**SECURITIES AND EXCHANGE COMMISSION**

**Washington,D.C. 20549**

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**FORM 10-Q**

**(Mark One)**

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

**Forthe Quarterly Period Ended March 31, 2007**

**or**

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

**Forthe transition periodfrom                  to**

**Commissionfile number 0-19410**

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**Sepracor Inc.**

(Exact name of registrantas specified in its charter)

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

 

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

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

Indicate by check markwhether the registrant is a large accelerated filer, an accelerated filer, or anon-accelerated filer. See definition of “accelerated filer and largeaccelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):

Large acceleratedfiler x                     Accelerated filer o                     Non-acceleratedfiler o

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

Thenumber of shares outstanding of the registrant’s class of Common Stock as of April 30,2007 was: 106,431,299 shares.

 

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**SEPRACOR INC.**

**INDEX**
| **Part I—Financial Information** |   |                                                                                                                  |
|--------------------------------------------|--------|-----------------------------------------------------------------------------------------------------------------------|
| Item 1.                                    |   | Condensed Consolidated Interim Financial Statements  (Unaudited)                                                      |   |   |
|                                       |   | Consolidated  Balance Sheets as of March 31, 2007 (Unaudited) and December 31,  2006                        |   | 3 |
|                                       |   | Consolidated  Statements of Operations for the Three Months Ended March 31,  2007 and 2006 (Unaudited)      |   | 4 |
|                                       |   | Consolidated  Statements of Cash Flows for the Three Months Ended March 31, 2007  and 2006 (Unaudited) |   | 5 |
|                                       |   | Notes  to Condensed Consolidated Interim Financial Statements                                                         |   | 6 |
| Item  2.                                   |   | Management’s  Discussion and Analysis of Financial Condition and Results of Operations                           |   | 13 |
| Item  3.                                   |   | Quantitative  and Qualitative Disclosures About Market Risk                                                           |   | 24 |
| Item  4.                                   |   | Controls  and Procedures                                                                                              |   | 24 |
| **Part II—Other  Information**   |   | 25                                                                                                                    |
| Item 1.                                    |   | Legal  Proceedings                                                                                                    |   | 25 |
| Item 1A.                                   |   | Risk Factors                                                                                                          |   | 27 |
| Item 6.                                    |   | Exhibits                                                                                                              |   | 47 |
|                                       |   | Signatures                                                                                                            |   | 48 |
|                                       |   | Exhibit Index                                                                                                    |   |   |

 

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

|                                                                                                                                                                                                                                                                        | ** ** | **March 31,  2007** | ** ** | **December 31,  2006** | ** ** |
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|--------------------------|------------|-----------------------------|------------|
| ** **                                                                                                                                                                                                                                                             | ** ** | **(Unaudited)**          | ** ** | ** **                  | ** ** |
| **Assets**                                                                                                                                                                                                                                                             | ** ** | ** **               | ** ** | ** **                  | ** ** |
| Current assets:                                                                                                                                                                                                                                                        |       |                     |       |                        |       |
| Cash and cash  equivalents                                                                                                                                                                                                                                             |       | $                        | 187,744    |                        | $          | 415,411 |   |
| Short-term  investments                                                                                                                                                                                                                                                |       | 379,356                  |       | 568,037                     |       |
| Accounts receivable, net                                                                                                                                                                                                                                               |       | 198,333                  |       | 175,103                     |       |
| Inventories                                                                                                                                                                                                                                                            |       | 34,122                   |       | 37,087                      |       |
| Other assets                                                                                                                                                                                                                                                           |       | 50,663                   |       | 25,390                      |       |
| Total current assets                                                                                                                                                                                                                                                   |       | 850,218                  |       | 1,221,028                   |       |
| Long-term  investments                                                                                                                                                                                                                                                 |       | 263,177                  |       | 182,876                     |       |
| Property and equipment,  net                                                                                                                                                                                                                                           |       | 78,499                   |       | 72,811                      |       |
| Investment in affiliate                                                                                                                                                                                                                                                |       | 4,954                    |       | 5,107                       |       |
| Deferred financing costs  and patents, net                                                                                                                                                                                                                             |       | 10,554                   |       | 11,881                      |       |
| Other assets                                                                                                                                                                                                                                                           |       | 83                       |       | 90                          |       |
| Total assets                                                                                                                                                                                                                                                           |       | $                        | 1,207,485  |                        | $          | 1,493,793 |   |
| **Liabilities and Stockholders’ Equity**                                                                                                                                                                                                                          | ** ** | ** **               | ** ** | ** **                  | ** ** |
| Current liabilities:                                                                                                                                                                                                                                                   |       |                     |       |                        |       |
| Accounts payable                                                                                                                                                                                                                                                       |       | $                        | 27,277     |                        | $          | 10,751 |   |
| Accrued expenses                                                                                                                                                                                                                                                       |       | 164,041                  |       | 113,099                     |       |
| Current portion of notes  payable and capital lease obligation                                                                                                                                                                                                         |       | 1,468                    |       | 385                         |       |
| Current portion of  convertible subordinated debt                                                                                                                                                                                                                      |       | —                   |       | 440,000                     |       |
| Other current  liabilities                                                                                                                                                                                                                                             |       | 148,823                  |       | 115,877                     |       |
| Total current  liabilities                                                                                                                                                                                                                                             |       | 341,609                  |       | 680,112                     |       |
| Notes payable and  capital lease obligation                                                                                                                                                                                                                            |       | 2,743                    |       | 693                         |       |
| Convertible subordinated  debt                                                                                                                                                                                                                                         |       | 720,820                  |       | 720,820                     |       |
| Total liabilities                                                                                                                                                                                                                                                      |       | 1,065,172                |       | 1,401,625                   |       |
| Stockholders’ equity:                                                                                                                                                                                                                                             |       |                     |       |                        |       |
| Preferred stock, $1.00  par value, 1,000 shares authorized; none outstanding at March 31, 2007  and December 31, 2006                                                                                                                                        |       | —                   |       | —                      |       |
| Common stock, $.10 par  value, 240,000 shares authorized at March 31, 2007 and December 31,  2006, respectively; 110,534 and 110,040 shares issued, 106,273 and 105,779 shares  outstanding, at March 31, 2007 and December 31, 2006, respectively |       | 11,053                   |       | 11,004                      |       |
| Treasury stock, at cost  (4,261 shares at March 31, 2007 and December 31, 2006)                                                                                                                                                                         |       | (232,028                 | )          | (232,028                    | )          |
| Additional paid-in  capital                                                                                                                                                                                                                                            |       | 1,804,399                |       | 1,788,417                   |       |
| Accumulated deficit                                                                                                                                                                                                                                                    |       | (1,455,516               | )          | (1,478,065                  | )          |
| Accumulated other  comprehensive income                                                                                                                                                                                                                                |       | 14,405                   |       | 2,840                       |       |
| Total stockholders’  equity                                                                                                                                                                                                                                       |       | 142,313                  |       | 92,168                      |       |
| Total liabilities and stockholders’ equity                                                                                                                                                                                                                        |       | $                        | 1,207,485  |                        | $          | 1,493,793 |   |

