**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 September 30, 2005**

**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                   |   | (IRS Employer        |
| Incorporation or  Organization)                    |   | Identification  No.) |
| **84 Waterford Drive  Marlborough, Massachusetts** |   | **01752**            |
| (Address of  Principal Executive Offices)          |   | (Zip Code)           |

 

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

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

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

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

The number of sharesoutstanding of the registrant’s class of Common Stock as of October 31,2005 was: 106,082,131 shares.

 

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**SEPRACOR INC.INDEX**

| **Part I—Financial Information** |   |                                                                                                                          |
|--------------------------------------------|--------|-------------------------------------------------------------------------------------------------------------------------------|
| Item 1.                                    |   | Condensed Consolidated  Financial Statements (Unaudited)                                                                      |   |   |
|                                       |   | Consolidated Balance Sheets as of  September 30, 2005 and December 31, 2004  (Unaudited)                            |   | 3 |
|                                       |   | Consolidated Statements of  Operations for the Three and Nine Months Ended September 30,  2005 and 2004 (Unaudited) |   | 4 |
|                                       |   | Consolidated Statements of  Cash Flows for the Nine Months Ended September 30, 2005 and 2004 (Unaudited)       |   | 5 |
|                                       |   | Notes to Condensed  Consolidated Interim Financial Statements                                                                 |   | 6 |
| Item  2.                                   |   | Management’s Discussion and  Analysis of Financial Condition and Results of Operations                                   |   | 13 |
| Item  3.                                   |   | Quantitative and Qualitative  Disclosures About Market Risk                                                                   |   | 39 |
| Item  4.                                   |   | Controls and Procedures                                                                                                       |   | 39 |
| **Part II—Other  Information**   |   |                                                                                                                          |
| Item 1.                                    |   | Legal Proceedings                                                                                                             |   | 40 |
| Item 6.                                    |   | Exhibits                                                                                                                      |   | 40 |
|                                       |   | Signatures                                                                                                                    |   | 41 |
|                                       |   | Exhibit Index                                                                                                            |   | 42 |

 

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

| ** **                                                                                                                                                                                                                   | ** ** | **September 30,  2005** | ** ** | **December 31,  2004** | ** ** |
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|------------------------------|------------|-----------------------------|------------|
| **Assets**                                                                                                                                                                                                                   |       |                         |       |                        |       |   |   |
| Current assets:                                                                                                                                                                                                              |       |                         |       |                        |       |   |   |
| Cash and cash  equivalents                                                                                                                                                                                                   |       |                         | $          | 181,410                     |       |   | $ | 435,905 |   |
| Short-term  investments                                                                                                                                                                                                      |       |                         | 611,883    |                        |       | 303,303 |   |
| Accounts receivable, net                                                                                                                                                                                                     |       |                         | 103,166    |                        |       | 68,914 |   |
| Inventories                                                                                                                                                                                                                  |       |                         | 25,317     |                        |       | 13,086 |   |
| Other assets                                                                                                                                                                                                                 |       |                         | 21,703     |                        |       | 18,722 |   |
| Total current assets                                                                                                                                                                                                         |       |                         | 943,479    |                        |       | 839,930 |   |
| Long-term  investments                                                                                                                                                                                                       |       |                         | 149,205    |                        |       | 94,704 |   |
| Property and equipment,  net                                                                                                                                                                                                 |       |                         | 71,650     |                        |       | 70,860 |   |
| Investment in affiliate                                                                                                                                                                                                      |       |                         | 4,826      |                        |       | 5,535 |   |
| Patents and deferred  financing costs, net                                                                                                                                                                                   |       |                         | 23,531     |                        |       | 27,035 |   |
| Other assets                                                                                                                                                                                                                 |       |                         | 122        |                        |       | 1,054 |   |
| Total assets                                                                                                                                                                                                                 |       |                         | $          | 1,192,813                   |       |   | $ | 1,039,118 |   |
| **Liabilities and Stockholders’ Equity (Deficit)**                                                                                                                                                                      |       |                         |       |                        |       |   |   |
| Current liabilities:                                                                                                                                                                                                         |       |                         |       |                        |       |   |   |
| Accounts payable                                                                                                                                                                                                             |       |                         | $          | 29,862                      |       |   | $ | 5,772 |   |
| Accrued expenses                                                                                                                                                                                                             |       |                         | 118,791    |                        |       | 126,701 |   |
| Current portion of notes  payable and capital lease obligation                                                                                                                                                               |       |                         | 2,091      |                        |       | 1,926 |   |
| Other current  liabilities                                                                                                                                                                                                   |       |                         | 89,960     |                        |       | 69,711 |   |
| Total current  liabilities                                                                                                                                                                                                   |       |                         | 240,704    |                        |       | 204,110 |   |
| Notes payable and  capital lease obligation                                                                                                                                                                                  |       |                         | 1,218      |                        |       | 2,529 |   |
| Other long-term  liabilities                                                                                                                                                                                                 |       |                         | 2,859      |                        |       | 2,774 |   |
| Convertible subordinated  debt                                                                                                                                                                                               |       |                         | 1,160,820  |                        |       | 1,160,820 |   |
| Total liabilities                                                                                                                                                                                                            |       |                         | 1,405,601  |                        |       | 1,370,233 |   |
| Stockholders’ equity (deficit):                                                                                                                                                                                         |       |                         |       |                        |       |   |   |
| Preferred stock, $1.00  par value, 1,000 shares authorized; none outstanding at September 30,  2005 and December 31, 2004                                                                                          |       |                         | —     |                        |       | — |   |
| Common stock, $.10 par  value, 240,000 and 240,000 shares authorized; 107,533 and 105,309 shares  issued, 105,599 and 103,376 shares outstanding, at September 30, 2005  and December 31, 2004, respectively  |       |                         | 10, 753    |                        |       | 10,531 |   |
| Treasury stock, at cost  (1,934 and 1,933 shares at September 30, 2005 and December 31,  2004, respectively)                                                                                                  |       |                         | (100,400   | )                           |       | (100,321 | ) |
| Additional paid-in  capital                                                                                                                                                                                                  |       |                         | 1,525,823  |                        |       | 1,370,372 |   |
| Accumulated deficit                                                                                                                                                                                                          |       |                         | (1,657,682 | )                           |       | (1,625,486 | ) |
| Accumulated other  comprehensive income                                                                                                                                                                                      |       |                         | 8,718      |                        |       | 13,789 |   |
| Total stockholders’  equity (deficit)                                                                                                                                                                                   |       |                         | (212,788   | )                           |       | (331,115 | ) |
| Total liabilities and stockholders’ equity (deficit)                                                                                                                                                                    |       |                         | $          | 1,192,813                   |       |   | $ | 1,039,118 |   |

 

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

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**SEPRACOR INC.CONSOLIDATED STATEMENTSOF OPERATIONS(Unaudited)(In Thousands, Except Per Share Amounts)**

| ** **                                                             | ** ** | **Three Months Ended** | ** ** | **Nine Months Ended** | ** ** |
|------------------------------------------------------------------------|------------|----------------------------------|------------|---------------------------------|------------|
| ** **                                                             | ** ** | **September 30,  2005**     | ** ** | **September 30,  2004**    | ** ** | **September 30,  2005** | ** ** | **September 30,  2004** | ** ** |
| Revenues:                                                              |       |                             |       |                            |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Product sales                                                          |       |                             | $          | 193,357                         |       |   |   | $ | 60,122 |   |   |   | $ | 466,748 |   |   |   | $ | 202,628 |   |   |
| Royalties and other                                                    |       |                             | 12,363     |                            |       |   | 19,959 |   |   |   | 43,081 |   |   |   | 46,898 |   |   |
| Total revenues                                                         |       |                             | 205,720    |                            |       |   | 80,081 |   |   |   | 509,829 |   |   |   | 249,526 |   |   |
| Costs and expenses:                                                    |       |                             |       |                            |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Cost of product sold                                                   |       |                             | 15,491     |                            |       |   | 7,021 |   |   |   | 39,981 |   |   |   | 22,702 |   |   |
| Cost of royalties and other                                            |       |                             | 224        |                            |       |   | 285 |   |   |   | 629 |   |   |   | 634 |   |   |
| Research and development                                               |       |                             | 38,372     |                            |       |   | 38,744 |   |   |   | 104,073 |   |   |   | 121,117 |   |   |
| Selling, marketing and distribution                                    |       |                             | 162,696    |                            |       |   | 82,843 |   |   |   | 386,016 |   |   |   | 253,632 |   |   |
| General and administrative                                             |       |                             | 10,871     |                            |       |   | 7,465 |   |   |   | 29,200 |   |   |   | 22,398 |   |   |
| Total costs and expenses                                               |       |                             | 227,654    |                            |       |   | 136,358 |   |   |   | 559,899 |   |   |   | 420,483 |   |   |
| Loss from operations                                                   |       |                             | (21,934    | )                               |       |   | (56,277 | ) |   |   | (50,070 | ) |   |   | (170,957 | ) |   |
| Other income (expense):                                                |       |                             |       |                            |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Interest income                                                        |       |                             | 7,776      |                            |       |   | 2,039 |   |   |   | 18,446 |   |   |   | 4,718 |   |   |
| Interest expense                                                       |       |                             | (5,847     | )                               |       |   | (5,846 | ) |   |   | (17,528 | ) |   |   | (17,800 | ) |   |
| Loss on redemption of debt                                             |       |                             | —     |                            |       |   | — |   |   |   | — |   |   |   | (7,022 | ) |   |
| Gain on sale of equity investment                                      |       |                             | 18,345     |                            |       |   | — |   |   |   | 18,345 |   |   |   | — |   |   |
| Loss on conversion of debt                                             |       |                             | —     |                            |       |   | (69,768 | ) |   |   | — |   |   |   | (69,768 | ) |   |
| Equity in investee (losses)                                            |       |                             | (241       | )                               |       |   | (508 | ) |   |   | (709 | ) |   |   | (1,013 | ) |   |
| Other expense, net                                                     |       |                             | (323       | )                               |       |   | (3 | ) |   |   | (680 | ) |   |   | (91 | ) |   |
| Net loss                                                               |       |                             | $          | (2,224                          | )          |   |   | $ | (130,363 | ) |   |   | $ | (32,196 | ) |   |   | $ | (261,933 | ) |   |
| Basic and diluted net loss per common share                       |       |                             | $          | (.02                            | )          |   |   | $ | (1.40 | ) |   |   | $ | (.31 | ) |   |   | $ | (2.97 | ) |   |
| Shares used in computing  basic and diluted net loss per common share: |       |                             |       |                            |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Basic and diluted                                                      |       |                             | 105,427    |                            |       |   | 92,800 |   |   |   | 104,560 |   |   |   | 88,270 |   |   |

 

