manner or that new products, if developed, will be approved for theindications, and/or with the labeling, we expect or that they will achievemarket acceptance. In addition, our growth is dependent on our continuedability to penetrate new markets where we have limited experience andcompetition is intense. We cannot assure you that the markets we serve willgrow in the future, that our existing and new products will meet therequirements of these markets, that our products will achieve customeracceptance in these markets, that competitors will not force prices to anunacceptably low level or take market share from us, or that we can achieve ormaintain profits in these markets.

**Ifany third-party collaborator is not successful in development of ourproduct candidates, we may not realize the potential commercial benefits of thearrangement and our results of operations could be adversely affected.**

We have entered into acollaboration agreement with 3M for the scale-up and manufacturing of XOPENEXHFA MDI and we may enter into additional collaboration agreements in thefuture. Under our agreement with 3M, 3M is responsible for manufacturing an MDIformulation of XOPENEX. On March 11, 2005, the FDA approved our NDA forXOPENEX HFA MDI. Contingent upon successful resolution of outstandingmanufacturing issues and completion of process validation work, we aretargeting commercial launch of the product by the end of 2005. If 3M, or anyfuture development or commercialization collaborator, does not devotesufficient time and resources to its collaboration arrangement with us,breaches or terminates its agreement with us, fails to perform its obligationto us in a timely manner or is unsuccessful in its development and/orcommercialization efforts, we may not realize the potential commercial benefitsof the arrangement and our results of operations may be adversely affected. Inaddition, if regulatory approval or commercialization of any product candidateunder development by or in collaboration with a partner is delayed or limited,we may not realize, or may be delayed in realizing, the potential commercialbenefits of the arrangement.

**Wemay be unable to commercialize products for which we receive approval from theFDA.**

Commercialization of a product for which we havereceived approval from the FDA could be delayed for a number of reasons, someof which are outside of our control, including delays in delivery of theproduct due to importation regulations and/or problems with our distributionchannels or delays in the issuance of approvals from, or the completion ofrequired procedures by, agencies other than the FDA, such as the United StatesDrug Enforcement Administration. In addition, commercialization of FDA-approvedproducts may be delayed by our failure to timely finalize distribution or manufacturingarrangements, produce sufficient inventory and/or properly prepare our salesforce. If we are unable to commercialize a product promptly after approval, ourbusiness and financial position may be materially adversely affected due toreduced revenue from product sales during the period or periods thatcommercialization is delayed and the shortening of any lead time to market wemay have had over our competitors. In addition, the exclusivity period, or thetime during which the FDA will prevent generic pharmaceutical companies fromintroducing a generic copy of the product, begins to run upon FDA approval and,therefore, to the extent we are unable to commercialize a product upon receiptof an approval letter, our long-term product sales and revenues could beadversely affected.

Even if the FDA or similar foreign agencies grant usregulatory approval of a product, if we fail to comply with the applicableregulatory requirements, we may be subject to fines, suspension or withdrawalof regulatory approvals, product recalls, seizures of products, operatingrestrictions and criminal prosecution. In any such event, our product sales andrevenues could be adversely affected.

On March 11, 2005,the FDA approved our NDA for XOPENEX HFA MDI. We are working to resolveoutstanding manufacturing issues and to complete process validation work.Contingent upon 

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successfulresolution of these issues, we are targeting commercial launch of the productby the end of 2005. However, we cannot be certain that we will be able toresolve these issues and we have not yet manufactured sufficient quantities ofthe product to begin commercial sales. If we are unable to resolvemanufacturing issues or complete process validation, we will be unable to bringthe product to market. Any delays in the commercialization of XOPENEX HFA MDI,or any other product for which we may receive approval from the FDA in thefuture, may materially adversely affect our reputation, financial position andresults of operations.

**Theroyalties we receive under collaboration arrangements could be delayed, reducedor terminated if our collaboration partners terminate, or fail to perform theirobligations under, their agreements with us, or if our collaboration partnersare unsuccessful in their sales efforts.**

We have entered intocollaboration arrangements pursuant to which we license patents topharmaceutical companies and our revenues under these collaborationarrangements consist primarily of royalties on sales of products. Payments androyalties under these arrangements depend in large part on thecommercialization efforts of our collaboration partners in countries where wehold patents, including sales efforts and enforcement of patents, which wecannot control. If any of our collaboration partners does not devote sufficienttime and resources to its collaboration arrangement with us or focuses itsefforts in countries where we do not hold patents, we may not realize thepotential commercial benefits of the arrangement, our revenues under these arrangementsmay be less than anticipated and our results of operations may be adverselyaffected. If any of our collaboration partners was to breach or terminate itsagreement with us or fail to perform its obligations to us in a timely manner,the royalties we receive under the collaboration agreement could decrease orcease. If we are unable or fail to perform, or breach in our performance of,our obligations under a collaboration agreement, the royalties and benefits towhich we are otherwise entitled under the agreement could be reduced oreliminated. Any delay or termination of this type could have a material adverseeffect on our financial condition and results of operations because we may losetechnology rights and milestone or royalty payments from collaboration partnersand/or revenues from product sales, if any, could be delayed, reduced orterminated.

