**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, 2007**

**or**

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

**Forthe transition periodfrom                to                **

**Commissionfile number 0-19410**

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**Sepracor Inc.**

(Exact name of registrantas specified in its charter)

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

 

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

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

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

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

 

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

The number of shares outstanding of the registrant’sclass of Common Stock as of July 31, 2007 was: 107,309,679 shares.

 

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**SEPRACOR INC.INDEX**
| **Part I—Financial Information** | ** ** | ** **                                                                                                              |
|--------------------------------------------|------------|-------------------------------------------------------------------------------------------------------------------------|
| Item 1.                                    |       | Condensed Consolidated Interim Financial Statements  (Unaudited)                                                        |   |   |   |
|                                       |       | Consolidated  Balance Sheets as of June 30, 2007 (Unaudited) and  December 31, 2006                           |   | 3 |   |
|                                       |       | Consolidated Statements of Operations for the Three  and Six Months Ended  June 30, 2007 and 2006 (Unaudited) |   | 4 |   |
|                                       |       | Consolidated Statements of Cash Flows for the Six  Months Ended June 30, 2007 and 2006 (Unaudited)       |   | 5 |   |
|                                       |       | Notes to Condensed Consolidated Interim Financial  Statements                                                           |   | 6 |   |
| Item 2.                                    |       | Management’s Discussion and Analysis of Financial  Condition and Results of Operations                             |   | 14 |   |
| Item 3.                                    |       | Quantitative and Qualitative Disclosures About Market  Risk                                                             |   | 29 |   |
| Item 4.                                    |       | Controls and Procedures                                                                                                 |   | 29 |   |
| **Part II—Other Information**    |       | 31                                                                                                                      |   |
| Item  1.                                   |       | Legal  Proceedings                                                                                                      |   | 31 |   |
| Item 1A.                                   |       | Risk Factors                                                                                                            |   | 34 |   |
| Item 4.                                    |       | Submission of Matters to a Vote of Security Holders                                                                     |   | 58 |   |
| Item 6.                                    |       | Exhibits                                                                                                                |   | 58 |   |
|                                       |       | Signatures                                                                                                              |   | 59 |   |
|                                       |       | Exhibit Index                                                                                                      |   | 60 |   |

 

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**SEPRACOR INC.CONSOLIDATED BALANCE SHEETS(In Thousands)**

| ** **                                                                                                                                                                                                                                                                 | ** ** | **June 30,  2007** | ** ** | **December 31,  2006** | ** ** |
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-------------------------|------------|-----------------------------|------------|
| ** **                                                                                                                                                                                                                                                                 | ** ** | **(Unaudited)**         | ** ** | ** **                  | ** ** |
| **Assets**                                                                                                                                                                                                                                                                 | ** ** | ** **              | ** ** | ** **                  | ** ** |
| Current assets:                                                                                                                                                                                                                                                            |       |                    |       |                        |       |
| Cash and cash equivalents                                                                                                                                                                                                                                                  |       | $                       | 183,425    |                        | $          | 415,411 |   |
| Short-term investments                                                                                                                                                                                                                                                     |       | 409,087                 |       | 568,037                     |       |
| Accounts receivable, net                                                                                                                                                                                                                                                   |       | 105,965                 |       | 175,103                     |       |
| Inventories                                                                                                                                                                                                                                                                |       | 42,759                  |       | 37,087                      |       |
| Other assets                                                                                                                                                                                                                                                               |       | 50,330                  |       | 25,390                      |       |
| Total current  assets                                                                                                                                                                                                                                                      |       | 791,566                 |       | 1,221,028                   |       |
| Long-term investments                                                                                                                                                                                                                                                      |       | 268,341                 |       | 182,876                     |       |
| Property and equipment, net                                                                                                                                                                                                                                                |       | 82,821                  |       | 72,811                      |       |
| Investment in affiliate                                                                                                                                                                                                                                                    |       | 4,771                   |       | 5,107                       |       |
| Deferred financing costs and patents, net                                                                                                                                                                                                                                  |       | 9,560                   |       | 11,881                      |       |
| Other assets                                                                                                                                                                                                                                                               |       | 83                      |       | 90                          |       |
| Total assets                                                                                                                                                                                                                                                               |       | $                       | 1,157,142  |                        | $          | 1,493,793 |   |
| **Liabilities  and Stockholders’ Equity**                                                                                                                                                                                                                             | ** ** | ** **              | ** ** | ** **                  | ** ** |
| Current liabilities:                                                                                                                                                                                                                                                       |       |                    |       |                        |       |
| Accounts payable                                                                                                                                                                                                                                                           |       | $                       | 23,030     |                        | $          | 10,751 |   |
| Accrued expenses                                                                                                                                                                                                                                                           |       | 125,487                 |       | 113,099                     |       |
| Current portion of notes payable and capital lease  obligation                                                                                                                                                                                                             |       | 1,235                   |       | 385                         |       |
| Current portion of convertible subordinated debt                                                                                                                                                                                                                           |       | —                  |       | 440,000                     |       |
| Other current liabilities                                                                                                                                                                                                                                                  |       | 104,232                 |       | 115,877                     |       |
| Total current  liabilities                                                                                                                                                                                                                                                 |       | 253,984                 |       | 680,112                     |       |
| Notes payable and capital lease obligation                                                                                                                                                                                                                                 |       | 2,479                   |       | 693                         |       |
| Convertible subordinated debt                                                                                                                                                                                                                                              |       | 720,820                 |       | 720,820                     |       |
| Total liabilities                                                                                                                                                                                                                                                          |       | 977,283                 |       | 1,401,625                   |       |
| Stockholders’  equity:                                                                                                                                                                                                                                                |       |                    |       |                        |       |
| Preferred stock, $1.00 par value, 1,000 shares  authorized; none outstanding at June 30, 2007 and December 31,  2006                                                                                                                                        |       | —                  |       | —                      |       |
| Common stock, $.10 par value, 240,000 shares  authorized at June 30, 2007 and December 31, 2006; 111,499 and  110,040 shares issued, 107,238 and 105,779 shares outstanding, at  June 30, 2007 and December 31, 2006, respectively |       | 11,150                  |       | 11,004                      |       |
| Treasury stock, at cost (4,261 shares at June 30,  2007 and December 31, 2006)                                                                                                                                                                                   |       | (232,028                | )          | (232,028                    | )          |
| Additional paid-in capital                                                                                                                                                                                                                                                 |       | 1,836,556               |       | 1,788,417                   |       |
| Accumulated deficit                                                                                                                                                                                                                                                        |       | (1,449,369              | )          | (1,478,065                  | )          |
| Accumulated other comprehensive income                                                                                                                                                                                                                                     |       | 13,550                  |       | 2,840                       |       |
| Total  stockholders’ equity                                                                                                                                                                                                                                           |       | 179,859                 |       | 92,168                      |       |
| Total liabilities  and stockholders’ equity                                                                                                                                                                                                                           |       | $                       | 1,157,142  |                        | $          | 1,493,793 |   |

 

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,  2007**          | ** ** | **June 30,  2006**        | ** ** | **June 30,  2007** | ** ** | **June 30,  2006** | ** ** |
| Revenues:                                                                |       |                             |       |                           |       |   |   |   |   |
| Product sales                                                            |       | $                                | 265,662    |                           | $          | 256,427 |   | $ | 586,959 |   | $ | 533,932 |   |
| Royalties                                                                |       | 12,466                           |       | 7,979                          |       | 22,603 |   | 16,152 |   |
| Total revenues                                                           |       | 278,128                          |       | 264,406                        |       | 609,562 |   | 550,084 |   |
| Costs and expenses:                                                      |       |                             |       |                           |       |   |   |   |   |
| Cost of product sold                                                     |       | 25,141                           |       | 20,693                         |       | 56,493 |   | 46,226 |   |
| Cost of royalties                                                        |       | 389                              |       | 283                            |       | 655 |   | 442 |   |
| Research and development                                                 |       | 45,457                           |       | 36,360                         |       | 86,159 |   | 85,629 |   |
| Selling, marketing and distribution                                      |       | 191,516                          |       | 182,605                        |       | 383,634 |   | 372,596 |   |
| General and administrative                                               |       | 19,297                           |       | 18,087                         |       | 38,189 |   | 32,595 |   |
| Litigation settlement, net                                               |       | —                           |       | —                         |       | 34,000 |   | — |   |
| Total costs and expenses                                                 |       | 281,800                          |       | 258,028                        |       | 599,130 |   | 537,488 |   |
| Income (loss) from operations                                            |       | (3,672                           | )          | 6,378                          |       | 10,432 |   | 12,596 |   |
| Other income (expense):                                                  |       |                             |       |                           |       |   |   |   |   |
| Interest income                                                          |       | 11,107                           |       | 10,990                         |       | 23,709 |   | 20,784 |   |
| Interest expense                                                         |       | (113                             | )          | (5,543                         | )          | (2,870 | ) | (11,094 | ) |
| Equity in investee losses                                                |       | (132                             | )          | (95                            | )          | (404 | ) | (353 | ) |
| Other expense                                                            |       | (558                             | )          | (256                           | )          | (286 | ) | (312 | ) |
| Income before income taxes                                               |       | 6,632                            |       | 11,474                         |       | 30,581 |   | 21,621 |   |
| Income taxes                                                             |       | 485                              |       | 430                            |       | 1,885 |   | 541 |   |
| Net income after income taxes                                            |       | $                                | 6,147      |                           | $          | 11,044 |   | $ | 28,696 |   | $ | 21,080 |   |
| Basic net income per common share                                        |       | $                                | 0.06       |                           | $          | 0.11 |   | $ | 0.27 |   | $ | 0.20 |   |
| Diluted net income per common share                                      |       | $                                | 0.05       |                           | $          | 0.10 |   | $ | 0.25 |   | $ | 0.18 |   |
| Shares used in computing  basic and diluted net income per common share: |       |                             |       |                           |       |   |   |   |   |
| Basic                                                                    |       | 106,567                          |       | 104,587                        |       | 106,275 |   | 104,441 |   |
| Diluted                                                                  |       | 116,635                          |       | 115,371                        |       | 116,839 |   | 115,344 |   |

 

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

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

| ** **                                                                                        | ** ** | **Six Months Ended** | ** ** |
|---------------------------------------------------------------------------------------------------|------------|--------------------------------|------------|
| ** **                                                                                        | ** ** | **June 30,  2007**        | ** ** | **June 30,  2006** | ** ** |
| Cash flows from  operating activities:                                                            |       |                           |       |   |   |
| Net income                                                                                        |       | $                              | 28,696     |   | $ | 21,080 |   |
| Adjustments to reconcile  net income to net cash provided by (used in) operating activities: |       |                           |       |   |   |
| Depreciation and amortization                                                                     |       | 10,585                         |       | 10,723 |   |
| Equity in investee losses                                                                         |       | 404                            |       | 353 |   |
| Stock compensation                                                                                |       | 17,589                         |       | 20,843 |   |
| Loss (gain) on asset disposal                                                                     |       | 200                            |       | (150 | ) |
| Changes in operating  assets and liabilities:                                                     |       |                           |       |   |   |
| Accounts receivable                                                                               |       | 69,139                         |       | (18,772 | ) |
| Inventories                                                                                       |       | (4,887                         | )          | (11,016 | ) |
| Other current assets                                                                              |       | (24,867                        | )          | (6,756 | ) |
| Accounts payable                                                                                  |       | 12,233                         |       | 3,470 |   |
| Accrued expenses                                                                                  |       | 12,293                         |       | (63,423 | ) |
| Other current liabilities                                                                         |       | (11,645                        | )          | 8,007 |   |
| Net cash provided  by (used in) operating activities                                              |       | 109,740                        |       | (35,641 | ) |
| Cash flows from  investing activities:                                                            |       |                           |       |   |   |
| Purchases of short and long-term investments                                                      |       | (577,314                       | )          | (617,961 | ) |
| Sales and maturities of short and long-term  investments                                          |       | 659,456                        |       | 582,858 |   |
| Additions to property and equipment                                                               |       | (14,252                        | )          | (8,663 | ) |
| Proceeds from sales of equipment                                                                  |       | —                         |       | 150 |   |
| Investment in non-affiliate                                                                       |       | —                         |       | (8,939 | ) |
| Net cash provided  by (used in) investing activities                                              |       | 67,890                         |       | (52,555 | ) |
| Cash flows from  financing activities:                                                            |       |                           |       |   |   |
| Net proceeds from issuance of common stock                                                        |       | 30,696                         |       | 17,290 |   |
| Repayments of long-term debt and capital  leases                                                  |       | (440,597                       | )          | (1,180 | ) |
| Net cash provided  by (used in) financing activities                                              |       | (409,901                       | )          | 16,110 |   |
| Effect of  exchange rate changes on cash and cash equivalents                                     |       | 285                            |       | 66 |   |
| Net decrease in  cash and cash equivalents                                                        |       | (231,986                       | )          | (72,020 | ) |
| Cash and cash  equivalents at beginning of period                                                 |       | 415,411                        |       | 178,144 |   |
| Cash and cash  equivalents at end of period                                                       |       | $                              | 183,425    |   | $ | 106,124 |   |
| Supplemental  schedule of cash flow information:                                                  |       |                           |       |   |   |
| Cash paid during the period for interest                                                          |       | $                              | 22,084     |   | $ | 22,052 |   |
| Cash paid during the period for income taxes                                                      |       | $                              | 3,873      |   | $ | 94 |   |
| Non cash  activities:                                                                             |       |                           |       |   |   |
| Additions to  capital leases                                                                      |       | $                              | 3,260      |   | $ | — |   |

 

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

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**NOTES TO CONDENSEDCONSOLIDATED INTERIM FINANCIAL STATEMENTS (UNAUDITED)**

**1.**                 Basisof Presentation

The accompanying condensed consolidated interimfinancial statements are unaudited and have been prepared on a basissubstantially consistent with the audited financial statements. Certaininformation and footnote disclosures normally included in our annual financialstatements have been condensed or omitted. The consolidated interim financialstatements, in the opinion of our management, reflect all adjustments(consisting of normal recurring accruals) necessary for a fair presentation ofthe results for the interim periods ended June 30, 2007 and 2006.

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

The consolidated results of operations for the interimperiods are not necessarily indicative of the results of operations to beexpected for the full fiscal year. These condensed consolidated interimfinancial statements should be read in conjunction with the audited financialstatements for the year ended December 31, 2006, which are contained inour annual report on Form 10-K for the year ended December 31,2006, filed with the 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 February 2007, the Financial AccountingStandards Board, or FASB, issued Statement of Financial Accounting Standards,or SFAS, No. 159, “The Fair Value Option for Financial Assets andFinancial Liabilities,” or SFAS 159, which allows entities the option tomeasure eligible financial instruments and certain other items at fair value.SFAS 159 is effective for fiscal years beginning after November 15, 2007.We do not expect the adoption of SFAS 159 to have a material impact on ourconsolidated financial statements.

In June 2006, theFASB issued FASB Interpretation, or FIN, No. 48, “Accounting forUncertainty in Income Taxes,” or FIN 48. FIN 48 clarifies theapplication of SFAS No. 109, “Accounting for Income Taxes,” by providingdetailed guidance for the financial statement recognition, measurement anddisclosure of uncertain tax positions recognized in an enterprise’s financialstatements. Tax positions must meet a more likely than not recognitionthreshold at the effective date to be recognized upon the adoption ofFIN 48 and in subsequent periods. We adopted FIN 48 in January 2007.As noted in footnote 10 below, the adoption of FIN 48 did not have a materialimpact on our consolidated financial statements or results of operations.

**3.**                 Basicand Diluted Earnings Per Common Share

Basic earnings per share, or EPS, excludes dilutionand is computed by dividing net income by the weighted-average number ofcommon shares outstanding for the period. Diluted EPS is based upon theweighted average number of common shares outstanding during the period plus theadditional weighted average potential common shares during the period.Potential common shares result from the assumed conversion of convertiblesubordinated debt and the assumed exercise of outstanding stock options, the 

6

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proceeds of which are thenassumed to have been used to repurchase outstanding stock options using thetreasury stock method. Potential common shares are not included in the pershare calculation when the effect of their inclusion would be anti-dilutive.

For the three andsix months ended June 30, 2007 and 2006, the following securities wereexcluded from the computation of diluted EPS because they would have had ananti-dilutive effect:

a.                 Optionsto purchase shares of common stock:

| ** **            | ** ** | **Three Months  Ended  June 30, 2007**                         | ** **      | **Three Months  Ended  June 30, 2006** | ** ** | **Six Months  Ended  June 30, 2007** | ** ** | **Six Months  Ended  June 30, 2006** | ** **      |
|-----------------------|------------|-------------------------------------------------------------------------------|-----------------|-------------------------------------------------------|------------|-----------------------------------------------------|------------|-----------------------------------------------------|-----------------|
| ** **            | ** ** | **(in thousands, except price per share data)** | ** **      |
| Number of options     |       | 6,645                                                                         |            | 8,192                                                 |       | 6,618                                               |       | 8,072                                               |            |
| Price range per share |       | $                                                                             | 44.78 to $87.50 |                                                  | $          | 38.26 to $87.50                                     |       | $                                                   | 44.78 to $87.50 |   | $ | 38.26 to $87.50 |   |
|                       |            |                                                                               |                 |                                                       |            |                                                     |            |                                                     |                 |  |  |  |  |

 

b.                Sharesof common stock reserved for issuance upon conversion of convertible subordinateddebt:

| ** **                                       | ** ** | **June 30,  2007** | ** ** | **June 30,  2006** | ** ** |
|--------------------------------------------------|------------|-------------------------|------------|-------------------------|------------|
| ** **                                       | ** ** | **(in thousands)** | ** ** |
| 5% convertible  subordinated debentures due 2007 |       |                    | —     |                    |       |   | 4,763 |   |   |
| Total                                            |       |                    | —     |                    |       |   | 4,763 |   |   |

 

We have issued 0%convertible subordinated notes due 2024, which were not convertible into equityas of June 30, 2007 or 2006 or at any time during the six months ended June 30,2007 or 2006. Once these notes become convertible into equity, shares of commonstock will be reserved under the conversion formula for issuance uponconversion if and when our common stock price exceeds $67.20 per share on theNASDAQ Global Select Market. Prior to such occurrence, the notes are onlyconvertible into cash.

**4.**                 Inventories

Inventories consist of the following:

| ** **     | ** ** | **June 30,  2007** | ** ** | **December 31,  2006** | ** ** |
|----------------|------------|-------------------------|------------|-----------------------------|------------|
| ** **     | ** ** | **(in thousands)** | ** ** |
| Raw materials  |       | $                       | 22,586     |                        |       | $ | 21,611 |   |   |
| Finished goods |       | 20,173                  |       |                        | 15,476     |   |   |
| Total          |       | $                       | 42,759     |                        |       | $ | 37,087 |   |   |

 

**5.**                 DeferredFinancing and Patents Costs

The following scheduledetails the carrying value of our patents and deferred financing costs:

| ** **                       | ** ** | **June 30,  2007** | ** ** | **December 31,  2006** | ** ** |
|----------------------------------|------------|-------------------------|------------|-----------------------------|------------|
| ** **                       | ** ** | **(in thousands)** | ** ** |
| Deferred  financing costs, gross |       | $                       | 20,407     |                        |       | $ | 34,440 |   |   |
| Accumulated  amortization        |       | (11,418                 | )          |                        | (23,215    | ) |   |
| Deferred  financing costs, net   |       | $                       | 8,989      |                        |       | $ | 11,225 |   |   |
| Patents, gross                   |       | $                       | 2,259      |                        |       | $ | 2,259 |   |   |
| Accumulated amortization         |       | (1,688                  | )          |                        | (1,603     | ) |   |
| Patents, net                     |       | $                       | 571        |                        |       | $ | 656 |   |   |

 

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

| ** **                                | ** ** | **Three Months Ended** | ** ** | **Six Months Ended** | ** ** |
|-------------------------------------------|------------|----------------------------------|------------|--------------------------------|------------|
| ** **                                | ** ** | **June 30,  2007**          | ** ** | **June 30,  2006**        | ** ** | **June 30,  2007** | ** ** | **June 30,  2006** | ** ** |
| ** **                                | ** ** | **(in thousands)**          | ** ** |
| Amortization of  deferred financing costs |       |                             | $          | 960                            |       |   |   | $ | 1,435 |   |   |   | $ | 2,236 |   |   |   | $ | 2,870 |   |   |
| Amortization of  patents                  |       |                             | 34         |                           |       |   | 70 |   |   |   | 85 |   |   |   | 126 |   |   |
| Total                                     |       |                             | $          | 994                            |       |   |   | $ | 1,505 |   |   |   | $ | 2,321 |   |   |   | $ | 2,996 |   |   |

 

**6.**                 ConvertibleSubordinated Debt

Convertible subordinateddebt consists of the following:

| ** **                                                                     | ** ** | **June 30,  2007** | ** ** | **December 31,  2006** | ** ** |
|--------------------------------------------------------------------------------|------------|-------------------------|------------|-----------------------------|------------|
| ** **                                                                     | ** ** | **(in thousands)** | ** ** |
| 5% convertible  subordinated debentures due February 2007                 |       | $                       | —     |                        |       | $ | 440,000 |   |   |
| 0% Series A  convertible senior subordinated notes due December 2008 |       | 72,800                  |       |                        | 72,800     |   |   |
| 0% Series B  convertible senior subordinated notes due December 2010 |       | 148,020                 |       |                        | 148,020    |   |   |
| 0% convertible  senior subordinated notes due October 2024                |       | 500,000                 |       |                        | 500,000    |   |   |
| Total                                                                          |       | $                       | 720,820    |                        |       | $ | 1,160,820 |   |   |

 

**7.**                 ComprehensiveIncome (Loss)

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

| ** **                                                   | ** ** | **Three Months Ended** | ** ** | **Six Months Ended** | ** ** |
|--------------------------------------------------------------|------------|----------------------------------|------------|--------------------------------|------------|
| ** **                                                   | ** ** | **June 30,  2007**          | ** ** | **June 30,  2006**        | ** ** | **June 30,  2007** | ** ** | **June 30,  2006** | ** ** |
| ** **                                                   | ** ** | **(in thousands)**          | ** ** |
| Comprehensive  income (loss):                                |       |                             |       |                           |       |   |   |   |   |
| Net income                                                   |       | $                                | 6,147      |                           | $          | 11,044 |   | $ | 28,696 |   | $ | 21,080 |   |
| Net foreign  currency translation adjustment                 |       | 1,791                            |       | 722                            |       | 1,844 |   | 681 |   |
| Net unrealized  gain (loss) on available-for-sale securities |       | (2,646                           | )          | (14,670                        | )          | 8,866 |   | (3,864 | ) |
| Total comprehensive  income (loss)                           |       | $                                | 5,292      |                           | $          | (2,904 | ) | $ | 39,406 |   | $ | 17,897 |   |

 

**8.**                 LegalProceedings

***Tecastemizole Class Action Complaints***

In June 2007, we filed in the United StatesDistrict Court for the District of Massachusetts, or the Court, a Stipulationof Settlement regarding two securities class action lawsuits, or class actions,pending in the Court naming Sepracor and certain of our current and formerofficers and one director as defendants. As previously disclosed, the classactions, which were filed on behalf of certain purchasers of our equity anddebt securities, or the plaintiffs, allege that the defendants violated theFederal securities laws by making false and misleading statements relating tothe testing, safety and likelihood of approval of tecastemizole by the UnitedStates Food and Drug Administration, or FDA.