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

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

| ** **                                                                   | ** ** | **Nine Months Ended** | ** ** |
|------------------------------------------------------------------------------|------------|---------------------------------|------------|
| ** **                                                                   | ** ** | **September 30,  2005**    | ** ** | **September 30,  2004** | ** ** |
| Cash flows from operating activities:                                        |       |                            |       |   |   |   |   |   |   |
| Net loss                                                                     |       |                            | $          | (32,196 | ) |   |   | $ | (261,933 | ) |   |
| Adjustments to reconcile net loss to net cash used  in operating activities: |       |                            |       |   |   |   |   |   |   |
| Depreciation and  amortization                                               |       |                            | 11,307     |   |   |   | 13,947 |   |   |
| Equity in investee  losses                                                   |       |                            | 709        |   |   |   | 1,013 |   |   |
| Loss on conversion of  debt                                                  |       |                            | —     |   |   |   | 69,768 |   |   |
| Loss on redemption of  debt                                                  |       |                            | —     |   |   |   | 7,022 |   |   |
| Loss on asset disposal                                                       |       |                            | 603        |   |   |   | 374 |   |   |
| Gain on sale of equity  investment                                           |       |                            | (18,345    | ) |   |   | — |   |   |
| Changes in operating assets and liabilities:                                 |       |                            |       |   |   |   |   |   |   |
| Accounts receivable                                                          |       |                            | (34,252    | ) |   |   | 9,671 |   |   |
| Inventories                                                                  |       |                            | (12,073    | ) |   |   | (9,139 | ) |   |
| Other current assets                                                         |       |                            | (2,937     | ) |   |   | (6,061 | ) |   |
| Accounts payable                                                             |       |                            | 24,000     |   |   |   | (5,763 | ) |   |
| Accrued expenses                                                             |       |                            | (7,905     | ) |   |   | (28,015 | ) |   |
| Other current  liabilities                                                   |       |                            | 20,335     |   |   |   | 3,717 |   |   |
| Other liabilities                                                            |       |                            | —     |   |   |   | 30,231 |   |   |
| Net cash used in  operating activities                                       |       |                            | (50,754    | ) |   |   | (175,168 | ) |   |
| Cash flows from investing activities:                                        |       |                            |       |   |   |   |   |   |   |
| Purchases of short and  long-term investments                                |       |                            | (1,011,167 | ) |   |   | (270,914 | ) |   |
| Sales and maturities of  short and long-term investments                     |       |                            | 668,994    |   |   |   | 154,182 |   |   |
| Additions to property  and equipment                                         |       |                            | (9,524     | ) |   |   | (8,498 | ) |   |
| Investment in ACADIA                                                         |       |                            | (7,143     | ) |   |   | — |   |   |
| Change in other assets                                                       |       |                            | 932        |   |   |   | 37 |   |   |
| Net cash used in  investing activities                                       |       |                            | (357,908   | ) |   |   | (125,193 | ) |   |
| Cash flows from financing activities:                                        |       |                            |       |   |   |   |   |   |   |
| Redemption of  convertible subordinated notes                                |       |                            | —     |   |   |   | (433,709 | ) |   |
| Conversion of  convertible subordinated notes                                |       |                            | —     |   |   |   | (47,342 | ) |   |
| Net proceeds from  issuance of common stock                                  |       |                            | 31,796     |   |   |   | 36,745 |   |   |
| Proceeds from sale of  convertible subordinated debt                         |       |                            | —     |   |   |   | 650,000 |   |   |
| Costs associated with  sale of convertible subordinated debt                 |       |                            | —     |   |   |   | (18,315 | ) |   |
| Settlement of call  spread options                                           |       |                            | 123,798    |   |   |   | 50,006 |   |   |
| Purchase of treasury  stock                                                  |       |                            | —     |   |   |   | (100,321 | ) |   |
| Repayments of long-term  debt and capital leases                             |       |                            | (1,592     | ) |   |   | (771 | ) |   |
| Net cash provided by  financing activities                                   |       |                            | 154,002    |   |   |   | 136,293 |   |   |
| Effect of exchange rate  changes on cash and cash equivalents                |       |                            | 165        |   |   |   | 202 |   |   |
| Net decrease in cash and  cash equivalents                                   |       |                            | (254,495   | ) |   |   | (163,866 | ) |   |
| Cash and cash  equivalents at beginning of period                            |       |                            | $          | 435,905 |   |   |   | $ | 705,802 |   |   |
| Cash and cash  equivalents at end of period                                  |       |                            | $          | 181,410 |   |   |   | $ | 541,936 |   |   |
| Non cash activities:                                                         |       |                            |       |   |   |   |   |   |   |
| Additions to capital  leases                                                 |       |                            | $          | 529 |   |   |   | $ | 4,707 |   |   |
| Conversion of convertible subordinated notes                                 |       |                            | $          | — |   |   |   | $ | 529,180 |   |   |

 

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**NOTESTO CONDENSED CONSOLIDATED INTERIM FINANCIAL STATEMENTS**

**1.**   Basisof Presentation

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

The condensed consolidated financial statementsinclude our accounts and the accounts of our wholly-owned subsidiaries,including Sepracor Canada Limited. We also have an investment in 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, 2004, which are contained inour annual report on Form 10-K for the year ended December 31,2004, 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 November 2004, the Financial AccountingStandards Board, or FASB, issued Statement of Financial Accounting Standards,or SFAS, No. 151, “Inventory Costs—an amendment of ARB No. 43,Chapter 4,” or SFAS No. 151, in an effort to conform U.S. accountingstandards for inventories to International Accounting Standards. SFAS No. 151requires idle facility expenses, freight, handling costs and wasted material(spoilage) costs to be recognized as current-period charges. It alsorequires that the allocation of fixed production overhead costs to the costs ofconversion be based on the normal capacity of the relevant productionfacilities. SFAS No. 151 will be effective for inventory costs incurredduring fiscal years beginning after June 15, 2005. We do not expect theadoption of SFAS No. 151 to have a material impact on our financialcondition or our results of operations.

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

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

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

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

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

Basic earnings (loss) per share, or EPS, excludesdilution and is computed by dividing net income by the weighted-averagenumber of common shares outstanding for the period. Diluted EPS is based uponthe weighted average number of common shares outstanding during the period plusthe additional weighted average common equivalent shares during the period.Other potential common shares are not included in the per share calculationwhen the effect of their inclusion would be anti-dilutive. Other potentialcommon shares result from the assumed conversion of preferred stock,convertible subordinated debt and the assumed exercise of outstanding stockoptions, the proceeds of which are then assumed to have been used to repurchaseoutstanding stock options using the treasury stock method. Purchased calloptions are also not included in the per share calculations because includingthem would be anti-dilutive.

For the three and nine months ended September 30,2005 and 2004, basic and diluted net loss per common share is computed based onthe weighted-average number of common shares outstanding during theperiod because certain other potential common shares would have had ananti-dilutive effect due to net losses for these periods. These excludedsecurities include the following:

a.                 Options topurchase shares of common stock:

| ** **            | ** ** | **September 30, 2005**                                              | ** ** | **September 30, 2004** | ** ** |
|-----------------------|------------|-------------------------------------------------------------------------------|------------|----------------------------------|------------|
| ** **            | ** ** | **(in thousands, except price per share data)** | ** ** |
| Number of options     |       |                                                                          | 11,422     |                             |       |   | 12,274 |   |   |
| Price range per share |       |                                                                          | $          | 5.75 to $87.50                   |       |   |   | $ | 2.63 to $87.50 |   |   |
|                       |            |                                                                               |            |                                  |            |  |  |  |  |  |  |

 

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b.                Shares of commonstock reserved for issuance upon conversion of convertible subordinated debt:

| ** **                                                            | ** ** | **September 30,  2005** | ** ** | **September 30,  2004** | ** ** |
|-----------------------------------------------------------------------|------------|------------------------------|------------|------------------------------|------------|
| ** **                                                            | ** ** | **(in thousands)**      | ** ** |
| 5% convertible  subordinated debentures due 2007                 |       |                         | 4,763      |                         |       |   | 4,763 |   |   |
| 0% Series A  convertible senior subordinated notes due 2008 |       |                         | 2,283      |                         |       |   | 2,283 |   |   |
| 0% Series B  convertible senior subordinated notes due 2010 |       |                         | 4,961      |                         |       |   | 4,961 |   |   |
| Total                                                                 |       |                         | 12,007     |                         |       |   | 12,007 |   |   |

 

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

**4.**   Accountingfor Stock-Based Compensation

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

Thefollowing table illustrates the effect on net loss and loss per share if we hadapplied the fair value recognition provisions of SFAS No. 123 to stock-basedemployee compensation:

| ** **                                                                                                     | ** ** | **Three Months Ended**                                   | ** ** | **Nine Months Ended** | ** ** |
|----------------------------------------------------------------------------------------------------------------|------------|--------------------------------------------------------------------|------------|---------------------------------|------------|
| ** **                                                                                                     | ** ** | **September 30,  2005**                                       | ** ** | **September 30,  2004**    | ** ** | **September 30,  2005** | ** ** | **September 30,  2004** | ** ** |
| ** **                                                                                                     | ** ** | **(in thousands, except per share data)** | ** ** |
| Net loss  attributable to common stockholders                                                                  |       |                                                               | $          | (2,224                          | )          |   |   | $ | (130,363 | ) |   |   | $ | (32,196 | ) |   |   | $ | (261,933 | ) |   |
| Total stock-based  employee compensation expense determined under fair value based method for  all awards |       |                                                               | (11,326    | )                               |       |   | (12,537 | ) |   |   | (35,458 | ) |   |   | (35,332 | ) |   |
| Pro forma net  loss                                                                                            |       |                                                               | $          | (13,550                         | )          |   |   | $ | (142,900 | ) |   |   | $ | (67,654 | ) |   |   | $ | (297,265 | ) |   |
| Net loss per common share:                                                                                     |       |                                                               |       |                            |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Basic and  diluted—as reported                                                                            |       |                                                               | $          | (0.02                           | )          |   |   | $ | (1.40 | ) |   |   | $ | (0.31 | ) |   |   | $ | (2.97 | ) |   |
| Basic and diluted—pro  forma                                                                              |       |                                                               | $          | (0.13                           | )          |   |   | $ | (1.54 | ) |   |   | $ | (0.65 | ) |   |   | $ | (3.37 | ) |   |

 

**5.**   Inventories

Inventoriesconsist of the following:

| ** **       | ** ** | **September 30,  2005** | ** ** | **December 31,  2004** | ** ** |
|------------------|------------|------------------------------|------------|-----------------------------|------------|
| ** **       | ** ** | **(in thousands)**      | ** ** |
| Raw materials    |       |                         | $          | 11,790                      |       |   |   | $ | 3,905 |   |   |
| Work in progress |       |                         | —     |                        |       |   | 292 |   |   |
| Finished goods   |       |                         | 13,527     |                        |       |   | 8,889 |   |   |
| Total            |       |                         | $          | 25,317                      |       |   |   | $ | 13,086 |   |   |

 

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We expense costs relatingto inventory until such time as we receive an approval letter from the UnitedStates Food and Drug Administration, or FDA, for a new product, and then webegin to capitalize the inventory costs for subsequent purchases or productionrelating to that product. In March 2005, we received an approval letterfrom the FDA for XOPENEX HFATM (levalbuterol tartrate) Inhalation Aerosol, ahydrofluoralkane metered-dose inhaler, or MDI. As a result of this policy, wecapitalized $4,405,000 of XOPENEX HFA raw material and finished goods inventorypurchased and produced during the second and third quarters of 2005.

**6.**   Patentsand Deferred Financing Costs

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

| ** **                       | ** ** | **September 30,  2005** | ** ** | **December 31,  2004** | ** ** |
|----------------------------------|------------|------------------------------|------------|-----------------------------|------------|
| ** **                       | ** ** | **(in thousands)**      | ** ** |
| Deferred  financing costs, gross |       |                         | $          | 34,440                      |       |   |   | $ | 34,440 |   |   |
| Accumulated  amortization        |       |                         | (13,909    | )                           |       |   | (11,200 | ) |   |
| Deferred  financing costs, net   |       |                         | $          | 20,531                      |       |   |   | $ | 23,240 |   |   |
| Patents, gross                   |       |                         | $          | 5,807                       |       |   |   | $ | 6,439 |   |   |
| Accumulated  amortization        |       |                         | (2,807     | )                           |       |   | (2,644 | ) |   |
| Patents, net                     |       |                         | $          | 3,000                       |       |   |   | $ | 3,795 |   |   |

 

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

| ** **                                | ** ** | **Three Months Ended** | ** ** | **Nine Months Ended** | ** ** |
|-------------------------------------------|------------|----------------------------------|------------|---------------------------------|------------|
| ** **                                | ** ** | **September 30,  2005**     | ** ** | **September 30,  2004**    | ** ** | **September 30,  2005** | ** ** | **September 30,  2004** | ** ** |
| ** **                                | ** ** | **(in thousands)**          | ** ** |
| Amortization of  deferred financing costs |       |                             | $          | 903                             |       |   |   | $ | 1,222 |   |   |   | $ | 2,709 |   |   |   | $ | 3,928 |   |   |
| Amortization of  patents                  |       |                             | 136        |                            |       |   | 173 |   |   |   | 426 |   |   |   | 521 |   |   |
| Total                                     |       |                             | $          | 1,039                           |       |   |   | $ | 1,395 |   |   |   | $ | 3,135 |   |   |   | $ | 4,449 |   |   |

 

We currently estimate thatour amortization expense will be $1,039,000 for the fourth quarter of 2005 and$4,201,000, $2,564,000, $2,208,000 and $1,807,000 for the years ending December 31,2006, 2007, 2008 and 2009, respectively.

**7.**   ConvertibleSubordinated Debt

Convertiblesubordinated debt consists of the following:

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

 

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**8.**   Equity

In December 2003, we used approximately$94,820,000 of the proceeds from the issuance of 0% Series A convertiblesenior subordinated notes due 2008 and 0% Series B convertible seniorsubordinated notes due 2010 to purchase four series of call spread options onour common stock expiring at various dates between May 12, 2004 and December 9,2005. We received proceeds on the first three of these series of settledoptions of $50,006,000, $74,327,000 and $123,798,000, respectively, which wererecorded as an increase to additional paid-in capital. The fourth and onlyoutstanding call spread option series consists of 4,919,496 options expiring inequal installments on each business day from November 11, 2005 through December 9,2005 and we have the option to settle them in either net shares or in cash. Wecurrently intend to settle the fourth series of call spread options for sharesof our common stock in net share settlements.

