**SECURITIES AND EXCHANGE COMMISSION**

**Washington,D.C. 20549**

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**FORM 10-Q/A**

**AMENDMENT NO.  1**

**(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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**EXPLANATORY NOTE**

**Restatement of ConsolidatedFinancial Statements**

We are filing thisAmendment No. 1 to our Quarterly Report on Form 10-Q for thethree and nine months ended September 30, 2005, which we refer to as the September 30, 2005 Form 10-Q, originally filed on November 8, 2005, torestate our consolidated balance sheets as of September 30, 2005, ourconsolidated statements of operations and comprehensive income (loss) for thethree and nine months ended September 30, 2005 and 2004, and our consolidatedstatements of cash flows for the nine months ended September 30, 2005 and2004. Please refer to Note 12 to the accompanying condensed consolidated financial statements for additionalinformation.

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

Based on these reviews, wehave determined that the measurement dates for certain stock option grants toemployees, officers and directors during prior periods differed from therecorded dates for such awards primarily due to the following circumstances:(i) stock option grants which specified effective dates that may havepreceded the dates of receipt of all necessary signatures or approvals,finalization of lists specifying stock option grants or an employee’s firstdate of employment; and (ii) stock option awards that were approved withexercise prices lower than fair market value on the effective date of grant. Inaddition, we have determined that (a) the modification of certain stockoption grants in connection with an employee’s termination of employment and(b) the exercise of certain stock options that had not vested prior to anemployee’s termination resultedin a new measurement date for such stock options.  As a result, we are required to record non-cash adjustments for additional stock-based compensation expense in accordance with APB No 25, “Accounting for Stock Issued to Employees” for the three and nine months endedSeptember 30, 2005. Thesenon-cash charges had no impact on previously reported revenues, cash or cashequivalents or total assets.

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

On August 9, 2006, ouraudit committeeconcluded that our consolidated financial statements referred to above shouldbe restated to record the additional non-cashstock-based compensation expense items that had been incorrectly accounted for under generally acceptedaccounting principles, or GAAP. As wehave previously announced, the consolidated financial statements and relatedfinancial information contained in such previously filed reports should nolonger be relied upon. We have not modified or updated disclosures presented inthe September 30, 2005 Form 10-Q in this Form 10-Q/A, exceptas required to reflect the effects of the items discussed above. Accordingly,this Form 10-Q/A does not reflect events occurring after the filingof the September 30, 2005 Form 10-Q or modify or update those disclosuresaffected by subsequent events or discoveries. Therefore, thisForm 10-Q/A should be read in conjunction with the filings we have madewith the SEC subsequent to the filing of the September 30, 2005Form 10-Q, including our amended filings.

We have acceptedservice of three stockholder derivativecomplaints relating to certain of our stock option grants that were filed in the Superior Court, Middlesex County,Commonwealth of Massachusetts, naming Sepracor as nominal defendant and alsonaming as defendants certain current members of our board of directors andcertain of our current and former employees. The complaints allege purportedbreaches of fiduciary duties and unjust enrichment in connection with certainstock option grants made by 

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us between June 1998 and May 2001. Thecomplaints seek monetary damages in unspecified amounts, equitable andinjunctive relief, including disgorgement of profits obtained by certaindefendants and other relief as determined by the Court. On August 30, 2006, the parties in all threeactions moved to consolidate the actions and to transfer them to the BusinessLitigation Session of the Superior Court, Suffolk County.

For the convenience of the reader, this Form 10-Q/Arestates the September 30, 2005 Form 10-Q in its entirety. However, we have onlyamended disclosures presented in the September 30, 2005 Form 10-Q as required to reflect the matters described above and, accordingly, have amendedonly the following items:

·  Part I—Item 1—Financial Information

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

·  Part I—Item 4—Controls andProcedures

·  Part II—Item 1—Legal Proceedings

·  Part II—Item 6—Exhibits 

In addition, in accordancewith applicable SEC rules, this Form 10-Q/A includes updatedcertifications from our Chief Executive Officer andChief Financial Officer asExhibits 31.1, 31.2, 32.1 and 32.2.

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**SEPRACOR INC.INDEX**
| **Part I—Financial Information** |   |                                                                                                                                       |
|--------------------------------------------|--------|--------------------------------------------------------------------------------------------------------------------------------------------|
| Item 1.                                    |   | Condensed Consolidated Financial Statements  (Unaudited)                                                                                   |   |   |
|                                       |   | Consolidated  Balance Sheets as of September 30, 2005 and December 31, 2004 (Restated and Unaudited)                             |   | 3 |
|                                       |   | Consolidated  Statements of Operations for the Three and Nine Months Ended  September 30, 2005 and 2004 (Restated and Unaudited) |   | 4 |
|                                       |   | Consolidated  Statements of Cash Flows for the Nine Months Ended September 30, 2005  and 2004 (Restated and Unaudited)      |   | 5 |
|                                       |   | Notes to Condensed Consolidated Interim Financial  Statements (Restated and Unaudited)                            |   | 6 |
| Item  2.                                   |   | Management’s  Discussion and Analysis of Financial Condition and Results of Operations                                 |   | 14 |
| Item  3.                                   |   | Quantitative  and Qualitative Disclosures About Market Risk                                                                                |   | 40 |
| Item  4.                                   |   | Controls  and Procedures                                                                                                                   |   | 40 |
| **Part II—Other  Information**   |   |                                                                                                                                       |
| Item 1.                                    |   | Legal  Proceedings                                                                                                                         |   | 41 |
| Item 6.                                    |   | Exhibits                                                                                                                                   |   | 42 |
|                                       |   | Signatures                                                                                                                                 |   | 43 |
|                                       |   | Exhibit Index                                                                                                                         |   | 44 |

x

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

| ** **                                                                                                                                                                                                             | ** ** | **September 30,  2005  (as restated)** | ** ** | **December 31,  2004  (as restated)** | ** ** |
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|--------------------------------------------------|------------|-------------------------------------------------|------------|
| **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                                                                                                                                                                                             |       |                                             | 1,567,674  |                                            |       |   | 1,411,440 |   |   |
| Accumulated deficit                                                                                                                                                                                                    |       |                                             | (1,699,533 | )                                               |       |   | (1,666,554 | ) |   |
| 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 statementsThe 