**Theapproval of sale of certain medications without a prescription may adverselyaffect our business.**

In May 2001, anadvisory panel to the FDA recommended that the FDA allow certain popularallergy medications to be sold without a prescription. In November 2002,the FDA approved CLARITIN®, an allergy medication, to be sold without aprescription. In the future, the FDA may also allow sale of other allergy medicationswithout a prescription. Sale of CLARITIN and/or, if allowed, sale of otherallergy medications without a prescription, may have a material adverse effecton our business because the market for prescription drugs, including ALLEGRAand CLARINEX, for which we receive royalties on sales, has been and maycontinue to be adversely affected.

**Wewill be required to expend significant resources for research, development,testing and regulatory approval of our drugs under development and these drugsmay not be developed successfully.**

We develop andcommercialize proprietary products for primary care and specialty markets. Mostof our drug candidates are still undergoing clinical trials or are in earlystages of development. Our drugs may not provide greater benefits or fewer sideeffects than other drugs used to treat the same condition and our researchefforts may not lead to discovery of new drugs with benefits over existingtreatments or development of new therapies. All of our drugs under developmentwill require significant additional research, development, preclinical and/orclinical testing, regulatory approval and a commitment of significantadditional resources prior to their commercialization. Our potential productsmay not:

·       bedeveloped successfully;

·       beproven safe and efficacious in clinical trials;

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·       offertherapeutic or other improvements over comparable drugs;

·       meetapplicable regulatory standards;

·       beapproved for commercialization by the FDA;

·       becapable of being produced in commercial quantities at acceptable costs; or

·       be successfully marketed.

**Oursales depend on payment and reimbursement from third-party payors, and areduction in payment rate or reimbursement could result in decreased use orsales of our products.**

Sales of our products are dependent, in part, on theavailability of reimbursement from third-party payors such as state andFederal governments, under programs such as Medicare and Medicaid, and privateinsurance plans. There have been, there are, and we expect there will continueto be, state and Federal legislative and/or administrative proposals that couldlimit the amount that state or Federal governments will pay to reimburse thecost of pharmaceutical and biologic products. The Medicare Prescription DrugImprovement and Modernization Act of 2003, or the MMA, was signed into law in December 2003.We are not able to predict the full impact of the MMA and its regulatoryrequirements on our business. However, we believe that legislative oradministrative acts that reduce reimbursement for our products could adverselyimpact our business. In addition, we believe that private insurers, such asmanaged care organizations, may adopt their own reimbursement reductions inresponse to legislation. Reduction in reimbursement for our products could havea material adverse effect on our results of operations. Also, we believe theincreasing emphasis on managed care in the U.S. has and will continue to putpressure on the price and usage of our products, which may adversely impact productsales. Further, when a new drug product is approved, governmental and/orprivate reimbursement for that product is uncertain, as is the amount for whichthat product will be reimbursed. We cannot predict availability or amount ofreimbursement for our approved products or product candidates, including thoseat a late stage of development, and current reimbursement policies for marketedproducts may change at any time.

The MMA also establishes a prescription drug benefitbeginning in 2006 for all Medicare beneficiaries. We cannot be assured that ourproducts will be included in the Medicare prescription drug benefit. Even ifour products are included, the Federal government may acquire the ability tonegotiate price and demand discounts from pharmaceutical and biotechnologycompanies that may implicitly create price controls on prescription drugs. Onthe other hand, the drug benefit may increase the volume of pharmaceutical drugpurchases, offsetting at least in part these potential price discounts. In addition,Managed Care Organizations, or MCOs, Health Maintenance Organizations, or HMOs,Preferred Provider Organizations, or PPOs, healthcare institutions and othergovernment agencies continue to seek price discounts. MCOs, HMOs and PPOs andprivate health plans will administer the Medicare drug benefit, leading tomanaged care and private health plans influencing prescription decisions for alarger segment of the population. In addition, certain states have proposed andcertain other states have adopted various programs to control prices for theirseniors’ and low income drug programs, including price or patient reimbursementconstraints, restrictions on access to certain products, importation from othercountries, such as Canada, and bulk purchasing of drugs.

If reimbursement for ourmarketed products changes adversely or if we fail to obtain adequatereimbursement for our other current or future products, health care providersmay limit how much or under what circumstances they will prescribe or administerthem, which could reduce use of our products or cause us to reduce the price ofour products.