Thefollowing table sets forth the potential net share settlement from ourremaining call spread options using the closing price of our common stock on November 7,2005 to estimate the average per share trading price:

| ** **                                            | ** ** | **(c)**    | ** ** | **(b)**                     | ** ** | ** **        | ** ** | **(a)**        | ** ** | **(((a-b) x c) / a)**       | ** ** |
|-------------------------------------------------------|------------|------------|------------|-----------------------------|------------|-------------------|------------|----------------|------------|-------------------------------------------------|------------|
| **Expiration period**                            | ** ** | ** ** | ** ** | **Number of  Options** | ** ** | **Option  Price** | ** ** | **Cap  Price** | ** ** | **Average per  share trading  price** | ** ** | **Net Share  Settlement** | ** ** |
| November 11,  2005 through December 9, 2005 |       | 4,919,496  |       | $                           | 29.84      |              | $          | 65.00          |       |                                            | $          | 56.71 |   |   |   | 2,330,927 |   |   |
|                                                       |            |            |            |                             |            |                   |            |                |            |                                                 |            |  |  |  |  |  |  |  |  |  |

 

The average per share trading price for a given dayduring the expiration period could be higher or lower than $56.71, which willaffect the actual net share settlement from our call spread options.

**9.**   ComprehensiveIncome (Loss)

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

| ** **                                                      | ** ** | **Three Months Ended** | ** ** | **Nine Months Ended** | ** ** |
|-----------------------------------------------------------------|------------|----------------------------------|------------|---------------------------------|------------|
| ** **                                                      | ** ** | **September 30,  2005**     | ** ** | **September 30,  2004**    | ** ** | **September 30,  2005** | ** ** | **September 30,  2004** | ** ** |
| ** **                                                      | ** ** | **(in thousands)**          | ** ** |
| Comprehensive income  (loss):                                   |       |                             |       |                            |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Net loss                                                        |       |                             | $          | (2,224                          | )          |   |   | $ | (130,363 | ) |   |   | $ | (32,196 | ) |   |   | $ | (261,933 | ) |   |
| Net foreign  currency translation adjustment                    |       |                             | 826        |                            |       |   | 574 |   |   |   | 558 |   |   |   | 1,399 |   |   |
| Unrealized gain  (loss) on available-for-sale securities        |       |                             | 4,164      |                            |       |   | 1,075 |   |   |   | 12,716 |   |   |   | (2,338 | ) |   |
| Reclassification  adjustment for (gains) included in net income |       |                             | (18,345    | )                               |       |   | — |   |   |   | (18,345 | ) |   |   | — |   |   |
| Total comprehensive loss                                        |       |                             | $          | (15,579                         | )          |   |   | $ | (128,714 | ) |   |   | $ | (37,267 | ) |   |   | $ | (262,872 | ) |   |

 

The reclassificationadjustment for (gains) included in net income for the three and nine monthsended September 30, 2005 is a result of a realized gain on the sale ofVicuron stock of approximately $18,345,000.

**10.**   Commitments andContingencies

We enter into standard indemnification agreements inour ordinary course of business, under which we indemnify and hold harmlesscertain parties, including customers such as wholesalers, against claims,liabilities and losses brought by third parties to the extent that the claimsarise out of (1) injury or death to person or property caused by defectsin our products, (2) negligence in manufacture or distribution of our 

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products or (3) amaterial breach by us. We have no liabilities recorded for these agreements at September 30,2005 and, if liabilities were incurred, we have insurance policies coveringproduct liabilities, which could mitigate any losses.

Pursuant to the terms of our restated certificate ofincorporation, we indemnify our officers and directors for certain events oroccurrences while the officer or director is, or was, serving at our request insuch capacity. The term of the indemnification period is for the officer’s ordirector’s lifetime. The maximum potential amount of future payments we couldbe required to make under these indemnification provisions is unlimited;however, we believe the fair value of these indemnification agreements isminimal.

We and several of ourcurrent and former officers and a current director are named as defendants inseveral class action complaints which have been filed on behalf of certainpersons who purchased our common stock and/or debt securities during differenttime periods, beginning on various dates, the earliest being May 17, 1999,and all ending on March 6, 2002. These complaints allege violations of theSecurities Exchange Act of 1934, as amended, and the rules and regulationspromulgated thereunder by the SEC. Primarily they allege that the defendantsmade certain materially false and misleading statements relating to thetesting, safety and likelihood of FDA approval of tecastemizole. On April 11,2003, two consolidated amended complaints were filed, one on behalf of thepurchasers of our equity securities and the other on behalf of the purchasersof our debt securities. These consolidated amended complaints reiterate theallegations contained in the previously filed complaints and define the allegedclass periods as May 17, 1999 through March 6, 2002. On September 8,2005, in both the debt purchasers’ action and the equity purchasers’ action,the district court granted the plantiff’s motion for class certification. Theparties are currently engaged in discovery. We are unable to reasonablyestimate any possible range of loss related to these lawsuits due to theiruncertain resolution. However, any conclusion of these matters in a manneradverse to us would have a material adverse effect on our financial conditionand business.

**11.**   Investments

On January 10, 2005, we entered into a license,option and collaboration agreement, or collaboration, with ACADIAPharmaceuticals Inc., or ACADIA, for the development of new drugcandidates targeted toward the treatment of central nervous system disorders.The collaboration has been established to investigate potential clinicalcandidates resulting from screening ACADIA’s medicinal chemistry compoundlibrary against a broad array of selective muscarinic receptors, which arereceptors that respond to acetylcholine, a neurotransmitter in the centralnervous system. The collaboration includes ACADIA’s m1 agonistprogram, which is designed to target neuropsychiatric/neurologic conditions andneuropathic pain. We have agreed to collaborate with each other to research anddevelop certain compounds that interact with these muscarinic receptors. We arepermitted to develop and commercialize these compounds in any field outside ofthe prevention or treatment of ocular disease. The agreement also includes anoption to select a preclinical program from ACADIA’s 5-HT2aprogram for use in combination with LUNESTA. Antagonists of the 5-HT2areceptor have been shown in clinical studies to affect sleep architecture inhumans. We will have exclusive worldwide rights to develop and commercializecompounds developed under our collaboration with ACADIA.

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

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In connection with the ACADIA collaboration, we purchased1,077,029 shares of ACADIA common stock for an aggregate purchase price of$10,000,000 based on a per share price of approximately $9.2848, whichrepresents a 40 percent premium to the average closing price for the 30trading days prior to the signing of the agreement. We recorded the premiumamount of $2,857,000 as research and development expense and the remainingamount of $7,143,000 as an investment in ACADIA, which we have classified as anavailable-for-sale security. We will adjust this investment to its fair valueat each reporting date with unrealized gains and losses recorded as a componentof accumulated other comprehensive income (loss). Subject to certainconditions, we also agreed to purchase up to an additional $10,000,000 ofACADIA common stock at a 25 percent premium to the trailing 30-dayaverage closing price per share as of the one-year anniversary of thesigning of the agreement.

On June 15, 2005, Vicuron Pharmaceuticals, Inc.entered into an agreement and plan of merger, or merger agreement, with Pfizer, Inc.Under the merger agreement, Pfizer agreed to purchase all outstanding shares ofVicuron for a purchase price of $29.10 per share in cash. On September 11,2005, Pfizer announced the closing of the merger. At the time of the closing,we owned 687,766 shares of Vicuron common stock, which we were carrying at fairmarket value with the corresponding unrealized gain recorded through equity. Uponclosing of the merger, this gain was recognized in other income. In exchangefor our shares of Vicuron, we received approximately $20,014,000 in cash fromPfizer, of which, approximately $18,345,000 was recorded as a gain on sale ofinvestment and is included in other income on the consolidated statements ofoperations.

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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 “Factors Affecting Future Operating Results” below for a discussion ofimportant factors that could cause our actual results to differ materially fromthe results we discuss in our forward-looking statements.

**Executive Overview**

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

We currently manufacture and sell two products:XOPENEX® (levalbuterol HCl) Inhalation Solution, a short-actingbronchodilator, for the treatment or prevention of bronchospasm in patientswith reversible obstructive airway disease, such as asthma; and LUNESTATM(eszopiclone), for the treatment of insomnia. On March 11, 2005, wereceived an approval letter from the United States Food and DrugAdministration, or FDA, for our New Drug Application, or NDA, for XOPENEX HFATM(levalbuterol tartrate) Inhalation Aerosol, a hydrofluoroalkane, metered-doseinhaler. Metered-dose inhalers, or MDIs, are hand-held, pressurized canistersthat deliver inhaled medications directly to the lungs. We expect tocommercially launch XOPENEX HFA in the fourth quarter of 2005.

We market and sell XOPENEXInhalation Solution and LUNESTA directly through our sales force and we expectto market and sell XOPENEX HFA, if commercialized, through our sales force. Wehave entered into out-licensing arrangements with respect to several other compounds.We expect to commercialize products that we successfully develop through oursales force, through co-promotion agreements and through out-licensingpartnerships.

**Significant 2005 Developments**

On September 7, 2005, we announced that the FDAreceived an abbreviated new drug application, or ANDA, from Breath Limitedseeking marketing approval for generic copies of our 1.25mg, 0.63mg and 0.31mgXOPENEX Inhalation Solution unit dose vial products. XOPENEX InhalationSolution Concentrate is not subject to the ANDA. Breath Limited’s submissionincludes a Paragraph IV certification alleging that our patents listed in theOrange Book for XOPENEX Inhalation Solution are invalid, unenforceable or notinfringed by Breath Limited’s proposed product. On October 21, 2005, wefiled a civil action against Breath Limited for patent infringement. Should wesuccessfully enforce our patents, the FDA will not approve the ANDA untilexpiration of the applicable patents. Otherwise, the FDA will stay its approvalof the ANDA until March 7, 2008 or until a court decides that our patentsare invalid, unenforceable or not infringed, whichever is earlier.

During the second quarter of 2005, pursuant to callspread option agreements we entered into in December 2003, we settled4,919,496 call spread options for cash in the amount of $123,798,000. The 

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settled options expired atvarious dates beginning on May 12, 2005 and ending on June 9, 2005.We recorded the full amount of the call spread option settlement as an increaseto additional paid-in capital. Our remainingoutstanding call spread options expire at various dates beginning November 11,2005 and ending on December 9, 2005, and we have the option to settle themin either net shares or in cash. We currently expect to settle these callspread options for net shares, although the number of shares we receive uponsettlement, if any, will vary based on the price of our common stock on theoption expiration dates.

On April 4, 2005, we commercially launchedLUNESTA brand eszopiclone for the treatment of insomnia, following approvalfrom the FDA on December 15, 2004 of our NDA for LUNESTA 1 mg, 2 mgand 3 mg tablets. The recommended dosing to improve sleep onset and/ormaintenance is 2 mg or 3 mg for adult patients (ages 18 to 64). In olderadult patients (ages 65 and older), 2 mg is recommended for improvement insleep onset and/or maintenance while the 1 mg dose is recommended for sleeponset in older adult patients whose primary complaint is difficulty fallingasleep.

On March 11, 2005, we received approval from theFDA for XOPENEX HFA. On May 12, 2004, we submitted our NDA to the FDA forXOPENEX HFA for the treatment or prevention of bronchospasm in adults,adolescents and children 4 years of age and older with reversible obstructiveairway disease. We have resolved previously outstanding manufacturing issuesand have completed process validation work. We are targeting commercial launchof XOPENEX HFA by the end of 2005. We capitalized $4,405,000 of XOPENEX HFA rawmaterial inventory purchased and produced from the date of FDA approval to September 30,2005. Under our supply agreement with Minnesota Mining and Manufacture Company,or 3M, and 3M Innovative Properties Company, we are obligated to pay to 3M acombination of a fixed price per unit of product purchased and a percentageroyalty based on our net sales of XOPENEX HFA.

On January 10, 2005, we entered into a license,option and collaboration agreement, or collaboration, with ACADIAPharmaceuticals Inc., or ACADIA, for development of new drug candidatestargeted toward the treatment of central nervous system disorders. Thecollaboration has been established to investigate potential clinical candidatesresulting from screening ACADIA’s medicinal chemistry compound library againsta broad array of selective muscarinic receptors, which are receptors thatrespond to acetylcholine, a neurotransmitter in the central nervous system. Thecollaboration includes ACADIA’s m1 agonist program, which isdesigned to target neuropsychiatric/neurologic conditions and neuropathic pain.We have agreed to collaborate with each other to research and develop certaincompounds that interact with these muscarinic receptors. We are permitted todevelop and commercialize these compounds in any field outside of theprevention or treatment of ocular disease. The agreement also includes anoption to select a preclinical program from ACADIA’s 5-HT2aprogram for use in combination with LUNESTA. Antagonists of the 5-HT2areceptor have been shown in clinical studies to affect sleep architecture inhumans. We will have exclusive worldwide rights to develop and commercializecompounds developed under our collaboration with ACADIA.