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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** | ** ** |
| ** **                                                             | ** ** | **(as restated)**           | ** ** | **(as restated)**          | ** ** | **(as restated)** | ** ** | **(as restated)** | ** ** |
| 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                                    |       |                             | 162,731    |                            |       |   | 82,895 |   |   |   | 386,121 |   |   |   | 253,811 |   |   |
| General and administrative                                             |       |                             | 11,097     |                            |       |   | 7,690 |   |   |   | 29,878 |   |   |   | 23,211 |   |   |
| Total costs and expenses                                               |       |                             | 227,915    |                            |       |   | 136,635 |   |   |   | 560,682 |   |   |   | 421,475 |   |   |
| Loss from operations                                                   |       |                             | (22,195    | )                               |       |   | (56,554 | ) |   |   | (50,853 | ) |   |   | (171,949 | ) |   |
| 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                                                               |       |                             | $          | (2,485                          | )          |   |   | $ | (130,640 | ) |   |   | $ | (32,979 | ) |   |   | $ | (262,925 | ) |   |
| Basic and diluted  net loss per common share                           |       |                             | $          | (0.02                           | )          |   |   | $ | (1.41 | ) |   |   | $ | (0.32 | ) |   |   | $ | (2.98 | ) |   |
| 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 STATEMENTS OF CASH FLOWS(Unaudited)(In Thousands)**

| ** **                                                                   | ** ** | **Nine Months Ended**                  | ** ** |
|------------------------------------------------------------------------------|------------|--------------------------------------------------|------------|
| ** **                                                                   | ** ** | **September 30,  2005  (as restated)** | ** ** | **September 30,  2004  (as restated)** | ** ** |
| Cash flows from operating  activities:                                       |       |                                             |       |   |   |   |   |   |   |
| Net loss                                                                     |       |                                             | $          | (32,979 | ) |   |   | $ | (262,925 | ) |   |
| 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 |   |   |
| Stock compensation                                                           |       |                                             | 783        |   |   |   | 992 |   |   |
| 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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**NOTES TO CONDENSED CONSOLIDATED INTERIM FINANCIALSTATEMENTS**

**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 endedSeptember 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/A for the year endedDecember 31, 2005, filed with the Securities andExchange Commission, or SEC.

The preparation offinancial statements in conformity with generally accepted accountingprinciples requires management to make estimates and assumptions that affectthe following: (1) the reported amounts of assets and liabilities,(2) the disclosure of contingent assets and liabilities at the dates ofthe financial statements and (3) the reported amounts of revenues andexpenses during the 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. SFASNo. 151 requires idle facility expenses, freight, handling costs andwasted material (spoilage) costs to be recognized as current-periodcharges. It also requires that the allocation of fixed production overheadcosts to the costs of conversion be based on the normal capacity of therelevant production facilities. SFAS No. 151 will be effective forinventory costs incurred during fiscal years beginning after June 15,2005. We do not expect the adoption of SFAS No. 151 to have a materialimpact on our financial condition or our results of operations.

In December 2004, the FASB issued SFASNo. 123(R), “Share-Based Payment”, which replaces SFAS No. 123,“Accounting for Stock-Based Compensation,” and supersedes AccountingPrinciples Board Opinion No. 25, “Accounting for Stock Issued toEmployees”, or APB 25. SFAS No. 123(R) requires compensation costsrelating to share-based payment transactions be recognized in financialstatements, as well as more extensive disclosures concerning stock options thanrequired under current guidance. The new rule applies to option grantsmade after adoption as well as options that are not vested at the date ofadoption. The pro forma disclosure previously permitted under SFAS No. 123will no longer be an acceptable alternative to recognition of expenses in thefinancial statements. The SEC approved a rule delaying the implementationof SFAS No. 123(R) until the first annual reporting period thatbegins after June 15, 2005. We currently measure compensation costsrelated to share-based payments under APB 25, as allowed by SFASNo. 123, and provide disclosure in notes to financial statements asrequired 

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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 SFASNo. 153**,** “Exchanges ofNonmonetary Assets—an amendment of APB Opinion No. 29.” The amendmentsmade by SFAS No. 153 are based on the principle that exchanges ofnonmonetary assets should be measured based on the fair value of the assetsexchanged. The amendment also eliminates the narrow exception for nonmonetaryexchanges of similar productive assets and replaces it with a broader exceptionfor exchanges of nonmonetary assets that do not have commercial substance. Theprovisions of SFAS No. 153 are effective for nonmonetary asset exchangesoccurring in fiscal periods beginning after June 15, 2005. The adoption ofSFAS No. 153 has not had a material impact on our financial condition orour 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 |   |   |
|                       |            |                                                                                     |            |                                  |            |  |  |  |  |  |  |

 

7

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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 ofSeptember 30, 2005 or at any time during the three or nine months endedSeptember 30, 2005. Once these notes become convertible, shares of commonstock will be reserved under the conversion formula for issuance uponconversion if and when our common stock price exceeds $67.20 per share on theNasdaq National Market. Prior to such occurrence, the notes are onlyconvertible 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** | ** ** |
| ** **                                                                                         | ** ** | **(as  restated)**                                                       | ** ** | **(as  restated)**              | ** ** | **(as  restated)** | ** ** | **(as  restated)** | ** ** |
| ** **                                                                                         | ** ** | ** (in thousands, except per share data)** | ** ** |
| Net loss as reported                                                                               |       |                                                                     | $          | (2,485                          | )          |   |   | $ | (130,640 | ) |   |   | $ | (32,979 | ) |   |   | $ | (262,925 | ) |   |
| Add: Stock-based employee  compensation expense included in restated results                  |       |                                                                     | 261        |                            |       |   | 277 |   |   |   | 783 |   |   |   | 992 |   |   |
| Less: Total stock-based employee compensation  expense determined under the fair value method |       |                                                                     | (11,587    | )                               |       |   | (12,814 | ) |   |   | (36,241 | ) |   |   | (36,324 | ) |   |
| Pro forma net loss                                                                                 |       |                                                                     | $          | (13,811                         | )          |   |   | $ | (143,177 | ) |   |   | $ | (68,437 | ) |   |   | $ | (298,257 | ) |   |
| Net loss per share:                                                                                |       |                                                                     |       |                            |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Basic and Diluted—as reported                                                            |       |                                                                     | $          | (0.02                           | )          |   |   | $ | (1.41 | ) |   |   | $ | (0.32 | ) |   |   | $ | (2.98 | ) |   |
| Basic and Diluted—pro forma                                                                   |       |                                                                     | $          | (0.13                           | )          |   |   | $ | (1.54 | ) |   |   | $ | (0.65 | ) |   |   | $ | (3.38 | ) |   |

 

 

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**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 |   |   |

 

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 endingDecember 31, 2006, 2007, 2008 and 2009, respectively.

9

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**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 |   |   |

 

**8.**   Equity

In December 2003, weused approximately $94,820,000 of the proceeds from the issuance of 0%Series A convertible senior subordinated notes due 2008 and 0%Series B convertible senior subordinated notes due 2010 to purchase fourseries of call spread options on our common stock expiring at various datesbetween May 12, 2004 and December 9, 2005. We received proceeds onthe first three of these series of settled options of $50,006,000, $74,327,000and $123,798,000, respectively, which were recorded as an increase toadditional paid-in capital. The fourth and only outstanding call spread optionseries consists of 4,919,496 options expiring in equal installments on eachbusiness day from November 11, 2005 through December 9, 2005 and wehave the option to settle them in either net shares or in cash. We currentlyintend to settle the fourth series of call spread options for shares of ourcommon 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 onNovember 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 sharetrading price for a given day during the expiration period could be higher orlower than $56.71, which will affect the actual net share settlement from ourcall spread options.