 

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

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

| ** **                                                               | ** ** | **Three Months Ended** | ** ** |
|--------------------------------------------------------------------------|------------|----------------------------------|------------|
| ** **                                                               | ** ** | **March 31,  2007**         | ** ** | **March 31,  2006** | ** ** |
| Revenues:                                                                |       |                             |       |   |   |
| Product sales                                                            |       | $                                | 321,297    |   | $ | 277,505 |   |
| Royalties                                                                |       | 10,137                           |       | 8,173 |   |
| Total revenues                                                           |       | 331,434                          |       | 285,678 |   |
| Costs and expenses:                                                      |       |                             |       |   |   |
| Cost of product sold                                                     |       | 31,352                           |       | 25,533 |   |
| Cost of royalties                                                        |       | 266                              |       | 159 |   |
| Research and development                                                 |       | 40,702                           |       | 49,269 |   |
| Selling, marketing and distribution                                      |       | 192,118                          |       | 189,991 |   |
| General and administrative                                               |       | 18,892                           |       | 14,508 |   |
| Litigation settlement (net)                                              |       | 34,000                           |       | — |   |
| Total costs and expenses                                                 |       | 317,330                          |       | 279,460 |   |
| Income from operations                                                   |       | 14,104                           |       | 6,218 |   |
| Other income (expense):                                                  |       |                             |       |   |   |
| Interest income                                                          |       | 12,602                           |       | 9,794 |   |
| Interest expense                                                         |       | (2,757                           | )          | (5,551 | ) |
| Equity in investee losses                                                |       | (272                             | )          | (258 | ) |
| Other income (expense)                                                   |       | 272                              |       | (56 | ) |
| Income before income taxes                                               |       | 23,949                           |       | 10,147 |   |
| Income taxes                                                             |       | 1,400                            |       | 111 |   |
| Net income after income taxes                                            |       | $                                | 22,549     |   | $ | 10,036 |   |
| Basic net income per common share                                        |       | $                                | 0.21       |   | $ | 0.10 |   |
| Diluted net income per common share                                      |       | $                                | 0.19       |   | $ | 0.09 |   |
| Shares used in computing  basic and diluted net income per common share: |       |                             |       |   |   |
| Basic                                                                    |       | 105,980                          |       | 104,292 |   |
| Diluted                                                                  |       | 117,050                          |       | 115,470 |   |

 

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)**

| ** **                                                                                   | ** ** | **Three Months Ended** | ** ** |
|----------------------------------------------------------------------------------------------|------------|----------------------------------|------------|
| ** **                                                                                   | ** ** | **March 31,  2007**         | ** ** | **March 31,  2006** | ** ** |
| Cash flows from  operating activities:                                                       |       |                             |       |   |   |
| Net income                                                                                   |       | $                                | 22,549     |   | $ | 10,036 |   |
| Adjustments to reconcile  net income to net cash provided by (used in) operating activities: |       |                             |       |   |   |
| Depreciation and amortization                                                                |       | 5,779                            |       | 4,968 |   |
| Equity in investee losses                                                                    |       | 272                              |       | 258 |   |
| Stock compensation                                                                           |       | 8,772                            |       | 10,048 |   |
| Changes in operating  assets and liabilities:                                                |       |                             |       |   |   |
| Accounts receivable                                                                          |       | (23,230                          | )          | (10,137 | ) |
| Inventories                                                                                  |       | 3,004                            |       | (3,836 | ) |
| Other current assets                                                                         |       | (25,238                          | )          | (10,976 | ) |
| Accounts payable                                                                             |       | 16,515                           |       | 15,138 |   |
| Accrued expenses                                                                             |       | 50,936                           |       | (71,196 | ) |
| Other current liabilities                                                                    |       | 32,946                           |       | 28,130 |   |
| Net cash provided  by (used in) operating activities                                         |       | 92,305                           |       | (27,567 | ) |
| Cash flows from  investing activities:                                                       |       |                             |       |   |   |
| Purchases of short and long-term investments                                                 |       | (284,226                         | )          | (333,674 | ) |
| Sales and maturities of short and long-term  investments                                     |       | 403,632                          |       | 310,825 |   |
| Additions to property and equipment                                                          |       | (6,498                           | )          | (5,833 | ) |
| Investment in non-affiliate                                                                  |       | —                           |       | (8,939 | ) |
| Net cash provided  by (used in) investing activities                                         |       | 112,908                          |       | (37,621 | ) |
| Cash flows from  financing activities:                                                       |       |                             |       |   |   |
| Net proceeds from issuance of common stock                                                   |       | 7,258                            |       | 6,987 |   |
| Repayments of long-term debt and capital  leases                                             |       | (440,093                         | )          | (588 | ) |
| Net cash provided  by (used in) financing activities                                         |       | (432,835                         | )          | 6,399 |   |
| Effect of  exchange rate changes on cash and cash equivalents                                |       | (45                              | )          | (20 | ) |
| Net decrease in  cash and cash equivalents                                                   |       | (227,667                         | )          | (58,809 | ) |
| Cash and cash  equivalents at beginning of period                                            |       | $                                | 415,411    |   | $ | 178,144 |   |
| Cash and cash  equivalents at end of period                                                  |       | $                                | 187,744    |   | $ | 119,335 |   |
| Supplemental  schedule of cash flow information:                                             |       |                             |       |   |   |
| Cash paid during the period for interest                                                     |       | $                                | 11,004     |   | $ | 11,019 |   |
| Cash paid during the period for income taxes                                                 |       | $                                | 1,411      |   | $ | 25 |   |
| Non cash  activities:                                                                        |       |                             |       |   |   |
| Additions to  capital leases                                                                 |       | $                                | 3,260      |   | $ | — |   |

 

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

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**NOTES TO CONDENSED CONSOLIDATED INTERIM FINANCIALSTATEMENTS (UNAUDITED)**

**1.**                 Basisof Presentation

The accompanying condensed consolidated interimfinancial statements are unaudited and have been prepared on a basissubstantially consistent with the audited financial statements. Certaininformation and footnote disclosures normally included in our annual financialstatements have been condensed or omitted. The consolidated interim financialstatements, in the opinion of our management, reflect all adjustments(consisting of normal recurring accruals) necessary for a fair presentation ofthe results for the interim periods ended March 31, 2007 and 2006.