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

In connection with thecollaboration, we purchased 1,077,029 shares of ACADIA common stock for anaggregate purchase price of $10,000,000 based on a per share price ofapproximately $9.2848, which represents a 40 percent premium to theaverage closing price for the 30 trading days prior to the signing of theagreement. We recorded the premium amount of $2,857,000 as research anddevelopment expense and the remaining amount of $7,143,000 as an investment inACADIA, which we have classified as an 

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available-for-salesecurity and will adjust to its fair value at each reporting date withunrealized gains and losses recorded as a component of accumulated othercomprehensive income (loss). Subject to certain conditions, we also agreed topurchase up to an additional $10,000,000 of ACADIA common stock at a25 percent premium to the trailing 30-day average closing price pershare in January 2006.

**Critical Accounting Policies**

We identified criticalaccounting policies in our annual report on Form 10-K for the yearended December 31, 2004. These critical accounting policies relate toproduct revenue recognition, royalty revenue recognition, rebate and returnreserves, patents, intangibles and other assets, accounts receivable and baddebt, income taxes, induced conversion of debt and inventory write-downs.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. No changes to these critical accountingpolicies have taken place since December 31, 2004.

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

*Revenues*

Product sales were $193,357,000 and $60,122,000 forthe three months ended September 30, 2005 and 2004, respectively, anincrease of approximately 222%. This increase is primarily a result of thecommercial introduction of LUNESTA brand eszopiclone in April 2005 and asignificant increase in XOPENEX Inhalation Solution revenue.

Sales of LUNESTA were $100,892,000 for the threemonths ended September 30, 2005 as compared to $0 for the same period in2004. The sales of LUNESTA for the three months ended September 30, 2005as compared to the three months ended June 30, 2005 increasedapproximately 21%. This increase is primarily due to an increase in the netselling price per unit as a result of launch discounts offered in only thesecond quarter in addition to an increase in units sold of approximately 5%.

Sales of XOPENEX Inhalation Solution were $92,466,000as compared to $60,122,000 for the same period in 2004, an increase ofapproximately 54%. The sales increase for XOPENEX Inhalation Solution for thethree months ended September 30, 2005 as compared with the same period in2004 is due to a 34% increase in the number of units sold and a 15% increase inthe net selling price per unit. The 34% increase in unit sales is a result ofincreased market growth and higher market shares, particularly in the hospitaland home health care market sectors. The 15% increase in the net selling priceper unit is due to a gross unit price increase of approximately 8% and adecrease in sales rebates and allowances as a percentage of sales. The decreasein sales rebates and allowances is primarily attributable to favorablereimbursement rate changes, as mandated by the Medicare Prescription DrugImprovement and Modernization Act of 2003, in the home health care marketsector. Favorable Medicare reimbursement has resulted in a decrease in therebates we pay to home health care providers. We cannot be certain whether, orfor how long, this favorable reimbursement rate will remain in effect.

Royalties and otherrevenue were $12,363,000 and $19,959,000 for the three months ended September 30,2005 and 2004, respectively, a decrease of approximately 38%. The decrease isprimarily due to the termination of our MedPointe agreement related to ourco-promotion of ASTELIN® on October 1, 2004. We recorded $5,051,000 ofother revenue related to our MedPointe agreement in the three months ended September 30,2004 and none in the same period in 2005. Royalties earned on sales of CLARINEX®,under our agreement with Schering-Plough Corporation, decreased to $2,300,000 from$5,105,000 for the three months ended September 30, 2005 versus the sameperiod in 2004. This was partially offset by an increase in royalties earnedfrom sales of XYZAL®/XUSALTM, under our agreement with UCB Farchim SA.

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Pursuant to the terms ofour U.S. agreement with sanofi-aventis, we expect our royalties on the sale ofALLEGRA in the United States, which have historically been $15 to $20 millionper year, will terminate based on the introduction of a generic equivalent ofthis product in September 2005. We are still entitled to receive royaltieson the sale of ALLEGRA outside of the United States in countries where we holdpatents covering ALLEGRA.

*Costs of Revenues*

Cost of products sold was $15,491,000 and $7,021,000for the three months ended September 30, 2005 and 2004, respectively.

Cost of LUNESTA sold as a percentage of LUNESTA saleswas approximately 7%, with the largest portion being the royalty paid on netsales of LUNESTA to a third party. In accordance with our accounting policies,we did not begin to capitalize product manufacturing costs associated withLUNESTA as inventory until the FDA approved the LUNESTA NDA. Therefore, weexpect costs of LUNESTA sold as a percentage of LUNESTA sales to increase afterwe have sold all of our product for which we have not capitalized manufacturingcosts. We expect this to occur around the beginning of 2006.

Cost of XOPENEX Inhalation Solution sold as apercentage of XOPENEX Inhalation Solution sales was flat at approximately 11%for the three months ended September 30, 2005 and for the same periodin 2004.

Cost of royalties earnedwas $224,000 and $285,000 for the three months ended September 30, 2005and 2004, respectively. The cost of royalties in both periods relates to anobligation to a third-party as a result of royalties we earn fromSchering-Plough Corporation based upon its sales of CLARINEX. Thisdecrease in third-party obligations is due to the decrease in royalties earnedin the three months ended September 30, 2005 as compared with the sameperiod in 2004.

*Research andDevelopment*

Research and development expenses were $38,372,000 and$38,744,000 for the three months ended September 30, 2005 and 2004,respectively, a decrease of approximately 1%. The decrease is primarily due toour decreased spending on two of our late-stage programs, LUNESTA andarformoterol. We commercially launched LUNESTA on April 4, 2005, however,we continue to spend on Phase IIIB/IV studies under our LUNESTA program. Wehave completed Phase III clinical trials for arformoterol, targeted as amaintenance treatment for chronic obstructive pulmonary disease, or COPD, andwe are currently preparing an NDA that we anticipate submitting to the FDA bythe end of 2005. Our decreased spending in these programs was partially offsetby our increased spending on two of our early-stage programs, SEP-226330,targeted for the treatment of restless legs syndrome, and SEP-225289,targeted for the treatment of depression. A preliminary analysis of data from aPhase II study of SEP-226330 for the treatment of restless legs syndromecompleted in the third quarter of 2005, suggested that the compound did notmeet our efficacy criteria for clinical advancement for this indication. Wecontinue to evaluate the data as we conduct preclinical evaluations of SEP-226330as a potential novel mechanistic approach for the treatment of other centralnervous system disorders, such as Parkinson’s disease.

Drug development andapproval in the United States is a multi-step process regulated by the FDA. Theprocess begins with the filing of an Investigational New Drug Application, orIND, which, if successful, allows the opportunity for study in humans, orclinical study, of the potential new drug. Clinical development typicallyinvolves three phases of study: Phase I, II and III. The most significantcosts in clinical development are in the Phase III clinical trials, as theytend to be the longest and largest studies in the drug development process.Following successful completion of Phase III clinical trials, an NDA must besubmitted to, and accepted by, the FDA, and the FDA must approve the NDA priorto commercialization of the drug. As further discussed above, we currently haveone product candidate, 

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arformoterol,in NDA preparation stage. 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 expenditure of substantial resources. Any failure by us toobtain, or delay in obtaining, regulatory approvals could materially adverselyaffect our business. We cannot assure you that we will obtain any approvalrequired by the FDA on a timely basis, if at all.

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

Belowis a summary of development of our product and product candidates thatrepresent 10% or more of our direct project research and development spendingfor the three months ended September 30, 2005. The “Estimate of Completionof Stage” column contains forward-looking statements regarding expectedtiming of completion of product development phases. Completion of productdevelopment, if successful, culminates in the submission of an NDA to the FDA.The actual timing of completion of phases could differ materially from theestimates provided in the table. The table is sorted by highest to lowestspending amounts, and the three product candidates listed accounted forapproximately 58% of our direct project research and development spending forthe three months ended September 30, 2005. No other product candidateaccounted for more than 8% of our direct research and development spending in this period.

| **Product Candidate** | ** ** | ** **              | ** ** | **Indication**          | ** ** | **Stage of Development** | ** ** | **Estimate of  Completion of  Stage** | ** ** |
|----------------------------|------------|-------------------------|------------|-------------------------|------------|------------------------------------|------------|-------------------------------------------------|------------|
| XOPENEX HFA                |       | Respiratory—Asthma |       | NDA Approved            |       |                               | *          |                                            |       |
| LUNESTA                    |       | Insomnia                |       | NDA Approved / Launched |       |                               | N/A        |                                            |       |
| Arformoterol               |       | Respiratory—COPD   |       | NDA Preparation         |       |                               | 2005       |                                            |       |

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*                    TheFDA approved XOPENEX HFA on March 11, 2005. We are targeting commerciallaunch of the product by the end of 2005.

Belowis a summary of expenditure information related to our product candidatesrepresenting 10% or more of our direct project research and developmentspending during the three months ended September 30, 2005, and 2004, 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 or other costs which benefit multiple projects. As a result, fullyloaded research and development cost summaries by project are not presented.

| ** **   | ** ** | **Project costs for  the three  months ended  September 30, 2005** | ** ** | **Project costs to  date through  September 30,  2005** | ** ** | **Project costs for  the three  months ended  September 30, 2004** | ** ** | **Project costs to  date through  September 30,  2004** | ** ** |
|--------------|------------|--------------------------------------------------------------------------------------------------|------------|-----------------------------------------------------------------------------|------------|--------------------------------------------------------------------------------------------------|------------|-----------------------------------------------------------------------------|------------|
| ** **   | ** ** | **(in thousands)**                                                                          | ** ** |
| XOPENEX HFA  |       |                                                                                             | $          | 5,506                                                                       |       |                                                                                             |       | $                                                                           | 151,498    |   |   |   | $ | 3,385 |   |   |   | $ | 126,599 |   |   |
| LUNESTA      |       |                                                                                             | $          | 4,826                                                                       |       |                                                                                             |       | $                                                                           | 194,541    |   |   |   | $ | 15,331 |   |   |   | $ | 170,711 |   |   |
| Arformoterol |       |                                                                                             | $          | 3,976                                                                       |       |                                                                                             |       | $                                                                           | 155,932    |   |   |   | $ | 4,710 |   |   |   | $ | 139,531 |   |   |

 

Due to the length of timenecessary to develop a product, uncertainties related to the ability to obtaingovernmental approval for commercialization and difficulty in estimating costsof projects, it is difficult to make accurate and meaningful estimates of theultimate cost to bring our product candidates to FDA approved status. We do notbelieve it is possible to estimate, with any degree of accuracy, the costs ofproduct candidates that are in stages earlier than Phase III. We estimate thatthe cost range to bring arformoterol from its current state to an NDAsubmission is $3,000,000 to $5,000,000 based on a targeted NDA submission bythe end of 2005, provided that no significant delays are imposed by internalresource constraints or unanticipated FDA requirements.

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*Selling, Marketing and Distribution*

Selling, marketing anddistribution expenses were $162,696,000 and $82,843,000 for the three monthsended September 30, 2005 and 2004, respectively, an increase ofapproximately 96%. Of this increase, approximately 63% is due to an increase inmarketing, advertising and promotion costs in support of the commercial launchof LUNESTA, which took place in April 2005. Additionally, we incurredincreased sales commission expense for internal sales representatives as aresult of the 54% increase in XOPENEX Inhalation Solution product sales for thethree months ended September 30, 2005 as compared with the same period in2004 and the commercial launch of LUNESTA. Partially offsetting these increaseswas a decrease in sales commission expense paid to the Ross Products Divisionof Abbott Laboratories, or Ross, for the co-promotion of XOPENEX InhalationSolution, since we terminated our co-promotion agreement with Ross effective December 31,2004. Additionally, the increases are partially offset by decreases in travelexpenses from the same period in 2004 which were related to hiring and trainingour increased sales force.

We expect selling,marketing and distribution expenses to continue to increase in connection withincreased sales of LUNESTA and in anticipation of commercial launch of XOPENEXHFA, including an increase of sales professionals and sales management ofapproximately 193 employees which was completed in October 2005,commencement of additional marketing programs and an increase in salescommissions and distribution costs.

*General and Administrative*

General and administrativecosts were $10,871,000 and $7,465,000 for the three months ended September 30,2005 and 2004, respectively, an increase of approximately 46%. The increase isprimarily due to increased legal fees related to two class action complaintspending against us. We are currently investigating possible reimbursement of aportion of these legal fees from certain of our insurance providers. Theincrease is also due to increased payroll and related expenses resulting froman increase in permanent and temporary employees and contracted serviceproviders hired to support the commercialization of LUNESTA.