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**If wefail to adequately protect or enforce our intellectual property rights, then wecould lose revenue under our collaboration agreements or lose sales to genericversions of our products.**

Our success depends in part on our ability to obtain,maintain and enforce patents, and protect trade secrets. Our ability tocommercialize any drug successfully will largely depend upon our ability toobtain and maintain patents of sufficient scope to prevent third parties fromdeveloping substantially equivalent products. In the absence of patent andtrade secret protection, competitors may adversely affect our business byindependently developing and marketing substantially equivalent products. It isalso possible that we could incur substantial costs if we are required toinitiate litigation against others to protect or enforce our intellectualproperty rights.

We have filed patent applications covering compositionof, methods of making and methods of using our drugs and drug candidates. Ourrevenues under collaboration agreements with pharmaceutical companies depend inpart on the existence and scope of issued patents. We may not be issued patentsbased on patent applications already filed or that we file in the future and ifpatents are issued, they may be insufficient in scope to cover the productslicensed under these collaboration agreements. Generally, we do not receiveroyalty revenue from sales of products licensed under collaboration agreementsin countries where we do not have a patent for such products. The issuance of apatent in one country does not ensure the issuance of a patent in any othercountry. Furthermore, the patent position of companies in the pharmaceuticalindustry generally involves complex legal and factual questions, and has beenand remains the subject of much litigation. Legal standards relating to scopeand validity of patent claims are evolving. Any patents we have obtained, orobtain in the future, may be challenged, invalidated or circumvented. Moreover,the United States Patent and Trademark Office may commence interferenceproceedings involving our patents or patent applications. Any challenge to, orinvalidation or circumvention of, our patents or patent applications would becostly, would require significant time and attention of our management andcould have a material adverse effect on our business.

Should a generic drugcompany submit an Abbreviated New Drug Application to the FDA seeking approvalof a generic version of XOPENEX UDV, we would expect to enforce patents againstthe generic drug company. However, the resulting patent litigation wouldinvolve complex legal and factual questions, and we may not be able to excludea generic company, for the full term of our patents, from marketing a genericversion of XOPENEX UDV. Introduction of a generic copy of XOPENEX UDV beforethe expiration of our patents could have a material adverse effect on ourbusiness.

**If weface a claim of intellectual property infringement by a third party, then wecould be liable for significant damages or be prevented from commercializingour products.**

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

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renamethe affected product or product candidate, which could be costly and timeconsuming, and would result in the loss of any brand equity associated with theproduct name.

**Ifour products do not receive government approval, then we will not be able tocommercialize them.**

The FDA and similar foreign agencies must approve formarketing any pharmaceutical products developed by us or our developmentpartners. These agencies impose substantial requirements on drug manufacturingand marketing. Any unanticipated preclinical and clinical studies we arerequired to undertake could result in a significant increase in the cost ofadvancing our products to commercialization. In addition, failure by us or ourcollaborative development partners to obtain regulatory approval on a timelybasis, or at all, or the attempt by us or our collaborative developmentpartners to receive regulatory approval to achieve labeling objectives, couldprevent or adversely affect the timing of commercial introduction of, or ourability to market and sell, our products.

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

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

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

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

·       productsmay not be shown to be safe and efficacious.

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

**Thedevelopment and commercialization of our product candidates could be delayed orterminated if we are unable to enter into collaboration agreements in thefuture or if any future collaboration agreement is subject to lengthygovernment review.**

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

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

·       revenuefrom product sales could be delayed; or

·       wemay elect not to commercialize the drugs.

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

**Ourlimited sales and marketing experience may restrict our success in commercializingour products.**

We have limited marketing and sales experience. If wesuccessfully develop and obtain regulatory approval for the products we aredeveloping, we may (1) market and sell them through our sales force,(2) license some of them to large pharmaceutical companies or(3) market and sell them through other arrangements, includingco-promotion arrangements. We have established a sales force to market XOPENEXUDV, LUNESTA and XOPENEX HFA MDI. We have incurred significant expense in expandingour sales force and expect to incur additional expense as we further expand.With respect to products under development, we may incur significant costs inexpanding our sales force before the products have been approved for marketing.For example, we expanded our sales force in 2004 in anticipation of themarketing and sale of LUNESTA. In addition, if we enter into co-promotionarrangements or market and sell additional products directly, we may need tosignificantly expand our sales force.

Our ability to realize significant revenues fromdirect marketing and sales activities depends on our ability to attract andretain qualified personnel in the pharmaceutical industry. Competition forthese persons is intense. If we are unable to attract and retain qualifiedsales personnel, we will not be able to successfully expand our marketing anddirect sales force on a timely or cost effective basis. We may also need toenter into additional co-promotion arrangements with third parties, for examplewhere our own direct sales force is not large enough or sufficiently wellaligned to achieve maximum penetration in the market. We may not be successfulin entering into any co-promotion arrangements, and the terms of anyco-promotion arrangements may not be favorable to us.