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

The consolidated results of operations for the interimperiods are not necessarily indicative of the results of operations to beexpected for the full fiscal year. These condensed consolidated interimfinancial statements should be read in conjunction with the audited financialstatements for the year ended December 31, 2006, which are contained inour annual report on Form 10-K for the year ended December 31,2006, filed with the Securities and Exchange Commission, or SEC.

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

**2.**                 RecentAccounting Pronouncements

In February 2007, the Financial AccountingStandards Board, or FASB, issued Statement of Financial Accounting Standards,or SFAS, No. 159, “The Fair Value Option for Financial Assets andFinancial Liabilities,” or SFAS 159, which allows entities the option tomeasure eligible financial instruments and certain other items at fair value. SFAS159 is effective for fiscal years beginning after November 15, 2007. We donot expect the adoption of SFAS 159 to have a material impact on ourconsolidated financial statements.

In June 2006, theFASB issued FASB Interpretation, or FIN, No. 48, “Accounting forUncertainty in Income Taxes,” or FIN 48. FIN 48 clarifies theapplication of SFAS No. 109, “Accounting for Income Taxes,” by providingdetailed guidance for the financial statement recognition, measurement anddisclosure of uncertain tax positions recognized in an enterprise’s financialstatements. Tax positions must meet a more likely than not recognitionthreshold at the effective date to be recognized upon the adoption ofFIN 48 and in subsequent periods. We adopted FIN 48 during the quarterended March 31, 2007. As noted in footnote 10 below, the adoption of FIN48 did not have a material impact on our consolidated financial statements orresults of operations.

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

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

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

For the threemonths ended March 31, 2007 and 2006, the following securities wereexcluded from the computation of diluted EPS because they would have had ananti-dilutive effect. These securities include the following:

a.                 Optionsto purchase shares of common stock:

| ** **            | ** ** | **Three Months  Ended  March 31, 2007**                        | ** **      | **Three Months  Ended  March 31, 2006** | ** ** |
|-----------------------|------------|-------------------------------------------------------------------------------|-----------------|--------------------------------------------------------|------------|
| ** **            | ** ** | **(in thousands, except price per share data)** | ** **      |
| Number of options     |       | 6,188                                                                         |            | 7,853                                                  |       |
| Price range per share |       | $                                                                             | 44.78 to $87.50 |                                                   | $          | 44.15 to $87.50 |   |
|                       |            |                                                                               |                 |                                                        |            |  |  |

 

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

| ** **                                            | ** ** | **March 31,  2007** | ** ** | **March 31,  2006** | ** ** |
|-------------------------------------------------------|------------|--------------------------|------------|--------------------------|------------|
| ** **                                            | ** ** | **(in thousands)**  | ** ** |
| 5% convertible  subordinated debentures due 2007 |       |                     | —     |                     |       |   | 4,763 |   |   |
| Total                                                 |       |                     | —     |                     |       |   | 4,763 |   |   |

 

We have issued 0%convertible subordinated notes due 2024, which were not convertible into equityas of March 31, 2007 or 2006 or at any time during the three months ended March 31,2007 or 2006. Once these notes become convertible into equity, shares of commonstock will be reserved under the conversion formula for issuance uponconversion if and when our common stock price exceeds $67.20 per share on theNASDAQ Global Select Market. Prior to such occurrence, the notes are onlyconvertible into cash.

**4.**                 Inventories

Inventoriesconsist of the following:

| ** **     | ** ** | **March 31,  2007** | ** ** | **December 31,  2006** | ** ** |
|----------------|------------|--------------------------|------------|-----------------------------|------------|
| ** **     | ** ** | **(in thousands)**  | ** ** |
| Raw materials  |       |                     | $          | 22,106                      |       |   |   | $ | 21,611 |   |   |
| Finished goods |       |                     | 12,016     |                        |       |   | 15,476 |   |   |
| Total          |       |                     | $          | 34,122                      |       |   |   | $ | 37,087 |   |   |

 

**5.**                 DeferredFinancing and Patents Costs

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

| ** **                       | ** ** | **March 31,  2007** | ** ** | **December 31,  2006** | ** ** |
|----------------------------------|------------|--------------------------|------------|-----------------------------|------------|
| ** **                       | ** ** | **(in thousands)**  | ** ** |
| Deferred  financing costs, gross |       | $                        | 20,407     |                        |       | $ | 34,440 |   |   |
| Accumulated  amortization        |       | (10,458                  | )          |                        | (23,215    | ) |   |
| Deferred  financing costs, net   |       | $                        | 9,949      |                        |       | $ | 11,225 |   |   |
| Patents, gross                   |       | $                        | 2,259      |                        |       | $ | 2,259 |   |   |
| Accumulated  amortization        |       | (1,654                   | )          |                        | (1,603     | ) |   |
| Patents, net                     |       | $                        | 605        |                        |       | $ | 656 |   |   |

 

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

| ** **                                | ** ** | **Three Months Ended** | ** ** |
|-------------------------------------------|------------|----------------------------------|------------|
| ** **                                | ** ** | **March 31,  2007**         | ** ** | **March 31,  2006** | ** ** |
| ** **                                | ** ** | **(in thousands)**          | ** ** |
| Amortization of  deferred financing costs |       |                             | $          | 1,276 |   |   |   | $ | 1,435 |   |   |
| Amortization of  patents                  |       |                             | 51         |   |   |   | 56 |   |   |
| Total                                     |       |                             | $          | 1,327 |   |   |   | $ | 1,491 |   |   |

 

**6.**                 ConvertibleSubordinated Debt

Convertiblesubordinated debt consists of the following:

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

 