**9.**   ComprehensiveIncome (Loss)

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

| ** **                                                      | ** ** | **Three Months Ended**            | ** ** | **Nine Months Ended**             | ** ** |
|-----------------------------------------------------------------|------------|---------------------------------------------|------------|---------------------------------------------|------------|
| ** **                                                      | ** ** | **September 30,  2005  (as restated)** | ** ** | **September 30,  2004  (as restated)** | ** ** | **September 30,  2005  (as restated)** | ** ** | **September 30,  2004  (as restated)** | ** ** |
| ** **                                                      | ** ** | **(in thousands)**                     | ** ** |
| Comprehensive  income (loss):                                   |       |                                        |       |                                        |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Net loss                                                        |       |                                        | $          | (2,485                                      | )          |   |   | $ | (130,640 | ) |   |   | $ | (32,979 | ) |   |   | $ | (262,925 | ) |   |
| 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                                        |       |                                        | $          | (15,840                                     | )          |   |   | $ | (128,991 | ) |   |   | $ | (38,050 | ) |   |   | $ | (263,864 | ) |   |

 

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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 ourproducts or (3) a material breach by us. We have no liabilities recordedfor these agreements at September 30, 2005 and, if liabilities wereincurred, we have insurance policies covering product liabilities, which couldmitigate 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 defendants madecertain materially false and misleading statements relating to the testing,safety and likelihood of FDA approval of tecastemizole. On April 11, 2003,two consolidated amended complaints were filed, one on behalf of the purchasersof our equity securities and the other on behalf of the purchasers of our debtsecurities. These consolidated amended complaints reiterate the allegationscontained in the previously filed complaints and define the alleged classperiods 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 agonist program, which is designed to targetneuropsychiatric/neurologic conditions and neuropathic pain. We have agreed tocollaborate with each other to research and develop certain compounds thatinteract with these muscarinic receptors. We are permitted to develop andcommercialize these compounds in any field outside of the prevention ortreatment of ocular disease. The agreement also includes an option to select apreclinical program from ACADIA’s 5-HT2a program for use in combination with LUNESTA.Antagonists of the 5-HT2a receptor have been shown in clinical studiesto affect sleep architecture in humans. We will have exclusive worldwide rightsto develop and commercialize compounds developed under our collaboration withACADIA.

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

In connection with the ACADIA collaboration, 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 ofmerger, or merger agreement, with Pfizer, Inc. Under the merger agreement,Pfizer agreed to purchase all outstanding shares of Vicuron for a purchaseprice of $29.10 per share in cash. On September 11, 2005, Pfizer announcedthe closing of the merger. At the time of the closing, we owned 687,766 sharesof Vicuron common stock, which we were carrying at fair market value with thecorresponding unrealized gain recorded through equity. Upon closing of themerger, this gain was recognized in other income. In exchange for our shares ofVicuron, we received approximately $20,014,000 in cash from Pfizer, of which,approximately $18,345,000 was recorded as a gain on sale of investment and isincluded in other income on the consolidated statements of operations.

**12.   Restatement of Financial Statements Basedon Review of Stock Option Practices**

Subsequent to the filing ofour Form 10-Q for the period ended September 30, 2005, weconcluded that based on errors identified in a stock option investigation, wewould need to restate our financial statements for the three and nine monthsended September 30, 2005 and 2004.

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

Based on these reviews, we have determined that themeasurement dates for certain stock option grants to employees, officers anddirectors during prior periods differed from the recorded dates for such awardsprimarily due to the following circumstances: (i) stock option grantswhich specified effective dates that may have preceded the dates of receipt ofall necessary signatures or approvals, finalization of lists specifying stockoption grants or an employee’s first date of employment; and (ii) stockoption awards that were approved with exercise prices lower than fair marketvalue on the effective date of grant. In addition, we have determined that(a) the modification of certain stock option grants in connection with anemployee’s termination of employment and (b) the exercise of certain stockoptions that had not vested prior to an employee’s termination resulted in a new measurementdate for such stock options. As a result, we are required to record non-cash adjustments forstock-based compensation expense in accordance with 

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APB  25  for the three and nine months endedSeptember 30, 2005 and 2004.  These non-cash charges had no impact on reportedrevenue, cash or cash equivalents or total assets.

The table below sets forth the impact of thenon-cash charges for stock-based compensation expense within our consolidatedstatement of operations that we recorded for the three and nine months endedSeptember 30, 2005 and 2004.

| ** **                                                          | ** ** | **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 as previously reported                                     |       |                                                                     | $          | (2,224                          | )          |   |   | $ | (130,363 | ) |   |   | $ | (32,196 | ) |   |   | $ | (261,933 | ) |   |
| Charge for additional stock-based  compensation                     |       |                                                                     | (261       | )                               |       |   | (277 | ) |   |   | (783 | ) |   |   | (992 | ) |   |
| Net loss as restated                                                |       |                                                                     | $          | (2,485                          | )          |   |   | $ | (130,640 | ) |   |   | $ | (32,979 | ) |   |   | $ | (262,925 | ) |   |
| Basic and diluted net loss per common share as previously  reported |       |                                                                     | $          | (0.02                           | )          |   |   | $ | (1.40 | ) |   |   | $ | (0.31 | ) |   |   | $ | (2.97 | ) |   |
| Basic and diluted net loss per common share as restated.            |       |                                                                     | $          | (0.02                           | )          |   |   | $ | (1.41 | ) |   |   | $ | (0.32 | ) |   |   | $ | (2.98 | ) |   |

 

The table below sets forth the impact of thenon-cash charges for stock-based compensation expense within our consolidatedbalance sheet that we recorded for the quarters ended September 30, 2005 and 2004. 

| ** **                 | ** ** | **Periods Ended**       | ** ** |
|----------------------------|------------|------------------------------|------------|
| ** **                 | ** ** | **September 30,  2005** | ** ** | **December 31,  2004** | ** ** |
| ** **                 | ** ** | **(in thousands)**      | ** ** |
| Additional paid-in capital |       |                         |       |   |   |   |   |   |   |
| As previously reported     |       |                         | $          | 1,525,823 |   |   |   | $ | 1,370,372 |   |   |
| As restated                |       |                         | $          | 1,567,674 |   |   |   | $ | 1,411,440 |   |   |
| Accumulated deficit        |       |                         |       |   |   |   |   |   |   |
| As previously reported     |       |                         | $          | (1,657,682 | ) |   |   | $ | (1,625,486 | ) |   |
| As restated                |       |                         | $          | (1,699,533 | ) |   |   | $ | (1,666,554 | ) |   |

 

Although the special committee has completed itsreview, the committee will remain in place for the duration of the SEC'sinquiry. Should additional information become available to us in connectionwith the SEC inquiry, the special committee may be required to reopen itsreview and our current determination of stock-based compensation could change.