**If we do notmaintain current Good Manufacturing Practices, then the FDA could refuse toapprove marketing applications or force us to recall or withdraw our products.**

We do not have the capability to manufacture insufficient quantities all of the products that may be approved for sale, anddeveloping and obtaining this capability will be time consuming and expensive.The FDA and other regulatory authorities require that our products bemanufactured according to their Good Manufacturing Practices regulations. Thefailure by us, our collaborative development partners or third-partymanufacturers to maintain current Good Manufacturing Practices complianceand/or our failure to scale up our manufacturing processes could lead torefusal by the FDA to approve marketing applications. Failure in either respectcould also be the basis for action by the FDA to withdraw approvals previouslygranted, to recall products and for other regulatory action.

On October 22, 2004, we commenced notifying drugwholesalers, hospitals and pharmacies of a manufacturer-initiatedvoluntary Class III recall of one component of our XOPENEX UDV productline, XOPENEX Inhalation Solution Concentrate (1.25mg/0.5mL), which we hadintroduced in August 2004. The recall, which affects only XOPENEXConcentrate and no other components of our XOPENEX UDV product line, wasnecessitated by packaging process validation issues relating to the automatedprocess of placing finished vials into a foil pouch. We have suspendedmanufacture and sale of XOPENEX Concentrate until the issues giving rise to therecall have been fully addressed. We do not expect to re-introduceXOPENEX Concentrate before the fourth quarter of 2005. If our manufacturercannot remedy the Good Manufacturing Practices deficiencies giving rise to therecall of XOPENEX 

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Concentrate, or if theseor similar deficiencies are found to extend to other components or our XOPENEXUDV product line, our ability to supply product to the market may be limited orinterrupted indefinitely, which would have a material adverse effect on ourbusiness.

Failure to increase ourmanufacturing capabilities may mean that even if we develop promising newproducts, we may not be able to produce them. We currently operate amanufacturing plant, which is compliant with current Good ManufacturingPractices, that we believe can produce commercial quantities of the activepharmaceutical ingredient for XOPENEX UDV and LUNESTA and support theproduction of our product candidates in amounts needed for our clinical trials.However, we will not have the capability to manufacture in sufficientcommercial quantities all of the products that may be approved for sale.Accordingly, we will be required to spend money to expand our currentmanufacturing facility, build an additional manufacturing facility or contractthe production of these drugs to third-party manufacturers.

**Our reliance onthird-party manufacturers could adversely affect our ability to meet ourcustomers’ demands.**

Cardinal Health, Inc. is currently the solefinished goods manufacturer of our XOPENEX UDV Inhalation Solution,Patheon Inc. is the sole manufacturer of LUNESTA brand eszopiclone and 3Mwill be the sole manufacturer and supplier of XOPENEX HFA MDI. If CardinalHealth, Patheon or 3M experiences delays or difficulties in producing,packaging or delivering XOPENEX UDV, LUNESTA, or XOPENEX HFA MDI, as the casemay be, we could be unable to meet our customers’ demands for such products,which could lead to customer dissatisfaction and damage to our reputation. Furthermore,if we are required to change manufacturers, we will be required to verify thatthe new manufacturer maintains facilities and procedures that comply withquality standards and with all applicable regulations and guidelines, includingFDA guidelines. The delays associated with the verification of a newmanufacturer for XOPENEX UDV, LUNESTA or XOPENEX HFA MDI could negativelyaffect our ability to produce such products in a timely manner or withinbudget.

3M owns certainproprietary technology required to manufacture our XOPENEX HFA MDI. If 3M isunable or unwilling to fulfill its obligations to us under our agreement, wemay be unable to manufacture XOPENEX HFA MDI on terms that are acceptable tous, if at all. Our other current contract manufacturers, as well as any futurecontract manufacturers, may also independently own technology related tomanufacturing of our products. If so, we would be heavily dependent on suchmanufacturer and such manufacturer could require us to obtain a license in orderto have another party manufacture our products.

**If we or ourcollaboration partners fail to obtain an adequate level of reimbursement forour existing or future products or services by third-party payors, theremay be no commercially viable markets for our products or services.**

The availability and amounts of reimbursement bygovernmental and other third-party payors affects the market forpharmaceutical product and service. Third-party payors continuallyattempt to contain or reduce the cost of health care by challenging the pricescharged for medical products and services. In certain foreign countries,including the countries of the European Union, prescription pharmaceuticalpricing is subject to governmental control. We may not be able to sell our productsprofitably if reimbursement is unavailable or limited in scope or amount.

In both the United Statesand certain foreign jurisdictions, there have been a number of recentlegislative and regulatory changes to the health care system. The potentialeffect on our business of these changes is not yet clear. Further regulatoryand legislative proposals are likely. The recent changes, and the potential foradoption of the additional proposals, may affect our ability to raise capital,obtain additional collaboration partners and market our products. We expect toexperience pricing pressure for our existing 

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productsand any future products for which marketing approval is obtained due to thetrend toward managed health care, the increasing influence of health maintenanceorganizations and additional legislative proposals.