**7.**                 ComprehensiveIncome

Totalcomprehensive income consists of net income, net foreign currency translationadjustments and net unrealized gain on available-for-sale securities.

| ** **                                        | ** ** | **Three Months Ended** | ** ** |
|---------------------------------------------------|------------|----------------------------------|------------|
| ** **                                        | ** ** | **March 31,  2007**         | ** ** | **March 31,  2006** | ** ** |
| ** **                                        | ** ** | **(in thousands)**          | ** ** |
| Comprehensive income:                             |       |                             |       |   |   |   |   |   |   |
| Net income                                        |       |                             | $          | 22,549 |   |   |   | $ | 10,036 |   |   |
| Net foreign  currency translation adjustment      |       |                             | 53         |   |   |   | (41 | ) |   |
| Unrealized gain  on available-for-sale securities |       |                             | 11,512     |   |   |   | 10,806 |   |   |
| Total comprehensive  income                       |       |                             | $          | 34,114 |   |   |   | $ | 20,801 |   |   |

 

**8.**                 LegalProceedings

***Tecastemizole Class ActionComplaints***

On April 20, 2007, we entered into a Memorandumof Understanding, or MOU, regarding the settlement of two securities classaction lawsuits, or class actions, pending in the United States District Courtfor the District of Massachusetts, or the Court, naming Sepracor and certain ofour current and former officers and one director as defendants. As previouslydisclosed, the class actions, which were filed on behalf of certain purchasersof our equity and debt securities, or the plaintiffs, allege that thedefendants violated the Federal securities laws by making false and misleadingstatements relating to the testing, safety and likelihood of approval oftecastemizole by the United States Food and Drug Administration, or FDA.

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Under the terms of the MOU, which outlines certainelements of a settlement that will require the execution by all parties ofdefinitive settlement agreement(s), notice to the plaintiffs and final approvalby the Court, we have agreed with counsel for the lead plaintiffs to pay orcause to be paid $52.5 million in settlement of the class actions. Of thisamount, we expect to pay $34.0 million, and we expect that our insurancecarriers will pay the remaining $18.5 million. In consideration of thissettlement payment, counsel for the lead plaintiffs has agreed that thesettlement will include a dismissal of the class actions with prejudice and arelease of claims by the plaintiffs.

The MOU contains no admission of wrongdoing. Sepracorand the other defendants have always maintained and continue to believe that wedid not engage in any wrongdoing or otherwise commit any violation of Federalor state securities laws or other laws. However, given the potential cost andburden of continued litigation, we believe the settlement is in our bestinterests and the best interests of our stockholders.

We can provide noassurance that we will be able to settle these lawsuits on the terms describedabove or at all. We may not be able to agree on final settlement terms withlead counsel to the plaintiffs and, if we do, the Court may not approve thesettlement, the plaintiffs may appeal or raise objections to the settlement andthe insurers may not contribute to the settlement the amounts to which theyhave agreed. If we are unable to settle these lawsuits, we will need tocontinue to defend against them, which could have a material adverse effect onour financial condition and business. If these matters were concluded in amanner adverse to us, we could be required to pay substantially more in damagesthan the proposed settlement amount. In addition, the costs to us of defendingany litigation 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.

***LevalbuterolHydrochloride Inhalation Solution Abbreviated New Drug Applications***

In September 2005, we received notification thatthe FDA had received an Abbreviated New Drug Application, or ANDA, from BreathLimited seeking approval of a generic version of our 1.25 mg, 0.63 mg and 0.31mg levalbuterol hydrochloride inhalation solution. Breath Limited’s submissionincludes a Paragraph IV certification alleging that our patents listed in theFDA publication entitled “Approved Drug Products With Therapeutic EquivalenceEvaluations,” commonly referred to as the “Orange Book,” for XOPENEX InhalationSolution are invalid, unenforceable or not infringed by Breath Limited’sproposed product. We have filed a civil action against Breath Limited forpatent infringement. We were notified in January 2006 of a second ANDAseeking approval of a generic version of our 1.25 mg, 0.63 mg and 0.31 mglevalbuterol hydrochloride inhalation solution including a Paragraph IVcertification, which was submitted to the FDA by Dey, L.P. We have filed acivil action against Dey, L.P. for patent infringement.

In April 2006, we were notified of an ANDAseeking approval of a generic version of our 1.25 mg, 0.63 mg and 0.31 mglevalbuterol hydrochloride inhalation solution including a Paragraph IVcertification, which was submitted to the FDA by Watson Laboratories, Inc.Watson’s Paragraph IV certification was limited to our patent that expires in2021 and covers certain levalbuterol hydrochloride inhalation solutions,including XOPENEX Inhalation Solution. We have decided not to file a civilaction against Watson Laboratories, Inc. for patent infringement at this time.

In August 2006, we received notification that theFDA had received an ANDA, including a Paragraph IV certification, fromDey, L.P. seeking approval of a generic version of our 1.25 mg/0.5 mLlevalbuterol hydrochloride inhalation solution concentrate. We have filed acivil action against Dey, L.P. for patent infringement.

Should we successfully enforce our patents, ANDAapproval will not occur until the expiration of the applicable patents.Otherwise, the FDA will stay its approval of the relevant ANDA until 30 months 

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following the date wereceived notice of such ANDA or until a court decides that our patents areinvalid, 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 companies, 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 would have a material adverse effect on ourbusiness.

***BROVANA PatentInfringement Claim***

On April 5, 2007, wewere served with a complaint filed by Dey, L.P. and Dey, Inc., referred tocollectively as Dey, alleging that BROVANATM (arformoterol tartrate) InhalationSolution infringes or will induce infringement of a single U.S. patent forwhich Dey owns all rights, title and interest. We have filed an answer andcounterclaim to this complaint, however it is too early to make a reasonableassessment as to the likely outcome or impact of this litigation. We are unableto reasonably estimate any possible range of loss related to this lawsuit due toits uncertain resolution.

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

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

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

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Three stockholder derivative complaints relating tothe same subject matter were filed against Sepracor, certain current and formermembers of our board of directors and certain of our current and formeremployees in the United States District Court for the District of Massachusettson September 28, 2006, October 3, 2006 and October 12, 2006. Inaddition to several common law theories alleging breaches of fiduciary duty andunjust enrichment, these complaints allege violations of Federal securitieslaws. On January 30, 2007, the Court consolidated the actions and aconsolidated complaint was filed. On April 9, 2007, we moved to stay the Federalcourt lawsuit pending resolution of the state court motion to dismiss, andon May 4, 2007 the Court entered an order granting the motion and stayingthe Federal case.