**Derivative Stockholder Complaints Relating to StockOption Grants**

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

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

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

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

The discussion and analysis set forth in thisItem 2 has been amended to reflect the restatement as described in theExplanatory Note at the beginning of this quarterly report on Form 10-Q/Aand in Note 12 to our condensedconsolidated financialstatements. The impact of additionalstock-based compensation expense for the three and nine months endedSeptember 30, 2005 is approximately $261,000 and $783,000, respectively, ascompared to $277,000 and $992,000 for the three and nine months endedSeptember 30, 2004, respectively. See the Explanatory Note and Note 12 for additional information about thereview and restatement.

**CautionaryStatement Regarding Forward-Looking Statements**

This quarterly report on Form 10-Q/Acontains, in addition to historical information, forward-lookingstatements within the meaning of Section 21E of the Securities ExchangeAct of 1934, as amended, which we refer to as the Exchange Act. These forward-lookingstatements involve risks and uncertainties and are not guarantees of futureperformance. Words such as “expect,” “anticipate,” “intend,” “plan,” “believe,”“seek,” “estimate” and variations of these words and similar expressions areintended to identify forward-looking statements. Our actual results coulddiffer significantly from the results we discuss in these forward-lookingstatements. These forward-looking statements represent our expectationsas of the date of our quarterly report on Form 10-Q for thethree and nine months ended September 30, 2005, filed with the Securitiesand Exchange Commission on November 8, 2005. Subsequentevents will cause our expectations to change. However, while we may elect toupdate these forward-looking statements, we specifically disclaim anyobligation to do so. See the section entitled “Factors Affecting FutureOperating Results” below for a discussion of important factors that could causeour actual results to differ materially from the results we discuss in ourforward-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, 

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are hand-held, pressurizedcanisters that 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 settled options expired at various datesbeginning on May 12, 2005 and ending on June 9, 2005. We recorded thefull amount of the call spread option settlement as an increase to additionalpaid-in capital. Our remaining outstandingcall spread options expire at various dates beginning November 11, 2005and ending on December 9, 2005, and we have the option to settle them ineither net shares or in cash. We currently expect to settle these call spreadoptions 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 reversibleobstructive airway disease. We have resolved previously outstandingmanufacturing issues and have completed process validation work. We aretargeting commercial launch of XOPENEX HFA by the end of 2005. We capitalized$4,405,000 of XOPENEX HFA raw material inventory purchased and produced from thedate of FDA approval to September 30, 2005. Under our supply agreementwith Minnesota Mining and Manufacture Company, or 3M, and 3M InnovativeProperties Company, we are obligated to pay to 3M a combination of a fixedprice per unit of product purchased and a percentage royalty based on our netsales 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 

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to acetylcholine, aneurotransmitter in the central nervous system. The collaboration includesACADIA’s m1 agonist program, which is designed to targetneuropsychiatric/neurologic conditions and neuropathic pain. We have agreed tocollaborate with each other to research and develop certain compounds thatinteract with these muscarinic receptors. We are permitted to develop andcommercialize these compounds in any field outside of the prevention ortreatment of ocular disease. The agreement also includes an option to select apreclinical program from ACADIA’s 5-HT2a program for use in combination with LUNESTA. Antagonistsof the 5-HT2a receptor have been shown in clinical studiesto affect sleep architecture in humans. We will have exclusive worldwide rightsto develop and commercialize compounds developed under our collaboration withACADIA.

During the three-year research term of thecollaboration agreement, we will provide ACADIA with $2,000,000 of research fundingeach year, which will be recorded as research and development expense. Inaddition, 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 available-for-sale security and willadjust to its fair value at each reporting date with unrealized gains andlosses recorded as a component of accumulated other comprehensive income(loss). Subject to certain conditions, we also agreed to purchase up to anadditional $10,000,000 of ACADIA common stock at a 25 percent premium tothe trailing 30-day average closing price per share in January 2006.

**Critical Accounting Policies**

We identified criticalaccounting policies as of December 31,2004 in our annual report on Form 10-K/A for the year ended December 31,2005.These critical accounting policies relate to product revenue recognition,royalty revenue recognition, rebate and return reserves, patents, intangiblesand other assets, accounts receivable and bad debt, income taxes, inducedconversion of debt and inventory write-downs. These policies require usto make estimates in the preparation of our financial statements as of a givendate. Because of the uncertainty inherent in these matters, our actual resultscould differ from the estimates we use in applying the critical accountingpolicies. No changes to these critical accounting policies have taken placesince December 31, 2004.

**ThreeMonth Periods ended September 30, 2005 and 2004 (Restated)**

*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%.

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Sales of XOPENEXInhalation Solution were $92,466,000 as compared to $60,122,000 for the sameperiod in 2004, an increase of approximately 54%. The sales increase forXOPENEX Inhalation Solution for the three months ended September 30, 2005as compared with the same period in 2004 is due to a 34% increase in the numberof units sold and a 15% increase in the net selling price per unit. The 34%increase in unit sales is a result of increased market growth and higher marketshares, particularly in the hospital and home health care market sectors. The15% increase in the net selling price per unit is due to a gross unit priceincrease of approximately 8% and a decrease in sales rebates and allowances asa percentage of sales. The decrease in sales rebates and allowances isprimarily attributable to favorable reimbursement rate changes, as mandated bythe Medicare Prescription Drug Improvement and Modernization Act of 2003, inthe home health care market sector. Favorable Medicare reimbursement hasresulted in a decrease in the rebates we pay to home health care providers. Wecannot be certain whether, or for how long, this favorable reimbursement ratewill 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 $2,300,000from $5,105,000 for the three months ended September 30, 2005 versus thesame period in 2004. This was partially offset by an increase in royaltiesearned from sales of XYZAL®/XUSALTM, under our agreement with UCB Farchim SA.

Pursuant to the terms of our U.S. agreement withsanofi-aventis, we expect our royalties on the sale of ALLEGRA in the UnitedStates, which have historically been $15 to $20 million per year, willterminate based on the introduction of a generic equivalent of this product in September 2005.We are still entitled to receive royalties on the sale of ALLEGRA outside ofthe United States in countries where we hold patents covering ALLEGRA.

*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 same periodin 2004.