**We could be exposedto significant liability claims that could prevent or interfere with ourproduct commercialization efforts.**

We may be subjected toproduct liability claims that arise through testing, manufacturing, marketingand sale of human health care products. These claims could expose us tosignificant liabilities that could prevent or interfere with our productcommercialization efforts. Product liability claims could require us to spendsignificant time and money in litigation or to pay significant damages.Although we maintain product liability insurance coverage for both the clinicaltrials and commercialization of our products, it is possible that we will notbe able to obtain further product liability insurance on acceptable terms, ifat all, and that our insurance coverage may not provide adequate coverageagainst all potential claims.

**We will spendconsiderable time and money complying with Federal and state laws andregulations and, if we are unable to fully comply with such laws andregulations, we could face substantial penalties.**

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

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

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

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

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

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

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

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

·       stateand foreign law equivalents of the foregoing;

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

·       statelaws that prohibit practice of medicine by non-physicians and fee-splittingarrangements between physicians and non-physicians, as well as state lawequivalents to the Federal Medicare and 

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Medicaid Anti-KickbackLaws, which may not be limited to government reimbursed items or services.

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

**If our Medicaidrebate program practices are investigated, the costs could be substantial andcould divert the attention of management.**

We are a participant inthe Medicaid rebate program established by the Omnibus Budget ReconciliationAct of 1990. Under amendments of that law that became effective in 1993. Underthe Medicaid rebate program, we pay a rebate for each unit of our productreimbursed by Medicaid. The amount of the rebate for each product is set bylaw. We are also required to pay certain statutorily defined rebates onMedicaid purchases for reimbursement on prescription drugs under state Medicaidplans. Both the Federal government and state governments have initiatedinvestigations into the rebate practices of many pharmaceutical companies toensure compliance with these rebate programs. Any investigation of our rebatepractices could be costly, could divert the attention of our management andcould damage our reputation.

**We have significantlong-term debt and we may not be able to make interest or principal paymentswhen due.**

As of June 30, 2005, our total long-term debtexcluding the current portion was approximately $1.2 billion and ourstockholders’ equity (deficit) was ($201.3) million. None of our 5% debenturesdue 2007, our 0% Series A notes due 2008, our 0% Series B notes due2010 nor our 0% notes due 2024 restricts our or our subsidiaries’ ability toincur 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 Bnotes due 2010, which are senior to the 5% debentures due 2007. Additionalindebtedness that we incur may in certain circumstances rank senior to or onparity with this debt. Our ability to satisfy our obligations will depend uponour future performance, which is subject to many factors, including factorsbeyond our control. The conversion prices for the 5% debentures due 2007, 0% Series Anotes due 2008 and 0% Series B notes due 2010 are $92.38, $31.89 and$29.84, respectively. On July 29, 2005, the closing sale price of ourcommon stock was $52.35. If the market price for our common stock does notexceed the conversion price, the holders of our outstanding convertible debtmay not convert their securities into common stock. Our 0% notes due 2024 areconvertible into cash and, if applicable, shares of our common stock at aconversion price of approximately $67.20, at the option of the holders undercertain circumstances. We may not be able to make the required cash paymentsupon conversion of the 0% notes due 2024.

Historically, we have hadnegative cash flow from operations. For the six months ended June 30,2005, net cash used in operating activities was approximately $66.9 million.Our annual debt service through 

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2006,assuming no additional interest-bearing debt is incurred and noadditional 5% debentures due 2007 are converted, redeemed, repurchased orexchanged, is approximately $22.0 million. Unless we are able to generatesufficient operating cash flow to service our outstanding debt, we will berequired to raise additional funds or default on our obligations under thedebentures and notes. If revenue generated from sales of XOPENEX UDV andLUNESTA do not meet expected levels, it is likely that we would be required toraise additional funds in order to repay our outstanding convertible debtand/or make cash payments upon conversion of the 0% notes due 2024. There canbe no assurance that, if required, we would be able to raise the additionalfunds on favorable terms, if at all.

**Our exchanges ofdebt into shares of common stock would result in additional dilution.**

As of June 30, 2005,we had approximately $1.2 billion of outstanding convertible debt. In orderto reduce future cash interest payments, as well as future payments due atmaturity, we may, from time to time, depending on market conditions, repurchaseadditional outstanding convertible debt for cash; exchange debt for shares ofour common stock, warrants, preferred stock, debt or other consideration; or acombination of any of the foregoing. If we exchange shares of our capitalstock, or securities convertible into or exercisable for our capital stock, foroutstanding convertible debt or use proceeds from the issuance of convertibledebt to fund redemption of outstanding convertible debt with a higherconversion ratio, the number of shares that we might issue as a result of suchexchanges would significantly exceed the number of shares originally issuableupon conversion of such debt and, accordingly, such exchanges would result inmaterial dilution to holders of our common stock. We cannot assure you that wewill repurchase or exchange any additional outstanding convertible debt.