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Under the terms of the Stipulation of Settlement, inJune 2007 we paid into escrow $52.5 million in settlement of the class actionsand received an $18.5 million reimbursement in July 2007, from ourinsurance carriers. The total settlement amount will be released from escrowupon the Court’s final approval of the Stipulation of Settlement. The litigationsettlement expense of $34.0 million, relating to this matter, was recordedduring the quarter ended March 31, 2007.

The Stipulation of Settlement contains no admission ofwrongdoing. Sepracor and the other defendants have always maintained and continueto believe that we did not engage in any wrongdoing or otherwise commit anyviolation of Federal or state securities laws or other laws. However, given thepotential cost and burden of continued litigation, we believe the settlement isin our best interests and the best interests of our stockholders.

If the Court grants finalapproval of the Stipulation of Settlement, the Court will dismiss the classactions with prejudice and the plaintiffs will be deemed to have released allclaims against us. We can provide no assurance that the Court will approve theStipulation of Settlement or that members of the classes will not opt out ofthe settlement and elect to pursue litigation against us regarding the mattersalleged in the class actions. If the Court does not approve the Stipulation ofSettlement, or members of the classes opt out and pursue litigation against usdespite finalization of the settlement, or we determine to terminate theStipulation of Settlement pursuant to its terms due to the percentage ofmembers who opt out, we will need to continue to defend against these claims,which could have a material adverse effect on our financial condition andbusiness. If these matters were concluded in a manner adverse to us, we couldbe required to pay substantially more in damages than the amount provided forin the Stipulation of Settlement. In addition, the costs to us of defending anylitigation or other proceeding, even if resolved in our favor, could besubstantial. Such litigation could also substantially divert the attention ofour management and our resources in general. Uncertainties resulting from theinitiation and continuation of any litigation or other proceedings could harmour ability to compete in the marketplace.

***Litigation Related to Generic Competition***

**LevalbuterolHydrochloride Inhalation Solution Abbreviated New Drug Applications**

In September 2005, we received notification thatthe FDA had received an Abbreviated New Drug Application, or ANDA, from BreathLimited, or Breath, seeking approval of a generic version of our 1.25 mg/3 mL,0.63 mg/3 mL and 0.31 mg/3 mL XOPENEX® (levalbuterol hydrochloride) InhalationSolution. Breath’s submission includes a Paragraph IV certification allegingthat our patents listed in the FDA publication entitled “Approved Drug ProductsWith Therapeutic Equivalence Evaluations,” commonly referred to as the “OrangeBook,” for these three concentrations of XOPENEX (levalbuterol hydrochloride)Inhalation Solution are invalid, unenforceable or not infringed by the genericversion for which Breath is seeking approval. We have filed a civil actionagainst Breath for patent infringement.

In January 2006, we received notification thatthe FDA had received an ANDA, including a Paragraph IV certification, from Dey,L.P., seeking approval of a generic version of our 1.25 mg/3 mL, 0.63 mg/3mL, and 0.31 mg/3 mL XOPENEX (levalbuterol hydrochloride) Inhalation Solution. Dey,L.P.’s submission includes a Paragraph IV certification alleging that ourpatents listed in the Orange Book for these three concentrations of XOPENEX(levalbuterol hydrochloride) Inhalation Solution are invalid, unenforceable, ornot infringed by the generic version for which Dey, L.P. is seeking approval. Wefiled a civil action against Dey, L.P. for patent infringement.

In April 2006, we were notified of an ANDAseeking approval of a generic version of our 1.25 mg/3 mL, 0.63 mg/3mL and 0.31 mg/3 mL XOPENEX (levalbuterol hydrochloride) Inhalation Solutionincluding a Paragraph IV certification, which was submitted to the FDA byWatson Laboratories, Inc., or Watson. Watson’s Paragraph IV certificationwas limited to our patent that expires in 2021 and covers certain levalbuterolhydrochloride inhalation solution, including our XOPENEX 

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(levalbuterolhydrochloride) Inhalation Solution. We have decided not to file a civil actionagainst Watson for patent infringement at this time.

In August 2006, we received notification that theFDA had received an ANDA including a Paragraph IV certification, from Dey,L.P. seeking approval of a generic version of our 1.25 mg/0.5 mL XOPENEX(levalbuterol hydrochloride) Inhalation Solution concentrate. We have filed acivil action against Dey, L.P. for patent infringement. In September 2006,both civil actions we filed against Dey, L.P. were consolidated into a singlesuit.

In May 2007, wereceived notification that the FDA had received an ANDA, from Barr Laboratories, Inc.,or Barr, seeking approval of a generic version of our 1.25 mg/3 mL, 0.63 mg/3mL and 0.31 mg/3 mL XOPENEX (levalbuterol hydrochloride) Inhalation Solution. Barr’ssubmission includes a Paragraph IV certification alleging that our patentslisted in the Orange Book for these three concentrations of XOPENEX(levalbuterol hydrochloride) Inhalation Solution are invalid, unenforceable ornot infringed by the generic version for which Barr is seeking approval. On July 12,2007, we filed a civil action against Barr for patent infringement.

**DesloratadineAbbreviated New Drug Applications**

In June 2007, we received notification that theFDA had received an ANDA from Glenmark Pharmaceuticals, Ltd. and GlenmarkPharmaceuticals, Inc., USA, which we refer to collectively as Glenmark,seeking approval of a generic version of Schering-Plough Corporation, or Schering-Plough’s,5 mg tablets of CLARINEX® branddesloratadine. Glenmark’s submission includes a Paragraph IV certificationalleging that our patents that Schering-Plough (as licensee of such patents)listed in the Orange Book for its CLARINEX brand desloratadine are invalid,unenforceable or not infringed by the generic version for which Glenmark isseeking approval. In July 2007, we and the University of Massachusetts,co-owners of certain patents listed in the Orange Book, filed a civil action againstGlenmark for patent infringement.

In July 2007, we received notification that theFDA had received an ANDA from Sun Pharmaceutical Industries, Ltd., seekingapproval of a generic version of Schering-Plough’s 5 mg tablets of CLARINEXbrand desloratadine. Sun Pharmaceutical Industries, Ltd.’s submission includesa Paragraph IV certification alleging that our patents listed bySchering-Plough (as licensee of such patents) in the Orange Book for CLARINEXbrand desloratadine are invalid, unenforceable, or are not infringed by thegeneric version for which Sun Pharmaceutical Industries, Ltd. is seekingapproval. We are contemplating filing a civil action against SunPharmaceuticals Industries, Ltd. for patent infringement.

Should we successfully enforce our U.S. patents, ANDAapproval will not occur until the expiration of the applicable patents.Otherwise, the FDA will stay its approval of the relevant ANDA until thirtymonths following the date we received notice of such ANDA or until a courtdecides that our patents are invalid, unenforceable or not infringed, whicheveris earlier. Should we successfully enforce our foreign patents, genericcompanies will be prevented from obtaining patent protection for similar drugs,and will be deterred from market entry until the expiration of the applicablepatent(s).

Patent litigation involvescomplex legal and factual questions. We can provide no assurance concerning theoutcome or the duration of any patent related lawsuits. If we, or third partiesfrom whom we receive royalties, are not successful in enforcing our respective patents,the generic companies will not be excluded, for the full term of our patents,from marketing their generic versions of our products or third party productsfor which we have licensed rights to our patents. Introduction of genericcopies of any of our products or third party products for which we havelicensed rights to our patents before the expiration of our patents would havea material adverse effect on our business.

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***BROVANA Patent Infringement Claim***

In April 2007, wewere served with a complaint filed by Dey, L.P. and Dey, Inc., referred tocollectively as Dey, alleging that the manufacture and sale of BROVANATM(arformoterol tartrate) Inhalation Solution infringes or will induceinfringement of a single U.S. patent for which Dey owns all rights, title andinterest. In April 2007, we filed an answer and counterclaim to thiscomplaint seeking to invalidate the originally asserted patent and a secondrelated patent. In May 2007, Dey filed a reply asserting infringement ofthe second patent. It is too early to make a reasonable assessment as to thelikely outcome or impact of this litigation. We are unable to reasonablyestimate any possible range of loss or liability related to this lawsuit due toits uncertain resolution.

***Stock Option Inquiry and Derivative StockholderComplaints***

We announced in June 2006 that the SEC isconducting an informal inquiry into our stock option grants and stock optiongranting practices. A special committee of our outside directors, with theassistance of outside legal counsel and outside accounting specialists,reviewed the stock option grants to our officers, directors and employees from1996 to June 2006 under our various stock option plans in effect duringthis period. Our finance department also reviewed the stock option grants andstock option practices from 1996 to June 2006. Their review resulted inthe restatement of our financial statements for the quarters ended March 31,June 30 and September 30, 2005, the quarter ended March 31, 2006and the years ended December 31, 2005, 2004 and 2003. Representatives fromthe U.S. Attorneys Office attended some of the earlier meetings that ouroutside counsel had with the SEC. While the U.S. Attorneys Office has notinitiated an investigation, we cannot be certain that it will not. In October 2006,the Internal Revenue Service, or IRS, commenced an audit into our 2005 and 2004U.S. Federal income tax returns and has requested, among other things, certaininformation relating to our stock option grants and granting practices. The SECand/or any other governmental agency that may initiate a formal investigationmay reach different conclusions and, if so, we could be subject to monetarydamages, fines and penalties, and our officers and/or directors could beprohibited from serving as officers and directors of any public company andcould be subject to criminal penalties and/or disgorgement.

We have accepted service of three stockholderderivative complaints relating to certain of our stock option grants that werefiled in the Superior Court, Middlesex County, Commonwealth of Massachusetts,naming Sepracor as nominal defendant and also naming as defendants certaincurrent members of our board of directors and certain of our current and formeremployees. The complaints allege purported breaches of fiduciary duties andunjust enrichment in connection with certain stock option grants made by usbetween June 1998 and May 2001. The complaints seek monetary damagesin unspecified amounts, equitable and injunctive relief, including disgorgementof profits obtained by certain defendants and other relief as determined by theCourt. On September 12, 2006, the three complaints were consolidated intoone action, and on September 22, 2006, the action was transferred to theBusiness Litigation Session of the Superior Court, Suffolk County, Commonwealthof Massachusetts. On October 19, 2006, plaintiffs filed a consolidatedcomplaint alleging breaches of fiduciary duty and unjust enrichment inconnection with certain stock option grants we made between December 1995and April 2003. On November 20, 2006, we moved to dismiss theConsolidated Amended Complaint and a hearing on the motion was held on March 20,2007. The court has stayed all discovery in this case, and no decision on thismotion has been rendered at this time.

Three stockholder derivative complaints relating tothe same subject matter were filed against Sepracor, certain current and formermembers of our board of directors and certain of our current and formeremployees in the United States District Court for the District of Massachusettson September 28, 2006, October 3, 2006 and October 12, 2006. Inaddition to several common law theories alleging breaches of fiduciary duty andunjust enrichment, these complaints allege violations of Federal securitieslaws. On January 30, 2007, the Court consolidated the actions and aconsolidated complaint was filed. On April 9, 

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2007, we moved to stay theFederal court lawsuit pending resolution of the state court motion todismiss, and on May 4, 2007, the Court entered an order granting themotion and staying the Federal case.

We are unable toreasonably estimate any possible range of loss or liability related to thestock option inquiry and/or derivative suits due to their uncertain resolution.

***LUNESTA Trademark Claim***

In September 2006, Tharos Laboratories, Inc.,or Tharos, filed suit against us in the United States District Court, Districtof Utah, Central Division, alleging trademark infringement, dilution, unfaircompetition, false advertising and false designation of origin arising out ofour use of our silk luna moth design in connection with LUNESTA®. Tharos seeks unspecifiedmonetary damages and to enjoin our use of the silk luna moth design. In October 2006,we filed a motion to dismiss Tharos’ claims. On February 9, 2007, thecourt granted our motion in respect of the state unfair competition claims anddenied it in respect of Tharos’ other claims. On March 6, 2007, we filedan answer to Tharos’ complaint. In addition, we filed counterclaims againstTharos for cancellation of Tharos’ alleged trademark and for false advertising.We continue to defend our trademark in this litigation but we are unable atthis stage to predict its ultimate resolution.

From time to time we areparty to other legal proceedings in the course of our business. We do not,however, expect such other legal proceedings to have a material adverse effecton our business or financial condition.

**9.**                 Commitmentsand Contingencies

In conjunction with thereview of our stock option granting practices, we have also evaluated therelated tax issues to determine if we may be subject to additional taxliability as a result of the matters under review. As a result of such additionaltax liability, previously deducted compensation related to exercised stockoptions may be non-deductible under Section 162(m) of the InternalRevenue Code. Accordingly, our net operating loss carryforward may be reduced;however, we have a full valuation allowance against our deferred tax assetsand, as a result, do not expect any material impact on our financial positionor results of operations. In addition, due to the revision of measurementdates, certain stock options that we previously treated as incentive stockoptions do not actually qualify for such treatment and must be treated asnon-statutory stock options. Accordingly, we may be subject to fines and/orpenalties relating to the tax treatment of such stock options. However, we donot believe it is probable that we will incur any material additional taxliability as a result of the matters under review and any such amount is not expectedto have a material impact on our financial position or results of operations.The SEC and/or any other governmental agency that may initiate a formalinvestigation may reach different conclusions and, if so, we could be subjectto monetary damages, fines and penalties, and our officers and/or directorscould be prohibited from serving as officers and directors of any publiccompany and could be subject to criminal penalties and disgorgement.

**10.**          IncomeTaxes

Deferred tax assets and liabilities are recognized forthe estimated future tax consequences attributable to tax benefit carryforwardsand to differences between the financial statement amounts of assets andliabilities and their respective tax basis. Deferred tax assets and liabilitiesare measured using enacted tax rates in effect for the year in which thedifferences are expected to reverse. A valuation allowance is established if,based on management’s review of both positive and negative evidence, it is morelikely than not that all or a portion of the deferred tax asset will not berealized. Our historical losses from operations represent significant negativeevidence that indicates the need for a valuation allowance. Accordingly, avaluation allowance has been established for the full amount of the deferredtax asset. If we 

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determine, based on futureprofitability, that these deferred tax assets are more likely than not to berealized, a release of all, or part, of the related valuation allowance couldresult in an immediate material income tax benefit in the period of decreaseand material income tax provisions in future periods.

We adopted FIN 48 in January 2007. Theimplementation of FIN 48 did not have a material impact on our consolidatedfinancial statements or results of operations. We are currently in the processof conducting a study of our research and development credit carryforwards.This study may result in an adjustment to our research and development creditcarryforwards. However, until the study is completed and any adjustment isknown, no amounts are being presented as an uncertain tax position under FIN 48.We reasonably estimate that our unrecognized tax benefits position will notchange significantly within the next twelve months.

We file tax returns in the U.S. Federal jurisdictionand in various state, local and foreign jurisdictions. During the fourthquarter of 2006, the IRS commenced an audit of our 2005 and 2004 U.S. Federalincome tax returns. We are no longer subject to IRS examination for years priorto 2004, although carryforward attributes that were generated prior to 2004 maystill be adjusted upon examination by the IRS if they either have been or willbe used in a future period. There are currently no state audits in progress.With limited exceptions, we are no longer subject to state or localexaminations for years prior to 2003, however, carryforward attributes thatwere generated prior to 2003 may still be adjusted upon examination by state orlocal tax authorities if they either have been or will be used in a futureperiod.

The foreign jurisdictions where we currently fileincome tax returns are Canada and the Netherlands Antilles. We are currentlyunder examination by Canada Revenue Agency, or CRA, for our Scientific Researchand Experimental Development claims for the years ended December 31, 2004and 2003. There are currently no examinations being conducted by the taxauthorities in the Netherlands Antilles. With limited exceptions, we are nolonger subject to examination in Canada and the Netherlands Antilles for yearsprior to 2003 and 1999, respectively, although carryforward attributes thatwere generated prior to these respective periods may still be adjusted uponexamination if they either have been or will be used in a future period.

We recognize accrued interest and penalties related tounrecognized tax benefits as a component of tax expense. This policy did notchange as a result of the adoption of FIN 48. For the quarter ended June 30,2007, we did not recognize any accrued interest and penalties in ourconsolidated statement of operations or our consolidated balance sheet.

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**ITEM 2.**                MANAGEMENT’SDISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

**CautionaryStatement Regarding Forward-Looking Statements**

This quarterly report on Form 10-Qcontains, in addition to historical information, forward-looking statementswithin the meaning of Section 21E of the Securities Exchange Act 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 “Risk Factors” below for a discussion of important factors that couldcause our actual results to differ materially from the results we discuss inour forward-looking statements.

**Executive Overview**

We are a research-based pharmaceutical companyfocused on discovering, developing and commercializing differentiated productsthat address large and growing markets and unmet medical needs and can bemarketed to primary care physicians and certain specialists through our salesforce.

We currentlymanufacture and sell four products:

·       XOPENEX® (levalbuterolHCl) Inhalation Solution, a short-acting bronchodilator, for thetreatment or prevention of bronchospasm in patients with reversible obstructiveairway disease;

·       XOPENEXHFA® (levalbuterol tartrate) Inhalation Aerosol, ahydrofluoroalkane, or HFA, metered-dose inhaler, or MDI, for the treatment orprevention of bronchospasm in adults, adolescents and children four years ofage and older with reversible obstructive airway disease;

·       BROVANATM******(arformoterol tartrate) as along-term, twice-daily maintenance treatment of bronchoconstriction in patientswith chronic obstructive pulmonary disease, or COPD, including chronic bronchitisand emphysema; and

·       LUNESTA® (eszopiclone) for the treatment of insomnia.

We market and sell XOPENEX Inhalation Solution,XOPENEX HFA, BROVANA and LUNESTA directly through our sales force. We haveentered into out-licensing arrangements with respect to the sale of eszopiclonein Japan and with respect to several other compounds. We expect tocommercialize any additional products that we may successfully develop oracquire through our sales force, through co-promotion agreements and/or throughout-licensing partnerships.

Critical near-termsuccess factors for us include our ability to:

·       continueto increase our LUNESTA revenues, despite increasing competition;

·       growXOPENEX Inhalation Solution revenues outside of the Medicare market bymaintaining targeted sales and marketing efforts aimed at the retail andhospital market segments. Medicare market revenues may be adversely affected bypotential restrictions on Medicare Part B coverage or additional changesin the Medicare Part B reimbursement amount for XOPENEX InhalationSolution;

·       continueto increase our XOPENEX HFA revenues;

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·       successfullymarket and sell BROVANA, particularly in the home health care market segment,which could be adversely affected by potential restrictions on Medicare Part Breimbursement or changes in the Medicare Part B reimbursement amount forBROVANA;

·       manageexpenses effectively to preserve profitability and positive cash flow fromoperations; and

·       maintainpatent protection for our products, particularly for XOPENEX InhalationSolution for which four Abbreviated New Drug Applications, or ANDAs, have beensubmitted to the United States Food and Drug Administration, or FDA.