*Other Income (Expense)*

Interest income was$7,776,000 and $2,039,000 for the three months ended September 30, 2005and 2004, respectively, an increase of approximately 281%. The increase is dueto higher average balances of cash and short- and long-term investmentscombined with an increase in the interest rates earned on investments in 2005.Our monthly average cash and investment balance was approximately $945,104,000and $589,302,000 for the three months ended September 30, 2005 and 2004,respectively. For the three months ended September 30, 2005 and 2004 theaverage annualized interest rate that we earned on our investments was 3.29%and 1.38%, respectively.

Interest expense was$5,847,000 and $5,846,000 for the three months ended September 30, 2005and 2004, respectively. The expense in both periods is primarily related to theinterest we paid on our 5% convertible subordinated debentures.

Gain on sale of equityinvestment was $18,345,000 and $0 for the three months ended September 30,2005 and 2004, respectively. This gain represents the gain we recorded when wereceived cash in exchange for our shares of Vicuron Pharmaceuticals inconnection with the merger of Pfizer and Vicuron in September 2005.

Loss on conversion of debtwas $0 and $69,768,000 for the three months ended September 30, 2005 and2004, respectively. During September 2004, we converted $177,200,000 ofour 0% Series A notes due 2008 and $351,980,000 of our 0% Series Bnotes due 2010 into 17,354,000 shares of common stock. The loss represents thecash payments of $23,868,250 and $45,899,900 that we paid to the holders of the0% Series A notes due 2008 and 0% Series B notes due 2010,respectively, as an inducement to convert their notes.

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Equity in investee(losses) were ($241,000) and ($508,000) for the three months ended September 30,2005 and 2004, respectively, a decrease of approximately 53%. The lossrepresents our portion of BioSphere losses.

**NineMonth Periods ended September 30, 2005 and 2004**

*Revenues*

Product sales were$466,748,000 and $202,628,000 for the nine months ended September 30, 2005and 2004, respectively, an increase of approximately 130%, primarily as aresult of the commercial introduction of LUNESTA in April 2005 and asignificant increase in XOPENEX revenue.

Sales of LUNESTA were$184,351,000 for the nine months ended September 30, 2005 as compared to$0 for the same period in 2004.

Sales of XOPENEXInhalation Solution were $282,398,000 as compared to $202,628,000 for the sameperiod in 2004, an increase of 39%. The sales increase for XOPENEX InhalationSolution for the nine months ended September 30, 2005 as compared with thesame period in 2004 is due to a 24% increase in the number of units sold and a13% increase in the net selling price per unit. The 24% increase in unit salesis a result of increased market growth and higher market shares, particularlyin the hospital and home health care market sector. The 13% increase in the netselling price per unit is due to a gross unit price increase of approximately7% and a decrease in sales rebates and allowances. The decrease in salesrebates and allowances is primarily attributable to favorable reimbursementrate changes, as mandated by the Medicare Prescription Drug Improvement andModernization Act of 2003, in the home health care sector of our business.Favorable Medicare reimbursement has resulted in a decrease in the rebates wepay to home health care providers. We cannot be certain whether, or for howlong, this favorable reimbursement rate will remain in effect.

Royalties and otherrevenue were $43,081,000 and $46,898,000 for the nine months ended September 30,2005 and 2004, respectively, a decrease of approximately 8%. The decrease forthe nine months ended September 30, 2005 as compared with the same periodin 2004 is primarily due to a decrease in other revenue earned from MedPointerelated to our promotion of ASTELIN, which were $0 for the nine months ended September 30,2005 compared to $8,946,000 for the nine months ended September 30, 2004and a $1,680,000 decrease in royalties earned on sales of CLARINEX, under ouragreement with Schering-Plough Corporation. We terminated our agreement withMedPointe in October 2004. These decreases were partially offset by increasesin royalties earned on sales of ALLEGRA under our agreement withsanofi-aventis, which were $31,669,000 for the nine months ended September 30,2005 as compared with $25,894,000 for the nine months ended September 30,2004, with the majority of the increase occurring in Japan and by an increasein royalties earned on sales of XYZAL/XUSAL, under our agreement with UCBFarchim SA.

Pursuant to the terms ofthe U.S. agreement with sanofi-aventis, we expect our royalties on the sale ofALLEGRA in the United States, which have historically been $15 to $20 millionper year, will terminate based upon the introduction of a generic equivalent ofthis product in September 2005. We are still entitled to receive royaltieson the sale of ALLEGRA outside of the United States in countries where we holdpatents covering ALLEGRA.

*Costs of Revenues*

Cost of products sold was$39,981,000 and $22,702,000 for the nine months ended September 30, 2005and 2004, respectively.

Cost of LUNESTA sold as apercentage of LUNESTA sales was approximately 7%, with the largest portionbeing the royalty paid on net sales of LUNESTA to a third party. In accordancewith our accounting policies, we did not begin to capitalize productmanufacturing costs associated with LUNESTA 

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asinventory until the FDA approved the LUNESTA NDA Therefore, we expect costs ofLUNESTA sold as a percentage of LUNESTA sales to increase after we have soldall of our product for which we have not capitalized manufacturing costs. Weexpect this to occur around the beginning of 2006.

Cost of XOPENEX Inhalation Solution sold as apercentage of XOPENEX Inhalation Solution sales was approximately 10% for thenine months ended September 30, 2005 as compared to 11% for the sameperiod in 2004. This decrease was due to a lower manufacturing cost per unitwhich resulted from an increase in the number of units of XOPENEX InhalationSolution produced.

Cost of royalties earnedwas $629,000 and $634,000 for the nine months ended September 30, 2005 and2004, respectively, a decrease of approximately 1%. The cost of royalties inboth periods relates to an obligation to a third-party as a result ofroyalties we earn from Schering-Plough Corporation based upon its salesof CLARINEX. This decrease in third-party obligations is due to the decrease inroyalties earned in the nine months ended September 30, 2005 as comparedwith the same period in 2004.

*Research andDevelopment*

Research and development expenses were $104,073,000and $121,117,000 for the nine months ended September 30, 2005 and 2004,respectively, a decrease of approximately 14%. The decrease in the nine monthsended September 30, 2005 as compared with the same period in 2004 isprimarily due to our decreased spending on two of our late-stage programs,LUNESTA and arformoterol. We commercially launched LUNESTA on April 4,2005. However, we continue to spend on Phase IIIB/IV studies under our LUNESTAprogram. We have completed Phase III clinical trials for arformoterol, targetedas a maintenance treatment for chronic obstructive pulmonary disease, or COPD,and we are currently preparing an NDA that we anticipate submitting to the FDAby the end of 2005. Our decreased spending in these programs was partiallyoffset by our increased spending on two of our early-stage programs, SEP-226330,targeted for the treatment of restless legs syndrome, and SEP-225289,targeted for the treatment of depression. A preliminary analysis of data from aPhase II study of SEP-226330 for the treatment of restless legs syndromecompleted in the third quarter of 2005, suggested that the compound did notmeet our efficacy criteria for clinical advancement for this indication. Wecontinue to evaluate the data as we conduct preclinical evaluations of SEP-226330as a potential novel mechanistic approach for the treatment of other centralnervous system disorders, such as Parkinson’s disease.

Belowis a summary of development of our products and product candidates thatrepresent 10% or more of our direct project research and development spendingfor the nine months ended September 30, 2005 and 2004. The “Estimate ofCompletion of Stage” column contains forward-looking statements regardingexpected timing of completion of product development phases. Completion ofproduct development, if successful, culminates in the submission of an NDA tothe FDA. The actual timing of completion of phases could differ materially fromthe estimates provided in the table. The table is sorted by highest to lowestspending amounts, and the three product candidates listed accounted forapproximately 65% of our direct project research and development spending forthe nine months ended September 30, 2005. No other product candidateaccounted for more than 6% of our direct research and development spending inthis period.

| **Product Candidate** | ** ** | ** **              | ** ** | **Indication**          | ** ** | **Stage of Development** | ** ** | **Estimate of  Completion of  Stage** | ** ** |
|----------------------------|------------|-------------------------|------------|-------------------------|------------|------------------------------------|------------|-------------------------------------------------|------------|
| XOPENEX HFA                |       | Respiratory—Asthma |       | NDA Approved            |       |                               | *          |                                            |       |
| Arformoterol               |       | Respiratory—COPD   |       | NDA Preparation         |       |                               | 2005       |                                            |       |
| LUNESTA                    |       | Insomnia                |       | NDA Approved / Launched |       |                               | N/A        |                                            |       |

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*                    The FDAapproved XOPENEX HFA on March 11, 2005. We are targeting commercial launchof the product by the end of 2005.

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Belowis a summary of expenditure information related to our product candidatesrepresenting 10% or more of our direct project research and developmentspending during the nine months ended September 30, 2005, as well as thecosts incurred to date on these projects. The costs in this analysis includeonly direct costs and do not include certain indirect labor, overhead or othercosts which benefit multiple projects. As a result, fully loaded research anddevelopment cost summaries by project are not presented.

| ** **   | ** ** | **Project costs for  the nine  months ended  September 30, 2005** | ** ** | **Project costs to  date through  September 30, 2005** | ** ** | **Project costs for  the nine  months ended  September 30, 2004** | ** ** | **Project costs to  date through  September 30, 2004** | ** ** |
|--------------|------------|-------------------------------------------------------------------------------------------------|------------|---------------------------------------------------------------------------------|------------|-------------------------------------------------------------------------------------------------|------------|---------------------------------------------------------------------------------|------------|
| ** **   | ** ** | **(in thousands)**                                                                              | ** ** |
| XOPENEX HFA  |       |                                                                                            | $18,801    | ** **                                                                      |       |                                                                                            | $151,498   | ** **                                                                      |       |   | $15,836 | ** ** |   |   | $126,599 | ** ** |   |
| Arformoterol |       |                                                                                            | $12,413    | ** **                                                                      |       |                                                                                            | $155,932   | ** **                                                                      |       |   | $21,407 | ** ** |   |   | $139,531 | ** ** |   |
| LUNESTA      |       |                                                                                            | $10,978    | ** **                                                                      |       |                                                                                            | $194,541   | ** **                                                                      |       |   | $34,981 | ** ** |   |   | $170,711 | ** ** |   |

 

*Selling, Marketingand Distribution*

Selling, marketing and distribution expenses were$386,016,000 and $253,632,000 for the nine months ended September 30, 2005and 2004, respectively, an increase of approximately 52%. Included in the ninemonths ended September 30, 2004 is an expense of $30,671,000, whichrepresented the then-present value of termination payments totaling $33,000,000that we are required to make to the Ross Products Division of AbbottLaboratories, or Ross. Approximately 61% of the increase, excluding the currentvalue of the Ross termination payments, is due to an increase in marketing andpromotion expenses in support of the commercial launch of LUNESTA, which tookplace in April 2005. Additionally, 28% of the increase is a result ofincreased salary, commission and benefit costs as a result of havingapproximately 800 more sales representatives whom we hired in the secondquarter of 2004. We also incurred increased sales commission expense for internalsales representatives as a result of the 39% increase in XOPENEX InhalationSolution product sales for the nine months ended September 30, 2005 ascompared with the same period in 2004 and the commercial launch of LUNESTA.Offsetting these increases was a decrease in sales commission expense paid toRoss for the co-promotion of XOPENEX Inhalation Solution, as a result oftermination of our co-promotion agreement with Ross effective December 31,2004 and decreases in travel expenses from the same period in 2004, which wererelated to hiring and training our increased sales force.

We expect selling,marketing and distribution expenses to continue to increase in connection withincreased sales of LUNESTA and in anticipation of commercial launch of XOPENEXHFA, including an increase of sales professionals and sales management ofapproximately 193 employees which was completed in October 2005,commencement of additional marketing programs and an increase in salescommissions and distribution costs.

*General andAdministrative*

General and administrativecosts were $29,200,000 and $22,398,000 for the nine months ended September 30,2005 and 2004, respectively, an increase of approximately 30%. The increase isprimarily due to increased legal fees related to two class action complaintspending against us. We are currently investigating possible reimbursement of aportion of these legal fees from certain of our insurance providers. Theincrease is also due to increased payroll and related expenses resulting froman increase in permanent and temporary employees and contracted serviceproviders hired to support the commercialization of LUNESTA.

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*Other Income(Expense)*

Interest income was$18,446,000 and $4,718,000 for the nine months ended September 30, 2005and 2004, respectively, an increase of approximately 291%. The increase is dueprimarily to higher average balances of cash and short- and long-terminvestments combined with an increase in the interest rates earned oninvestments in 2005. Our monthly average cash and investment balance wasapproximately $860,497,000 and $549,222,000 for the nine months ended September 30,2005 and 2004, respectively. For the nine months ended September 30, 2005and 2004 the average annualized interest rate that we earned on our investmentswas 2.86% and 1.15%, respectively.