**If the estimates wemake, or the assumptions on which we rely, in preparing our financialstatements prove inaccurate, our actual results may vary from these reflectedin our projections and accruals.**

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

**If sufficient fundsto finance our business are not available to us when needed or on acceptableterms, then we may be required to delay, scale back, eliminate or alter ourstrategy for our programs.**

We may requireadditional funds for our research and product development programs, operatingexpenses, repayment of debt, the pursuit of regulatory approvals, license oracquisition opportunities and the expansion of our production, sales andmarketing capabilities. Historically, we have satisfied our funding needsthrough collaboration arrangements with corporate partners and equity and debtfinancings. These funding sources may not be available to us when needed in thefuture, and, if available, they may not be on terms acceptable to us.Insufficient funds could require us to delay, scale back or eliminate certainof our research and product development programs or to enter into licenseagreements with third parties to commercialize products or technologies that wewould otherwise develop or commercialize ourselves. Our cash requirements mayvary materially from those now planned because of factors including:

·       patentdevelopments;

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·       licensingor acquisition opportunities;

·       relationshipswith collaboration partners;

·       theFDA regulatory process;

·       ourcapital requirements; and

·       selling,marketing and manufacturing expenses in connection with commercialization ofproducts.

**We expect to faceintense competition and our competitors have greater resources and capabilitiesthan we have.**

Developments by others may render our products ortechnologies obsolete or noncompetitive. We expect to encounter intensecompetition in the sale of our current and future products. If we are unable tocompete effectively, our financial condition and results of operations could bematerially adversely affected because we may use our financial resources toseek to differentiate ourselves from our competition and because we may not achieveour product revenue objectives. Many of our competitors and potentialcompetitors, which include pharmaceutical companies, biotechnology firms,universities and other research institutions, have substantially greaterresources, manufacturing and marketing capabilities, research and developmentstaff and production facilities than we have. The fields in which we competeare subject to rapid and substantial technological change. Our competitors maybe able to respond more quickly to new or emerging technologies or to devotegreater resources to the development, manufacture and marketing of new productsand/or technologies than we can. As a result, any products and/or technologiesthat we develop may become obsolete or noncompetitive before we can recoverexpenses incurred in connection with their development.

XOPENEX UDV and genericalbuterol account for the majority of beta-agonist inhalation solutionprescriptions. Albuterol has existed for many years, is well established andsells at prices substantially lower than XOPENEX UDV. To continue successfullymarketing XOPENEX UDV, we must continue to demonstrate that the efficacy andsafety features of the drug outweigh its higher cost. In the sleep disordermarket, we face intense competition from established products, such as AMBIENand SONATA. We will also face competition from a newly approved sleep agent,ROZEREMTM. There are also other potentially competitive therapies that are inlate-stage clinical development for the treatment of insomnia.

**Several classaction lawsuits have been filed against us which may result in litigation thatis costly to defend and the outcome of which is uncertain and may harm ourbusiness.**

We and several of our current and former officers anda current director are named as defendants in several class action complaintswhich have been filed on behalf of certain persons who purchased our commonstock and/or debt securities during different time periods, beginning onvarious dates, the earliest being May 17, 1999, and all ending on March 6,2002. These complaints allege violations of the Exchange Act and the rules andregulations promulgated thereunder by the SEC. Primarily they allege that thedefendants made certain materially false and misleading statements relating tothe testing, safety and likelihood of FDA approval of tecastemizole. On April 11,2003, two consolidated amended complaints were filed, one on behalf of thepurchasers of our common stock and the other on behalf the purchasers of ourdebt securities. These consolidated amended complaints reiterate theallegations contained in the previously filed complaints and define the allegedclass periods as May 17, 1999 through March 6, 2002. We filed amotion to dismiss both consolidated amended complaints on May 27, 2003. OnMarch 11, 2004, the court, while granting in part the motion to dismiss,did allow much of the case to proceed. The parties are currently engaged indiscovery.

We can provide noassurance as to the outcome of these lawsuits. Any conclusion of these mattersin a manner adverse to us would have a material adverse effect on our financialcondition and business. In 

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addition,the costs to us of defending any litigation or other proceeding, even ifresolved in our favor, could be substantial. Such litigation could alsosubstantially divert the attention of our management and our resources ingeneral. Uncertainties resulting from the initiation and continuation of anylitigation or other proceedings could harm our ability to compete in themarketplace.

**Fluctuations in thedemand for products, the success and timing of collaboration arrangements andregulatory approval, any termination of development efforts, expenses and theresults of operations of our subsidiaries will cause fluctuations in ourquarterly operating results, which could cause volatility in our stock price.**

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

·       timingof product sales and market penetration;

·       timingof operating expenses, including selling and marketing expenses and the costsof expanding and maintaining a direct sales force;

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

·       timingof product launch;

·       resultsof clinical trials with respect to products under development;

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

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

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

·       timingof expenses we may incur with respect to any license or acquisitions ofproducts or technologies.