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

***LUNESTA TrademarkClaim***

In September 2006, Tharos Laboratories, Inc.filed suit against us in the United States District Court, District of Utah,Central Division, alleging trademark infringement, dilution, unfaircompetition, false advertising and false designation of origin arising out ofour use of our silk moth design in connection with LUNESTA® (eszopiclone). Tharos seeks unspecifiedmonetary damages and an injunction of our use of the silk moth design. In October 2006,we filed a motion to dismiss Tharos’ claims. On February 9, 2007, thecourt granted our motion in respect of the state unfair competition claims anddenied it in respect of Tharos’ other claims. We are unable to reasonablyestimate any possible range of loss related to this lawsuit due to itsuncertain resolution.

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

**9.**                 Commitmentsand Contingencies

In conjunction with thereview of our stock option granting practices, we have also evaluated therelated tax issues to determine if we may be subject to additional taxliability as a result of the matters under review. As a result of such charges,previously deducted compensation related to exercised stock options may benon-deductible under Section 162(m) of the Internal Revenue Code.Accordingly, our net operating loss carryforward, may be reduced; however, wehave a full valuation allowance against our deferred tax assets and, as aresult, do not expect any material impact on our financial position or resultsof operations. In addition, due to the revision of measurement dates, certainstock options that we previously treated as incentive stock options do notactually qualify for such treatment and must be treated as non-statutory stockoptions. Accordingly, we may be subject to fines and/or penalties relating tothe tax treatment of such stock options. However, we do not believe it isprobable that we will incur any material additional tax liability as a result ofthe matters under review and any such amount is not expected to have a materialimpact on our financial position or results of operations. The SEC and/or anyother governmental agency that may initiate a formal investigation may reachdifferent conclusions and, if so, we could be subject to monetary damages,fines and penalties, and our officers and/or directors could be prohibited fromserving as officers and directors of any public company and could be subject tocriminal penalties and disgorgement.

**10.**          IncomeTaxes

Deferred tax assets and liabilities are recognized forthe estimated future tax consequences attributable to tax benefit carryforwardsand to differences between the financial statement amounts of assets andliabilities and their respective tax basis. Deferred tax assets and liabilitiesare measured using enacted tax rates in effect for the year in which thedifferences are expected to reverse. A valuation 

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allowance is establishedif, based on management’s review of both positive and negative evidence, it ismore likely than not that all or a portion of the deferred tax asset will notbe realized. Our historical losses from operations represent significantnegative evidence that indicates the need for a valuation allowance.Accordingly, a valuation allowance has been established for the full amount ofthe deferred tax asset. If we determine, based on future profitability, thatthese deferred tax assets are more likely than not to be realized, a release ofall, or part, of the related valuation allowance could result in an immediatematerial income tax benefit in the period of decrease and material income taxprovisions in future periods.

We adopted FIN 48 on January 1, 2007. Theimplementation of FIN 48 did not have a material impact on our consolidatedfinancial statements or results of operations. We are currently in the processof conducting a study of our research and development credit carryforwards.This study may result in an adjustment to our research and development creditcarryforwards. However, until the study is completed and any adjustment isknown, no amounts are being presented as an uncertain tax position under FIN48.

We file tax returns in the U.S. Federal jurisdictionand in various state, local and foreign jurisdictions.  During the fourth quarter of 2006, the IRScommenced an audit of our 2005 and 2004 U.S. Federal income tax returns. We areno longer subject to IRS examination for years prior to 2004, althoughcarryforward attributes that were generated prior to 2004 may still be adjustedupon examination by the IRS if they either have been or will be used in afuture period. There are currently no state audits in progress. With limitedexceptions, we are no longer subject to state or local examinations for yearsprior to 2003, however, carryforward attributes that were generated prior to2003 may still be adjusted upon examination by state or local tax authoritiesif they either have been or will be used in a future period.

The foreign jurisdictions where we currently fileincome tax returns are Canada and the Netherlands Antilles. We are currentlyunder examination by Canada Revenue Agency, or CRA, for our Scientific Researchand Experimental Development claims for the years ended December 31, 2003 and 2004.There are currently no examinations being conducted by the tax authorities inthe Netherlands Antilles. With limited exceptions, we are no longer subject toexamination in Canada and the Netherlands Antilles for years prior to 2003 and1999, respectively, although carryforward attributes that were generated priorto these respective periods may still be adjusted upon examination if theyeither have been or will be used in a future period.

We recognize accrued interest and penalties related tounrecognized tax benefits as a component of tax expense. This policy did notchange as a result of the adoption of FIN 48. For the quarter ended March 31,2007 we did not recognize any accrued interest and penalties in ourconsolidated statement of operations or our consolidated balance sheet.

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

**CautionaryStatement Regarding Forward-Looking Statements**

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

**Executive Overview**

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

We currentlymanufacture and sell four products:

·       XOPENEX® (levalbuterol HCl) Inhalation Solution, ashort-acting bronchodilator, for the treatment or prevention ofbronchospasm in patients with reversible obstructive airway disease;

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

·       BROVANATM******(arformoterol tartrate) InhalationSolution as a long-term, twice-daily maintenance treatment ofbronchoconstriction in patients with chronic obstructive pulmonary disease, orCOPD, including chronic bronchitis and emphysema;

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

We market and sell XOPENEX Inhalation Solution,XOPENEX HFA, BROVANA and LUNESTA directly through our sales force. We haveentered into out-licensing arrangements with respect to several othercompounds. We expect to commercialize any additional products that we maysuccessfully develop or acquire through our sales force, through co-promotionagreements and/or through out-licensing partnerships.

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

·       continueto increase our LUNESTA revenues, despite increasing competition;

·       continueto increase our XOPENEX Inhalation Solution revenues by maintaining targetedsales and marketing efforts aimed at the retail, hospital and home health caremarket segments, which could be adversely affected by potential restrictions onMedicare Part B reimbursement or changes in the Medicare Part Breimbursement amount for XOPENEX Inhalation Solution;

·       continueto increase our XOPENEX HFA revenues;

·       successfullymarket and sell BROVANA;

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

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

Our long-term success depends in part on our abilityto successfully develop or acquire and commercialize new product candidates.