Our long-term success depends in large part on ourability to successfully develop or acquire and commercialize new productcandidates.

We expect that sales of LUNESTA and XOPENEX InhalationSolution will represent the majority of our total revenues in 2007. We do nothave long-term sales contracts with our customers, and we rely on purchaseorders for sales of our products. Reductions, delays or cancellations of ordersfor LUNESTA, XOPENEX Inhalation Solution, XOPENEX HFA or BROVANA couldadversely affect our operating results. If sales of LUNESTA, XOPENEX InhalationSolution, XOPENEX HFA and/or BROVANA do not meet our expectations, we may nothave sufficient revenues to achieve our business plan and our business will notbe successful.

In 2007, we expect to beprofitable for the year on an operating and net income basis. We expect salesand marketing expenses to continue to increase as compared to 2006 as we incurincreasing sales commission and marketing costs related to anticipated productrevenue growth. We expect research and development expenses to continue toincrease as compared to 2006 as we continue to invest in research anddevelopment activities relating to studies for LUNESTA, additional studies forBROVANA, and continued development of our SEP-225289, SEP-227162and SEP-225441 drug candidates, as well as increased drug discoveryefforts. As part of our business strategy for the remainder of 2007 and thefuture, we expect to consider and, as appropriate, consummate acquisitions ofother technologies, product candidates, approved products and/or businesses.

**Significant 2007Developments**

In July 2007, we announced that we had submitteda Marketing Authorization Application, or MAA, to the European regulatory authoritiesfor LUNIVIA® brand eszopiclone, marketed as LUNESTA in theUnited States, for the treatment of insomnia in the European Union. Approval ofthe MAA, which is the European Union equivalent of a New Drug Application, orNDA, in the United States, would allow authorization to market LUNIVIA in theEuropean Union.

In July 2007, we also announced that we hadentered into an agreement with Eisai Co. Ltd., or Eisai, for the developmentand commercialization of our eszopiclone product, marketed as LUNESTA in theUnited States. Under this agreement, Eisai will be responsible forcompleting remaining clinical trials necessary for attaining marketing approvalfrom the Japanese regulatory authorities and, contingent on obtainingregulatory approval, commercialization of the product in Japan. We received aninitial milestone payment and will be entitled to receive subsequent paymentsupon accomplishment of various development, regulatory and pricing milestones,as well as royalties on product sales. We will also be responsible for, andwill receive compensation in connection with, the manufacture and supply ofbulk tablets and/or active ingredient.

In June 2007, we announced that the Centers forMedicare and Medicaid Services, or CMS, issued its new, bundled, third quarter2007 payment amount for XOPENEX Inhalation Solution and generic albuterolinhalation solution products. The new Medicare Part B reimbursement rateannounced by CMS currently is $0.525 per 0.5 mg of levalbuterol and $0.525 per1 mg of generic albuterol. This translates into $1.31 per unit dose for the1.25 mg dose of XOPENEX Inhalation Solution, which is the dose of 

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XOPENEX InhalationSolution most commonly used by Medicare Part B beneficiaries. Thisreimbursement rate went into effect on July 1, 2007. Revenues from thesale of XOPENEX Inhalation Solution for the quarter ended June 30, 2007were, and we expect will continue to be, adversely affected as a result of achange in the reimbursement Medicare Part B rate.

In June 2007, we filed in the United StatesDistrict Court for the District of Massachusetts, or the Court, a Stipulationof Settlement regarding two securities class action lawsuits, or class actions,pending in the Court naming Sepracor and certain of our current and formerofficers and one director as defendants. As previously disclosed, the classactions, which were filed on behalf of certain purchasers of our equity anddebt securities, or the plaintiffs, allege that the defendants violated theFederal securities laws by making false and misleading statements relating tothe testing, safety and likelihood of approval of tecastemizole by the FDA.

Under the terms of the Stipulation of Settlement, inJune 2007 we paid into escrow $52.5 million in settlement of the classactions and received an $18.5 million reimbursement in July 2007,from our insurance carriers. The total settlement amount will be released fromescrow upon the Court’s final approval of the Stipulation of Settlement. The litigationsettlement expense of $34.0 million, relating to this matter, was recordedduring the quarter ended March 31, 2007.

The Stipulation of Settlement contains no admission ofwrongdoing. Sepracor and the other defendants have always maintained andcontinue to believe that we did not engage in any wrongdoing or otherwisecommit any violation of Federal or state securities laws or other laws.However, given the potential cost and burden of continued litigation, webelieve the settlement is in our best interests and the best interests of ourstockholders.

If the Court grants final approval of the Stipulationof Settlement, the Court will dismiss the class actions with prejudice and theplaintiffs will be deemed to have released all claims against us. We canprovide no assurance that the Court will approve the Stipulation of Settlementor that members of the classes will not opt out of the settlement and elect topursue litigation against us regarding the matters alleged in the class actions.If the Court does not approve the Stipulation of Settlement, or members of theclasses opt out and pursue litigation against us despite finalization of thesettlement, or we determine to terminate the Stipulation of Settlement pursuantto its terms due to the percentage of members who opt out, we will need tocontinue to defend against these claims, which could have a material adverseeffect on our financial condition and business. If these matters were concludedin a manner adverse to us, we could be required to pay substantially more indamages than the amount provided for in the Stipulation of Settlement. Inaddition, the costs to us of defending any litigation or other proceeding, evenif resolved 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.

In May 2007, we announced that Adrian Adams,President and Chief Operating Officer of Sepracor, was elected to the role ofPresident and Chief Executive Officer. Mr. Adams assumed the ChiefExecutive Officer role from Timothy J. Barberich, who was simultaneously electedExecutive Chairman of the Board of Directors.

In April 2007, we announced the commercialavailability of BROVANA (arformoteroltartrate) for the treatment of COPD. In April 2007, CMS announcedthat it is recommending that BROVANA be awarded a unique reimbursement codeunder the Medicare Part B prescription drug benefit. The final decision isexpected in the fourth quarter of 2007 and, if favorable, would becomeeffective on January 1, 2008. In June 2007, CMS announced coveragecriteria and interim reimbursement coding for BROVANA that will remain ineffect for the remainder of 2007.

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In April 2007, we were served with a complaint filedby Dey, L.P. and Dey, Inc., referred to collectively as Dey, alleging thatthe manufacture and sale of BROVANA (arformoterol tartrate) infringes or willinduce infringement of a single U.S. patent for which Dey owns all rights, titleand interest. In April 2007, we filed an answer and counterclaim to thiscomplaint seeking to invalidate the originally asserted patent and a secondrelated patent. In May 2007, Dey filed a reply asserting infringement ofthe second patent. It is too early to make a reasonable assessment as to thelikely outcome or impact of this litigation. We are unable to reasonablyestimate any possible range of loss or liability related to this lawsuit due toits uncertain resolution.

In March 2007, we announced that W. James O’Sheahad resigned as our President and Chief Operating Officer and was elected ViceChairman. In addition, we announced that, effective March 1, 2007, ourboard had elected Adrian Adams to the positions of President and ChiefOperating Officer and Andrew I. Koven to the positions of Executive VicePresident, General Counsel and Secretary. The board, upon the recommendation ofthe nominating and corporate governance committee, also elected Mr. Adamsto the board of directors, as a Class II director. Douglas E.Reedich, Senior Vice President, Legal Affairs, plans to leave Sepracor but willremain in this position for a short transition period to ensure an orderlytransition in the handling of our legal matters.

In February 2007,we paid in full $440.0 million in aggregate principal amount ofoutstanding 5% convertible subordinated debentures,which matured on February 15, 2007, plus approximately $11.0 million inaccrued interest.

**Three Month Periodsended June 30, 2007 and 2006**

**Revenues**

Product sales were $265.7 million and $256.4 millionfor the three months ended June 30, 2007 and 2006, respectively, anincrease of approximately 4%.

Sales of XOPENEX Inhalation Solution were $104.9million and $115.7 million for the three months ended June 30, 2007 and2006, respectively, a decrease of approximately 9%. The decrease is primarilydue to a 9% decrease in the net selling price as a result of a higher rate ofsales discounts and allowances during the three months ended June 30, 2007,primarily related to an increase in Medicaid and Medicare Part Bgovernment rebates. The number of units sold decreased by less than 1% for thethree months ended June 30, 2007 as compared to the same period in 2006.Adjustments recorded to gross sales are disclosed below under the heading “Analysisof gross sales to net sales.”

Sales of XOPENEX HFA were $12.3million and $1.6 million for the three months ended June 30, 2007 and2006, respectively, an increase of approximately 670%.The increase is due to a 331% increase in the number of unitssold, and a 79% increase in the net selling price, which is primarily relatedto fewer units sold in the three months ended June 30, 2007 under agovernment contract with the Departmentof Veterans Affairs, or VA, as compared to the same period in 2006.Adjustments recorded to gross sales are disclosed below under the heading “Analysisof gross sales to net sales.”

Sales of BROVANA were $5.5 million and $0 million forthe three months ended June 30, 2007 and 2006, respectively. We introducedBROVANA commercially in April 2007.

Sales of LUNESTA were $143.0 million and $139.1million for the three months ended June 30, 2007 and 2006, respectively,an increase of approximately 3%. The increase is primarily the result of a 10%increase in the gross selling price, which yielded an increase of approximately6% in net selling price due to a higher rate of sales discounts and allowances,particularly with respect to Medicaid and Medicare Part D governmentrebates. This 6% net selling price increase was offset by a 4% decrease in thenumber of units sold in the three months ended June 30, 2007 compared tothe same period in 2006. Adjustments recorded to gross sales are disclosedbelow under the heading “Analysis of gross sales to net sales.”

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***Analysis of gross sales to net sales—******We*********record product sales net ofthe following significant categories of product sales allowances: payment termdiscounts, government and commercial rebates and discounts, returns and otherdiscounts. Calculating each of these items involves significant estimates andjudgments and requires us to use information from external sources. Werecompute these amounts each quarter and, historically, our estimates have notmaterially differed from actual results. *The*following table presents theadjustments deducted from gross sales to arrive at total net sales:

| ** **                                           | ** ** | **For the Three Months Ended June 30,** | ** ** |
|------------------------------------------------------|------------|-----------------------------------------------------------------------|------------|
| ** **                                           | ** ** | **2007**                                                              | ** ** | **% of  Sales** | ** ** | **2006** | ** ** | **% of  Sales** | ** ** | **$  Change** | ** ** | **%  Change** | ** ** |
| ** **                                           | ** ** | **(dollars in thousands)**                                  | ** ** |
| Gross sales                                          |       | $                                                                     | 336,960    |   | 100.0 | % | $ | 298,292 |   | 100.0 | % | $ | 38,668 |   |   | 13 | % |   |
| Adjustments to  gross sales:                         |       |                                                                  |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Payment term discounts                               |       | 6,741                                                                 |       | 2.0 | % | 6,414 |   | 2.2 | % | 327 |   |   | 5 | % |   |
| Wholesaler fee-for-service                           |       | 3,712                                                                 |       | 1.1 | % | 7,291 |   | 2.4 | % | (3,579 | ) |   | (49 | )% |   |
| Government and commercial rebates and discounts |       | 51,747                                                                |       | 15.4 | % | 23,413 |   | 7.8 | % | 28,334 |   |   | 121 | % |   |
| Returns                                              |       | 3,831                                                                 |       | 1.1 | % | 4,268 |   | 1.4 | % | (437 | ) |   | (10 | )% |   |
| Other (includes product introduction discounts)      |       | 5,267                                                                 |       | 1.6 | % | 479 |   | 0.2 | % | 4,788 |   |   | 1,000 | % |   |
| Sub-total  adjustments                               |       | 71,298                                                                |       | 21.2 | % | 41,865 |   | 14.0 | % | 29,433 |   |   | 70 | % |   |
| Net sales                                            |       | $                                                                     | 265,662    |   | 78.8 | % | $ | 256,427 |   | 86.0 | % | $ | 9,235 |   |   | 4 | % |   |

 

The increase in adjustments to gross sales as apercentage of gross sales for the three months ended June 30, 2007 ascompared to the three months ended June 30, 2006 primarily reflects anincrease in government and commercial rebates and discounts as a result of anincrease in Medicaid discounts that we offered on the sales of LUNESTA, XOPENEXInhalation Solution and XOPENEX HFA; an increase in discounts given throughMedicare Part B program that we offered on the sales of XOPENEX InhalationSolution; and an increase in discounts given through our managed care programthat we offered on the sales of LUNESTA and XOPENEX HFA. In addition,adjustments to gross sales increased as a result of an increase in discounts weoffered through voucher and coupon programs on the sales of LUNESTA and XOPENEXHFA. Partially offsetting these increases in adjustments to gross sales as apercentage of gross sales was adecrease in wholesaler fee-for-service adjustments primarily related to aLUNESTA price increase in June 2007.

Royalties were $12.5 million and $8.0 million for thethree months ended June 30, 2007 and 2006, respectively, an increase ofapproximately 56%.

Royalties earned on the sales of ALLEGRA® (fexofenadine HCl), under our agreement withsanofi-aventis, increased to $6.3 million for the three months ended June 30,2007 compared to $3.2 million for the same period in 2006, primarily resultingfrom increased sales in Japan.

Royalties earned on sales of CLARINEX® (desloratadine), under ouragreement with Schering-Plough Corporation, or Schering-Plough, were $4.8million for the three months ended June 30, 2007 compared to $3.5 millionfor the same period in 2006.

Royalties earned on sales of XYZAL®/XUSALTM (levocetirizine) underour agreement with UCB Pharma SA, Belgium, or UCB, increased slightly to $1.4million for the three months ended June 30, 2007 as compared to $1.3million for the same period in 2006.

A number of the patents weown and license to third parties for which we receive these royalties are thesubject of patent invalidation or revocation claims. We can provide noassurance concerning the outcome or the duration of any patent relatedlawsuits. If we, or third parties from whom we receive 

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royalties,are not successful in enforcing our respective patents, the generic companieswill not be excluded from marketing their generic versions of these products.Introduction of generic copies of any of these products before the expirationof our patents or the patents of our licensees could have a material adverseeffect on our business.

**Costs of Revenues**

Cost of products sold was $25.1 million and $20.7million for the three months ended June 30, 2007 and 2006, respectively.

Cost of XOPENEX Inhalation Solution sold as apercentage of XOPENEX Inhalation Solution gross sales was approximately 7% forboth the three months ended June 30, 2007 and 2006.

Cost of XOPENEX HFA sold as a percentage of XOPENEXHFA gross sales was approximately 15% and 17% for the three months ended June 30,2007 and 2006, respectively. Included in the costs of XOPENEX HFA sold is aroyalty paid on net sales of XOPENEX HFA to 3M Company, or 3M, our third-partyfinished goods manufacturer of the product. The decrease in the cost as apercentage of gross sales is primarily due to a decrease in manufacturingcosts.

Cost of BROVANA sold as a percentage of BROVANA grosssales was approximately 20% for the three months ended June 30, 2007. Weintroduced BROVANA commercially in April 2007.

Cost of LUNESTA sold as a percentage of LUNESTA grosssales was approximately 6% for both the three months ended June 30, 2007and 2006, with the largest portion being the royalty paid on net sales ofLUNESTA to a third party.

Cost of royalties earnedwas $389,000 and $283,000 for the three months ended June 30, 2007 and2006, respectively, an increase of approximately 37%. The cost of royalties inboth periods relates to an obligation to a third party as a result of royaltieswe earn from Schering-Plough based on its sales of CLARINEX. Thisincrease in third-party obligations is due to the increase in royalties earnedduring the three months ended June 30, 2007 as compared with the sameperiod in 2006.

**Research andDevelopment**

Research and development expenses were $45.5 millionand $36.3 million for the three months ended June 30, 2007 and 2006,respectively, an increase of approximately 25%. The increase is primarily dueto higher spending on our Phase IV LUNESTA program, early stage SEP-227162program and Phase IV BROVANA program.

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, allowsthe opportunity for study in humans, or clinical study, of the potential newdrug. Clinical development typically involves three phases of study: Phase I, IIand III. The most significant costs in clinical development are in Phase IIIclinical trials, as they tend to be the longest and largest studies in the drugdevelopment process. Following successful completion of Phase III clinicaltrials, an NDA must be submitted to, and accepted by, the FDA, and the FDA mustapprove the NDA, prior to commercialization of the drug. We may elect either onour own, or at the request of the FDA, to conduct further studies that arereferred to as Phase IIIB and IV studies, which if conducted, could cause us toincur substantial costs. Phase IIIB studies are initiated and either completedor substantially completed while the NDA is under FDA review. These studies areconducted under an IND. Phase IV studies, also referred to as post-marketingstudies, are studies that are initiated and conducted after the FDA has approveda product for marketing. Phase IV studies may be requested by the FDA eitherbefore or after the FDA has approved an NDA. These studies may also beindependently initiated by the company for which an NDA has been 

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approved. The FDA and thecompanies conducting post-marketing studies use them to gather additionalinformation about a product’s safety, efficacy or optimal use.

Successful development of our product candidates ishighly uncertain. Completion dates and completion costs can vary significantlyfor each product candidate and are difficult to predict. The lengthy process ofseeking FDA approvals, and subsequent compliance with applicable statutes andregulations, require the expenditure of substantial resources. Any failure byus to obtain, or delay in obtaining, regulatory approvals could materiallyadversely affect our business. We cannot provide assurance that we will obtainany approval required 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 “Risk Factors.”

Belowis a summary of development of our products and product candidates thatrepresent approximately 10% or more of our direct project research anddevelopment spending for the three months ended June 30, 2007. The “Estimateof Completion of Phase” column contains forward-looking statementsregarding expected timing of completion of product development phases.Completion of product development, if successful, culminates in the submissionof an NDA to the FDA; however, there can be no assurance that the FDA willaccept for filing, or approve, any NDA. The actual timing of completion ofphases could differ materially from the estimates provided in the table. In thetable below, the three commercial products and the two product candidateslisted accounted for approximately 86% of our direct project research anddevelopment spending for the three months ended June 30, 2007. No otherproduct candidate accounted for more than 5% of our direct research anddevelopment spending in this period.

| **Product or Product Candidate** | ** ** | ** **              | ** ** | **Indication** | ** ** | **Phase of  Development** | ** ** | **Estimate of  Completion of   Phase** | ** ** |
|-------------------------------------------------|------------|-------------------------|------------|----------------|------------|--------------------------------|------------|-------------------------------------------------------|------------|
| LUNESTA (eszopiclone)                           |       | Insomnia                |       |           | *          |                           |       |                                                  | *          |   |   |
| XOPENEX HFA  (levalbuterol tartrate)            |       | Respiratory—Asthma |       |           | **         |                           |       |                                                  | **         |   |   |
| BROVANA (arformoterol  tartrate)                |       | Respiratory—COPD   |       |           | ***        |                           |       |                                                  | ***        |   |   |
| SEP-225289                                      |       | Depression              |       |           | Phase I    |                           |       |                                                  | 2007       |   |   |
| SEP-227162                                      |       | Depression              |       |           | Phase I    |                           |       |                                                  | 2007       |   |   |

----

*                    Wecommercially introduced LUNESTA in April 2005.

**             We commerciallyintroduced XOPENEX HFA in December 2005.

***      We commercially introducedBROVANA in April 2007.

Belowis a summary of expenditure information related to our products and productcandidates representing approximately 10% or more of our direct project researchand development spending during the three months ended June 30, 2007 or2006, as well as the costs incurred to date on these projects. The costs inthis analysis include only direct costs and do not include certain indirectlabor, overhead, share-based compensation or other costs that benefit multipleprojects. As a result, fully-loaded research and development cost summaries byproject are not presented.

| ** **                           | ** ** | **Project costs for  the three  months ended  June 30, 2007** | ** ** | **Project costs to  date through  June 30, 2007** | ** ** | **Project costs for  the three  months ended  June 30, 2006** | ** ** | **Project costs to  date through  June 30, 2006** | ** ** |
|--------------------------------------|------------|---------------------------------------------------------------------------------------------|------------|----------------------------------------------------------------------------|------------|---------------------------------------------------------------------------------------------|------------|----------------------------------------------------------------------------|------------|
| ** **                           | ** ** | **(in thousands)**                                                                     | ** ** |
| LUNESTA (eszopiclone)                |       |                                                                                        | $          | 5,921                                                                      |       |                                                                                        |       | $                                                                          | 231,549    |   |   |   | $ | 2,841 |   |   |   | $ | 210,544 |   |   |
| XOPENEX HFA  (levalbuterol tartrate) |       |                                                                                        | $          | 1,961                                                                      |       |                                                                                        |       | $                                                                          | 172,219    |   |   |   | $ | 3,126 |   |   |   | $ | 165,204 |   |   |
| BROVANA (arformoterol  tartrate)     |       |                                                                                        | $          | 3,886                                                                      |       |                                                                                        |       | $                                                                          | 181,343    |   |   |   | $ | 2,007 |   |   |   | $ | 167,228 |   |   |
| SEP-225289                           |       |                                                                                        | $          | 2,596                                                                      |       |                                                                                        |       | $                                                                          | 17,565     |   |   |   | $ | 2,402 |   |   |   | $ | 9,270 |   |   |
| SEP-227162                           |       |                                                                                        | $          | 3,071                                                                      |       |                                                                                        |       | $                                                                          | 12,151     |   |   |   | $ | 1,318 |   |   |   | $ | 4,373 |   |   |

 

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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 ofthe ultimate cost to bring our product candidates to FDA-approved status.We do not believe it is possible to estimate, with any degree of accuracy, thecosts of product candidates that are in stages earlier than Phase III.Accordingly, because all of our product candidates are in Phase I development,we have not provided any such estimates.