*Research and Development*

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 

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to our decreased spendingon two of our late-stage programs, LUNESTA and arformoterol. We commerciallylaunched LUNESTA on April 4, 2005, however, we continue to spend on PhaseIIIB/IV studies under our LUNESTA program. We have completed Phase III clinicaltrials for arformoterol, targeted as a maintenance treatment for chronicobstructive pulmonary disease, or COPD, and we are currently preparing an NDAthat we anticipate submitting to the FDA by the end of 2005. Our decreasedspending in these programs was partially offset by our increased spending ontwo of our early-stage programs, SEP-226330, targeted for thetreatment of restless legs syndrome, and SEP-225289, targeted for thetreatment of depression. A preliminary analysis of data from a Phase II studyof SEP-226330 for the treatment of restless legs syndrome completed inthe third quarter of 2005, suggested that the compound did not meet ourefficacy criteria for clinical advancement for this indication. We continue toevaluate the data as we conduct preclinical evaluations of SEP-226330 asa potential novel mechanistic approach for the treatment of other centralnervous system disorders, such as Parkinson’s disease.

Drug development and approval in the United States isa multi-step process regulated by the FDA. The process begins with the filingof an Investigational New Drug Application, or IND, which, if successful,allows the opportunity for study in humans, or clinical study, of the potentialnew drug. Clinical development typically involves three phases of study: PhaseI, II and III. The most significant costs in clinical development are inthe Phase III clinical trials, as they tend to be the longest and largeststudies in the drug development process. Following successful completion ofPhase III clinical trials, an NDA must be submitted to, and accepted by, theFDA, and the FDA must approve the NDA prior to commercialization of the drug.As further discussed above, we currently have one product candidate, 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 discussion of the risks anduncertainties associated with completing development of potential productcandidates, see “Factors Affecting Future Operating Results”.

Belowis a summary of development of our product and product candidates thatrepresent 10% or more of our direct project research and development spendingfor the three months ended 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.

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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 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.

*Selling, Marketing and Distribution*

Selling, marketing anddistribution expenses were $162,731,000 and $82,895,000for the three months ended September 30, 2005 and 2004, respectively, anincrease of approximately 96%. Of this increase, approximately 64%is due to an increase in marketing, advertising and promotion costs in supportof the commercial launch of LUNESTA, which took place in April 2005.Additionally, we incurred increased sales commission expense for internal salesrepresentatives as a result of the 54% increase in XOPENEX Inhalation Solutionproduct sales for the three months ended September 30, 2005 as comparedwith the same period in 2004 and the commercial launch of LUNESTA. Partiallyoffsetting these increases was a decrease in sales commission expense paid tothe Ross Products Division of Abbott Laboratories, or Ross, for theco-promotion of XOPENEX Inhalation Solution, since we terminated ourco-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 $11,097,000 and $7,690,000for the three months ended September 30, 2005 and 2004, respectively, anincrease of approximately 44%. The increase is primarily dueto increased legal fees related to two class action complaints pending againstus. We are currently investigating possible reimbursement of a portion of theselegal fees from certain of our insurance providers. The increase is also due toincreased payroll and related expenses resulting from an increase in 

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permanentand temporary employees and contracted service providers hired to support thecommercialization 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.

Equity in investee(losses) were ($241,000) and ($508,000) for the three months endedSeptember 30, 2005 and 2004, respectively, a decrease of approximately53%. The loss represents our portion of BioSphere losses.

**NineMonth Periods ended September 30, 2005 and 2004 (Restated)**

*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.

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Royalties and other revenue 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 for the nine monthsended September 30, 2005 as compared with the same period in 2004 isprimarily due to a decrease in other revenue earned from MedPointe related toour 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 byincreases in 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 increase inroyalties earned on sales of XYZAL/XUSAL, under our agreement with UCB FarchimSA.

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 $22,702,000for the nine 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 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 in bothperiods 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, 

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SEP-226330, targetedfor the treatment of restless legs syndrome, and SEP-225289, targeted forthe treatment of depression. A preliminary analysis of data from a Phase IIstudy of SEP-226330 for the treatment of restless legs syndrome completedin the third quarter of 2005, suggested that the compound did not meet ourefficacy criteria for clinical advancement for this indication. We continue toevaluate the data as we conduct preclinical evaluations of SEP-226330 asa 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.

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$386,121,000and $253,811,000for the nine months ended September 30, 2005 and 2004, respectively, anincrease of approximately 52%. Included in the nine months ended September 30,2004 is an expense of $30,671,000, which represented the then-present value oftermination payments totaling $33,000,000 that we are required to make to theRoss Products Division of Abbott Laboratories, or Ross. Approximately 66% of the increase, excluding thecurrent value of the Ross termination payments, is due to an increase inmarketing and promotion expenses in support of the commercial launch ofLUNESTA, which took place in April 2005. Additionally, 35% of the increase is a result ofincreased salary, commission and benefit costs as a result of havingapproximately 800 more sales 

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representatives whom wehired in the second quarter of 2004. We also incurred increased salescommission expense for internal sales representatives as a result of the 39%increase in XOPENEX Inhalation Solution product sales for the nine months endedSeptember 30, 2005 as compared with the same period in 2004 and thecommercial launch of LUNESTA. Offsetting these increases was a decrease insales commission expense paid to Ross for the co-promotion of XOPENEXInhalation Solution, as a result of termination of our co-promotion agreementwith Ross effective December 31, 2004 and decreases in travel expensesfrom the same period in 2004, which were related to hiring and training ourincreased sales force.

We expect selling,marketing and distribution expenses to continue to increase in connection withincreased sales of LUNESTA and in anticipation of commercial launch of XOPENEXHFA, 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 $29,878,000and $23,211,000for the nine months ended September 30, 2005 and 2004, respectively, anincrease of approximately 29%.The increase is primarily due to increased legal fees related to two classaction complaints pending against us. We are currently investigating possiblereimbursement of a portion of these legal fees from certain of our insuranceproviders. The increase is also due to increased payroll and related expensesresulting from an increase in permanent and temporary employees and contractedservice providers hired to support the commercialization of LUNESTA.

*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$351,980,000 of our 0% Series B notes due 2010, respectively. The lossrepresents the cash payments 

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of $23,868,250 and$45,899,900 that we paid to the holders of the 0% Series A notes due 2008and 0% Series B notes due 2010, respectively, as an inducement to converttheir 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 (Restated)**

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 $32,979,000adjusted by a non-cash benefit of $4,943,000,which consists primarily of a gain on sale of an equity investment anddepreciation and amortization expense. Accounts receivable increased by$34,252,000 due primarily to LUNESTA sales. Inventory increased by $12,231,000due primarily to capitalization of LUNESTA and XOPENEX HFA inventory as well ashigher XOPENEX Inhalation Solution inventory balances in order to meetadditional demand. Accounts payable increased by $24,090,000 primarily due totiming of vendor payments. Accrued expenses decreased by $7,910,000 primarilydue to a decrease in research and development related accruals, which are theresult of decreased research and development expenditures, partially offset byan increase in accrued commissions based on increased sales. Other currentliabilities increased by $20,249,000 primarily due to an increase in accrualsfor product revenue rebates related to XOPENEX Inhalation Solution and LUNESTAproduct sales.