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

In 2007, we expect to beprofitable for the year on an operating and net income basis. We expect salesand marketing expenses to increase as compared to 2006 as we incur increasingsales commission and marketing costs related to anticipated product revenuegrowth. We expect to continue to invest in marketing programs related toLUNESTA, and marketing support for the BROVANA commercial introduction. Weexpect research and development expenses to increase as compared to 2006 as wecontinue to invest in research and development activities relating to studiesfor LUNESTA, for additional studies for BROVANA, and for continued developmentof our SEP-225289 and SEP-227162 drug candidates, as well asincreased drug discovery efforts. As part of our business strategy, for 2007and the future, we expect to consider and, as appropriate, consummateacquisitions of other technologies, product candidates, approved productsand/or businesses.

**Significant 2007Developments**

On April 20, 2007, we entered into a Memorandumof Understanding, or MOU, regarding the settlement of two securities classaction lawsuits, or class actions, pending in the United States District Courtfor the District of Massachusetts, or the Court, naming Sepracor and certain ofour current and former officers and one director as defendants. As previouslydisclosed, the class actions, which were filed on behalf of certain purchasersof our equity and debt securities, or the plaintiffs, allege that thedefendants violated the Federal securities laws by making false and misleadingstatements relating to the testing, safety and likelihood of approval oftecastemizole by the FDA.

Under the terms of the MOU, which outlines certainelements of a settlement that will require the execution by all parties ofdefinitive settlement agreement(s), notice to the plaintiffs and final approvalby the Court, we have agreed with counsel for the lead plaintiffs to pay orcause to be paid $52.5 million in settlement of the class actions. Of thisamount, we expect to pay $34.0 million, and we expect that our insurancecarriers will pay the remaining $18.5 million. In consideration of thissettlement payment, counsel for the lead plaintiffs has agreed that thesettlement will include a dismissal of the class actions with prejudice and arelease of claims by the plaintiffs.

The MOU contains no admission of wrongdoing. Sepracorand the other defendants have always maintained and continue to believe that wedid not engage in any wrongdoing or otherwise commit any violation of Federalor state securities laws or other laws. However, given the potential cost andburden of continued litigation, we believe the settlement is in our bestinterests and the best interests of our stockholders.

In April 2007, we announced the commercial availabilityof BROVANA (arformoterol tartrate)Inhalation Solution for the treatment of COPD. In October 2006, weannounced that the FDA approved 

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BROVANA InhalationSolution 15 micrograms (mcg) as a long-term, twice-daily (morning and evening),maintenance treatment of bronchoconstriction in patients with COPD includingchronic bronchitis and emphysema. BROVANA is for use by nebulization only.

In March 2007, we announced that we received noticethat Dey, L.P. and Dey, Inc., referred to collectively as Dey, had filed apatent infringement suit concerning BROVANA. On April 5, 2007, we were servedwith a complaint filed by Dey alleging that BROVANA infringes or will induceinfringement of a single U.S. patent for which Dey owns all rights, title andinterest. We have filed an answer and counterclaim to this complaint, however itis too early to make a reasonable assessment as to the likely outcome or impactof this litigation. We are unable to reasonably estimate any possible range ofloss related to this lawsuit due to its uncertain resolution.

In March 2007, we announced that W. James O’Sheahad resigned as our President and Chief Operating Officer and had been electedas Vice Chairman. In addition, we announced that, effective March 1, 2007,our board had elected Adrian Adams to the positions of President and ChiefOperating Officer and Andrew I. Koven to the positions of Executive VicePresident, General Counsel and Secretary. The board, upon the recommendation ofthe nominating and corporate governance committee, also elected Mr. Adamsto the board of directors, as a Class II director. We expect that Mr. Adamswill be elected to the position of Chief Executive Officer in the near future.Douglas E. Reedich, Senior Vice President, Legal Affairs, plans to leaveSepracor but will remain in this position for a short transition period toensure an orderly transition in the handling of our legal matters.

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

**Three Month Periodsended March 31, 2007 and 2006**

**Revenues**

Product sales were $321.3 million and $277.5 millionfor the three months ended March 31, 2007 and 2006, respectively, anincrease of approximately 16%.

Sales of LUNESTA were $148.3 million and $138.1million for the three months ended March 31, 2007 and 2006, respectively,an increase of approximately 7%. The increase is primarily the result of a 10%increase in the gross selling price and a 2% increase in the number of unitssold, offset by a higher rate of sales discounts and allowances. Adjustmentsrecorded to gross sales are disclosed below under the heading “Analysis ofgross sales to net sales.”

Sales of XOPENEX Inhalation Solution were $152.5million and $134.1 million for the three months ended March 31, 2007 and2006, an increase of approximately 14%. The increase is primarily due to a 10%increase in the number of units sold and a lower rate of sales discounts andallowances. Adjustments recorded to gross sales are disclosed below under theheading “Analysis of gross sales to net sales.”

Sales of XOPENEX HFA were $20.5million and $5.3 million for the three months ended March 31, 2007 and2006, respectively, an increase of approximately 283%.The increase is due to a lower rate of sales discounts andallowances and a 202% increase in the number of units sold. Adjustmentsrecorded to gross sales are disclosed below under the heading “Analysis ofgross sales to net sales.”

***Analysis of gross sales to net sales—******We*** recordproduct sales net of the following significant categories of product salesallowances: payment term discounts, government rebates and contractual discounts,returns and other discounts. We recompute these amounts each quarter and,historically, our estimates have not materially differed from actual results.Calculating each of these items involves significant 