**Selling, Marketingand Distribution**

Selling, marketing anddistribution expenses were $191.5 million and $182.6 million for the threemonths ended June 30, 2007 and 2006, respectively, an increase ofapproximately 5%. This increase is largely due to an increase in marketing,advertising and promotional costs associated with our April 2007commercialization of BROVANA.

**General andAdministrative**

General and administrativecosts were $19.3 million and $18.1 million for the three months ended June 30,2007 and 2006, respectively, an increase of approximately 7%. The increase isprimarily the result of increased legal fees largely related to patent andshareholder litigation.

**Other Income(Expense)**

Interest income was $11.1 million and $11.0 millionfor the three months June 30, 2007 and 2006, respectively, an increase ofapproximately 1%. The increase is primarily due to higher interest rates earnedon investments in 2007. For the three months ended June 30, 2007 and 2006,the average annualized interest rate that we earned on our investments was5.23% and 4.75%, respectively.

Interest expense was $113,000 and $5.5 million for thethree months ended June 30, 2007 and 2006, respectively. The expense inboth periods is primarily related to the interest we paid on our 5% convertiblesubordinated debentures, which we repaid in full upon their maturity on February 15,2007.

Equity in investee losseswere $132,000 and $95,000 for the three months ended June 30, 2007 and2006, respectively, an increase of approximately 39%. The loss represents ourportion of BioSphere losses.

**Income Taxes**

Income tax expense was$485,000 and $430,000 for the three months ended June 30, 2007 and 2006,respectively. The increase in income tax expense for the three months ended June 30,2007 as compared to the three months ended June 30, 2006 is primarily dueto foreign income taxes, as well as U.S. Federal and state alternative minimumtax, or AMT. Although we had Federal and state tax net operating losscarryforwards as of December 31, 2006, the utilization of these losscarryforwards is limited in the calculation of AMT. For the three months ended June 30,2007 and 2006, income tax expense includes Federal, state and foreign incometax expense. Our historical losses from operations continue to representsignificant negative evidence that indicates the need for a valuationallowance. Accordingly, a valuation allowance has been established for the fullamount of our deferred tax asset. If we determine, based on futureprofitability, that these deferred tax assets are more likely than not to berealized, a release of all, or part, of the related valuation allowance couldresult in an immediate material income tax benefit in the period of decreaseand material income tax provisions in future periods.

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**Six Month Periodsended June 30, 2007 and 2006**

**Revenues**

Product sales were $587.0 million and $533.9 millionfor the six months ended June 30, 2007 and 2006, respectively, an increaseof approximately 10%.

Sales of XOPENEX Inhalation Solution were $257.4million for the six months ended June 30, 2007 as compared to $249.8million for the same period in 2006, an increase of approximately 3%. Theincrease is primarily due to a 5% increase in the number of units sold offsetby a 2% decrease in the net selling price, primarily related to increaseddiscounts with respect to Medicaid and Medicare Part B government rebates.This increase in government rebates was partially offset by lower amountsaccrued for product returns in the six months ended June 30, 2007 ascompared to the same period in 2006. Adjustments recorded to gross sales aredisclosed below under the heading “Analysis of gross sales to net sales.”

Sales of XOPENEX HFA were $32.8 million for the sixmonths ended June 30, 2007, as compared to $6.9 million for the sameperiod in 2006, an increase of approximately 372%.The increase is due to a 242% increase in the number of unitssold, and a 38% increase in the net selling price, which is primarily relatedto fewer units sold under a government contract with the VA in the six monthsended June 30, 2007 as compared to the same period in 2006. Adjustmentsrecorded to gross sales are disclosed below under the heading “Analysis ofgross sales to net sales.”

Sales of BROVANA were $5.5 million for the six monthsended June 30, 2007, as compared to $0 million for the same period in2006. We introduced BROVANA commercially in April 2007.

Sales of LUNESTA were $291.3 million and $277.2million for the six months ended June 30, 2007 and 2006, respectively, anincrease of approximately 5%. The increase is primarily the result of a 10%increase in the gross selling price, which yielded an increase of approximately6% in the net selling price due to a higher rate of sales discounts andallowances, particularly with respect to Medicare Part D governmentrebates and managed care commercial discounts. The number of units solddecreased by less than 1% for the six months ended June 30, 2007 ascompared to the same period in 2006. Adjustments recorded to gross sales aredisclosed below under the heading “Analysis of gross sales to net sales.”

***Analysis of gross sales to net sales—******The***followingtable presents the adjustments deducted from gross sales to arrive at netsales:

| ** **                                           | ** ** | **For the Six Months Ended June 30,** | ** ** |
|------------------------------------------------------|------------|---------------------------------------------------------------------|------------|
| ** **                                           | ** ** | **2007**                                                            | ** ** | **% of  sales** | ** ** | **2006** | ** ** | **% of  sales** | ** ** | **$  Change** | ** ** | **%  Change** | ** ** |
| ** **                                           | ** ** | **(dollars in thousands)**                                | ** ** |
| Gross sales                                          |       | $                                                                   | 748,746    |   | 100.0 | % | $ | 638,707 |   | 100.0 | % | $ | 110,039 |   |   | 17 | % |   |
| Adjustments to  gross sales:                         |       |                                                                |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Payment term discounts                               |       | 14,966                                                              |       | 2.0 | % | 13,299 |   | 2.1 | % | 1,667 |   |   | 13 | % |   |
| Wholesaler fee for service                           |       | 13,862                                                              |       | 1.9 | % | 15,852 |   | 2.5 | % | (1,990 | ) |   | (13 | )% |   |
| Government and commercial rebates and discounts |       | 117,634                                                             |       | 15.7 | % | 63,605 |   | 10.0 | % | 54,029 |   |   | 85 | % |   |
| Returns                                              |       | 8,950                                                               |       | 1.2 | % | 10,550 |   | 1.6 | % | (1,600 | ) |   | (15 | )% |   |
| Other (includes product introduction discounts)      |       | 6,375                                                               |       | 0.8 | % | 1,469 |   | 0.2 | % | 4,906 |   |   | 334 | % |   |
| Sub-total  adjustments                               |       | 161,787                                                             |       | 21.6 | % | 104,775 |   | 16.4 | % | 57,012 |   |   | 54 | % |   |
| Net sales                                            |       | $                                                                   | 586,959    |   | 78.4 | % | $ | 533,932 |   | 83.6 | % | $ | 53,027 |   |   | 10 | % |   |

 

The increase in adjustments to gross sales as apercentage of gross sales for the six months ended June 30, 2007 ascompared to the six months ended June 30, 2006 primarily reflects anincrease in 

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government and commercialrebates and discounts as a result of an increase in Medicaid discounts that weoffered on the sales of XOPENEX Inhalation Solution and XOPENEX HFA; anincrease in discounts given through Medicare Part D program that weoffered on the sales of LUNESTA; and an increase in discounts given through ourmanaged care program that we offered on the sales of LUNESTA. Partiallyoffsetting these increases in adjustments to gross sales as a percentage ofgross sales was adecrease in wholesaler fee-for-service adjustments primarily related to aLUNESTA price increase in June 2007.

Royalties were $22.6 million and $16.2 million for thesix months ended June 30, 2007 and 2006, respectively, an increase ofapproximately 40%.

Royalties earned on the sales of ALLEGRA (fexofenadineHCl), under our agreement with sanofi-aventis, increased to $12.1 million forthe six months ended June 30, 2007 compared to $8.7 million for the sameperiod in 2006, resulting primarily from increased sales in Japan.

Royalties earned on sales of CLARINEX (desloratadine),under our agreement with Schering-Plough were $8.1 million for the six monthsended June 30, 2007 compared to $5.5 million for the same period in 2006.

Royalties earned on sales of XYZAL/XUSAL (levocetirizine)under our agreement with UCB, increased slightly to $2.4 million for the sixmonths ended June 30, 2007 as compared to $2.0 million for the same periodin 2006.

A number of the patents weown and license to third parties for which we receive these royalties are thesubject of patent invalidation or revocation claims. We can provide noassurance concerning the outcome or the duration of any patent relatedlawsuits. If we, or third parties from whom we receive royalties, are notsuccessful in enforcing our respective patents, the generic companies will notbe excluded from marketing their generic versions of these products.Introduction of generic copies of any of these products before the expirationof our patents or the patents of our licensees could have a material adverseeffect on our business.

**Costs of Revenues**

Cost of products sold was $56.5 million and $46.2million for the six months ended June 30, 2007 and 2006, respectively.

Cost of XOPENEX Inhalation Solution sold as apercentage of XOPENEX Inhalation Solution gross sales was approximately 7% and8% for the six months ended June 30, 2007 and 2006, respectively. Thedecrease in the cost as a percentage of gross sales is primarily due to lower reservesfor product quality and expiration concerns and lower manufacturing costsduring the six months ended June 30, 2007 as compared to the same periodin 2006.

Cost of XOPENEX HFA sold as a percentage of XOPENEXHFA gross sales was approximately 15% for both the six months ended June 30,2007 and 2006. Included in the costs of XOPENEX HFA sold is a royalty paid onnet sales of XOPENEX HFA to 3M, our third-party finished goods manufacturer ofthe product.

Cost of BROVANA sold as a percentage of BROVANA grosssales was approximately 20% for the six months ended June 30, 2007. Weintroduced BROVANA commercially in April 2007.

Cost of LUNESTA sold as a percentage of LUNESTA grosssales was approximately 6% for both the six months ended June 30, 2007 and2006, with the largest portion being the royalty paid on net sales of LUNESTAto a third party.

Cost of royalties earnedwas $655,000 and $442,000 for the six months ended June 30, 2007 and 2006,respectively, an increase of approximately 48%. The cost of royalties in bothperiods relates to an 

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obligationto a third party as a result of royalties we earn from Schering-Plough basedupon its sales of CLARINEX. This increase in third-party obligations is due tothe increase in royalties earned during the six months ended June 30, 2007as compared with the same period in 2006.

**Research andDevelopment**

Research and development expenses were $86.2 millionand $85.6 million for the six months ended June 30, 2007 and 2006,respectively, an increase of approximately 1%. The increase is primarily due toincreased spending on our LUNESTA Phase IV program and early-stage programs SEP-227162and SEP-225441, as well as an increase in non-project-specificpersonnel-related expenses. These increases were offset by a decrease inspending on our XOPENEX HFA MDI formulation.

Belowis a summary of development of our products and product candidates thatrepresent approximately 10% or more of our direct project research anddevelopment spending for the six months ended June 30, 2007. The “Estimateof Completion of Phase” column contains forward-looking statementsregarding expected timing of completion of product development phases.Completion of product development, if successful, culminates in the submissionof an NDA to the FDA; however, there can be no assurance that the FDA willaccept for filing, or approve, any NDA. The actual timing of completion ofphases could differ materially from the estimates provided in the table. In thetable below, the three commercial products and the two product candidateslisted accounted for approximately 88% of our direct project research anddevelopment spending for the six months ended June 30, 2007. No otherproduct candidate accounted for more than 5% of our direct research anddevelopment spending in this period.

| **Product or Product Candidate** | ** ** | ** **              | ** ** | **Indication** | ** ** | **Phase of  Development** | ** ** | **Estimate of  Completion of   Phase** | ** ** |
|-------------------------------------------------|------------|-------------------------|------------|----------------|------------|--------------------------------|------------|-------------------------------------------------------|------------|
| LUNESTA  (eszopiclone)                          |       | Insomnia                |       |           | *          |                           |       |                                                  | *          |   |   |
| XOPENEX HFA  (levalbuterol tartrate)            |       | Respiratory—Asthma |       |           | **         |                           |       |                                                  | **         |   |   |
| BROVANA  (arformoterol tartrate)                |       | Respiratory—COPD   |       |           | ***        |                           |       |                                                  | ***        |   |   |
| SEP-225289                                      |       | Depression              |       |           | Phase  I   |                           |       |                                                  | 2007       |   |   |
| SEP-227162                                      |       | Depression              |       |           | Phase I    |                           |       |                                                  | 2007       |   |   |

----

*                    Wecommercially introduced LUNESTA in April 2005.

**             We commerciallyintroduced XOPENEX HFA in December 2005.

***      We commercially introducedBROVANA in April 2007.

Belowis a summary of expenditure information related to our product candidatesrepresenting approximately 10% or more of our direct project research anddevelopment spending during the six months ended June 30, 2007 or 2006, aswell as the costs incurred to date on these projects. The costs in thisanalysis include only direct costs and do not include certain indirect labor,overhead, share-based compensation or other costs which benefit multipleprojects. As a result, fully loaded research and development cost summaries byproject are not presented.

| ** **                           | ** ** | **Project costs for  the six  months ended  June 30, 2007** | ** ** | **Project costs to  date through  June 30, 2007** | ** ** | **Project costs for  the six  months ended  June 30, 2006** | ** ** | **Project costs to  date through  June 30, 2006** | ** ** |
|--------------------------------------|------------|-------------------------------------------------------------------------------------------|------------|----------------------------------------------------------------------------|------------|-------------------------------------------------------------------------------------------|------------|----------------------------------------------------------------------------|------------|
| ** **                           | ** ** | **(in thousands)**                                                                   | ** ** |
| LUNESTA  (eszopiclone)               |       |                                                                                      | $          | 11,526                                                                     |       |                                                                                      |       | $                                                                          | 231,549    |   |   |   | $ | 10,822 |   |   |   | $ | 210,544 |   |   |
| XOPENEX HFA  (levalbuterol tartrate) |       |                                                                                      | $          | 2,921                                                                      |       |                                                                                      |       | $                                                                          | 172,219    |   |   |   | $ | 8,413 |   |   |   | $ | 165,204 |   |   |
| BROVANA  (arformoterol tartrate)     |       |                                                                                      | $          | 7,412                                                                      |       |                                                                                      |       | $                                                                          | 181,343    |   |   |   | $ | 5,650 |   |   |   | $ | 167,228 |   |   |
| SEP-225289                           |       |                                                                                      | $          | 4,455                                                                      |       |                                                                                      |       | $                                                                          | 17,565     |   |   |   | $ | 5,201 |   |   |   | $ | 9,270 |   |   |
| SEP-227162                           |       |                                                                                      | $          | 4,010                                                                      |       |                                                                                      |       | $                                                                          | 12,151     |   |   |   | $ | 2,627 |   |   |   | $ | 4,373 |   |   |

 

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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. Accordingly,because all of our product candidates are in Phase I development, we havenot provided any such estimates.

**Selling, Marketingand Distribution**

Selling, marketing anddistribution expenses were $383.6 million and $372.6 million for the six monthsended June 30, 2007 and 2006, respectively, an increase of approximately3%. The increase is primarily attributable to an increase in salary and othercompensation related expense as a result of hiring additional salesrepresentatives and management in the second quarter of 2006 to support ourmarketed products, in addition to increased costs associated with our April 2007commercialization of BROVANA. These increases were offset by a decrease inmarketing, advertising and promotional expenses primarily related to costs tosupport LUNESTA.

**General andAdministrative**

General and administrativecosts were $38.2 million and $32.6 million for the six months ended June 30,2007 and 2006, respectively, an increase of approximately 17%. The increase isprimarily the result of increased legal fees largely related to patent andshareholder litigation, as well as expenses associated with responding to theSecurities and Exchange Commission, or SEC’s, informal inquiry into our stockoption granting practices.

**LitigationSettlement**

Litigation settlementexpense was $34.0 million and $0 million for the six months ended June 30,2007 and 2006, respectively. In June 2007, we filed in the Court, aStipulation of Settlement regarding two class actions, pending in the Courtnaming Sepracor and certain of our current and former officers and one directoras defendants. As previously disclosed, the class actions, which were filed onbehalf of the plaintiffs, allege that the defendants violated the Federalsecurities laws by making false and misleading statements relating to thetesting, safety and likelihood of approval of tecastemizole by the FDA. Underthe terms of the Stipulation of Settlement, in June 2007 we paid into escrow $52.5million in settlement of the class actions and received an $18.5 million reimbursementin July 2007, from our insurance carriers. The total settlement amountwill be released from escrow upon the Court’s final approval of the Stipulationof Settlement. The litigation settlement expense of $34.0 million, relating tothis matter, was recorded during the quarter ended March 31, 2007.

**Other Income(Expense)**

Interest income was $23.7 million and $20.8 millionfor the six months ended June 30, 2007 and 2006, respectively, an increaseof approximately 14%. The increase is primarily due to higher interest ratesearned on investments in 2007. Our monthly average cash and investment balancewas approximately $903.5 million and $937.8 million for the six months ended June 30,2007 and 2006, respectively. For the six months ended June 30, 2007 and2006, the average annualized interest rate that we earned on our investmentswas 5.25% and 4.43%, respectively.

Interest expense was $2.9 million and $11.1 millionfor the six months ended June 30, 2007 and 2006, respectively. The expensein both periods is primarily related to the interest we paid on our 5%convertible subordinated debentures, which we repaid in full upon theirmaturity on February 15, 2007.

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Equity in investee losseswere $404,000 and $353,000 for the six months ended June 30, 2007 and2006, respectively, an increase of approximately 14%. The loss represents ourportion of BioSphere losses.

**Income Taxes**

Income tax expense was$1.9 million and $541,000 for the six months ended June 30, 2007 and 2006,respectively. The increase in income tax expense for the six months ended June 30,2007 as compared to the six months ended June 30, 2006 is primarily due toU.S. Federal and state AMT, and foreign taxes as a result of an increase in netincome. Although we had Federal and state tax net operating loss carryforwardsas of December 31, 2006, the utilization of these loss carryforwards islimited in the calculation of AMT. For the six months ended June 30, 2007and 2006, income tax expense includes Federal, state and foreign income taxexpense. Our historical losses from operations continue to representsignificant negative evidence that indicates the need for a valuationallowance. Accordingly, a valuation allowance has been established for the fullamount of our deferred tax asset. If we determine, based on futureprofitability, that these deferred tax assets are more likely than not to berealized, a release of all, or part, of the related valuation allowance couldresult in an immediate material income tax benefit in the period of decreaseand material income tax provisions in future periods.

**Liquidity andCapital Resources**

Our liquidity requirements have historically consistedof research and development expenses, sales and marketing expenses, capitalexpenditures, working capital, debt service and general corporate expenses.Historically, we have funded these requirements and the growth of our businessprimarily through convertible subordinated debt offerings, the issuance ofcommon stock, including the exercise of stock options, sales of our productsand license agreements for our drug compounds. We now expect to fund ourliquidity requirements primarily with revenue generated from product sales. Wealso believe we have the ability to meet our short-term liquidity needs throughthe use of our cash and short-term investments on hand at June 30, 2007.

Cash, cash equivalents and short- and long-terminvestments totaled $860.9 million, or 74% of total assets, at June 30,2007, compared to $1.2 billion, or 78% of total assets, at December 31,2006.

Net cash provided by operating activities for the sixmonths ended June 30, 2007 was $109.7 million, which includes netincome of $28.7 million. Our net income includes non-cash charges of $28.8million, consisting primarily of share-based compensation and depreciation andamortization expense. Accounts receivable decreased by $69.1 million primarilydue to timing of product sales. Inventory on hand increased by $4.9 million asa result of lower than expected product sales. Other current assets increasedby $24.9 million, which is primarily attributable to an increase in prepaidexpenses and the insurance receivable resulting from the preliminary settlementof two class actions. Accounts payable increased by $12.2 million primarily dueto timing of vendor payments. Accrued expenses increased by $12.3 millionprimarily due to the timing of employee vacation usage and the timing ofpayments relating to commissions offset by a decline in accrued interest as aresult of the February 2007 payment in full of our 5% convertiblesubordinated debentures. Other current liabilities decreased by $11.6 millionprimarily due to a decrease in accruals for product revenue rebates related toXOPENEX Inhalation Solution and LUNESTA product sales.

Net cash provided by investing activities for the sixmonths ended June 30, 2007 was $67.9 million, which is primarilyattributable to cash provided by net sales of short- and long-terminvestments of $82.2 million offset by purchases of property and equipment of$14.3 million.