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 andlong-term debt.

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.

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

Based on our current operatingplan, we believe that we will not be required to raise additional capital tofund the repayment of our outstanding convertible debt when due. If revenuegenerated from sales of XOPENEX Inhalation Solution and LUNESTA do not meetexpected 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 obligationsrepresent future cash commitments and liabilities under agreements with thirdparties and exclude contingent liabilities for which we cannot reasonablypredict future payment. As of September 30, 2005, our contractualobligations as of December 31,2004 disclosed in our annual report on Form10-K for the yearended December 31, 2004 has not materially changed sincewe filed that report, with the exception of our purchase obligations which, intotal for the next five years, increased by approximately $188,989,000. Theincrease primarily represents the increase in obligations associated with ourLUNESTA product launch in April 2005 as well as our anticipated launch ofXOPENEX HFA, expectedby the end of 2005. These purchase obligations relate to open purchase ordersfor the acquisition of goods and services in the ordinary course of business.Our obligation to pay certain of these amounts may be reduced or eliminatedbased on certain future events.

**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. (Restated)**

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$2.5 million and $33.0 million for the three andnine months ended September 30, 2005, respectively, and $296.9 millionfor the year ended December 31, 2004. We expect to continue to incursignificant operating expenditures. As a result, we will need to generatesignificant revenues to achieve and maintain profitability. We cannot assure youthat we 

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willachieve significant revenues or that we will ever achieve profitability. Evenif we do achieve profitability, we cannot assure you that we will be able tosustain or increase profitability on a quarterly or annual basis in the future.If revenues grow more slowly than we anticipate or if operating expenses exceedour expectations or cannot be adjusted accordingly, our business, results ofoperations and financial condition will be materially and adversely affected.

**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.

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, althoughwe cannot be assured this product candidate will be accepted for filing by theFDA or approved by the FDA on a timely basis, or at all.

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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.

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.

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

We have entered into a collaboration agreement with 3Mfor the scale-up and manufacturing of XOPENEX HFA and we may enter intoadditional collaboration agreements in the future. Under our agreement with 3M,3M is responsible for manufacturing an MDI formulation of XOPENEX. OnMarch 11, 2005, the FDA approved our NDA for XOPENEX HFA. We are targetingcommercial launch of the product by the end of 2005. If 3M, or any future developmentor commercialization collaborator, does not devote sufficient time andresources to its collaboration arrangement with us, breaches or terminates itsagreement with us, fails to perform its obligation to us in a timely manner oris unsuccessful in its development and/or commercialization efforts, we may notrealize the potential commercial benefits of the arrangement and our results ofoperations may be adversely affected. In addition, if regulatory approval orcommercialization of any product candidate under development by or incollaboration with a partner is delayed or limited, we may not realize, or maybe delayed in realizing, the potential commercial benefits of the arrangement.

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**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 thecompletion of required procedures by, agencies other than the FDA, such as theUnited States Drug Enforcement Administration. In addition, commercializationof FDA-approved products may be delayed by our failure to timely finalizedistribution or manufacturing arrangements, produce sufficient inventory and/orproperly prepare our sales force. If we are unable to commercialize a productpromptly after receipt of an approval letter, our business and financialposition may be materially adversely affected due to reduced revenue fromproduct sales during the period or periods that commercialization is delayedand the shortening of any lead time to market we may have had over ourcompetitors. In addition, the exclusivity period, which is the time duringwhich the FDA will prevent generic pharmaceutical companies from introducing ageneric copy of the product, begins to run upon FDA approval and, therefore, tothe extent we are unable to commercialize a product promptly after receipt ofan approval letter, our long-term product sales and revenues could be adverselyaffected.

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

On March 11, 2005,the FDA approved our NDA for XOPENEX HFA. 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 these arrangementsdepend in large part on the commercialization efforts of our licensing partnersin countries where we hold patents, including sales efforts and enforcement ofpatents, which we cannot control. If any of our licensing partners does notdevote sufficient time and resources to its licensing arrangement with us orfocuses its efforts in countries where we do not hold patents, we may notrealize the potential commercial benefits of the arrangement, our revenuesunder these arrangements may be less than anticipated and our results ofoperations may be adversely affected. If any of our licensing partners was tobreach or terminate its agreement with us or fail to perform its obligations tous in a timely manner, the royalties we receive under the licensing agreementcould decrease or cease. If we are unable or fail to perform, or breach in ourperformance of, our obligations under a licensing agreement, the royalties andbenefits to which we are otherwise entitled under the agreement could bereduced or eliminated. Any delay or termination of this type could have amaterial adverse effect on our financial condition and results of operationsbecause we may lose technology rights and milestone or royalty payments fromlicensing partners and/or revenues from product sales, if any, could bedelayed, reduced or terminated.

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**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,including CLARINEX, for which we receive royalties on sales, has been and maycontinue to be adversely affected.

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

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 significantadditional research, development, preclinical and/or clinical testing, regulatoryapproval and a commitment of significant additional resources prior to theircommercialization. Our potential products may not:

·  be developed successfully;

·  be proven safe and efficacious in clinicaltrials;

·  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 

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product is uncertain, asis the amount for which that product will be reimbursed. We cannot predictavailability or amount of reimbursement for our approved products or productcandidates, including those at a late stage of development, and currentreimbursement policies for marketed 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 Medicaidprogram may be adversely affected. In some states that have adopted PDLs, wehave been, and may continue to be, required to provide substantial supplementalrebates to state Medicaid authorities in order for our drugs to be included onthe 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 or administerthem, which could reduce use of our products or cause us to reduce the price ofour 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 

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thesubject of much litigation. Legal standards relating to scope and validity ofpatent claims are evolving. Any patents we have obtained, or obtain in thefuture, may be challenged, invalidated or circumvented. Moreover, the UnitedStates Patent and Trademark Office may commence interference proceedingsinvolving our patents or patent applications. Any challenge to, or invalidationor circumvention of, our patents or patent applications would be costly, wouldrequire significant time and attention of our management and could have amaterial adverse effect on our business.

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

**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.

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**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 withdrawal of regulatory approvals, product recalls, seizure of products,operating restrictions 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.

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**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) marketand sell them through other arrangements, including co-promotion arrangements.We have established a sales force to market XOPENEX Inhalation Solution,LUNESTA and XOPENEX HFA. We have incurred significant expense in expanding oursales force and expect to incur additional expense as we further expand. Withrespect to products under development, we may incur significant costs inexpanding our sales force before the products have been approved for marketing.For example, we expanded our sales force in 2004 in anticipation of marketingand selling LUNESTA and in 2005 in anticipation of marketing and sellingXOPENEX HFA. In addition, if we enter into co-promotion arrangements or marketand sell additional products directly, we may need to significantly expand oursales force.