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estimates and judgments and requires us to useinformation from external sources. *The*following table presents theadjustments deducted from gross sales to arrive at total net sales:

| ** **                                      | ** ** | **For the Three Months Ended March 31,** | ** ** |
|-------------------------------------------------|------------|------------------------------------------------------------------------|------------|
| ** **                                      | ** ** | **2007**                                                               | ** ** | **% of  Sales** | ** ** | **2006** | ** ** | **% of  Sales** | ** ** | **$ Change** | ** ** | **%  Change** | ** ** |
| ** **                                      | ** ** | **(dollars in thousands)**                                   | ** ** |
| Gross sales                                     |       | $                                                                      | 411,786    |   | 100.0 | % | $ | 340,415 |   | 100.0 | % | $ | 71,371 |   |   | 21 | % |   |
| Adjustments to gross  sales:                    |       |                                                                   |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Payment term discounts                          |       | 8,225                                                                  |       | 2.0 | % | 6,885 |   | 2.0 | % | 1,340 |   |   | 19 | % |   |
| Wholesaler fee-for-service                      |       | 10,150                                                                 |       | 2.5 | % | 8,561 |   | 2.5 | % | 1,589 |   |   | 19 | % |   |
| Government rebates and contractual discounts    |       | 65,887                                                                 |       | 16.0 | % | 40,192 |   | 11.8 | % | 25,695 |   |   | 64 | % |   |
| Returns                                         |       | 5,119                                                                  |       | 1.2 | % | 6,282 |   | 1.9 | % | (1,163 | ) |   | (19 | )% |   |
| Other (includes product introduction discounts) |       | 1,108                                                                  |       | 0.3 | % | 990 |   | 0.3 | % | 118 |   |   | 12 | % |   |
| Sub-total  adjustments                          |       | 90,489                                                                 |       | 22.0 | % | 62,910 |   | 18.5 | % | 27,579 |   |   | 44 | % |   |
| Net sales                                       |       | $                                                                      | 321,297    |   | 78.0 | % | $ | 277,505 |   | 81.5 | % | $ | 43,792 |   |   | 16 | % |   |

 

The increase in adjustments to gross sales as apercentage of gross sales for the three months ended March 31, 2007 ascompared to the three months ended March 31, 2006 primarily reflects anincrease in government rebates and contractual discounts as a result of anincrease in Medicaid discounts that we offered on the sales of XOPENEX HFA anddiscounts given through Medicare Part D and Managed Care programs that weoffered on the sales of LUNESTA, partially offset by a reduction in chargebacksdue to the termination of contractual discounts to a governmental agencyrelated to the sale of XOPENEX HFA during the first quarter of 2007. Partiallyoffsetting this increase in adjustments to gross sales as a percentage of grosssales was adecrease in sales returns adjustments primarily due to lower accrued returnrates for XOPENEX Inhalation Solution as a result of actual returns trendinglower over the past year.

A reserve has been established for Medicaid primaryand supplemental rebates that is included in the government rebates andcontractual adjustment to gross sales. We must pay a minimum primary rebate of15.1% on all utilization of our products by Medicaid beneficiaries. Thisprimary rebate may be higher if we provide discounts to commercial customersthat are greater than the statutorily mandated minimum rebate. In addition,several state Medicaid programs have implemented preferred drug lists, or PDLs.Products placed on a state Medicaid program’s PDL are not subject torestrictions on their utilization such as prior authorization before use. Tosecure a place on a given state PDL, we provide discounts to the state Medicaidprogram in the form of supplemental rebates.

As reflected in the table above, the allowance forgovernment rebates and discounts, which includes, among other things, Medicaidrebates and Medicare discounts, represents a significant portion of our salesallowances. Both the Federal and several state and local governments haveinitiated investigations and filed lawsuits concerning the rebate and discountpractices of many pharmaceutical companies to ensure compliance with theseprograms, and we were recently named as a defendant, together with numerousother companies, in one such suit. The formulas for determining these rebatesand discounts are set by law, are based on a number of different factors andcan be complicated. We recompute these amounts each quarter based on ourup-to-date knowledge of the statutory requirements and believe our calculationsare accurate and based on reasonable assumptions and judgments. However, as aresult of an investigation or lawsuit, we could be required to pay additionalrebates and/or discounts on sales made in prior periods and/or be subject tofines and/or other penalties. In addition, even if decided in our favor, aninvestigation or lawsuit concerning our rebate and discount practices could becostly, could divert attention of our management from our core business andcould harm our reputation.

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Royalties were $10.1 million and $8.2 million for thethree months ended March 31, 2007 and 2006, respectively, an increase ofapproximately 24%. The increase is primarily due to the increase in royaltiesearned on sales of CLARINEX®(desloratadine), under our agreement with Schering-PloughCorporation, or Schering-Plough, which were $3.3 million for the three monthsended March 31, 2007 compared to $2.0 million for the same period in 2006.In August 2006, we were notified that several ANDAs containing ParagraphIV certifications had been received by the FDA seeking approval of genericversions of certain of Schering-Plough’s CLARINEX products. If and while ageneric version of a CLARINEX product is marketed in the United States withoutSchering-Plough’s consent, Schering-Plough will have no obligation to payroyalties to us on the U.S. sales of CLARINEX products.

Royalties earned on the sales of ALLEGRA® (fexofenadine HCl), under our agreement withsanofi-aventis, increased slightly to $5.9 million for the three months ended March 31,2007 compared to $5.4 million for the same period in 2006.

Royalties earned on salesof XYZAL®/XUSALTM(levocetirizine) under our agreement with UCB, increased slightly to $954,000for the three months ended March 31, 2007 as compared $753,000 for thesame period in 2006.

**Costs of Revenues**

Cost of products sold was $31.4 million and $25.5million for the three months ended March 31, 2007 and 2006, respectively.

Cost of LUNESTA sold as a percentage of LUNESTA grosssales was approximately 6% for the three months ended March 31, 2007 and2006, with the largest portion being the royalty paid on net sales of LUNESTAto a third party.

Cost of XOPENEX Inhalation Solution sold as apercentage of XOPENEX Inhalation Solution gross sales was approximately 7% and9% for the three months ended March 31, 2007 and 2006, respectively.The decrease in the cost as a percentage of gross sales is primarily due to anincrease in our gross sales price, which occurred in the first quarter of 2006.

Cost of XOPENEX HFA sold as a percentage of XOPENEXHFA gross sales was approximately 16% and 14% for the three months ended March 31,2007 and 2006, respectively. Included in the costs of XOPENEX HFA sold is aroyalty paid on net sales of XOPENEX HFA to Minnesota Mining and Manufacturing Company,or 3M, our third-party finished goods manufacturer of the product. Theincrease in the cost as a percentage of gross sales is primarily due to anincrease in the cost of materials used in manufacturing.

Cost of royalties earnedwas $266,000 and $159,000 for the three months ended March 31, 2007 and2006, respectively, an increase of approximately 67%. The cost of royalties inboth periods relates to an obligation to a third party as a result of royaltieswe earn from Schering-Plough based on its sales of CLARINEX. Thisincrease in third-party obligations is due to the increase in royalties earnedin the three months ended March 31, 2007 as compared with the same periodin 2006.