Interest expense was $17,528,000 and $17,800,000 forthe nine months ended September 30, 2005 and 2004, respectively, adecrease of approximately 2%. The decrease is due primarily to not incurringinterest expense during the nine months ended September 30, 2005 on our5.75% convertible subordinated notes, which we redeemed on January 9,2004.

Loss on debt redemption was $0 and $7,022,000 for thenine months ended September 30, 2005 and 2004, respectively. The loss inthe nine months ended September 30, 2004 resulted from our redemption ofthe remaining outstanding $430,000,000 face value of our 5.75% convertiblesubordinated notes due 2006 for aggregate cash consideration of $430,000,000,excluding accrued interest. The loss represents the write-off of $7,022,000 ofdeferred financing costs related to the notes.

Gain on sale of equity investment was $18,345,000 and$0 for the nine months ended September 30, 2005 and 2004, respectively. Thisgain represents the gain we recorded when we received cash in exchange for ourshares of Vicuron Pharmaceuticals in connection with the merger of Pfizer andVicuron in September 2005.

Loss on conversion of debt was $0 and $69,768,000 forthe nine months ended September 30, 2005 and 2004, respectively. During September 2004,we converted $177,200,000 of our 0% Series A notes due 2008 and $351,980,000of our 0% Series B notes due 2010, respectively. The loss represents thecash payments of $23,868,250 and $45,899,900 that we paid to the holders of the0% Series A notes due 2008 and 0% Series B notes due 2010,respectively, as an inducement to convert their notes.

Equity in investee(losses) were ($709,000) and ($1,013,000) for the nine months ended September 30,2005 and 2004, respectively, a decrease of approximately 30%. The lossrepresents our portion of BioSphere losses.

**Liquidity and Capital Resources**

Cash, cash equivalents and short-and long-terminvestments totaled $942,498,000 at September 30, 2005, compared to$833,912,000 at December 31, 2004.

Net cash used in operating activities for the ninemonths ended September 30, 2005 was $50,754,000. Net cash used inoperating activities includes a net loss of $32,196,000 adjusted by a non-cashbenefit of $5,726,000, which consists primarily of a gain on sale of an equityinvestment and depreciation and amortization expense. Accounts receivable increasedby $34,252,000 due primarily to LUNESTA sales. Inventory increased by$12,231,000 due primarily to capitalization of LUNESTA and XOPENEX HFAinventory as well as higher XOPENEX Inhalation Solution inventory balances inorder to meet additional demand. Accounts payable increased by $24,090,000primarily due to timing of vendor payments. Accrued expenses decreased by$7,910,000 primarily due to a decrease in research and development relatedaccruals, which are the result of decreased research and developmentexpenditures, partially offset by an increase in accrued commissions based onincreased sales. Other current liabilities increased by $20,249,000 primarilydue to an increase in accruals for product revenue rebates related to XOPENEXInhalation Solution and LUNESTA product sales.

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Net cash used in investing activities for the ninemonths ended September 30, 2005 was $357,908,000. Cash used in netpurchases of short-and long-term investments was $342,173,000. We madepurchases of property and equipment of $9,524,000. We also used $7,143,000 topurchase 1,077,029 shares of ACADIA common stock in connection with ourcollaboration agreement with ACADIA.

Net cash provided by financing activities for the ninemonths ended September 30, 2005 was $154,002,000. We received proceeds of$31,796,000 from issuing common stock upon the exercise of stock options issuedunder our stock option plans and $123,798,000 from settlement of call spreadoptions. We also used $1,592,000 to repay capital lease obligations and long-termdebt.

We believe ourexisting cash and the anticipated cash flow from product sales and our currentstrategic alliances will be sufficient to support existing operations through2007. Our actual future cash requirements and our ability to generate revenue,however, will depend on many factors, including:

·       XOPENEXInhalation Solution and LUNESTA sales;

·       successfulcommercialization of XOPENEX HFA, for which we received approval from the FDAon March 11, 2005;

·       approvalof our late-stage product candidates;

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

·       achievementof milestones under our strategic alliance arrangements;

·       acquisitions;

·       theterms of any additional strategic alliances and licensing arrangements we mayenter; and

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

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

Based on our currentoperating plan, we believe that we will not be required to raise additionalcapital to fund the repayment of our outstanding convertible debt when due. Ifrevenue generated from sales of XOPENEX Inhalation Solution and LUNESTA do notmeet expected levels, it is likely that we would be required to raise additionalfunds in order to repay our outstanding convertible debt. There can be noassurance that, if required, we would be able to raise the additional funds onfavorable terms, if at all.

**Off-Balance Sheet Arrangements**

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

**Contractual Obligations**

Contractual obligations represent future cashcommitments and liabilities under agreements with third parties and excludecontingent liabilities for which we cannot reasonably predict future payment.As of September 30, 2005, our contractual obligations disclosure in ourannual report on Form 10-K for the year ended December 31, 2004 has notmaterially changed since we filed that report, with the exception of ourpurchase obligations which, in total for the next five years, increased byapproximately $188,989,000. The increase primarily represents the increase inobligations associated with our LUNESTA product launch in April 2005 aswell as our anticipated launch of XOPENEX HFA, expected by the end of 2005. 

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Thesepurchase obligations relate to open purchase orders for the acquisition ofgoods and services in the ordinary course of business. Our obligation to paycertain of these amounts may be reduced or eliminated based on certain futureevents.

**FactorsAffecting Future Operating Results**

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

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

We have not beenprofitable since inception, and it is possible that we will not achieveprofitability. We incurred net losses on a consolidated basis of approximately$2.2 and $32.2 million for the three and nine months ended September 30,2005, respectively, and $295.7 million for the year ended December 31, 2004.We expect to continue to incur significant operating expenditures. As a result,we will need to generate significant revenues to achieve and maintainprofitability. We cannot assure you that we will achieve significant revenuesor that we will ever achieve profitability. Even if we do achieveprofitability, we cannot assure you that we will be able to sustain or increaseprofitability on a quarterly or annual basis in the future. If revenues growmore slowly than we anticipate or if operating expenses exceed our expectationsor cannot be adjusted accordingly, our business, results of operations andfinancial condition will be materially and adversely affected.

**Salesof XOPENEX Inhalation Solution and LUNESTA represent substantially all of ourrevenues; if sales of XOPENEX Inhalation Solution and LUNESTA do not continueto increase and we are unable to successfully commercialize other products, wemay not have sufficient revenues to achieve our business plan and our businesswill not be successful.**

All of our revenues from product sales for the threemonths ended September 30, 2005 resulted from sales of XOPENEX InhalationSolution and LUNESTA. In April 2005, we commercially launched LUNESTA as anew product in a competitive market and we cannot be certain that it willachieve continued commercial success. In addition, we do not have long-termsales contracts with our customers, and we rely on purchase orders for sales ofXOPENEX Inhalation Solution and LUNESTA. Reductions, delays or cancellations oforders for XOPENEX Inhalation Solution or LUNESTA could adversely affect ouroperating results. If sales of XOPENEX Inhalation Solution and LUNESTA do notcontinue to increase, we may not have sufficient revenues to achieve ourbusiness plan or repay our outstanding debt, and our business will not besuccessful. On March 11, 2005, the FDA approved our NDA for XOPENEX HFA.We expect to commercialize XOPENEX HFA before the end of 2005. If we are unableto commercialize XOPENEX HFA successfully, our revenues from XOPENEX InhalationSolution and LUNESTA sales may not be sufficient for us to achieve our businessplan and our business and financial position may be materially adverselyaffected.

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In the respiratory market,we compete primarily against generic albuterol. XOPENEX Inhalation Solution ismore expensive than generic albuterol. We must continue to demonstrate tophysicians and other healthcare professionals that the benefits of XOPENEXInhalation Solution justify the higher price. In the sleep disorder market, weface intense competition from established products, such as AMBIEN® andSONATA®. We also face competition from the newly approved sleep agents ROZEREMTMand AMBIEN CRTM. There are also other potentially competitive therapies that arein late-stage clinical development for the treatment of insomnia. If XOPENEXInhalation Solution and LUNESTA do not continue to compete successfully againstcompetitive products, our business will be materially adversely affected.

**If wefail to successfully develop our principal product candidates, we will beunable to commercialize the product candidates and our business may beadversely affected.**

Our ability to achieve and maintain profitability willdepend in large part on successful development and commercialization of ourprincipal products under development. If we fail to successfully develop andcommercialize any of our products under development, our business may bematerially adversely affected. Before we commercialize any product candidate,we will need to successfully develop the product candidate by completingsuccessful clinical trials, submit an NDA for the product candidate that isaccepted by the FDA and receive FDA approval to market the candidate. If wefail to successfully develop a product candidate and/or the FDA delays ordenies approval of any submitted NDA or any NDA that we 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. Weexpect to submit an NDA for arformoterol for the treatment of COPD by the endof 2005, although we cannot be assured this product candidate will be acceptedfor filing by the FDA or approved by the FDA on a timely basis, or at all.

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

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

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

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

·       wemay not receive regulatory approval for our product candidates;

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

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

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Our success depends on ourcontinued ability to develop and market new products. We expect to submit anNDA for arformoterol by the end of 2005. Our other current product candidatesunder development are in earlier stages of development. We cannot assure youthat we will be able to develop and introduce new products in a timely manneror that new products, if developed, will be approved for the indications,and/or with the labeling, we expect or that they will achieve marketacceptance. In addition, our growth is dependent on our continued ability topenetrate new markets where we have limited experience and competition isintense. We cannot assure you that the markets we serve will grow in thefuture, that our existing and new products will meet the requirements of thesemarkets, that our products will achieve customer acceptance in these markets,that competitors will not force prices to an unacceptably low level or takemarket share from us, or that we can achieve or maintain profits in thesemarkets.

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

We have entered into acollaboration agreement with 3M for the scale-up and manufacturing of XOPENEXHFA and we may enter into additional collaboration agreements in the future.Under our agreement with 3M, 3M is responsible for manufacturing an MDIformulation of XOPENEX. On March 11, 2005, the FDA approved our NDA forXOPENEX HFA. We are targeting commercial launch of the product by the end of2005. If 3M, or any future development or commercialization collaborator, doesnot devote sufficient time and resources to its collaboration arrangement withus, breaches or terminates its agreement with us, fails to perform itsobligation to us in a timely manner or is unsuccessful in its developmentand/or commercialization efforts, we may not realize the potential commercialbenefits of the arrangement and our results of operations may be adverselyaffected. In addition, if regulatory approval or commercialization of anyproduct candidate under development by or in collaboration with a partner isdelayed or limited, we may not realize, or may be delayed in realizing, thepotential commercial benefits of the arrangement.

**We may be unable tocommercialize products for which we receive approval from the FDA.**

Commercialization of a product for which we havereceived an approval letter from the FDA could be delayed for a number ofreasons, some of which are outside of our control, including delays in deliveryof the product due to importation regulations and/or problems with ourdistribution channels or delays in the issuance of approvals from, or the completionof required procedures by, agencies other than the FDA, such as the UnitedStates Drug Enforcement Administration. In addition, commercialization of FDA-approvedproducts may be delayed by our failure to timely finalize distribution ormanufacturing arrangements, produce sufficient inventory and/or properlyprepare our sales force. If we are unable to commercialize a product promptlyafter receipt 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 will prevent genericpharmaceutical companies from introducing a generic copy of the product, beginsto run upon FDA approval and, therefore, to the extent we are unable tocommercialize a product promptly after receipt of an approval letter, ourlong-term product sales and revenues could be adversely affected.

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

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On March 11, 2005,the FDA approved our NDA for XOPENEX HFA. However there were previouslyunresolved manufacturing and process validation issues that prevented us fromlaunching promptly after approval. We have since resolved the previouslyoutstanding manufacturing issues and completed the process validation work. Weare targeting commercial launch of the product by the end of 2005. Any furtherdelays in the commercialization of XOPENEX HFA, or any other product for whichwe may receive approval from the FDA in the future, may materially adverselyaffect our reputation, financial position and results of operations.

**Theroyalties we receive under licensing arrangements could be delayed, reduced orterminated if our licensing partners terminate, or fail to perform theirobligations under, their agreements with us, or if our licensing partners areunsuccessful 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 holdpatents, we may not realize the potential commercial benefits of the arrangement,our revenues under these arrangements may be less than anticipated and ourresults of operations may be adversely affected. If any of our licensingpartners was to breach or terminate its agreement with us or fail to performits obligations to us in a timely manner, the royalties we receive under thelicensing agreement could decrease or cease. If we are unable or fail toperform, or breach in our performance of, our obligations under a licensingagreement, the royalties and benefits to which we are otherwise entitled underthe agreement could be reduced or eliminated. Any delay or termination of thistype could have a material adverse effect on our financial condition andresults of operations because we may lose technology rights and milestone orroyalty payments from licensing partners and/or revenues from product sales, ifany, could be delayed, reduced or terminated.