Net cash used in financing activities for the sixmonths ended June 30, 2007 was $409.9 million. We received proceeds of$30.7 million from issuing common stock upon the exercise of stock optionsissued 

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under our stock optionplans and we used $440.6 million to repay capital lease obligations andlong-term debt.

We believe ourexisting cash and the cash flow that we anticipate from operations and currentstrategic alliances will be sufficient to support existing operations throughat least 2008. In the longer term, we expect to continue to fund our operationswith revenue generated from product sales. Our actual future cash requirementsand our ability to generate revenue, however, will depend on many factors,including:

·       LUNESTAsales;

·       XOPENEXInhalation Solution and XOPENEX HFA sales;

·       BROVANAsales;

·       successfulacquisition of technologies, product candidates, approved products and/orbusinesses;

·       successfulexpansion into foreign markets;

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

·       progressof our preclinical and clinical research programs and the number and breadth ofthese programs;

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

·       achievementof milestones under our strategic alliance arrangements;

·       royaltiesfrom agreements with parties to which we have licensed our technology; and

·       theoutcome of pending litigation and/or the informal SEC inquiry.

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 otherwise borrowing money. However, we may not be able to raisesuch funds on favorable terms, or at all.

Based on our currentoperating plan, we believe that we will not be required to raise additionalcapital to fund the repayment of our outstanding convertible debt when due;however, we may choose to do so. If we are not able to successfully continue togrow our revenue and properly manage our expenses, it is likely that ourbusiness would be materially and adversely affected and that we would berequired to raise additional funds in order to repay our outstandingconvertible debt. We cannot assure that, if required, we would be able to raisethe additional funds on favorable terms, if at all.

**Critical AccountingPolicies and Estimates**

We identified critical accounting policies andestimates in our annual report on Form 10-K for the year ended December 31,2006. These critical accounting policies relate to product revenue recognition,royalty revenue recognition, rebate and return reserves, patents, intangiblesand other assets, accounts receivable and bad debt, income taxes, inducedconversion of debt, inventory write-downs and stock-based compensation.These policies require us to make estimates in the preparation of our financialstatements as of a given date. Because of the uncertainty inherent in thesematters, our actual results could differ from the estimates we use in applyingthe critical accounting policies.

A summary of significant accounting policies and adescription of accounting policies that are considered critical may be found inPart II, Item 7 of our Annual Report on Form 10-K for the yearended December 31, 2006 in the “Critical Accounting Policies and Estimates”section. Other than as described below, our critical accounting policies andestimates are as set forth in the Form 10-K.

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***Product sales allowances and reserves—******The***followingtable summarizes activity in each of our productsales allowances and reserve categories for the six months ended June 30,2007:

| ** **                             | ** ** | **Payment  Terms  Discount** | ** ** | **Wholesaler  Fee  for Service** | ** ** | **Government  and  Commercial  Rebates and  Discounts** | ** ** | **Returns** | ** ** | **Other  Discounts** | ** ** | **Total** | ** ** |
|----------------------------------------|------------|------------------------------|------------|---------------------------------------|------------|--------------------------------------------------------------|------------|-------------|------------|----------------------|------------|-----------|------------|
| ** **                             | ** ** | **(in thousands)**      | ** ** |
| **Balance  at December 31, 2006** |       | $                            | (4,351     | )                                     |       | $                                                            | (16,669    | )           |       |                 | $          | (74,249   | )          |   | $ | (23,218 | ) |   | $ | (1,511 | ) |   | $ | (119,998 | ) |
| Current  provision:                    |       |                         |       |                                  |       |                                                         |       |        |       |                 |       |      |       |   |   |   |   |   |   |
| Current year                           |       | (14,966                      | )          |                                  | (14,319    | )                                                            |       |        | (116,997   | )                    |       | (8,950    | )          |   | (6,674 | ) |   | (161,906 | ) |
| Prior year                             |       | —                       |       |                                  | 457        |                                                         |       |        | (637       | )                    |       | —    |       |   | 299 |   |   | 119 |   |
| Total                                  |       | (14,966                      | )          |                                  | (13,862    | )                                                            |       |        | (117,634   | )                    |       | (8,950    | )          |   | (6,375 | ) |   | (161,787 | ) |
| Actual:                                |       |                         |       |                                  |       |                                                         |       |        |       |                 |       |      |       |   |   |   |   |   |   |
| Current year                           |       | 12,720                       |       |                                  | 12,241     |                                                         |       |        | 55,621     |                 |       | 219       |       |   | 5,094 |   |   | 85,895 |   |
| Prior year                             |       | 4,378                        |       |                                  | 14,123     |                                                         |       |        | 56,813     |                 |       | 13,741    |       |   | 587 |   |   | 89,642 |   |
| Total                                  |       | 17,098                       |       |                                  | 26,364     |                                                         |       |        | 112,434    |                 |       | 13,960    |       |   | 5,681 |   |   | 175,537 |   |
| **Balance at June 30, 2007**      |       | $                            | (2,219     | )                                     |       | $                                                            | (4,167     | )           |       |                 | $          | (79,449   | )          |   | $ | (18,208 | ) |   | $ | (2,205 | ) |   | $ | (106,248 | ) |

 

Calculating each of these product sales allowances andreserves involves significant estimates and judgments and requires us to useinformation from external sources. Based on known market events and trends,internal and external historical trends, third-party data, customer buyingpatterns and up-to-date knowledge of contractual and statutory requirements, wehave been able to make reasonable estimates of sales discounts. Historically,our estimates have not materially differed from our actual results.

***Provision forIncome Taxes—******Deferred***taxassets and liabilities are recognized for the estimated future tax consequencesattributable to tax benefit carryforwards and to differences between thefinancial statement amounts of assets and liabilities and their respective taxbasis. Deferred tax assets and liabilities are measured using enacted tax ratesin effect for the year in which the differences are expected to reverse. Avaluation allowance is established if, based on management’s review of bothpositive and negative evidence, it is more likely than not that all or aportion of the deferred tax asset will not be realized. Our historical lossesfrom operations represent significant negative evidence that indicates the needfor a valuation allowance. Accordingly, a valuation allowance has beenestablished for the full amount of the deferred tax asset. If we determine,based on future profitability, that these deferred tax assets are more likelythan not to be realized, a release of all, or part, of the related valuationallowance could result in an immediate material income tax benefit in theperiod of decrease and material income tax provisions in future periods.

We adopted the Financial Accounting Standards Board,or FASB, interpretation, or FIN, No. 48, “Accounting for Uncertainty inIncome Taxes,” or FIN 48, on January 1, 2007. The implementation ofFIN 48 did not have a material impact on our consolidated financialstatements or results of operations. We are currently in the process ofconducting a study of our research and development credit carryforwards. Thisstudy may result in an adjustment to our research and development creditcarryforwards. However, until the study is completed and any adjustment isknown, no amounts are being presented as an uncertain tax position under FIN 48.We reasonably estimate that our unrecognized tax benefits position will notchange significantly within the next twelve months.

We file tax returns in the U.S. Federal jurisdictionand in various state, local and foreign jurisdictions. During the fourthquarter of 2006, the Internal Revenue Service, or IRS, commenced an audit ofour 2005 and 2004 U.S. Federal income tax returns. We are no longer subject toIRS examination for years prior to 2004, although carryforward attributes thatwere generated prior to 2004 may still be adjusted upon examination by the IRSif they either have been or will be used in a future period. There arecurrently no 

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state audits in progress.With limited exceptions, we are no longer subject to state or localexaminations for years prior to 2003, however, carryforward attributes thatwere generated prior to 2003 may still be adjusted upon examination by state orlocal tax authorities if they either have been or will be used in a futureperiod.

The foreign jurisdictions where we currently fileincome tax returns are Canada and the Netherlands Antilles. We are currentlyunder examination by Canada Revenue Agency, or CRA, for our Scientific Researchand Experimental Development claims for the years ended December 31, 2004and 2003. There are currently no examinations being conducted by the taxauthorities in the Netherlands Antilles. With limited exceptions, we are nolonger subject to examination in Canada and the Netherlands Antilles for yearsprior to 2003 and 1999, respectively, although carryforward attributes thatwere generated prior to these respective periods may still be adjusted uponexamination if they either have been or will be used in a future period.

We recognize accruedinterest and penalties related to unrecognized tax benefits as a component oftax expense. This policy did not change as a result of the adoption of FIN 48.For the quarter ended June 30, 2007, we did not recognize any accruedinterest and penalties in our consolidated statement of operations or ourconsolidated balance sheet.

**ContractualObligations**

As of June 30, 2007,our contractual obligations disclosure in our annual report on Form 10-Kfor the year ended December 31, 2006 has not materially changed with theexception of the February 2007 payment in full of our 5% convertiblesubordinated debentures.

**ITEM3.****                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 31,2006. As of August 8, 2007, there have been no material changes to themarket risks described in our annual report on Form 10-K for theyear ended December 31, 2006. Additionally, we do not anticipate anynear-term changes in the nature of our market risk exposures or in our management’sobjectives and strategies with respect to managing such exposures.

**ITEM 4.**                CONTROLSAND PROCEDURES

**Evaluation ofDisclosure Controls and Procedures**

Our management, with theparticipation of our chief executive officer and chief financial officer, evaluatedthe effectiveness of our disclosure controls and procedures as of June 30,2007. The term “disclosure controls 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 

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procedures.Based on the evaluation of our disclosure controls and procedures as of June 30,2007, our chief executive officer and chief financial officer concluded that,as of such date, our disclosure controls and procedures were effective at thereasonable assurance level.

**Change in andEvaluation of Internal Control 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, 2007 that hasmaterially affected, or is reasonably likely to materially affect, our internalcontrol over financial reporting.

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**PART II**

**OTHERINFORMATION**

**ITEM1.**                LEGAL PROCEEDINGS

***Tecastemizole Class ActionComplaints***

In June 2007, wefiled in the Court, a Stipulation of Settlement regarding the two class actionspending in the Court naming Sepracor and certain of our current and formerofficers and one director as defendants. As previously disclosed, the classactions, which were filed on behalf of the plaintiffs, allege that thedefendants violated the Federal securities laws by making false and misleadingstatements relating to the testing, safety and likelihood of approval oftecastemizole by the FDA.

Under the terms of theStipulation of Settlement, in June 2007 we paid into escrow $52.5 millionin settlement of the class actions and received an $18.5 millionreimbursement in July 2007, from our insurance carriers. The totalsettlement amount will be released from escrow upon the Court’s final approvalof the Stipulation of Settlement. The litigation settlement expense of $34.0million, relating to this matter, was recorded during the quarter ended March 31,2007.

The Stipulation ofSettlement contains no admission of wrongdoing. Sepracor and the otherdefendants have always maintained and continue to believe that we did notengage in any wrongdoing or otherwise commit any violation of Federal or statesecurities laws or other laws. However, given the potential cost and burden ofcontinued litigation, we believe the settlement is in our best interests andthe best interests of our stockholders.

If the Court grants finalapproval of the Stipulation of Settlement, the Court will dismiss the classactions with prejudice and the plaintiffs will be deemed to have released allclaims against us. We can provide no assurance that the Court will approve theStipulation of Settlement or that members of the classes will not opt out ofthe settlement and elect to pursue litigation against us regarding the mattersalleged in the class actions. If the Court does not approve the Stipulation ofSettlement, or members of the classes opt out and pursue litigation against usdespite finalization of the settlement, or we determine to terminate theStipulation of Settlement pursuant to its terms due to the percentage ofmembers who opt out, we will need to continue to defend against these claims,which could have a material adverse effect on our financial condition andbusiness. If these matters were concluded in a manner adverse to us, we couldbe required to pay substantially more in damages than the amount provided forin the Stipulation of Settlement. In addition, the costs to us of defending anylitigation or other proceeding, even if resolved in our favor, could besubstantial. Such litigation could also substantially divert the attention ofour management and our resources in general. Uncertainties resulting from theinitiation and continuation of any litigation or other proceedings could harmour ability to compete in the marketplace.

***Litigation Relatedto Generic Competition***

**Levalbuterol Hydrochloride Inhalation SolutionAbbreviated New Drug Applications**

In September 2005, wereceived notification that the FDA had received an ANDA, from Breath Limited,or Breath, seeking approval of a generic version of our 1.25 mg/3 mL, 0.63 mg/3mL and 0.31 mg/3 mL XOPENEX (levalbuterol hydrochloride) Inhalation Solution. Breath’ssubmission includes a Paragraph IV certification alleging that our patentslisted in the FDA publication entitled “Approved Drug Products With TherapeuticEquivalence Evaluations,” commonly referred to as the “Orange Book,” for thesethree concentrations of XOPENEX (levalbuterol hydrochloride) InhalationSolution are invalid, unenforceable or not infringed by the generic version forwhich Breath is seeking approval. We have filed a civil action against Breath forpatent infringement.

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In January 2006, wereceived notification that the FDA had received an ANDA, including a ParagraphIV certification, from Dey, L.P., seeking approval of a generic version of our1.25 mg/3 mL, 0.63 mg/3 mL, and 0.31 mg/3 mL XOPENEX (levalbuterolhydrochloride) Inhalation Solution. Dey, L.P.’s submission includes a ParagraphIV certification alleging that our patents listed in the Orange Book for thesethree concentrations of XOPENEX (levalbuterol hydrochloride) InhalationSolution are invalid, unenforceable, or not infringed by the generic versionfor which Dey, L.P. is seeking approval. We filed a civil action against Dey,L.P. for patent infringement.

In April 2006, wewere notified of an ANDA seeking approval of a generic version of our 1.25 mg/3 mL,0.63 mg/3 mL and 0.31 mg/3 mL XOPENEX (levalbuterol hydrochloride) InhalationSolution including a Paragraph IV certification, which was submitted to the FDAby Watson Laboratories, Inc., or Watson. Watson’s Paragraph IVcertification was limited to our patent that expires in 2021 and covers certainlevalbuterol hydrochloride inhalation solution, including our XOPENEX(levalbuterol hydrochloride) Inhalation Solution. We have decided not to file acivil action against Watson for patent infringement at this time.

In August 2006, wereceived notification that the FDA had received an ANDA including aParagraph IV certification, from Dey, L.P. seeking approval of a genericversion of our 1.25 mg/0.5 mL XOPENEX (levalbuterol hydrochloride) InhalationSolution concentrate. We have filed a civil action against Dey, L.P. for patentinfringement. In September 2006, both civil actions we filed against Dey,L.P. were consolidated into a single suit.

In May 2007, wereceived notification that the FDA had received an ANDA, from Barr Laboratories, Inc.,or Barr, seeking approval of a generic version of our 1.25 mg/3 mL, 0.63 mg/3mL and 0.31 mg/3 mL XOPENEX (levalbuterol hydrochloride) Inhalation Solution. Barr’ssubmission includes a Paragraph IV certification alleging that our patentslisted in the Orange Book for these three concentrations of XOPENEX(levalbuterol hydrochloride) Inhalation Solution are invalid, unenforceable ornot infringed by the generic version for which Barr is seeking approval. On July 12,2007, we filed a civil action against Barr for patent infringement.

**Desloratadine Abbreviated New Drug Applications**

In June 2007, wereceived notification that the FDA had received an ANDA from GlenmarkPharmaceuticals, Ltd. and Glenmark Pharmaceuticals, Inc., USA, which werefer to collectively as Glenmark, seeking approval of a generic version ofSchering-Plough’s 5 mg tablets of CLARINEX brand desloratadine. Glenmark’ssubmission includes a Paragraph IV certification alleging that our patents thatSchering-Plough (as licensee of such patents) listed in the Orange Book for itsCLARINEX brand desloratadine are invalid, unenforceable or not infringed by thegeneric version for which Glenmark is seeking approval. In July 2007, we andthe University of Massachusetts, co-owners of certain patents listed in theOrange Book, filed a civil action against Glenmark for patent infringement.

In July 2007, wereceived notification that the FDA had received an ANDA from Sun PharmaceuticalIndustries, Ltd., seeking approval of a generic version of Schering-Plough’s 5mg tablets of CLARINEX brand desloratadine. Sun Pharmaceutical Industries, Ltd.’ssubmission includes a Paragraph IV certification alleging that our patentslisted by Schering-Plough (as licensee of such patents) in the Orange Book forCLARINEX brand desloratadine are invalid, unenforceable, or are not infringedby the generic version for which Sun Pharmaceutical Industries, Ltd. is seekingapproval. We are contemplating filing a civil action against SunPharmaceuticals Industries, Ltd. for patent infringement.

Should we successfullyenforce our U.S. patents, ANDA approval will not occur until the expiration ofthe applicable patents. Otherwise, the FDA will stay its approval of therelevant ANDA until thirty months following the date we received notice of suchANDA or until a court decides that our patents are invalid, unenforceable ornot infringed, whichever is earlier. Should we successfully enforce our foreignpatents, 

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genericcompanies will be prevented from obtaining patent protection for similar drugs,and will be deterred from market entry until the expiration of the applicablepatent(s).

Patent litigation involvescomplex legal and factual questions. We can provide no assurance concerning theoutcome or the duration of any patent related lawsuits. If we, or third partiesfrom whom we receive royalties, are not successful in enforcing our respective patents,the generic companies will not be excluded, for the full term of our patents,from marketing their generic versions of our products or third party productsfor which we have licensed rights to our patents. Introduction of genericcopies of any of our products or third party products for which we havelicensed rights to our patents before the expiration of our patents would havea material adverse effect on our business.

***BROVANA PatentInfringement Claim***

In April 2007, wewere served with a complaint filed by Dey, alleging that the manufacture andsale of BROVANA (arformoterol tartrate) infringes or will induce infringementof a single U.S. patent for which Dey owns all rights, title and interest. In April 2007,we filed an answer and counterclaim to this complaint seeking to invalidate theoriginally asserted patent and a second related patent. In May 2007, Deyfiled a reply asserting infringement of the second patent. It is too early tomake a reasonable assessment as to the likely outcome or impact of thislitigation. We are unable to reasonably estimate any possible range of loss orliability related to this lawsuit due to its uncertain resolution.

***Stock OptionInquiry and Derivative Stockholder Complaints***

We announced in June 2006that the SEC is conducting an informal inquiry into our stock option grants andstock option granting practices. A special committee of our outside directors,with the assistance of outside legal counsel and outside accountingspecialists, reviewed the stock option grants to our officers, directors andemployees from 1996 to June 2006 under our various stock option plans ineffect during this period. Our finance department also reviewed the stockoption grants and stock option practices from 1996 to June 2006. Theirreview resulted in the restatement of our financial statements for the quartersended March 31, June 30 and September 30, 2005, the quarterended March 31, 2006 and the years ended December 31, 2005, 2004 and2003. Representatives from the U.S. Attorneys Office attended some of theearlier meetings that our outside counsel had with the SEC. While the U.S.Attorneys Office has not initiated an investigation, we cannot be certain thatit will not. In October 2006, the Internal Revenue Service, or IRS,commenced an audit into our 2005 and 2004 U.S. Federal income tax returns andhas requested, among other things, certain information relating to our stockoption grants and granting practices. The SEC and/or any other governmentalagency that may initiate a formal investigation may reach different conclusionsand, if so, we could be subject to monetary damages, fines and penalties, andour officers and/or directors could be prohibited from serving as officers anddirectors of any public company and could be subject to criminal penaltiesand/or disgorgement.

We have accepted serviceof three stockholder derivative complaints relating to certain of our stockoption grants that were filed in the Superior Court, Middlesex County,Commonwealth of Massachusetts, naming Sepracor as nominal defendant and alsonaming as defendants certain current members of our board of directors andcertain of our current and former employees. The complaints allege purportedbreaches of fiduciary duties and unjust enrichment in connection with certainstock option grants made by us between June 1998 and May 2001. Thecomplaints seek monetary damages in unspecified amounts, equitable and injunctiverelief, including disgorgement of profits obtained by certain defendants andother relief as determined by the Court. On September 12, 2006, the threecomplaints were consolidated into one action, and on September 22, 2006,the action was transferred to the Business Litigation Session of the SuperiorCourt, Suffolk County, Commonwealth of Massachusetts. On October 19, 2006,plaintiffs filed a consolidated complaint alleging breaches of fiduciary dutyand unjust enrichment in connection with certain stock option grants we madebetween December 1995 and April 2003. On November 20, 2006, we 

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moved todismiss the Consolidated Amended Complaint and a hearing on the motion washeld on March 20, 2007. The court has stayed all discovery in this case,and no decision on this motion has been rendered at this time.

Three stockholderderivative complaints relating to the same subject matter were filed againstSepracor, certain current and former members of our board of directors andcertain of our current and former employees in the United States District Courtfor the District of Massachusetts on September 28, 2006, October 3,2006 and October 12, 2006. In addition to several common law theoriesalleging breaches of fiduciary duty and unjust enrichment, these complaintsallege violations of Federal securities laws. On January 30, 2007, theCourt consolidated the actions and a consolidated complaint was filed. On April 9,2007, we moved to stay the Federal court lawsuit pending resolution of thestate court motion to dismiss, and on May 4, 2007, the Court enteredan order granting the motion and staying the Federal case.