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

**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 drugwholesalers, hospitals and pharmacies of a manufacturer-initiatedvoluntary Class III recall of one component of our XOPENEX InhalationSolution product line, XOPENEX Inhalation Solution Concentrate (1.25mg/0.5mL),which we introduced in August 2004. The recall, which affects only XOPENEXInhalation Solution Concentrate and no other components of our XOPENEXInhalation Solution product line, was necessitated by packaging processvalidation issues relating to the automated process of placing finished vialsinto a foil pouch. We have suspended manufacture and sale of XOPENEX InhalationSolution Concentrate until the issues giving rise to the recall have been fullyaddressed. We do not expect to re-introduce XOPENEX Inhalation SolutionConcentrate before the second quarter of 2006. If our manufacturer cannotremedy the GMP deficiencies giving rise to the recall of XOPENEX InhalationSolution Concentrate, or if these or similar deficiencies are found to extendto other components or our XOPENEX Inhalation Solution product line, ourability to supply product to the market may be limited or interruptedindefinitely, which would have a material adverse effect on our business.

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**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 for such products, which could lead to customerdissatisfaction and damage to our reputation. Furthermore, if we are requiredto change manufacturers, we will be required to verify that the newmanufacturer maintains facilities and procedures that comply with qualitystandards and with all applicable regulations and guidelines, including FDAguidelines. The delays associated with the verification of a new manufacturerfor XOPENEX Inhalation Solution, LUNESTA or XOPENEX HFA could negatively affectour ability to produce such products in a timely manner or within budget.

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

**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 product commercializationefforts. Product liability claims could require us to spend significant timeand money in litigation or to pay significant damages. Although we maintainproduct liability insurance coverage for both the clinical trials andcommercialization of our products, it is possible that we will not be able toobtain further product liability insurance on acceptable terms, if at all, andthat our insurance coverage may not provide adequate coverage against allpotential 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 

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which payment may be madeunder Federal healthcare programs such as the Medicare and Medicaid programs;

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

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

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

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

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

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

·       stateand foreign law equivalents of the foregoing;

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

·       statelaws that prohibit practice of medicine by non-physicians and fee-splittingarrangements between physicians and non-physicians, as well as state lawequivalents to the Federal Medicare and 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, including civiland criminal penalties, damages, fines, exclusion from Medicare and Medicaidprograms and curtailment or restructuring of our operations. Similarly, if ourcustomers are found non-compliant with applicable laws, they may be subject tosanctions, which could also have a negative impact on us. In addition, if weare required to obtain permits or licenses under these laws that we do notalready possess, we may become subject to substantial additional regulation orincur significant expense. Any penalties, damages, fines, curtailment orrestructuring of our operations would adversely affect our ability to operateour business and our financial results. The risk of our being found inviolation of these laws is increased by the fact that many of them have notbeen fully interpreted by the regulatory authorities or the courts, and theirprovisions are open to a variety of interpretations, and additional legal orregulatory change. Any action against us for violation of these laws, even ifwe successfully defend against it, could cause us to incur significant legalexpenses, divert our management’s attention from operating our business anddamage 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 

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productreimbursed by Medicaid. The amount of the rebate for each product is set bylaw. We are also required to pay certain statutorily defined rebates onMedicaid purchases for reimbursement on prescription drugs under state Medicaidplans. Both the Federal government and state governments have initiatedinvestigations into the rebate practices of many pharmaceutical companies toensure compliance with these rebate programs. Any investigation of our rebatepractices could be costly, could divert the attention of our management andcould damage our reputation.

**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 uponour future performance, which is subject to many factors, including factorsbeyond our control. The conversion prices for the 5% debentures due 2007, 0% Series Anotes due 2008 and 0% Series B notes due 2010 are $92.38, $31.89 and$29.84, respectively. On 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.

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**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.

**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 licenseagreements with third parties to commercialize products or technologies that wewould otherwise develop or commercialize ourselves. Our cash requirements mayvary materially from those now planned because of factors including:

·       patentdevelopments;

·       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 mayrender our products or technologies obsolete or noncompetitive. We expect toencounter intense competition in the sale of our current and future products.If we are unable to compete effectively, our financial condition and results ofoperations could be materially adversely affected because we may use ourfinancial resources to seek to differentiate ourselves from our competition andbecause we may not achieve our product revenue objectives. Many of ourcompetitors and potential competitors, which include pharmaceutical companies,biotechnology firms, universities and other research institutions, havesubstantially greater resources, manufacturing and marketing capabilities,research and development staff and production facilities than we have. Thefields in which we compete are subject to rapid and substantial technologicalchange. Our competitors may be able to respond more quickly to new or emergingtechnologies or to devote greater resources to the development, manufacture andmarketing of new products and/or technologies than we can. As a result, anyproducts and/or technologies that we 

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developmay become obsolete or noncompetitive before we can recover expenses incurredin 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.

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

We and several of ourcurrent and former officers and a current director are named as defendants inseveral class action complaints which have been filed on behalf of certainpersons who purchased our common stock and/or debt securities during differenttime periods, beginning on various dates, the earliest being May 17, 1999,and all ending on March 6, 2002. These complaints allege violations of theExchange Act and the rules and regulations promulgated thereunder by theSEC. Primarily they allege that the defendants made certain materially falseand misleading statements relating to the testing, safety and likelihood of FDAapproval of tecastemizole. On April 11, 2003, two consolidated amendedcomplaints were filed, one on behalf of the purchasers of our equity securitiesand the other on behalf the purchasers of our debt securities. Theseconsolidated amended complaints reiterate the allegations contained in thepreviously filed complaints and define the alleged class periods as May 17,1999 through March 6, 2002. On September 8, 2005, in both the debtpurchasers’ action and the equity purchasers’ action, the district court grantedthe plaintiff’s motion for class certification. The parties are currentlyengaged 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 operating expenses,including selling and marketing expenses and the costs of expanding andmaintaining 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;

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·       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.

**Wehave various mechanisms in place to discourage takeover attempts, which mayreduce or eliminate our stockholders’ ability to sell their shares for a premiumin 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 to benefitfrom a change of control or change in our management and board of directors.These provisions include:

·       preferred stock that couldbe issued by our board of directors to make it more difficult for a third partyto acquire, or to discourage a third party from acquiring, a majority of ouroutstanding voting stock;

·       classification of ourdirectors into three classes with respect to the time for which they holdoffice;

·       non-cumulative voting fordirectors;

·       control by our board ofdirectors of the size of our board of directors;

·       limitations on the abilityof stockholders to call special meetings of stockholders;

·       inability of ourstockholders to take any action by written consent; and

·       advance notice requirementsfor nominations of candidates for election to our board of directors or forproposing matters that can be acted upon by our stockholders at stockholdermeetings.