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

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

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

Wedevelop and commercialize proprietary products for primary care and specialtymarkets. Most of our drug candidates are still undergoing clinical trials orare in early stages of development. Our drugs may not provide greater benefitsor fewer side effects than other drugs used to treat the same condition and ourresearch efforts may not lead to discovery of new drugs or development of newtherapies. All of our drugs under development will require significant additionalresearch, development, preclinical and/or clinical testing, regulatory approvaland a commitment of significant additional resources prior to theircommercialization. Our potential products may not:

·  be developed successfully;

·  be proven safe and efficacious in clinicaltrials;

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·  offer therapeutic or other improvements overcomparable drugs;

·  meet applicable regulatory standards;

·  be approved for commercialization by the FDA;

·  be capable of being produced in commercialquantities at acceptable costs; or

·  besuccessfully marketed.

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

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

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

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

Some states have adopted preferred drug lists, orPDLs, for their Medicaid programs. More states may adopt this practice. If ourdrugs are not included on Medicaid PDLs, use of our drugs in the Medicaid 

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program may be adverselyaffected. In some states that have adopted PDLs, we have been, and may continueto be, required to provide substantial supplemental rebates to state Medicaidauthorities in order for our drugs to be included on the PDL.

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.

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

Our success depends inpart on our ability to obtain, maintain and enforce patents, and protect tradesecrets. Our ability to commercialize any drug successfully will largely dependupon our ability to obtain and maintain patents of sufficient scope to preventthird parties from developing substantially equivalent products. In the absenceof patent and trade secret protection, competitors may adversely affect ourbusiness by independently developing and marketing substantially equivalentproducts. It is also possible that we could incur substantial costs if we arerequired to initiate litigation against others to protect or enforce our intellectualproperty rights.

We have filed patentapplications covering composition of, methods of making and methods of usingour drugs and drug candidates. Our revenues under collaboration agreements withpharmaceutical companies depend in part on the existence and scope of issuedpatents. We may not be issued patents based on patent applications alreadyfiled or that we file in the future and if patents are issued, they may beinsufficient in scope to cover the products licensed under these collaborationagreements. Generally, we do not receive royalty revenue from sales of productslicensed under collaboration agreements in countries where we do not have apatent for such products. The issuance of a patent in one country does notensure the issuance of a patent in any other country. Furthermore, the patentposition of companies in the pharmaceutical industry generally involves complexlegal and factual questions, and has been and remains the subject of muchlitigation. Legal standards relating to scope and validity of patent claims areevolving. Any patents we have obtained, or obtain in the future, may bechallenged, invalidated or circumvented. Moreover, the United States Patent andTrademark Office may commence interference proceedings involving our patents orpatent applications. Any challenge to, or invalidation or circumvention of, ourpatents or patent applications would be costly, would require significant timeand attention of our management and could have a material adverse effect on ourbusiness.

On September 7, 2005,we announced that the FDA received an abbreviated new drug application, or ANDAfrom Breath Limited seeking marketing approval for generic copies of our 1.25 mg,0.63 mg and 0.31 mg XOPENEX brand levalbuterol HCl InhalationSolution unit dose vial products. XOPENEX Inhalation Solution Concentrate isnot subject to the ANDA. Breath Limited’s submission includes a Paragraph IVcertification alleging that our patents listed in the Orange Book for XOPENEXInhalation Solution are invalid, unenforceable or not infringed by BreathLimited’s proposed product. On October 21, 2005, we filed a civil actionagainst Breath Limited for patent infringement. Should we successfully enforceour patents, the FDA will not approve the ANDA until expiration of theapplicable patents. Otherwise, the FDA will stay its approval of the ANDA untilMarch 7, 2008 or until a court decides that our patents are invalid,unenforceable or not infringed, whichever is earlier. Patent litigationinvolves complex legal and factual questions. We can provide no assuranceconcerning the outcome or the duration of the lawsuit. Any conclusion of thesematters in a manner adverse to us would have a material adverse effect on ourfinancial condition and business. If we are not successful in enforcing ourpatents, we will not be able to prevent the generic company, for the full termof our patents, from marketing their generic version of XOPENEX InhalationSolution. Introduction of a generic copy of XOPENEX Inhalation Solution beforethe expiration of our patents would have a material adverse effect on ourbusiness. In addition, the costs to 

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us ofconducting this proceeding, even if resolved in our favor, could be substantial.Such litigation could also substantially divert the attention of our managementand our resources in general. Uncertainties resulting from the initiation andcontinuation of any litigation or other proceedings could harm our ability tocompete in the marketplace.

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

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

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

The FDA and similar foreign agencies must approve forcommercialization any pharmaceutical products developed by us or ourdevelopment partners. These agencies impose substantial requirements 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, couldprevent or adversely affect the timing of commercial introduction of, or ourability to market and sell, our products.

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

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

·  results of clinical trials may not beconsistent with preclinical study results;

·  results from later phases of clinical trialsmay not be consistent with results from earlier phases; and

·  products may not be shown to be safe andefficacious.

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 

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withdrawalof regulatory approvals, product recalls, seizure of products, operatingrestrictions and criminal prosecution.

**Developmentand commercialization of our product candidates could be delayed or terminatedif we are unable to enter into collaboration agreements in the future or if anyfuture collaboration agreement is 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:

·  we may be required to expend additional fundsto advance the drugs to commercialization;

·       revenuefrom product sales could be delayed; or

·       wemay elect not to commercialize the drugs.

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

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

We have limited marketing and sales experience. If wesuccessfully develop and obtain regulatory approval for the products we aredeveloping, we may (1) market and sell them through our sales force,(2) license some of them to large pharmaceutical companies or(3) market and sell them through other arrangements, includingco-promotion arrangements. We have established a sales force to market XOPENEXInhalation Solution, LUNESTA and XOPENEX HFA. We have incurred significantexpense in expanding our sales force and expect to incur additional expense aswe further expand. With respect to products under development, we may incursignificant costs in expanding our sales force before the products have beenapproved for marketing. For example, we expanded our sales force in 2004 inanticipation of marketing and selling LUNESTA and in 2005 in anticipation ofmarketing and selling XOPENEX HFA. In addition, if we enter into co-promotionarrangements or market and sell additional products directly, we may need tosignificantly expand our sales force.

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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 sales personnel,we will not be able to successfully expand our marketing and direct sales forceon a timely or cost effective basis. We may also need to enter into additionalco-promotion arrangements with third parties, for example where our own directsales force is not large enough or sufficiently well aligned to achieve maximumpenetration in the market. We may not be successful in entering into anyco-promotion arrangements, and the terms of any co-promotion arrangements maynot be favorable to us.

**If weor our third-party manufacturers do not comply with current Good ManufacturingPractices, regulations, then the FDA could refuse to approve marketingapplications or force us to recall or withdraw our products.**

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

On October 22, 2004,we commenced notifying drug wholesalers, hospitals and pharmacies of amanufacturer-initiated voluntary Class III recall of one componentof our XOPENEX Inhalation Solution product line, XOPENEX Inhalation SolutionConcentrate (1.25mg/0.5mL), which we introduced in August 2004. Therecall, which affects only XOPENEX Inhalation Solution Concentrate and no othercomponents of our XOPENEX Inhalation Solution product line, was necessitated bypackaging process validation issues relating to the automated process ofplacing finished vials into a foil pouch. We have suspended manufacture andsale of XOPENEX Inhalation Solution Concentrate until the issues giving rise tothe recall have been fully addressed. We do not expect to re-introduceXOPENEX Inhalation Solution Concentrate before the second quarter of 2006. Ifour manufacturer cannot remedy the GMP deficiencies giving rise to the recallof XOPENEX Inhalation Solution Concentrate, or if these or similar deficienciesare found to extend to other components or our XOPENEX Inhalation Solutionproduct line, our ability to supply product to the market may be limited orinterrupted indefinitely, which would have a material adverse effect on ourbusiness.

**Werely on third-party manufacturers, and this reliance could adverselyaffect our ability to meet our customers’ demands.**

We currentlyoperate a manufacturing plant that we believe can meet our commercialrequirements of the active pharmaceutical ingredient for XOPENEX InhalationSolution, partially fulfill our commercial requirements of the activepharmaceutical ingredient for LUNESTA, and support production of our productcandidates in amounts needed for our clinical trials. We do not, however, havethe capability to manufacture all of our requirements for the activeingredients of our currently-approved products, and we have no facilities formanufacturing pharmaceutical dosage forms or finished drug products. Developingand obtaining this capability would be time consuming and expensive. Unless anduntil we develop this capability, we will rely substantially, and in somecases, entirely, on third-party manufacturers.  Cardinal Health, Inc. is currently thesole finished goods manufacturer of our XOPENEX Inhalation Solution,Patheon Inc. is the sole manufacturer of LUNESTA brand eszopiclone and 3Mwill be the sole manufacturer and supplier of XOPENEX HFA. Certain componentsof XOPENEX HFA are available from only a single source. If Cardinal Health,Patheon, 3M, or any of our sole-source component suppliers experiences delaysor difficulties in producing, packaging or delivering XOPENEX InhalationSolution, LUNESTA, or XOPENEX HFA, as the case may be, we could be unable tomeet our customers’ demands 

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forsuch products, 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,LUNESTA or XOPENEX HFA could negatively affect our ability to produce suchproducts in a timely manner or within budget.

3M owns certainproprietary technology required to manufacture our XOPENEX HFA. If 3M is unableor unwilling to fulfill its obligations to us under our agreement, we may beunable to manufacture XOPENEX HFA on terms that are acceptable to us, if at all.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.

**Wecould be exposed to significant liability claims that could prevent orinterfere with our product commercialization efforts.**

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

**Wewill spend considerable time and money complying with Federal and state lawsand regulations and, if we are unable to fully comply with such laws andregulations, we could face substantial penalties.**

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

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

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

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

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

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

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

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

·       stateand foreign law equivalents of the foregoing;

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

·       statelaws that prohibit practice of medicine by non-physicians and fee-splittingarrangements between physicians and non-physicians, as well as state lawequivalents to the Federal Medicare and 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 additionalregulation or incur significant expense. Any penalties, damages, fines,curtailment or restructuring of our operations would adversely affect ourability to operate our business and our financial results. The risk of ourbeing found in violation of these laws is increased by the fact that many ofthem have not been fully interpreted by the regulatory authorities or thecourts, and their provisions are open to a variety of interpretations, andadditional legal or regulatory change. Any action against us for violation ofthese laws, even if we successfully defend against it, could cause us to incursignificant legal expenses, divert our management’s attention from operatingour business and damage our reputation.

**Ifour Medicaid rebate program practices are investigated, the costs could besubstantial and could 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 pay a rebate for each unitof our product reimbursed by Medicaid. The amount of the rebate for eachproduct is set by law. We are also required to pay certain statutorily definedrebates on Medicaid purchases for reimbursement on prescription drugs understate Medicaid plans. Both the Federal government and state governments haveinitiated investigations into the rebate practices of many pharmaceuticalcompanies to ensure compliance with these rebate programs. Any investigation ofour rebate practices could be costly, could divert the attention of ourmanagement and could damage our reputation.

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

As of September 30, 2005, our total long-termdebt excluding the current portion was approximately $1.2 billion and ourstockholders’ equity (deficit) was ($212.8) million. None of our 5% debenturesdue 2007, our 0% Series A notes due 2008, our 0% Series B notes due2010 nor our 0% notes due 2024 restricts our or our subsidiaries’ ability toincur additional indebtedness, including debt that ranks senior to the notes.The 0% notes due 2024 are senior to the Series A notes due 2008 and Series Bnotes due 2010, which are senior to the 5% debentures due 2007. Additionalindebtedness that we incur may in certain circumstances rank senior to or onparity with this debt. Our ability to satisfy our obligations will depend 

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upon our futureperformance, which is subject to many factors, including factors beyond ourcontrol. The conversion prices for the 5% debentures due 2007, 0% Series Anotes due 2008 and 0% Series B notes due 2010 are $92.38, $31.89 and$29.84, respectively. On October 31, 2005, the closing sale price of ourcommon stock was $56.25. If the market price for our common stock does notexceed the conversion price, the holders of our outstanding convertible debtmay not convert their securities into common stock. Our 0% notes due 2024 areconvertible into cash and, if applicable, shares of our common stock at aconversion price of approximately $67.20, at the option of the holders undercertain circumstances. We may not be able to make the required cash paymentsupon conversion of the 0% notes due 2024.