**We have variousmechanisms in place to discourage takeover attempts, which may reduce oreliminate our stockholders’ ability to sell their shares for a premium in achange of control transaction.**

Various provisionsof our certificate of incorporation and by-laws and of Delaware corporate lawmay discourage, delay or prevent a change in control or takeover attempt of ourcompany by a third party that is opposed by our management and board ofdirectors. Public stockholders who might desire to participate in such atransaction may not have the opportunity to do so. These anti-takeoverprovisions could substantially impede the ability of public stockholders tobenefit from a change of control or change in our management and board of directors.These provisions include:

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

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

·       non-cumulativevoting for directors;

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

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

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

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

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

**The price of ourcommon stock historically has been volatile, which could cause you to lose partor all of your investment.**

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

**Our dilutedearnings per share may decrease in the future because we are now required toinclude the shares issuable upon conversion of our 0% notes due 2024 in ourdiluted earnings per share calculation.**

Because of our adoption ofa recent accounting pronouncement, we are required to include in our dilutedearnings per share calculation shares that are contingently issuable uponconversion of a debt instrument, regardless of whether or not the contingencyfor issuance has been met. This recent accounting pronouncement superseded aprior pronouncement that allowed such contingently issuable shares to beexcluded from the diluted earnings per share calculation. Our 0% notes due2024, unlike our other series of convertible debt, are convertible into common stockonly if certain conditions are met and, therefore, we had not previouslyincluded the shares issuable upon conversion of such notes in our dilutedearnings per share calculation. The inclusion of such contingently convertibleshares in our diluted earnings per share calculation has had no effect on ourcurrent or prior period diluted earnings per share. However, the inclusion ofshares contingently issuable upon conversion of our 0% notes due 2024, mayreduce our diluted earnings per share in future periods.

**ITEM 3.**                QUANTITATIVE ANDQUALITATIVE DISCLOSURES ABOUT MARKET RISK

**Market Risk**

We are exposed to marketrisk from changes in interest rates and equity prices, which could affect ourfuture results of operations and financial condition. These risks are describedin our annual report on Form 10-K for the year ended December 31,2004. As of August 9, 2005, there have been no material changes to themarket risks described in our annual report on Form 10-K for theyear ended December 31, 2004. Additionally, we do not anticipate anynear-term changes in the nature of our market risk exposures or in ourmanagement’s objectives and strategies with respect to managing such exposures.

**ITEM 4.**                CONTROLS ANDPROCEDURES

**Disclosure Controlsand Procedures**

Our management, with theparticipation of our chief executive officer and chief financial officer,evaluated the effectiveness of our disclosure controls and procedures as of June 30,2005. The term 

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“disclosurecontrols and procedures,” as defined in Rules 13a-15(e) and 15d-15(e) underthe Exchange Act, means controls and other procedures of a company that aredesigned to ensure that information required to be disclosed by a company inthe reports that it files or submits under the Exchange Act is recorded,processed, summarized and reported, within the time periods specified in theSEC’s rules and forms. Disclosure controls and procedures include, withoutlimitation, controls and procedures designed to ensure that informationrequired to be disclosed by a company in the reports that it files or submitsunder the Exchange Act is accumulated and communicated to the company’smanagement, including its principal executive and principal financial officers,as appropriate to allow timely decisions regarding required disclosure. Ourmanagement recognizes that any controls and procedures, no matter how welldesigned and operated, can provide only reasonable assurance of achieving theirobjectives and our management necessarily applies its judgment in evaluatingthe cost-benefit relationship of possible controls and procedures. Based on theevaluation of our disclosure controls and procedures as of June 30, 2005,our chief executive officer and chief financial officer concluded that, as ofsuch date, our disclosure controls and procedures were effective at thereasonable assurance level.

**Changes in InternalControl Over Financial Reporting**

There has been no change in our internal control overfinancial reporting (as defined in Rules 13a-15(f) and 15d-15(f) underthe Exchange Act) during our quarter ended June 30, 2005 that hasmaterially affected, or is reasonably likely to materially affect, our internalcontrol over financial reporting.