In addition, inJune 2002, our board of directors adopted a shareholder rights plan, theprovisions of which could make it more difficult for a potential acquirer ofSepracor to consummate an acquisition transaction.

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

The market price of our common stock, like that of thecommon stock of many other pharmaceutical and biotechnology companies, may behighly volatile. In addition, the stock market has experienced extreme priceand volume fluctuations. This volatility has significantly affected the marketprices of securities of many pharmaceutical and biotechnology companies forreasons frequently unrelated to or disproportionate to the operatingperformance of the specific companies. These broad market fluctuations mayadversely affect the market price of our common stock. Prices for our commonstock will be determined in the market place and may be influenced by manyfactors, including variations in our financial results and investors’perceptions of us, and changes in recommendations by securities analysts as wellas their perceptions of general economic, industry and market conditions.

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**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 aprior pronouncement that allowed such contingently issuable shares to beexcluded from the diluted earnings per share calculation. Our 0% notes due2024, unlike our other series of convertible debt, are convertible into commonstock only if certain conditions are met and, therefore, we had not previouslyincluded the shares issuable upon conversion of such notes in our dilutedearnings per share calculation. The inclusion of such contingently convertibleshares in our diluted earnings per share calculation has had no effect on ourcurrent or prior period diluted earnings per share. However, the inclusion ofshares contingently issuable upon conversion of our 0% notes due 2024, mayreduce our diluted earnings per share in future periods.

**ITEM3.**                QUANTITATIVE ANDQUALITATIVE DISCLOSURES ABOUT MARKET RISK

**Market Risk**

We are exposed to marketrisk from changes in interest rates and equity prices, which could affect ourfuture results of operations and financial condition. These risks for the year ended December 31, 2004are described in our annual report on Form 10-K/Afor the year ended December 31, 2005. As of November 8, 2005,there have been no material changes to the market risks for the year ended December 31, 2004described in our annual report on Form 10-K/Afor the year ended December 31, 2005. Additionally, we do notanticipate any near-term changes in the nature of our market risk exposures orin our management’s objectives and strategies with respect to managing such exposures.

**ITEM4.**                CONTROLS ANDPROCEDURES

**DisclosureControls and Procedures**

In August 2006, our management,with the participation of our chief executive officer and chief financialofficer, re-evaluatedthe effectiveness of our disclosure controls and procedures as of September 30,2005 taking into account theresults of the special committee’s stock option review. The term “disclosurecontrols and procedures,” as defined in Rules 13a-15(e) and 15d-15(e) underthe Exchange Act, means controls and other procedures of a company that aredesigned to ensure that information required to be disclosed by a company inthe reports that it files or submits under the Exchange Act is recorded,processed, summarized and reported, within the time periods specified in theSEC’s rules and forms. Disclosure controls and procedures include, withoutlimitation, controls and procedures designed to ensure that informationrequired to be disclosed by a company in the reports that it files or submitsunder the Exchange Act is accumulated and communicated to the company’smanagement, including its principal executive and principal financial officers,as appropriate to allow timely decisions regarding required disclosure. Ourmanagement recognizes that any controls and procedures, no matter how welldesigned and operated, can provide only reasonable assurance of achieving theirobjectives and our management necessarily applies its judgment in evaluatingthe cost-benefit relationship of possible controls and procedures. Based on there-evaluation of our disclosurecontrols and procedures as of September 30, 2005, our chief executiveofficer and chief financial officer concluded that, as of such date, ourdisclosure controls and procedures were effective at the reasonable assurancelevel.

**Changesin Internal Control Over Financial Reporting**

There has been no change in our internalcontrol over financial reporting (as defined in Rules 13a-15(f) and15d-15(f) under the Exchange Act) during our quarter ended September 30,2005 that has materially affected, or is reasonably likely to materiallyaffect, our internal control over financial reporting.

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**PART II**

**OTHER INFORMATION**

**ITEM 1.**                LEGALPROCEEDINGS

**Legal Proceedings As of September 30, 2005**

The following legalproceedings were pending as of September 30, 2005:

**Levalbuterol Hydrochloride Inhalation SolutionANDAs.**   On September 7,2005, we announced that the FDA received an abbreviated new drug application,or ANDA, from Breath Limited seeking marketing approval for generic copies ofour 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 it’s approval of the ANDAuntil March 7, 2008 or until a court decides that our patents are invalid,unenforceable or not infringed, whichever is earlier. Patent litigation involvescomplex legal and factual questions. We can provide no assurance concerning theoutcome or the duration of the lawsuit. If we are not successful in enforcingour patents, we will not be able to exclude the generic company, for the fullterm of our patents, from marketing their generic version of XOPENEX InhalationSolution. Introduction of a generic copy of XOPENEX Inhalation Solution beforethe expiration of our patents could have a material adverse effect on ourbusiness.

**Tecastemizole Class Action Complaints.**   Weand several of our current and former officers and a current director are namedas defendants in several class action complaints which have been filed onbehalf of certain persons who purchased our common stock and/or debt securitiesduring different time periods, beginning on various dates, the earliest being May 17,1999, and all ending on March 6, 2002. These complaints allege violationsof the Securities Exchange Act of 1934, as amended, and the rules andregulations promulgated thereunder by the 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 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.

**Legal Proceedings Relating to Stock Option Review**

The following legalproceedings relating to the stock option review discussed in the ExplanatoryNote at the beginning of this Form 10-Q/A and Note 12 to theconsolidated financial statements set forth herein were initiated afterSeptember 30, 2005:

**Stock Option Inquiry.****  **InJune 2006, we announced that we had received an informal letterof inquiry from the SEC requesting documents related to our stock option grantsand stock option practices. We appointed a special committee of outsidedirectors to conduct an internal review relating to our stock option grants andstock option practices. The special committee, with the assistance of outside legal 

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counsel and outside accounting specialists, has reviewed stock optiongrants to our officers, directors and employees from 1996 to present under ourvarious stock option plans in effect during this period. We have beencooperating with the review and our finance department has also reviewed our stockoption grants and stock option practices. Although the special committee has completed itsreview, the committee will remain in place for the duration of the SEC'sinquiry. Should additional information become available to us in connectionwith the SEC inquiry, the special committee may be required to reopen itsreview and our current determination of stock-based compensation could change.

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

**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: September 12, 2006 | By:               | /s/  TIMOTHY J. BARBERICH |
|                          | * *          | Timothy J.  Barberich*Chairman and Chief Executive Officer  (Principal Executive Officer)* |
| Date: September 12, 2006 | By:               | /s/  ROBERT F. SCUMACI |
|                          | * *          | Robert F. Scumaci*Executive Vice President, Finance and  Administration, and Treasurer  (Principal Accounting Officer)* |

 

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