Historically, we have hadnegative cash flow from operations. For the nine months ended September 30,2005, net cash used in operating activities was approximately $50.8 million.Our annual debt service through 2006, assuming no additional interest-bearingdebt is incurred and no additional 5% debentures due 2007 are converted,redeemed, repurchased or exchanged, is approximately $22.0 million. Unlesswe are able to generate sufficient operating cash flow to service ouroutstanding debt, we will be required to raise additional funds or default onour obligations under the debentures and notes. If revenue generated from salesof XOPENEX Inhalation Solution and LUNESTA do not meet expected levels, it islikely that we would be required to raise additional funds in order to repayour outstanding convertible debt and/or make cash payments upon conversion ofthe 0% notes due 2024. There can be no assurance that, if required, we would beable to raise the additional funds on favorable terms, if at all.

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

As of September 30,2005, we had approximately $1.2 billion of outstanding convertible debt.In order to reduce future cash interest payments, as well as future paymentsdue at maturity, we may, from time to time, depending on market conditions,repurchase additional outstanding convertible debt for cash; exchange debt forshares of our common stock, warrants, preferred stock, debt or otherconsideration; or a combination of any of the foregoing. If we exchange sharesof our capital stock, or securities convertible into or exercisable for ourcapital stock, for outstanding convertible debt or use proceeds from theissuance of convertible debt to fund redemption of outstanding convertible debtwith a higher conversion ratio, the number of shares that we might issue as aresult of such exchanges would significantly exceed the number of sharesoriginally issuable upon conversion of such debt and, accordingly, suchexchanges would result in material dilution to holders of our common stock. Wecannot assure you that we will repurchase or exchange any additionaloutstanding convertible debt.

**Ifthe estimates we make, or the assumptions on which we rely, in preparing ourfinancial statements prove inaccurate, our actual results may vary from thesereflected 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, revenues and expenses, the amounts of charges accrued by us andrelated disclosure of contingent assets and liabilities. We base our estimateson historical experience and on various other assumptions that we believe to bereasonable under the circumstances. We cannot assure you, however, that ourestimates, or the assumptions underlying them, will be correct. For example,our royalty revenue is recognized based upon our estimates of our collaborationpartners’ sales during the period and, if these sales estimates are greaterthan the actual sales that occur during the period, our net income would bereduced. This, in turn, could adversely affect our stock price.

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

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

·       patentdevelopments;

·       licensingor acquisition opportunities;

·       relationshipswith collaboration partners;

·       theFDA regulatory process;

·       litigation;

·       ourcapital requirements; and

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

**Weexpect to face intense competition and our competitors have greater resourcesand capabilities than we have.**

Developments by others may render our products ortechnologies obsolete or noncompetitive. We expect to encounter intensecompetition in the sale of our current and future products. If we are unable tocompete effectively, our financial condition and results of operations could bematerially adversely affected because we may use our financial resources toseek to differentiate ourselves from our competition and because we may notachieve our product revenue objectives. Many of our competitors and potentialcompetitors, which include pharmaceutical companies, biotechnology firms,universities and other research institutions, have substantially greaterresources, manufacturing and marketing capabilities, research and developmentstaff and production facilities than we have. The fields in which we competeare subject to rapid and substantial technological change. Our competitors maybe able to respond more quickly to new or emerging technologies or to devotegreater resources to the development, manufacture and marketing of new productsand/or technologies than we can. As a result, any products and/or technologiesthat we develop may become obsolete or noncompetitive before we can recoverexpenses incurred in connection with their development.

In the respiratory market,we compete primarily against generic albuterol. XOPENEX Inhalation Solution andgeneric albuterol account for the majority of beta-agonist inhalation solutionprescriptions. Albuterol has been marketed for many years, is well establishedand sells at prices substantially lower than XOPENEX Inhalation Solution. Tocontinue successfully marketing XOPENEX Inhalation Solution, we must continueto demonstrate that the efficacy and safety features of the drug outweigh itshigher cost. In the sleep disorder market, we face intense competition fromestablished products, such as AMBIEN and SONATA. We also face competition fromthe newly approved sleep agents ROZEREM and AMBIEN CR. There are also otherpotentially competitive therapies that are in late-stage clinical developmentfor the treatment of insomnia.

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

We and several of our current and former officers anda current director are named as defendants in several class action complaintswhich have been filed on behalf of certain persons who purchased our commonstock and/or debt securities during different time periods, beginning onvarious dates, the earliest being May 17, 1999, and all ending on March 6,2002. These complaints allege violations of the Exchange Act and the rules andregulations promulgated thereunder by the SEC. Primarily they allege that thedefendants made certain materially false and misleading statements relating tothe testing, safety and likelihood of FDA approval of tecastemizole. On April 11,2003, two consolidated amended complaints were filed, one on behalf of thepurchasers of our equity securities and the other on behalf the purchasers ofour debt securities. These consolidated amended complaints reiterate theallegations contained in the previously filed complaints and define the allegedclass periods as May 17, 1999 through March 6, 2002. On September 8,2005, in both the debt purchasers’ action and the equity purchasers’ action,the district court granted the plaintiff’s motion for class certification. Theparties are currently engaged in discovery.

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

**Fluctuationsin the demand for products, the success and timing of collaborationarrangements and regulatory approval, any termination of development efforts,expenses and the results of operations of our subsidiaries will causefluctuations in our quarterly operating results, which could cause volatilityin our stock price.**

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

·       timing of product sales andmarket penetration;

·       timing of operatingexpenses, including selling and marketing expenses and the costs of expandingand maintaining a direct sales force;

·       success and timing ofregulatory filings and approvals for products developed by us or our licensingpartners or for collaborative agreements;

·       timing of product launch;

·  introduction of competitive products into themarket;

·       results of clinical trialswith respect to products under development;

·       success and timing ofcollaboration agreements for development of our pharmaceutical candidates anddevelopment costs for those pharmaceuticals;

·       timing of receipt ofupfront, milestone or royalty payments under collaboration agreements;

·       termination of developmentefforts of any product under development or any collaboration agreement; and

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

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

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

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

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

·       non-cumulativevoting for directors;

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

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

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

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

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

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

The market price of ourcommon stock, like that of the common stock of many other pharmaceutical andbiotechnology companies, may be highly volatile. In addition, the stock markethas experienced extreme price and volume fluctuations. This volatility hassignificantly affected the market prices of securities of many pharmaceuticaland biotechnology companies for reasons frequently unrelated to or disproportionateto the operating performance of the specific companies. These broad marketfluctuations may adversely affect the market price of our common stock. Pricesfor our common stock will be determined in the market place 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.

**Ourdiluted earnings per share may decrease in the future because we are nowrequired to include the shares issuable upon conversion of our 0% notes due2024 in our diluted earnings per share calculation.**

Because of our adoption ofa recent accounting pronouncement, we are required to include in our dilutedearnings per share calculation shares that are contingently issuable uponconversion of a debt instrument, regardless of whether or not the contingencyfor issuance has been met. This recent accounting pronouncement superseded a priorpronouncement that allowed such contingently issuable shares to be excludedfrom the diluted earnings per share calculation. Our 0% notes due 2024, unlikeour other series of convertible debt, are convertible into common stock only ifcertain conditions are met and, therefore, we had not previously included theshares issuable upon conversion of such notes in our diluted earnings per sharecalculation. The inclusion of such contingently convertible shares in ourdiluted earnings per share 

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calculationhas had no effect on our current or prior period diluted earnings per share.However, the inclusion of shares contingently issuable upon conversion of our0% notes due 2024, may reduce our diluted earnings per share in future periods.

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

**Market Risk**

We are exposed to marketrisk from changes in interest rates and equity prices, which could affect ourfuture results of operations and financial condition. These risks are describedin our annual report on Form 10-K for the year ended December 31,2004. As of November 8, 2005, there have been no material changes to themarket risks described in our annual report on Form 10-K for theyear ended December 31, 2004. Additionally, we do not anticipate anynear-term changes in the nature of our market risk exposures or in ourmanagement’s objectives and strategies with respect to managing such exposures.

**ITEM 4.**                CONTROLSAND PROCEDURES

**Disclosure Controls and Procedures**

Our management, with theparticipation of our chief executive officer and chief financial officer,evaluated the effectiveness of our disclosure controls and procedures as of September 30,2005. The term “disclosure controls and procedures,” as defined in Rules 13a-15(e) and15d-15(e) under the Exchange Act, means controls and otherprocedures of a company that are designed to ensure that information requiredto be disclosed by a company in the reports that it files or submits under theExchange Act is recorded, processed, summarized and reported, within the timeperiods specified in the SEC’s rules and forms. Disclosure controls andprocedures include, without limitation, controls and procedures designed toensure that information required to be disclosed by a company in the reportsthat it files or submits under the Exchange Act is accumulated and communicatedto the company’s management, including its principal executive and principalfinancial officers, as appropriate to allow timely decisions regarding requireddisclosure. Our management recognizes that any controls and procedures, nomatter how well designed and operated, can provide only reasonable assurance ofachieving their objectives and our management necessarily applies its judgmentin evaluating the cost-benefit relationship of possible controls andprocedures. Based on the evaluation of our disclosure controls and proceduresas of September 30, 2005, our chief executive officer and chief financialofficer concluded that, as of such date, our disclosure controls and procedureswere effective at the reasonable assurance level.

**Changesin 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 September 30, 2005 that hasmaterially affected, or is reasonably likely to materially affect, our internalcontrol over financial reporting.

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**PART II**

**OTHER INFORMATION**

**ITEM 1.**                LEGALPROCEEDINGS

On September 7, 2005, we announced that the FDAreceived an abbreviated new drug application, or ANDA, from Breath Limitedseeking marketing approval for generic copies of our 1.25 mg, 0.63 mgand 0.31 mg XOPENEX brand levalbuterol HCl Inhalation Solution unit dosevial products. XOPENEX Inhalation Solution Concentrate is not subject to theANDA Breath Limited’s submission includes a Paragraph IV certification allegingthat our patents listed in the Orange Book for XOPENEX Inhalation Solution areinvalid, unenforceable or not infringed by Breath Limited’s proposed product. OnOctober 21, 2005, we filed a civil action against Breath Limited forpatent infringement. Should we successfully enforce our patents, the FDA willnot approve the ANDA until expiration of the applicable patents. Otherwise, theFDA will stay it’s approval of the ANDA until March 7, 2008 or until acourt decides that our patents are invalid, unenforceable or not infringed,whichever is earlier. Patent litigation involves complex legal and factualquestions. We can provide no assurance concerning the outcome or the durationof the lawsuit. If we are not successful in enforcing our patents, we will notbe able to exclude the generic company, for the full term of our patents, frommarketing their generic version of XOPENEX Inhalation Solution. Introduction ofa generic copy of XOPENEX Inhalation Solution before the expiration of ourpatents could have a material adverse effect on our business.

We and several of ourcurrent and former officers and a current director are named as defendants inseveral class action complaints which have been filed on behalf of certainpersons who purchased our common stock and/or debt securities during differenttime periods, beginning on various dates, the earliest being May 17, 1999,and all ending on March 6, 2002. These complaints allege violations of theSecurities Exchange Act of 1934, as amended, and the rules and regulationspromulgated thereunder by the SEC. Primarily they allege that the defendantsmade certain materially false and misleading statements relating to thetesting, safety and likelihood of FDA approval of tecastemizole. On April 11,2003, two consolidated amended complaints were filed, one on behalf of thepurchasers of our equity securities and the other on behalf of the purchasersof our debt securities. These consolidated amended complaints reiterate theallegations contained in the previously filed complaints and define the allegedclass periods as May 17, 1999 through March 6, 2002. On September 8,2005, in both the debt purchasers’ action and the equity purchasers’ action,the district court granted the plantiff’s motion for class certification. Theparties are currently engaged in discovery. We are unable to reasonablyestimate any possible range of loss related to these lawsuits due to theiruncertain resolution. However, any conclusion of these matters in a manneradverse to us would have a material adverse effect on our financial conditionand business.

**ITEMS 2-5.   NONE**

**ITEM 6.**                EXHIBITS
| 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: November 8,  2005 | By:               | /s/  TIMOTHY J. BARBERICH |
|                         | * *          | Timothy J.  Barberich*Chairman and Chief Executive Officer  (Principal Executive Officer)* |
| Date: November 8,  2005 | By:               | /s/  ROBERT F. SCUMACI |
|                         | * *          | Robert F. Scumaci*Executive Vice President, Finance and  Administration, and Treasurer  (Principal Accounting Officer)* |

 

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