We are unable toreasonably estimate any possible range of loss or liability related to thestock option inquiry and/or derivative suits due to their uncertain resolution.

***LUNESTA TrademarkClaim***

In September 2006,Tharos Laboratories, Inc., or Tharos, filed suit against us in the UnitedStates District Court, District of Utah, Central Division, alleging trademarkinfringement, dilution, unfair competition, false advertising and falsedesignation of origin arising out of our use of our silk luna moth design inconnection with LUNESTA. Tharos seeks unspecified monetary damages and toenjoin our use of the silk luna moth design. In October 2006, we filed amotion to dismiss Tharos’ claims. On February 9, 2007, the court grantedour motion in respect of the state unfair competition claims and denied it inrespect of Tharos’ other claims. On March 6, 2007, we filed an answer toTharos’ complaint. In addition, we filed counterclaims against Tharos forcancellation of Tharos’ alleged trademark and for false advertising. Wecontinue to defend our trademark in this litigation but we are unable at thisstage to predict its ultimate resolution.

From time to time we areparty to other legal proceedings in the course of our business. We do not,however, expect such other legal proceedings to have a material adverse effecton our business or financial condition.

**ITEM1A.**        RISK FACTORS

You should carefullyconsider the risks described below in addition to the other informationcontained in this report, before making an investment decision. Our business,financial condition or results of operations could be harmed by any of theserisks. The risks and uncertainties described below are not the only ones weface. Additional risks not currently known to us or other factors not perceivedby us to present significant risks to our business at this time also may impairour business operations, financial condition or results from operations.

**Risks Related to Our Financial Results and Our CommonStock**

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

Until the quarter ended December 31,2005, we had incurred net losses each quarter since our inception. It ispossible we will not be able to achieve profitability again or maintainprofitability on a quarterly or annual basis. We expect to continue to incursignificant operating expenditures to further develop and commercialize ourproducts and product candidates and in order to allow us to otherwise expandour product portfolio through drug discovery and business development efforts.As a result, we will need to generate significant revenues in future periods toachieve and maintain profitability. We cannot provide assurance that we will beable to maintain profitability for any substantial period of time. If 

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revenuesgrow more slowly than we anticipate or if operating expenses exceed ourexpectations or cannot be adjusted accordingly, our business, results ofoperations and financial condition will be materially and adversely affected.In addition, if we are unable to achieve or maintain profitability on aquarterly or annual basis, the market price of our common stock may decline.

***Almost all of our revenues are derived from sales ofLUNESTA and XOPENEX Inhalation Solution and our future success depends on thecontinued commercial success of these products as well as XOPENEX HFA andBROVANA.***

Approximately 90% of ourtotal revenues for the six months ended June 30, 2007 resulted from salesof LUNESTA and XOPENEX Inhalation Solution, and we expect that sales from thesetwo products will continue to represent a significant majority of our revenuesfor the coming year. In April 2005, we commercially introduced LUNESTA asa new product in a highly and increasingly competitive market, and we cannot becertain that it will achieve continued commercial success. In addition, we donot have long-term sales contracts with our customers, and we rely on purchaseorders for sales of LUNESTA and XOPENEX Inhalation Solution. Reductions, delaysor cancellations of orders for LUNESTA or XOPENEX Inhalation Solution could adverselyaffect our operating results. Additionally, revenues from the sale of XOPENEX InhalationSolution for the quarter ended June 30, 2007 were, and we expect will continueto be, adversely affected as a result of a change in the Medicare Part B reimbursementrate. If sales of LUNESTA do not increase and if sales of XOPENEX InhalationSolution in other markets do not offset the reduction in revenues resulting fromthe change in Medicare Part B reimbursement for the product, we may nothave sufficient revenues to achieve our business plan or repay our outstandingdebt, and our business will not be successful.

In December 2005, wecommercially introduced XOPENEX HFA and in April 2007, we commerciallyintroduced BROVANA. We cannot be certain that either XOPENEX HFA or BROVANAwill achieve commercial success.

With respect to XOPENEXInhalation Solution, four companies have filed ANDAs with the FDA seekingto market a generic version of levalbuterol hydrochloride inhalation solution.We have commenced patent litigation against three of these companies and wehave decided not to commence litigation against the fourth at this time. Afinding that the products these companies wish to market do not infringe ourpatents or that our patents are invalid or unenforceable will likely lead tothe introduction of generic levalbuterol inhalation solution. If this occurs,sales of XOPENEX Inhalation Solution will be adversely affected.

With respect to BROVANA, inApril 2007, we were served with a complaint filed by Dey alleging that the manufactureand sale of BROVANA (arformoterol tartrate) infringes or will induceinfringement of a single U.S. patent for which Dey owns all rights, title andinterest. In April 2007, we filed an answer and counterclaim to this complaintseeking to invalidate the originally asserted patent and a second relatedpatent. In May 2007, Dey filed a reply asserting infringement of the secondpatent. It is too early to make a reasonable assessment as to the likelyoutcome or impact of this litigation. We are unable to reasonably estimate anypossible range of loss or liability related to this lawsuit due to itsuncertain resolution.

Wecannot be certain that we will be able to continue to successfullycommercialize LUNESTA and/or XOPENEX Inhalation Solution or that any of ourproducts will continue to be accepted in their markets. Specifically, thefollowing factors, among others, could affect the level of success and marketacceptance of XOPENEX Inhalation Solution, XOPENEX HFA, BROVANA and/or LUNESTA:

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

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

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·       thelevel and effectiveness of our sales and marketing efforts;

·       anyunfavorable publicity regarding these products or similar products;

·       litigationor threats of litigation with respect to these products;

·       afinding that our patents are invalid or unenforceable or that generic versionsof our products do not infringe our products;

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

·       privateinsurers, such as managed care organizations, adopting their own coveragerestrictions or demanding price concessions in response to state, Federal oradministrative action, such as CMS’s proposed bundling action;

·       anychanges in government and other third-party payor reimbursement policies andpractices; and

·       regulatorydevelopments or other factors affecting the manufacture, marketing or use ofthese products.

Any adverse developmentswith respect to the sale of LUNESTA or XOPENEX Inhalation Solution could significantlyreduce revenues and have a material adverse effect on our ability to maintainprofitability and achieve our business plan.

***Sales of XOPENEXInhalation Solution have been negatively affected as a result of the recentchange in the Medicare Part B reimbursement rate and if our strategy for respondingto such change is not successful our revenue will be adversely affected.***

Since January 2005and through June 2007, Medicare reimbursed XOPENEX Inhalation Solutionpursuant to a unique reimbursement code. In March 2006, the DurableMedical Equipment Program Safeguard Contractors, or DME-PSCs, the entitiesresponsible for overseeing the Medicare Part B prescription drug benefitfor respiratory products, announced their intention to implement a Least CostlyAlternative, or LCA, reimbursement action for XOPENEX Inhalation Solution that,if it had been implemented, would have reduced the reimbursement paid forXOPENEX Inhalation Solution to that of generic racemic albuterol. InDecember 2006, CMS commenced a National Coverage Analysis, or NCA, todetermine when use of nebulized levalbuterol in treating COPD in the Medicarepopulation is reasonable and necessary. While the NCA for XOPENEX InhalationSolution was pending, the DME-PSCs announced that the proposed LCA would bestayed. On June 20, 2007, CMS announced its preliminary coveragedetermination, stating that, based on its review of the available data andcomments submitted, it was unable to determine the criteria for when XOPENEXInhalation Solution would be appropriate to use by the Medicare population andwould instead defer this determination to the DME-PSCs. As part of its coveragedetermination, CMS affirmed that the use of nebulized beta-adrenergic agonists (suchas XOPENEX Inhalation Solution and BROVANA) in the treatment of lung disease inthe home is medically necessary; such a determination is needed before CMS orthe DME-PSCs can establish the coverage criteria for a given prescription drugunder the Medicare Part B benefit. We have submitted comments in responseto the CMS proposed coverage memo. The final coverage determination is expectedin September 2007.

In May 2007, CMSannounced that, based on its interpretation of the statutory language of theMedicare Prescription Drug Improvement and Modernization Act of 2003, or MMA,it was required to discontinue the unique reimbursement codes for XOPENEXInhalation Solution, which had been in place since January 2005, andgeneric albuterol and bundled these products together in a newly createdreimbursement code. This reimbursement code became effective on July 1,2007. As a result of this coding change, reimbursement for XOPENEX InhalationSolution and generic albuterol is now based on the blended weighted averageselling price for the two products, resulting in reimbursement for XOPENEX 

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InhalationSolution that is considerably lower than the product’s published wholesaleacquisition cost, or WAC. Revenues from the sale of XOPENEX Inhalation Solutionfor the quarter ended June 30, 2007 were, and we expect will continue tobe, adversely affected as a result of this change. The bundling action alsoresulted in an unintended increase in Medicare Part B reimbursement forgeneric albuterol, significantly higher than the product’s average sellingprice (as publicly reported by the Medicare Part B program), creating thepotential for inappropriate reimbursement incentives to influence thedispensing decisions of providers. In July 2007, the U.S. House ofRepresentatives released draft legislation as part of the State Children’sHealth Insurance Program reauthorization that includes language addressing theMedicare Part B reimbursement scenario that may potentially impactphysician prescribing decisions based upon financial incentives. The draftlegislation provides that XOPENEX Inhalation Solution and generic albuterolwill be paid at the lower of their respective stand-alone average sellingprices or the blended XOPENEX Inhalation Solution/generic albuterol averageselling price. For generic albuterol, this will lower the reimbursementMedicare pays for the product to its stand-alone average selling price. ForXOPENEX Inhalation Solution, reimbursement will continue to be paid at theblended XOPENEX Inhalation Solution/generic albuterol average selling price.Medicare Part B reimbursement rates are updated quarterly. Should theproposed legislative change become law, it will be effective on January 1,2008. The impact of this potential legislative action on XOPENEX InhalationSolution revenues in the Medicare market in 2008 is not yet known.

We estimate thatapproximately 25 to 30 percent of our XOPENEX Inhalation Solution units soldare subject to reimbursement under Medicare Part B. We have been activelycontracting with home health care and retail pharmacy providers in an effort toensure the continued availability of XOPENEX Inhalation Solution to MedicarePart B beneficiaries with reversible obstructive airway disease. If thecontracting strategy for XOPENEX Inhalation Solution is not successful inmaintaining as much of the current unit sales levels for the product inMedicare as commercially feasible, if the reimbursement scenario that maypotentially impact physician prescribing decisions for generic albuterol is notchanged and/or if the DME-PSCs impose restrictive coverage policies on XOPENEXInhalation Solution, revenue from sales of XOPENEX Inhalation Solution will beadversely affected and our financial condition and results from operations willbe impaired.

***Revenues from BROVANAmay be negatively affected by the final Medicare determination expected to bemade in November 2007.***

We filed a health carecommon procedure coding system application, commonly referred to as aJ Code application, for BROVANA in January 2007, and it was acceptedby CMS as part of the 2008 coding cycle review. In April 2007, CMSannounced that its preliminary determination on the BROVANA J Code applicationwas favorable and CMS recommended that BROVANA be awarded a unique J Code. Thefinal decision on the BROVANA J Code application is expected inNovember 2007. If BROVANA is awarded a unique J Code by CMS inNovember 2007, it would become effective on January 1, 2008. InApril 2007, CMS informed us that the scope of the NCA includes BROVANA. Asstated above, CMS announced that it was deferring its coverage determination,including any determination for long-acting beta-agonists like BROVANA, to theDME-PSCs. On June 13, 2007, the DME-PSCs published an article detailingthe coverage criteria for BROVANA. The article also stated that, for theremainder of 2007, BROVANA would be reimbursed under Medicare Part Bpursuant to a miscellaneous or “not otherwise classified” reimbursement code.Unless otherwise modified by the DME-PSCs, the coverage criteria establishedfor BROVANA in the above-referenced article will remain in effect under themiscellaneous reimbursement code and any unique J Code that is awarded forthe product. We have initiated a contracting strategy with retail and home healthcare pharmacy providers for BROVANA that is intended to ensure the availabilityof the product for Medicare patients. If the contracting strategy for BROVANA isnot successful or if the coverage policies established by the DME-PSCs for theproduct are viewed by 

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physiciansand providers as too restrictive, revenue growth from sales of BROVANA in theMedicare market will be materially adversely affected.

***We have significantdebt and we may not be able to make principal payments when due.***

As of June 30, 2007,our total debt was approximately $721.0 million. None of our 0% Series Anotes due December 2008, our 0% Series B notes due December 2010nor our 0% notes due October 2024 restricts us or our subsidiaries’ability to incur additional indebtedness, including debt that ranks senior tothe notes. The 0% notes due 2024 are senior to the Series A notes due 2008and Series B notes due 2010. Additional indebtedness that we incur may incertain circumstances rank senior to or on parity with this debt. Our abilityto satisfy our obligations will depend upon our future performance, which issubject to many factors, including factors beyond our control. The conversionprices for the 0% Series A notes due 2008 and 0% Series B notes due2010 are $31.89 and $29.84, respectively. On July 31, 2007, the closingsale price of our common stock was $28.13. If the market price for our commonstock does not exceed the conversion price, the holders of our outstandingconvertible debt may decide not to convert their securities into common stock.For example, the holders of our 5% debentures did not convert such debenturesinto common stock, and on February 15, 2007, the maturity date for the 5%debentures, we repaid in cash the entire principal amount of $440.0 million,plus $11.0 million of accrued interest. Our 0% notes due 2024 are convertibleinto cash and, if applicable, shares of our common stock at a conversion priceof approximately $67.20, at the option of the holders in October 2009,2014, 2019 and 2024, as well as under certain circumstances. We may not beable to make the required cash payments upon conversion ofthe 0% notes due 2024.

Historically, we have hadnegative cash flow from operations, and in 2006, we experienced our first fullyear of positive cash flow from operating activities. Unless we have sufficientcash or are able to generate sufficient operating cash flow to pay off theprincipal of our outstanding debt, we will be required to raise additionalfunds or default on our obligations under the debentures and notes. If revenuegenerated from sales of LUNESTA and XOPENEX Inhalation Solution do not meetexpected levels, it is unlikely that we would have sufficient cash flow torepay our outstanding convertible debt and/or make cash payments uponconversion of the 0% notes due 2024. There can be no assurance that, ifrequired, we would be able to raise the additional funds on favorable terms, ifat all.

***If we exchange debtfor shares of common stock, there will be additional dilution to holders of ourcommon stock.***

As of June 30, 2007,we had approximately $721.0 million of outstanding debt that could beconverted into common stock. In order to reduce future payments due atmaturity, we may, from time to time, depending on market conditions, repurchaseadditional outstanding convertible debt for cash; exchange debt for shares of ourcommon 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 we make, or the assumptions on whichwe rely, in preparing our financial statements prove inaccurate, our actualresults may vary from those reflected in 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, net revenues and expenses, the 

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amountsof charges accrued by us and related disclosure of contingent assets andliabilities. We base our estimates on historical experience and on variousother assumptions that we believe to be reasonable under the circumstances. Wecannot assure you, however, that our estimates, or the assumptions underlyingthem, will not be materially different from actual results. For example, ourroyalty 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. In addition, we estimate product sales allowances, including paymentterm discounts, government and commercial rebates and returns and other discounts.If actual amounts differ from these estimates, net income could be adverselyaffected. Each, in turn, could adversely affect our stock price.

***If sufficient funds to finance our business are notavailable to us when needed or on acceptable terms, then we may be required todelay, scale back, eliminate or alter our strategy for our programs.***

We mayrequire additional funds for our research and product development programs,operating expenses, repayment of debt, the pursuit of regulatory approvals,license or acquisition opportunities and the expansion of our production, salesand marketing capabilities. Historically, we have satisfied our funding needsthrough collaboration arrangements with corporate partners, sales of products,and equity and debt financings. These funding sources may not be available tous when needed in the future, and, if available, they may not be on termsacceptable to us. Insufficient funds could require us to delay, scale back oreliminate certain of our research and product development programs and/orcommercialization efforts or to enter into license agreements with thirdparties to commercialize products or technologies that we would otherwisedevelop or commercialize ourselves. Our cash requirements may vary materiallyfrom those now planned because of factors including:

·       patentdevelopments;

·       licensingor acquisition opportunities;

·       drugdiscovery efforts;

·       relationshipswith collaboration partners;

·       theFDA regulatory process;

·       expansioninto foreign markets;

·       litigationand government inquiries and investigations;

·       ourcapital requirements; and

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

***Several class action lawsuits have been filed againstus which may result in litigation that is costly to defend and the outcome ofwhich is uncertain and may harm our business.***

In June 2007, wefiled in the Court, a Stipulation of Settlement regarding two securities classactions pending in the Court naming Sepracor and certain of our current andformer officers and one director as defendants. As previously disclosed, theclass actions, which were filed on behalf of the plaintiffs, allege that thedefendants violated the Federal securities laws by making false and misleadingstatements relating to the testing, safety and likelihood of approval oftecastemizole by the FDA.

Under the terms of theStipulation of Settlement in June 2007, we paid into escrow $52.5 millionin settlement of the class actions and received an $18.5 million reimbursementin July 2007, from our insurance carriers. The total settlement amountwill be released from escrow upon the Court’s final approval of the Stipulationof Settlement. The litigation settlement expense of $34.0 million, relating tothis matter, was recorded during the quarter ended March 31, 2007.

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The Stipulation ofSettlement contains no admission of wrongdoing. Sepracor and the otherdefendants have always maintained and continue to believe that we did notengage in any wrongdoing or otherwise commit any violation of Federal or statesecurities laws or other laws. However, given the potential cost and burden ofcontinued litigation, we believe the settlement is in our best interests andthe best interests of our stockholders.

If the Court grants finalapproval of the Stipulation of Settlement, the Court will dismiss the classactions with prejudice and the plaintiffs will be deemed to have released allclaims against us. We can provide no assurance that the Court will approve theStipulation of Settlement or that members of the classes will not opt out ofthe settlement and elect to pursue litigation against us regarding the mattersalleged in the class actions. If the Court does not approve the Stipulation ofSettlement, or members of the classes opt out and pursue litigation against us,despite finalization of the settlement, or we determine to terminate theStipulation of Settlement pursuant to its terms due to the percentage ofmembers who opt out, we will need to continue to defend against these claims,which could have a material adverse effect on our financial condition andbusiness. If these matters were concluded in a manner adverse to us, we couldbe required to pay substantially more in damages than the amount provided forin the Stipulation of Settlement. In addition, the costs to us of defending anylitigation or other proceeding, even if resolved in our favor, could besubstantial. Such litigation could also substantially divert the attention ofour management and our resources in general. Uncertainties resulting from theinitiation and continuation of any litigation or other proceedings could harmour ability to compete in the marketplace.

***Our stock optiongranting practices are the subject of an informal inquiry by the SEC.***

As we announced on June 2,2006, the SEC is conducting an informal inquiry into our stock option grantsand stock option practices and a special committee of our outside directorsoversaw a review of our stock option granting practices and the documentationrelating to such grants. Representatives from the U.S. Attorneys officeattended some of the earlier meetings that our outside legal counsel had withthe SEC. While the U.S. Attorneys Office has not initiated an investigation, wecannot be certain that it will not. In addition, as we have previouslyannounced, during October 2006, the IRS commenced an audit into our 2005and 2004 U.S. Federal income tax returns and has requested, among other things,certain information relating to our stock option grants and granting practices.As a result of the SEC inquiry, the IRS audit and/or other governmentalproceedings that could be initiated in the future, we could be subject tomonetary damages, fines and penalties and our officers and/or directors couldbe prohibited from serving as officers and directors of any public company andcould be subject to criminal penalties and disgorgement.

Based on the results ofthe special committee’s review, we have restated our financial statements forthe quarters ended March 31, June 30, and September 30, 2005,the quarter ended March 31, 2006 and the fiscal years ended December 31,2005, 2004 and 2003, and revised the financial information contained in ourearnings release for the period ended June 30, 2006. If the SEC disagreeswith the conclusions we and our special committee have made, including withregard to measurement dates for certain stock option grants, the amount ofadditional stock-based compensation expense we incurred and/or the adjustmentswe have recorded to non-cash charges to reflect the additional stock-basedcompensation, we may be required to further restate our historical financialstatements.

***We have civil litigation pending that relates to ourstock option granting practices, and we cannot predict the ultimate outcome ofthis litigation.***

We and certain of ourcurrent and former directors and officers are defendants in several derivativeactions relating to our stock option granting practices. The complaints allegepurported breaches of fiduciary duties and unjust enrichment in connection withcertain stock option grants made by us between June 1998 and May 2001.The complaints seek monetary damages in unspecified amounts, equitable and 

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injunctiverelief, including disgorgement of profits obtained by certain defendants andother relief as determined by the Court. These actions are in preliminarystages and we cannot predict the ultimate outcome or impact of this litigation.