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**PART II**

**OTHER INFORMATION**

**ITEM 1.**                LEGALPROCEEDINGS

We and several of ourcurrent and former officers and a current director are named as defendants inseveral class action complaints which have been filed on behalf of certainpersons who purchased our common stock and/or debt securities during differenttime periods, beginning on various dates, the earliest being May 17, 1999,and all ending on March 6, 2002. These complaints allege violations of theExchange Act and the rules and regulations promulgated thereunder by theSecurities and Exchange Commission. Primarily they allege that the defendantsmade certain materially false and misleading statements relating to thetesting, safety and likelihood of FDA approval of tecastemizole. On April 11,2003, two consolidated amended complaints were filed, one on behalf of thepurchasers of our common stock and the other on behalf of the purchasers of ourdebt securities. These consolidated amended complaints reiterate theallegations contained in the previously filed complaints and define the allegedclass periods as May 17, 1999 through March 6, 2002. We filed amotion to dismiss both consolidated amended complaints on May 27, 2003. OnMarch 11, 2004, the court, while granting in part the motion to dismiss,did allow much of the case to proceed. The parties are currently engaged indiscovery. We are unable to reasonably estimate any possible range of lossrelated to the lawsuits due to their uncertain resolution. However, anyconclusion of these matters in a manner adverse to us would have a materialadverse effect on our financial condition and business.

**ITEMS 2-3.**                     NONE

**ITEM 4.**                SUBMISSIONOF MATTERS TO A VOTE OF SECURITY HOLDERS

Our annual meetingof stockholders was held on May 19, 2005. The following represents theresults of the voting on proposals submitted to a vote of stockholders at theannual meeting:

1.                Toelect Timothy J. Barberich to serve as a Class II director until the 2008annual meeting and until his successor is duly elected and qualified.

| **For**    | ** ** | **Withheld Authority** |
|------------|------------|------------------------|
| 90,996,593 |       | 1,721,510              |

 

The terms of office of the following directorscontinued after the annual meeting:

James G. AndressRobert J. CresciJames F. MrazekDigby W. BarriosAlan A. Steigrod

2.                Toapprove an amendment to the our 2000 Stock Incentive Plan increasing from8,000,000 to 9,500,000 the number of shares reserved for issuance under the2000 plan.

| **For**    | ** ** | **Against** | ** ** | **Abstain** |
|------------|------------|-------------|------------|-------------|
| 44,448,992 |       | 29,938,172  |       | 913,203     |

 

3.                Toratify the selection of PricewaterhouseCoopers LLP as our independent registeredpublic accounting firm for the current fiscal year.

| **For**    | ** ** | **Against** | ** ** | **Abstain** |
|------------|------------|-------------|------------|-------------|
| 91,180,899 |       | 665,176     |       | 872,027     |

 

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**ITEM 5.**                NONE

**ITEM 6.**                EXHIBITS
| 10.1 |   | The Registrant’s 2000 Stock Incentive Plan, as  amended.                                                                                                  |
|------|--------|----------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 31.1 |   | Certification of Chief Executive Officer pursuant to  Rule 13a-14(a)/Rule 15d-14(a) of the Securities  Exchange Act of 1934, as amended.        |
| 31.2 |   | Certification of Chief Financial Officer pursuant to  Rule 13a-14(a)/Rule 15d-14(a) of the Securities  Exchange Act of 1934, as amended.        |
| 32.1 |   | Certification of Chief Executive Officer pursuant to  18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the  Sarbanes-Oxley Act of 2002. |
| 32.2 |   | Certification of Chief Financial Officer pursuant to  18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the  Sarbanes-Oxley Act of 2002. |

 

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**SIGNATURES**

Pursuantto the requirements of the Securities Exchange Act of 1934, the registrant hasduly caused this report to be signed on its behalf by the undersigned thereuntoduly authorized.
|                            | **SEPRACOR INC.** |
|----------------------------|-------------------|
| Date: August 9, 2005  | By:               | /s/  TIMOTHY J. BARBERICH |
|                       |              | Timothy J.  Barberich*Chairman and Chief Executive Officer  (Principal Executive Officer)* |
| Date: August 9,  2005 | By:               | /s/  TIMOTHY J. BARBERICH |
|                       |              | Robert F. Scumaci*Executive Vice President, Finance and  Administration, and Treasurer  (Principal Accounting Officer)* |

 

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**Exhibit Index**
| Exhibit No. | ** ** | ** **                                                                                                                                                     | **Description** |
|------------------|------------|----------------------------------------------------------------------------------------------------------------------------------------------------------------|-----------------|
| 10.1             |       | The Registrant’s 2000 Stock Incentive Plan, as  amended.                                                                                                  |
| 31.1             |       | Certification of Chief Executive Officer pursuant to  Rule 13a-14(a)/Rule 15d-14(a) of the Securities  Exchange Act of 1934, as amended.        |
| 31.2             |       | Certification of Chief Financial Officer pursuant to  Rule 13a-14(a)/Rule 15d-14(a) of the Securities  Exchange Act of 1934, as amended.        |
| 32.1             |       | Certification of Chief Executive Officer pursuant to  18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the  Sarbanes-Oxley Act of 2002. |
| 32.2             |       | Certification of Chief Financial Officer pursuant to  18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the  Sarbanes-Oxley Act of 2002. |
|                  |            |                                                                                                                                                                |                 |  |

 

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