***Fluctuations in the demand for our products, thesuccess and timing of clinical trials, regulatory approvals, productintroductions, collaboration and licensing arrangements, any termination ofdevelopment efforts and other material events will cause fluctuations in ourquarterly operating results, which could cause volatility in our stock price.***

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

·       timingand extent of product sales and market penetration;

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

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

·       timingand success of product introductions;

·       changesin third-party reimbursement policies;

·       introductionof competitive products into the market;

·       resultsof clinical trials with respect to products under development;

·       afinding that our patents are invalid or unenforceable or that generic versionsof our products do not infringe our products;

·       theinitiation of, or adverse developments in, any judicial litigation proceedingsor governmental investigations in which we are involved;

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

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

·       timingof receipt of upfront, milestone or royalty payments under collaboration orlicensing agreements;

·       timingand success of any business and/or product acquisitions;

·       timingand success of expansion into foreign markets;

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

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

***We have various mechanisms in place to discouragetakeover attempts, which may reduce or eliminate our stockholders’ ability tosell their shares for a premium in a change of control transaction.***

Variousprovisions of our certificate of incorporation and by-laws and of Delawarecorporate law may discourage, delay or prevent a change in control or takeoverattempt of our company by a third party that is opposed by our management andboard of directors. Public stockholders who might desire to participate 

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in such a transaction may not have the opportunity todo so. These anti-takeover provisions could substantially impede the ability ofpublic stockholders to benefit from a change of control or change in ourmanagement 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;

·       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, inJune 2002, our board of directors adopted a shareholder rights plan, theprovisions of which could make it more difficult for a potential acquirer ofSepracor to consummate 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, has been highly volatile. In addition, the stockmarket has experienced extreme price and volume fluctuations. The volatilityand market prices of securities of many pharmaceutical and biotechnologycompanies have been significantly affected 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 are determined in the marketplace and may beinfluenced by many factors, including variations in our financial results andinvestors’ perceptions of us, and changes in recommendations by securitiesanalysts as well as their perceptions of general economic, industry and marketconditions.

**Risks Related to Commercialization**

***We face intensecompetition and many of our competitors have greater resources and capabilitiesthan we have.***

We face intensecompetition in the sale of our current products, and expect to face intensecompetition in the sale of any future products we sell. If we are unable tocompete effectively, our financial condition and results of operations could bematerially adversely affected because we may not achieve our product revenueobjectives and because we may use our financial resources to seek to differentiateourselves from our competition. Large and small companies, academicinstitutions, governmental agencies and other public and private organizationsconduct research, seek patent protection, develop and acquire products,establish collaborative arrangements for product development and sell orlicense products in competition with us. Many of our competitors and potentialcompetitors have substantially greater resources, manufacturing and sales andmarketing capabilities, research and development staff and productionfacilities than we have. The fields in which we compete are subject to rapidand substantial technological change. Our competitors may be able to respondmore quickly to new or emerging technologies or to devote greater resources tothe development, manufacture and marketing of new products and/or technologiesthan we can. As a result, any products and/or technologies that we develop maybecome obsolete or noncompetitive before we can recover expenses incurred inconnection with their development.

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In the insomnia market, LUNESTA faces intensecompetition from established products such as AMBIEN®, SONATA®, AMBIEN CR® andROZEREMTM. We expect that LUNESTA will face increasing competition from otherpotentially competitive therapies, such as a generic version of AMBIEN, whichwas introduced in April 2007, a generic version of AMBIEN CR, which couldbe introduced as early as October 2008, and therapies in clinicaldevelopment and under FDA review for the treatment of insomnia. Tocontinue to be successful in the market with LUNESTA, we must continue todemonstrate that LUNESTA’s safety and efficacy features are superior to thoseof competing branded and generic products, some of which may be less expensivethan LUNESTA.

In the asthma and COPD markets, XOPENEX InhalationSolution, a short-acting beta-agonist, faces competition from generic albuteroland DUONEB®.Albuterol has been available generically for many years, is well establishedand sells at prices substantially lower than XOPENEX Inhalation Solution.DUONEB offers combination therapy of albuterol with ipratropium bromide.  A generic version of DUONEB has recently been commerciallyintroduced with additional generic entrants expected to follow. To besuccessful in the marketing of XOPENEX Inhalation Solution, we must continue todemonstrate that the efficacy and safety features of the drug outweigh itshigher price relative to generic albuterol and other competing products. Inaddition, as a consequence of the ongoing commercialization of BROVANA,prescription levels for XOPENEX Inhalation Solution**may be adversely affected to the extent a significantnumber of physicians prescribe BROVANA as a substitute product for theirpatients who are currently taking or would be prescribed XOPENEX InhalationSolution. Such substitution could have an adverse effect on sales of XOPENEXInhalation Solution and/or the growth of the combined revenue generated fromthe sale of XOPENEX Inhalation Solution and BROVANA.

Albuterol MDIs have been on the market for many yearsand are well established. In the asthma market, we face competition fromchlorofluorocarbons, or CFC-containing albuterol MDIs and branded HFA albuterolMDIs such as PROAIR® HFA, VENTOLIN® HFA and PROVENTIL® HFA. With the phase-out of CFC albuterolMDI products required by the end of December 2008, we expect thatcompetition from branded HFA MDIs will increase substantially. There arecurrently no generic short-acting beta-agonist HFA MDIs available. To besuccessful in the marketing of XOPENEX HFA, we must demonstrate that theefficacy and safety features of the drug outweigh its higher price as comparedto generic CFC albuterol MDIs and that these attributes differentiate theproduct from other HFA MDIs on the market.

BROVANA competes in the COPD market, as it does nothave an asthma indication. Competitive products include all nebulized productsused in the treatment of COPD including albuterol, XOPENEX Inhalation Solution,ATROVENT® (ipratropium bromide), DUONEB, genericalbuterol/ipratropium bromide combination product, and recently approved,nebulized PerforomistTM (formoterol fumarate) Inhalation Solution, which may becommercially introduced in the very near future. Even though BROVANA is anebulized product, it also faces competition from long-acting beta-agonists andanticholinergics delivered by MDI and dry-powder inhaler, or DPI, includingSEREVENT®, SPIRIVA® and FORADIL®. BROVANA also competes with combinationtherapy products used for COPD including ADVAIR® (salmeterol and fluticasone) and recentlycommercialized SYMBICORT® (formoterol and budesonide). To be successfulin the marketing of BROVANA, we must demonstrate that patients with COPD whouse a nebulizer will benefit by adding BROVANA as adjunctive therapy.

For all of our products,we need to demonstrate to physicians, patients and third-party payorsthat the cost of our product is reasonable and appropriate in light of itssafety, efficacy and health care benefits, each as compared to other competingproducts.

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***We may be unable to successfully commercializeproducts for which we receive approval from the FDA or similar foreignagencies.***

Commercialization of a product for which we havereceived an approval letter from the FDA or similar foreign agency could bedelayed for a number of reasons, some of which are outside of our control,including delays in delivery of the product due to importation regulationsand/or problems with our distribution channels or delays in the issuance ofapprovals from, or the completion of, required procedures by agencies otherthan the FDA, such as the United States Drug Enforcement Administration. Inaddition, commercialization of approved products may be delayed by our failureto timely finalize distribution arrangements, manufacturing processes andarrangements, produce sufficient inventory and/or properly prepare our salesforce. If we are unable to successfully commercialize a product promptly afterreceipt of an approval letter, our business and financial position may bematerially adversely affected due to reduced revenue from product sales duringthe period or periods that commercialization is delayed and the shortening ofany lead time to market we may have had over our competitors. In addition, theexclusivity period, which is the time during which the FDA or similar foreignagency will prevent generic pharmaceutical companies from introducing a genericcopy of the product, begins to run upon approval and, therefore, to the extentwe are unable to successfully commercialize a product promptly after receipt ofan approval letter, our long-term product sales and revenues could be adverselyaffected.

Even if the FDA or similarforeign agencies grant us regulatory approval of a product, if we fail tocomply with the applicable regulatory requirements, we may be forced to suspendand/or cease commercialization of the product due to suspension or withdrawalof regulatory approvals, product recalls, seizures of products and/or operatingrestrictions and may be subject to fines and criminal prosecution. In any suchevent, our ability to successfully commercialize the product would be impairedand sales and revenues could be materially adversely affected.

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

We have established a sales force to market XOPENEXInhalation Solution, XOPENEX HFA, BROVANA and LUNESTA. We have incurredsignificant expense in expanding our sales force and we may incur additionalexpense if we further expand. If we successfully develop and obtain regulatoryapproval for the products we are developing, we may (1) market and sellthem through our sales force, (2) license some of them to otherpharmaceutical companies or (3) market and sell them through otherarrangements, including co-promotion arrangements or contract sales forces. Wemay incur significant costs in expanding our sales force before the productsunder development have been approved for marketing. For example, we expandedour sales force in 2004 in anticipation of marketing and selling LUNESTA, in2005 in anticipation of marketing and selling XOPENEX HFA and in 2006 inanticipation of increased competition versus LUNESTA, and increased sales ofour products generally. In addition, we have expanded our sales force inanticipation of sales growth that may never occur.

Our ability to realizesignificant revenues from direct marketing and sales activities depends on ourability to attract and retain qualified sales personnel. Competition for thesepersons is intense. If we are unable to attract and retain qualified salespersonnel, we will not be able to successfully expand our marketing and directsales force on a timely or cost effective basis. We may also need to enter intoadditional co-promotion or other such arrangements with third parties, forexample, where our own direct sales force is not large enough or sufficientlywell aligned to achieve maximum penetration in the market. We may not besuccessful in entering into any co-promotion or other such arrangements, andthe terms of any co-promotion or other such arrangements may not be favorableto us.

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

The FDA and otherregulatory authorities require that our products be manufactured according totheir GMP regulations. The failure by us, our collaborative developmentpartners or our third-party manufacturers to comply with current GMPregulations could lead to delay in our development programs or refusal by theFDA to approve marketing applications. Following marketing approval of aproduct, failure in either respect could also impede commercial introduction oron-going distribution of the product and/or be the basis for action by the FDAto withdraw approvals previously granted, to recall products and for otherregulatory action.

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

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

***Buying patterns of our wholesalers may vary from timeto time, which could have a material impact on our financial condition, cashflows and results of operations.***

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

We have entered intowholesaler fee-for-service agreements, or FFSAs, with our three largestcustomers. We believe it is beneficial to enter into FFSAs to establish specifiedlevels of product inventory to be maintained by our wholesalers and to obtainmore precise information as to the level of our product inventory availablethroughout the product distribution channel. The FFSAs require that thewholesalers maintain certain minimum inventory levels that gradually declineover the next several quarters. We record the cost associated with the FFSAs asrevenue deductions. We cannot be certain that the FFSAs will be effective inlimiting speculative purchasing activity, that there will not be a futuredrawdown of inventory as a result of declining minimum inventory requirements,or otherwise, or that the inventory level data provided through our FFSAs areaccurate. If speculative purchasing does occur, if the wholesalers significantlydecrease their inventory levels, or if inventory level data provided throughFFSAs is inaccurate, our business, financial condition, cash flows and resultsof operations may also be adversely affected.

**Risks Related tothe Regulatory Environment**

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

The FDA and similarforeign agencies must approve for commercialization any pharmaceutical productsdeveloped by us or our development partners. These agencies impose substantialrequirements 

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on drugmanufacturing and marketing. Any unanticipated preclinical and clinical studieswe are required to undertake could result in a significant increase in the costof advancing our products to commercialization. In addition, failure by us orour collaborative development partners to obtain regulatory approval on atimely basis, or at all, or the attempt by us or our collaborative developmentpartners to receive regulatory approval to achieve labeling objectives, could preventor adversely affect the timing of commercial introduction of, or our ability tomarket and sell, our products.

***If we fail to successfully develop and receiveregulatory approval for product candidates, we will be unable to commercializethe product candidates and future sales and earnings growth will besubstantially hampered.***

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

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

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

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

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

·       wemay not receive regulatory approval for our product candidates;

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

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

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

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

***If the FDA, or similar foreign agency, delays ordenies approval of any NDA, or foreign equivalent, that we file, thencommercialization of the product subject to the filing will be delayed or terminated,which could have a material adverse effect on our 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;

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·       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.

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

Sales of our products are dependent, in part, on theavailability of reimbursement from third-party payors such as Federal andstate government agencies under programs such as Medicare and Medicaid, andprivate insurance plans. Third-party payors continually attempt tocontain or reduce the cost of health care by challenging the prices charged formedical products and services. We may not be able to sell our productsprofitably if reimbursement is unavailable or coverage is limited in scope oramount.

There have been, there are, and we expect there willcontinue to be, state and Federal legislative and/or administrative proposalsthat could limit the amount that state or Federal governments will pay toreimburse the cost of pharmaceutical products. The MMA, which was signed intolaw in December 2003, contains provisions that permit reductions ingovernment reimbursement for drugs. The full impact of the MMA and itsregulatory requirements on our business is not yet known. However, we believethat legislative or administrative acts that reduce reimbursement for ourproducts could adversely affect our business. In addition, private insurers,such as managed care organizations, may adopt their own coverage restrictionsor demand price concessions in response to legislation or administrativeaction. Reduction in reimbursement for our products could have a materialadverse effect on our results of operations. Also, the increasing emphasis onmanaged care in the United States may put increasing pressure on the price andusage of our products, which may adversely affect product sales. Further, whena new drug product is approved, governmental and/or private reimbursement forthat product is uncertain, as is the amount for which that product will bereimbursed and the extent of coverage for the product. We cannot predictavailability or amount of reimbursement for our approved products or productcandidates and current reimbursement policies for marketed products may changeat any time.

The MMA established a prescription drug benefitbeginning in 2006 for all Medicare beneficiaries. We do not know the extent towhich our products will continue to be included in the Medicare prescriptiondrug benefit, and we may be required to provide significant discounts orrebates to drug plans participating in the Medicare drug benefit. Moreover,Congress may enact legislation that permits the Federal government to directlynegotiate price and demand discounts on pharmaceutical products that mayimplicitly create price controls on prescription drugs. In addition, ManagedCare Organizations, or MCOs, Health Maintenance Organizations, or HMOs,Preferred Provider Organizations, or PPOs, health care institutions and othergovernment agencies continue to seek price discounts. MCOs, HMOs, PPOs andprivate health plans administer the Medicare drug benefit, leading to managedcare and private health plans influencing prescription decisions for a largersegment 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.

Since January 2005 and through June 2007,Medicare reimbursed XOPENEX Inhalation Solution pursuant to a uniquereimbursement code. In March 2006, the DME-PSCs, the entities responsiblefor 

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overseeing the Medicare Part Bprescription drug benefit for respiratory products, announced their intentionto implement a LCA, reimbursement action for XOPENEX Inhalation Solution that,if it had been implemented, would have reduced the reimbursement paid forXOPENEX Inhalation Solution to that of generic racemic albuterol. In December 2006,CMS commenced an NCA, to determine when use of nebulized levalbuterol intreating COPD in the Medicare population is reasonable and necessary. While theNCA for XOPENEX Inhalation Solution was pending, the DME-PSCs announced thatthe proposed LCA would be stayed. On June 20, 2007, CMS announced itspreliminary coverage determination, stating that, based on its review of theavailable data and comments submitted, it was unable to determine the criteriafor when XOPENEX Inhalation Solution would be appropriate to use by the Medicarepopulation and would instead defer this determination to the DME-PSCs. As partof its coverage determination, CMS affirmed that the use of nebulized beta-adrenergicagonists (such as XOPENEX Inhalation Solution and BROVANA) in the treatment oflung disease in the home is medically necessary; such a determination is neededbefore CMS or the DME-PSCs can establish the coverage criteria for a givenprescription drug under the Medicare Part B benefit. We have submittedcomments in response to the CMS proposed coverage memo. The final coveragedetermination is expected in September 2007.

In May 2007, CMS announced that, based on itsinterpretation of the statutory language of the MMA, it was required todiscontinue the unique reimbursement codes for XOPENEX Inhalation Solution, whichhad been in place since January 2005, and generic albuterol and bundledthese products together in a newly created reimbursement code. This reimbursementcode became effective on July 1, 2007. As a result of this coding change,reimbursement for XOPENEX Inhalation Solution and generic albuterol is nowbased on the blended weighted average selling price for the two products,resulting in reimbursement for XOPENEX Inhalation Solution that is considerablylower than the product’s published WAC. Revenues from the sale of XOPENEX InhalationSolution for the quarter ended June 30, 2007 were, and we expect willcontinue to be, adversely affected as a result of this change. The bundlingaction also resulted in an unintended increase in Medicare Part Breimbursement for generic albuterol, significantly higher than the product’saverage selling price (as publicly reported by the Medicare Part Bprogram), creating the potential for inappropriate reimbursement incentives toinfluence the dispensing decisions of providers. In July 2007, the U.S.House of Representatives released draft legislation as part of the StateChildren’s Health Insurance Program reauthorization that includes languageaddressing the Medicare Part B reimbursement scenario that may potentiallyimpact physician prescribing decisions based upon financial incentives. Thedraft legislation provides that XOPENEX Inhalation Solution and genericalbuterol will be paid at the lower of their respective stand-alone averageselling prices or the blended XOPENEX Inhalation Solution/generic albuterolaverage selling price. For generic albuterol, this will lower the reimbursementMedicare pays for the product to its stand-alone average selling price. ForXOPENEX Inhalation Solution, reimbursement will continue to be paid at theblended XOPENEX/generic albuterol average selling price. Medicare Part Breimbursement rates are updated quarterly. Should the proposed legislativechange become law, it will be effective on January 1, 2008. The impact ofthis potential legislative action on XOPENEX Inhalation Solution revenues inthe Medicare market in 2008 is not yet known.

We estimate thatapproximately 25 to 30 percent of our XOPENEX Inhalation Solution units soldare subject to reimbursement under Medicare Part B. We have been activelycontracting with home health care and retail pharmacy providers in an effort toensure the continued availability of XOPENEX Inhalation Solution to Medicare Part Bbeneficiaries with reversible obstructive airway disease. If the contractingstrategy for XOPENEX Inhalation Solution is not successful in maintaining asmuch of the current unit sales levels for the product in Medicare ascommercially feasible, if the reimbursement scenario that may potentiallyimpact physician prescribing decisions for generic albuterol is not correctedlegislatively, and/or if the DME-PSCs impose restrictive coverage policies onXOPENEX Inhalation Solution, revenue from sales of XOPENEX Inhalation Solutionwill be adversely affected and our financial condition and results fromoperations will be impaired.

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We filed a J Codeapplication, for BROVANA in January 2007, and it was accepted by CMS aspart of the 2008 coding cycle review. In April 2007, CMS announced thatits preliminary determination on the BROVANA J Code application was favorableand CMS recommended that BROVANA be awarded a unique J Code. The final decisionon the BROVANA J Code application is expected in November 2007.If BROVANA is awarded a unique J Code by CMS in November 2007, itwould become effective on January 1, 2008. In April 2007, CMSinformed us that the scope of the NCA includes BROVANA. As stated above, CMSannounced that it was deferring its coverage determination, including anydetermination for long-acting beta-agonists like BROVANA, to the DME-PSCs. On June 13, 2007,the DME-PSCs published an article detailing the coverage criteria for BROVANA. Thearticle also stated that, for the remainder of 2007, BROVANA would bereimbursed under Medicare Part B pursuant to a miscellaneous or “nototherwise classified” reimbursement code. Unless otherwise modified by theDME-PSCs, the coverage criteria established for BROVANA in the above-referencedarticle will remain in effect under the miscellaneous reimbursement code andany unique J Code that is awarded for the product. We have initiated acontracting strategy with retail and home health care pharmacy providers forBROVANA that is intended to ensure the availability of the product for Medicarepatients. If the contracting strategy for BROVANA is not successful or if thecoverage policies established by the DME-PSCs for the product are viewed byphysicians and providers as too restrictive, revenue growth from sales ofBROVANA in the Medicare market will be materially adversely affected.

Additionally, as we enterinto agreements to license our products for commercialization outside of theUnited States, we may be subject to pricing decisions made by regulatory bodiesand private insurers around the world, including Japan. Such pricing decisionsmay affect royalty rates and payments made to us under those agreements, ordecisions whether or not to commercialize our products in the applicablejurisdiction.  Efforts to obtain pricingdecisions are often the responsibility of the third party licensee and wecannot predict the success of any third party in obtaining desirable pricing,or how the actions of such third party or any regulatory body or privateinsurer will affect the ultimate commercial benefits of those transactions.

We pay a minimum rebate tostate Medicaid programs based on the utilization of our products by Medicaidbeneficiaries. This rebate is mandated by the Omnibus Budget Reconciliation Actof 1990 and is calculated and paid on a quarterly basis. The minimum rebate iscurrently 15.1% of the Average Manufacturers Price, or AMP, calculated for eachof our products and may be higher if we provide discounts to commercialcustomers that are greater than the statutorily mandated minimum rebate. Inaddition, several states have adopted Preferred Drug Lists, or PDLs, for theirMedicaid programs and more states may adopt this practice. Products placed on astate Medicaid program’s PDL are not subject to restrictions on theirutilization such as prior authorization before use. If our drugs are notincluded on Medicaid PDLs, use of our drugs in the Medicaid program may beadversely affected. In some states that have adopted PDLs, we have been, andmay continue to be, required to provide substantial supplemental rebates tostate Medicaid authorities in order for our drugs to be included on the PDL.

The Federal, state andlocal governments have initiated investigations and lawsuits concerning therebate practices of many pharmaceutical companies to ensure compliance withthese programs. We were recently named as a defendant, together with numerousother companies, in one such suit. The formulas for determining these rebatesand discounts are set by law, are based on a number of different factors, andcan be complicated. We recompute these amounts each quarter based on ourup-to-date knowledge of the statutory requirements and believe our calculationsare accurate and based on reasonable assumptions and judgments. However, as aresult of an investigation or lawsuit we may be required to pay additionalrebates and/or discounts on sales made in prior periods and/or be subject tofines and/or other penalties. In addition an investigation or lawsuitconcerning our rebate practices could be costly, could divert the attention ofour management from our core business and could damage our reputation.

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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 oradminister them, which could reduce use of our products or cause us to reducethe price of our products.

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

We aresubject to extensive regulation by Federal and state governments. The laws thatdirectly or indirectly affect our business include, but are not limited to, thefollowing:

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

·       otherMedicare and Medicaid laws and regulations that establish requirements forcoverage and payment 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, whichprohibits executing a scheme to defraud any health care benefit program,including private payors and, further, requires us to comply with standardsregarding privacy and security of individually identifiable health informationand conduct certain electronic transactions using standardized code sets;

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

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

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

·       thePrescription Drug User Fee Act, which governs the filing of applications formarketing approval of new prescription drug products;

·       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 Medicaid Anti-Kickback Laws, which maynot be limited to government reimbursed items or services.

If our past or presentoperations are found to be in violation of any of the laws described above orother governmental regulations to which we or our customers are subject, we maybe subject to the applicable penalty associated with the violation, includingcivil and criminal penalties, damages, fines, exclusion from Medicare andMedicaid programs and curtailment or restructuring of our operations.Similarly, if our customers are found non-compliant with applicable laws, 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 additional

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regulationor incur significant expense. Any penalties, damages, fines, curtailment orrestructuring of our operations would adversely affect our ability to operateour business and our financial results. The risk of our being found inviolation of these laws is increased by the fact that many of them have notbeen fully interpreted by the regulatory authorities or the courts and theirprovisions are open to a variety of interpretations. Any action against us forviolation of these laws, even if we successfully defend against it, could causeus to incur significant legal expenses, divert our management’s attention fromoperating our business and 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 the Medicaid rebate program, we are obligated to pay atleast a minimum primary rebate of 15.1% on all utilization of our products byMedicaid beneficiaries. Congress is considering legislation that may raise theminimum rebate level that we must pay to state Medicaid programs. In addition,this primary rebate may be higher if we provide discounts to commercialcustomers that are greater than the statutorily mandated minimum. Also, severalstate Medicaid programs have implemented PDLs. Products placed on a stateMedicaid program’s PDL are not subject to restrictions on their utilizationsuch as prior authorization before use. To secure a place on a given state PDL,we provide discounts to the state Medicaid program in the form of supplementalrebates.

Both the Federalgovernment and state and local governments have initiated investigations andlawsuits concerning the rebate practices of many pharmaceutical companies toensure compliance with these rebate programs. We were recently named as adefendant, together with numerous other companies, in one such suit. Theformulas for determining these rebates and discounts are set by law, are basedon a number of different factors and can be complicated. We recompute theseamounts each quarter based on our up-to-date knowledge of the statutoryrequirements and believe our calculations are accurate and based on reasonable assumptionsand judgments. However, as a result of an investigation or lawsuit we may berequired to pay additional rebates and/or discounts on sales made in priorperiods or be subject to fines and other penalties. In addition, aninvestigation or lawsuit concerning our rebate practices could be costly, coulddivert the attention of our management from our core business and could damageour reputation.

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

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

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**Risks Related toOur Intellectual Property**

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

Our success depends in large part on our ability toobtain, 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 patentapplications covering composition of, methods of making, and/or methods ofusing, our drugs and drug candidates. Our revenues under collaborationagreements with pharmaceutical companies depend in part on the existence andscope of issued patents. We may not be issued patents based on patentapplications already filed or that we file in the future and if patents areissued, they may be insufficient in scope to cover the products licensed underthese collaboration agreements. Generally, we do not receive royalty revenuefrom sales of products licensed under collaboration agreements in countrieswhere we do not have a patent for such products. The issuance of a patent inone country does not ensure the issuance of a patent in any other country.Furthermore, the patent position of companies in the pharmaceutical industrygenerally involves complex legal and factual questions, and has been andremains the subject of much litigation. Legal standards relating to scope andvalidity of patent claims are evolving. Any patents we have obtained, or obtainin the future, may be challenged, invalidated or circumvented. Moreover, theUnited States Patent and Trademark Office may commence interference proceedingsinvolving our patents or patent applications. Any challenge to, or invalidationor circumvention of, our patents or patent applications would be costly, wouldrequire significant time and attention of our management and could have amaterial adverse effect on our business. In addition, if we are not successfulin enforcing our patents, we will not be able to prevent others fromintroducing generic versions of our products.

***A number of our products and products for which wereceive royalties are the subject of patent invalidation claims.***

XOPENEX brand levalbuterol HCl Inhalation Solution iscurrently the subject of patent invalidity claims. The FDA has received ANDAsfrom Breath, Dey, L.P., Watson, and Barr seeking marketing approval for genericcopies of our XOPENEX Inhalation Solution products. These submissions includeParagraph IV certifications alleging that our patents listed in the OrangeBook for XOPENEX Inhalation Solution are invalid, unenforceable or notinfringed by the submitter’s proposed product. We have filed civil actionsagainst Breath, Dey, L.P., and Barr for patent infringement.

In June 2006, we were notified that TevaPharmaceutical Industries Limited and Teva UK Limited, referred to collectivelyas Teva, have filed a claim naming us as defendant in the United Kingdom’s HighCourt of Justice, Chancery Division, Patents Court. The claim alleges that ourtwo patents relating to fexofenandine hydrocloride, which we have licensed tosanofi-aventis in connection with its sale of ALLEGRA, are invalid, and seeksto have them invalidated. Sanofi-aventis is defending this action. Ifpatent-based exclusivity for ALLEGRA is lost in the United Kingdom or in anyother jurisdiction where a similar action is brought, our rights to receiveroyalty revenue in any such jurisdiction will terminate.

In August 2006, we were notified that severalANDAs containing Paragraph IV certifications had been received by the FDAseeking approval of generic versions of certain of Schering-Plough’s CLARINEXproducts. In June 2007, we received notification that the FDA had receivedan ANDA from Glenmark, seeking approval of a generic version of Schering-Plough’s5 mg tablets of CLARINEX brand 

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desloratadine. Glenmark’ssubmission includes a Paragraph IV certification alleging that our patents thatSchering-Plough (as licensee of such patents) listed in the Orange Book for itsCLARINEX brand desloratadine are invalid, unenforceable or not infringed by thegeneric version for which Glenmark is seeking approval. In July 2007, we andthe University of Massachusetts, co-owners of certain patents listed in theOrange Book, filed a civil action against Glenmark for patent infringement.

In July 2007, we received notification that theFDA had received an ANDA from Sun Pharmaceutical Industries, Ltd., seekingapproval of a generic version of Schering-Plough’s 5 mg tablets of CLARINEXbrand desloratadine. Sun Pharmaceutical Industries, Ltd.’s submission includesa Paragraph IV certification alleging that our patents listed bySchering-Plough (as licensee of such patents) in the Orange Book for CLARINEXbrand desloratadine are invalid and/or unenforceable, or are not infringed bythe generic version for which Sun Pharmaceutical Industries, Ltd. is seekingapproval. We are contemplating filing a civil action against SunPharmaceuticals Industries, Ltd. for patent infringement. If patent basedexclusivity for CLARINEX is lost in any of these cases, Schering-Plough willhave no obligation to pay royalties to us on the U.S. sales of CLARINEX products.

In June 2007, we received notification that Tevafiled an Action for Revocation of our European patent for levocetirizine in theHigh Chancery Court in the United Kingdom based on alleged invalidity of ourgranted patent and their intent to market a generic levocetirizine product thatwould infringe our granted patent. In July 2007, we received notificationthat Teva Pharmaceutical Industries Limited filed a Nullification Request forour European patent for levocetirizine in the German Federal Patent Court. Ourlevocetirizine patent is exclusively licensed to UCB in connection with itssale of XYZAL/XUSAL. We have retained counsel for the Action for Revocation inthe United Kingdom and we are in process of retaining counsel for the NullificationAction in Germany.

Should we successfully enforce our United Statespatents, ANDA approval will not occur until the expiration of the applicablepatents. Otherwise, the FDA will stay its approval of the relevant ANDA untilthirty months following the date we received notice of such ANDA or until acourt decides that our patents are invalid, unenforceable or not infringed,whichever is earlier. Should we successfully enforce our foreign patents,generic companies will be prevented from obtaining patent protection forsimilar drugs, and will be deterred from market entry until the expiration ofthe applicable patent(s).

Patent litigation involves complex legal and factualquestions. We can provide no assurance concerning the outcome or the durationof any patent related lawsuits. If we, or third parties from whom we receiveroyalties, are not successful in enforcing our respective patents, the genericcompanies will not be excluded, for the full term of our patents, frommarketing their generic versions of our products or third party products forwhich we have licensed rights to our patents. Introduction of generic copies ofany of our products or third party products for which we have licensed rightsto our patents before the expiration of our patents would have a materialadverse effect on our business.

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

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

Our success depends in part on our ability to operatewithout infringing upon proprietary rights of others, including patent andtrademark rights. Third parties, typically drug companies, hold patents orpatent applications covering compositions, methods of making and uses, coveringthe composition of matter for some of the drug candidates for which we havepatents or patent applications. Third parties also 

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hold patents relating todrug delivery technology that may be necessary for development orcommercialization of some of our drug candidates. In each of these 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.

Others may file suit against us alleging that ourproducts or product candidates infringe patents they hold. Even if resolved inour favor, any patent infringement litigation would be costly, would requiresignificant time and attention of our management, could prevent us fromcommercializing our products for a period of time and could require us to paysignificant damages and could have a material adverse effect on our business.If the matter is not resolved in our favor, we could be required to paysignificant damages and/or be prevented from commercializing our product andour business could be materially adversely affected. In April 2007, wewere served with a complaint filed by Dey, alleging that the manufacture andsale of BROVANA (arformoterol tartrate) infringes or will induce infringementof a single U.S. patent for which Dey owns all rights, title and interest. In April 2007,we filed an answer and counterclaim to this complaint seeking to invalidate theoriginally asserted patent and a second related patent. In May 2007, Dey fileda reply asserting infringement of the second patent. It is too early to make areasonable assessment as to the likely outcome or impact of this litigation. Weare unable to reasonably estimate any possible range of loss or liabilityrelated to this lawsuit due to its uncertain resolution.

If any of our trademarks,or our use of any of our trademarks on our products, is challenged, we may beforced to rename the affected product or product candidate, which could becostly and time consuming, and would result in the loss of any brand equityassociated with the product name. In September 2006, Tharos filed suitagainst us in the United States District Court, District of Utah, CentralDivision, alleging trademark infringement, dilution, unfair competition, falseadvertising and false designation of origin arising out of our use of our silkluna moth design in connection with LUNESTA. Tharos seeks unspecified monetarydamages and to enjoin our use of the silk luna moth design. In October 2006,we filed a motion to dismiss Tharos’ claims. On February 9, 2007, thecourt granted our motion in respect of the state unfair competition claims anddenied it in respect of Tharos’ other claims. On March 6, 2007, we filedan Answer to Tharos’ Complaint. In addition, we filed counterclaims againstTharos for cancellation of Tharos’ alleged trademark and for false advertising.We continue to defend our trademark in this litigation but we are unable atthis stage to predict its ultimate resolution.

**Risks Related toOur Dependence on Third Parties**

***If any third-party collaborator is notsuccessful in development of our product candidates, we may not realize thepotential commercial benefits of the arrangement and our results of operationscould be adversely affected.***

We have entered into a collaboration agreement with 3Mfor the scale-up and manufacturing of XOPENEX HFA.  Under this agreement, 3M is responsible formanufacturing an MDI formulation of XOPENEX. We commercially introduced XOPENEXHFA in December 2005.  We have alsoentered into an agreement with Eisai for development and commercialization ofour eszopiclone product, marketed as LUNESTA in the U.S. Under this agreement,Eisai will be responsible for completing remaining clinical trials necessaryfor attaining marketing approval from the Japanese regulatory authorities and,contingent on regulatory approval, commercialization of the product in Japan.

If 3M, Eisai or any futuredevelopment or commercialization collaborator do not devote sufficient time andresources to its collaboration arrangement with us, breaches or terminates itsagreement with us, fails to perform its obligations to us in a timely manner oris unsuccessful in its development and/or commercialization efforts, we may notrealize the potential commercial benefits of the arrangement and our results ofoperations may be adversely affected. In addition, if regulatory approval orcommercialization of any product candidate under development by or incollaboration with a partner is 

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delayedor limited, we may not realize, or may be delayed in realizing, the potentialcommercial benefits of the arrangement.

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

We have entered intolicensing arrangements pursuant to which we license patents to pharmaceuticalcompanies and our revenues under these licensing arrangements consist primarilyof royalties on sales of products. Payments and royalties under thesearrangements depend in large part on the commercialization efforts of ourlicensing partners in countries where we hold patents, including sales effortsand enforcement of patents, which we cannot control. If any of our licensingpartners does not devote sufficient time and resources to its licensingarrangement with us or focuses its efforts in countries where we do not hold patents,we may not realize the potential commercial benefits of the arrangement, ourrevenues under these arrangements may be less than anticipated and our resultsof operations may be adversely affected. If any of our licensing partners wasto breach or terminate its agreement with us or fail to perform its obligationsto us in a timely manner, the royalties we receive under the licensingagreement could decrease or cease. If we are unable or fail to perform, orbreach in our performance of, our obligations under a licensing agreement, theroyalties and benefits to which we are otherwise entitled under the agreementcould be reduced or eliminated. Any delay or termination of this type couldhave a material adverse effect on our financial condition and results ofoperations because we may lose technology rights and milestone or royaltypayments from licensing partners and/or revenues from product sales, if any,could be delayed, reduced or terminated.

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

We currently operate a manufacturing plant that webelieve can meet our commercial requirements of the active pharmaceuticalingredient for XOPENEX Inhalation Solution and XOPENEX HFA, partially fulfillour commercial requirements of the active pharmaceutical ingredient forLUNESTA, and support production of our product candidates in amounts needed forour clinical trials. We do not, however, have the capability to manufacture atour manufacturing facility all of our requirements for the active ingredientsof our currently approved products, and we have no facilities for manufacturingpharmaceutical dosage forms or finished drug products. Developing and obtainingthis capability would be time consuming and expensive. Unless and until wedevelop this capability, we will rely substantially, and in some cases,entirely, on third-party manufacturers. Catalent Pharma Solutions, LLC,or Catalent, formerly Cardinal Health, Inc., is currently the sole finishedgoods manufacturer of our XOPENEX Inhalation Solution and BROVANA. Patheon Inc.,or Patheon, is the sole manufacturer of LUNESTA and 3M is the sole manufacturerand supplier of XOPENEX HFA. Certain components of XOPENEX HFA are availablefrom only a single source. If Catalent, Patheon, 3M, or any of our sole-sourcecomponent suppliers experiences delays or difficulties in producing, packagingor delivering XOPENEX Inhalation Solution, XOPENEX HFA, BROVANA or LUNESTA, asthe case may be, we could be unable to meet our customers’ demands for suchproducts, which could lead to customer dissatisfaction and damage to ourreputation. Furthermore, if we are required to change manufacturers, we will berequired to verify that the new manufacturer maintains facilities andprocedures that comply with quality standards and with all applicableregulations and guidelines, including FDA guidelines. The delays associatedwith the verification of a new manufacturer for XOPENEX Inhalation Solution,XOPENEX HFA, BROVANA or LUNESTA could adversely affect our ability to producesuch products in a timely manner or within budget.

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

**Risks Related toGrowth of Our Business**

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

We are currently commercializing four products.However, all of our product candidates are in the early stages of development.In order to increase the likelihood that we will be able to successfullydevelop and/or commercialize additional drugs, we intend to acquire and developadditional product candidates and/or approved products. The success of thisgrowth strategy depends upon our ability to correctly establish criteria forsuch acquisitions and successfully identify, select and acquire productcandidates and/or products that meet such criteria. We will be required tointegrate any acquired product candidates into our research and developmentoperations and any acquired products into our sales and marketing operations. Managingthe development and/or commercialization of a new product involves numerousother financial and operational risks, including difficulties allocatingresources between existing and acquired assets and attracting and retainingqualified employees to develop and/or sell the product.

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

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

·       manufacturedor produced economically;

·       successfullycommercialized or be reimbursed at rates sufficient for us to achieve ormaintain profitability with respect to such products;

·       complementaryto our existing product portfolio; or

·       widelyaccepted in the marketplace.

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

***We may undertake strategic acquisitions in the futureand any difficulties from integrating such acquisitions could adversely affectour stock price, business operations, financial condition or results fromoperations.***

We may acquire additional businesses and products thatcomplement or augment our existing business. We have limited acquisitionexperience and may not be able to integrate any acquired business or productsuccessfully or operate any acquired business profitably. Integrating any newlyacquired business or product could be expensive and time-consuming. Integrationefforts often take a significant amount of time, place a significant strain onmanagerial, operational and financial resources and could prove to be 

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more difficult orexpensive than we predict. The diversion of our management’s attention and anydelay or difficulties encountered in connection with any future acquisitions wemay consummate could result in the disruption of our on-going business orinconsistencies in standards, controls, procedures and policies that couldadversely affect our ability to maintain relationships with customers,suppliers, collaborators, employees and others with whom we have businessdealings. Moreover, we may need to raise additional funds through public orprivate debt or equity financing to acquire any businesses or products, whichmay result in dilution for stockholders or the incurrence of indebtedness.

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

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

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

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

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

·       revenuefrom product sales could be delayed; or

·       wemay elect not to commercialize the drugs.

We are required tofile a notice under the Hart-Scott-Rodino Antitrust Improvements Actof 1976, as amended, or the HSR Act, for certain agreements containingexclusive license grants and to delay the effectiveness of any such exclusivelicense until expiration or earlier termination of the notice and waitingperiod under the HSR Act. If expiration or termination of the notice andwaiting 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.

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**ITEMS 2-3.**                              NONE

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

Our annual meetingof stockholders was held on May 15, 2007. The following represents theresults of the voting on proposals submitted to a vote of stockholders at theannual meeting:

1.                Toelect each of Digby W. Barrios and Alan A. Steigrod to serve as a Class IIIdirector until the 2010 annual meeting and until his successor is duly electedand qualified.

| ** **        | ** ** | **For**    | ** ** | **Withheld Authority** |
|-------------------|------------|------------|------------|-----------------------------|
| Digby W.  Barrios |       | 65,373,807 |       | 26,381,196                  |
| Alan A.  Steigrod |       | 76,043,289 |       | 15,711,714                  |

 

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

Adrian AdamsJames G. AndressTimothy J. BarberichRobert J. CresciJames F. MrazekTimothy J. Rink

2.                Toapprove an amendment to our 2000 Stock Incentive Plan increasing from11,500,000 to 13,500,000 the number of shares reserved for issuance under the2000 plan.

| **For**    | ** ** | **Against** | ** ** | **Abstain** | ** ** | **Broker Non-Votes** |
|------------|------------|-------------|------------|-------------|------------|----------------------|
| 58,230,705 |       | 20,976,410  |       | 66,021      |       | 12,481,867           |

 

3.                To ratify the selection ofPricewaterhouseCoopers LLP as our independent registered public accounting firmfor the current fiscal year.

| **For**    | ** ** | **Against** | ** ** | **Abstain** |
|------------|------------|-------------|------------|-------------|
| 91,370,689 |       | 309,294     |       | 75,019      |

 

**ITEM 5.**                NONE

**ITEM6.**                EXHIBITS
| 10.1 |   | 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 8,  2007 | By:               | /s/  ADRIAN ADAMS |
|                       |              | Adrian Adams |
|                       | * *          | *President  and Chief Executive Officer  (Principal Executive Officer)* |
| Date: August 8,  2007 | By:               | /s/  ROBERT F. SCUMACI |
|                       |              | Robert F. Scumaci |
|                       | * *          | *Executive  Vice President, Corporate Finance,  Administration and Technical Operations,  and Treasurer  (Principal Accounting Officer)* |

 

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**Exhibit Index**
| Exhibit No. | ** ** | ** **                                                                                                                                                     | ** ** | **Description** |
|------------------|------------|----------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------|
| 10.1             |       | 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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