**Research andDevelopment**

Research and development expenses were $40.7 millionand $49.3 million for the three months ended March 31, 2007 and 2006,respectively, a decrease of approximately 17%. The decrease is primarily due tolower spending on our XOPENEX HFA MDI formulation and co-morbid Phase IVLUNESTA clinical development programs.

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, 

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allows the opportunity forstudy in humans, or clinical study, of the potential new drug. Clinicaldevelopment typically involves three phases of study: Phase I, II and III.The most significant costs in clinical development are in Phase III clinicaltrials, as they tend to be the longest and largest studies in the drugdevelopment process. Following successful completion of Phase III clinicaltrials, a New Drug Application, or NDA, must be submitted to, and accepted by,the FDA, and the FDA must approve the NDA, prior to commercialization of thedrug. We may elect either on our own, or at the request of the FDA, to conductfurther studies that are referred to as Phase IIIB and IV studies, which ifconducted, could cause us to incur substantial costs. Phase IIIB studies areinitiated and either completed or substantially completed while the NDA isunder FDA review. These studies are conducted under an IND. Phase IV studies,also referred to as post-marketing studies, are studies that are initiated andconducted after the FDA has approved a product for marketing. Phase IV studiesmay be requested by the FDA either before or after the FDA has approved an NDA.These studies may also be independently initiated by the company for which anNDA has been approved. The FDA and the companies conducting post-marketingstudies use them to gather additional information about a product’s safety,efficacy or optimal use.

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

For additional discussion of the risks anduncertainties associated with completing development of potential productcandidates, see “Risk Factors.”

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Belowis a summary of development of our products and product candidates thatrepresent approximately 10% or more of our direct project research anddevelopment spending for the three months ended March 31, 2007 or 2006.The “Estimate of Completion of Phase” column contains forward-lookingstatements regarding expected timing of completion of product developmentphases. Completion of product development, if successful, culminates in thesubmission of an NDA to the FDA; however, there can be no assurance that theFDA will accept for filing, or approve, any NDA. The actual timing ofcompletion of phases could differ materially from the estimates provided in thetable. In the table below, the three FDA-approved products and the one productcandidate listed accounted for approximately 66% of our direct project researchand development spending for the three months ended March 31, 2007. Noother product candidate accounted for more than 5% of our direct research anddevelopment spending in this period.

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

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*                    Wecommercially introduced LUNESTA in April 2005.

**             We commerciallyintroduced XOPENEX HFA in December 2005.

***      We commercially introducedBROVANA in April 2007.

Belowis a summary of expenditure information related to our products and productcandidates representing approximately 10% or more of our direct projectresearch and development spending during the three months ended March 31,2007 or 2006, as well as the costs incurred to date on these projects. Thecosts in this analysis include only direct costs and do not include certainindirect labor, overhead, share-based compensation or other costs that benefitmultiple projects. As a result, fully-loaded research and development costsummaries by project are not presented.

| ** **                           | ** ** | **Project costs for  the three  months ended  March 31, 2007** | ** ** | **Project costs to  date through  March 31, 2007** | ** ** | **Project costs for  the three  months ended  March 31, 2006** | ** ** | **Project costs to  date through  March 31, 2006** | ** ** |
|--------------------------------------|------------|----------------------------------------------------------------------------------------------|------------|-----------------------------------------------------------------------------|------------|----------------------------------------------------------------------------------------------|------------|-----------------------------------------------------------------------------|------------|
| ** **                           | ** ** | **(in thousands)**                                                                      | ** ** |
| LUNESTA  (eszopiclone)               |       |                                                                                         | $          | 5,605                                                                       |       |                                                                                         |       | $                                                                           | 225,628    |   |   |   | $ | 7,981 |   |   |   | $ | 207,703 |   |   |
| XOPENEX HFA  (levalbuterol tartrate) |       |                                                                                         | $          | 960                                                                         |       |                                                                                         |       | $                                                                           | 170,258    |   |   |   | $ | 5,287 |   |   |   | $ | 162,078 |   |   |
| BROVANA  (arformoterol tartrate)     |       |                                                                                         | $          | 3,526                                                                       |       |                                                                                         |       | $                                                                           | 177,457    |   |   |   | $ | 3,643 |   |   |   | $ | 165,221 |   |   |
| SEP-225289                           |       |                                                                                         | $          | 1,859                                                                       |       |                                                                                         |       | $                                                                           | 14,969     |   |   |   | $ | 2,799 |   |   |   | $ | 6,750 |   |   |

 

*Due tothe length of time necessary to develop a product, uncertainties related to theability to obtain governmental approval for commercialization, and difficultyin estimating costs of projects, it is difficult to make accurate andmeaningful estimates of the ultimate cost to bring our product candidates toFDA-approved status. We do not believe it is possible to estimate, withany degree of accuracy, the costs of product candidates that are in stagesearlier than Phase III. Accordingly, because all of our product candidates arein Phase I development, we have not provided any such estimates.*

**Selling, Marketing and Distribution**

Selling, marketing anddistribution expenses were $192.1 million and $190.0 million for the threemonths ended March 31, 2007 and 2006, respectively, an increase ofapproximately 1%. The increase is primarily attributable to a $19.9 millionincrease in personnel-related expense as a result of hiring 

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additionalsales representatives and management in the second quarter of 2006 to supportour marketed products, in addition to increased costs associated with our April 2007commercialization of BROVANA. These increases were largely offset by a $20.4million decrease in marketing, advertising and promotional expenses primarilyrelated to costs to support LUNESTA.

**General and Administrative**

General and administrativecosts were $18.9 million and $14.5 million for the three months ended March 31,2007 and 2006, respectively, an increase of approximately 30%. The increase isprimarily the result of increased legal fees largely related to patent andshareholder litigation, as well as expenses associated with responding to the Securitiesand Exchange Commission, or SEC’s, informal inquiry into our stock optionpractices and the related internal investigation and derivative lawsuits.

**Litigation Settlement**

Litigation settlementexpense was $34.0 million and $0 for the three months ended March 31, 2007and 2006, respectively. In April 2007, we entered into a MOU regarding thesettlement of two class actions alleging that the we and certain of our currentand former officers and one director violated the Federal securities laws bymaking false and misleading statements relating to the testing, safety andlikelihood of approval of tecastemizole by the FDA. Under the terms of the MOU,which outlines certain elements of a settlement that will require the executionby all parties of definitive settlement agreement(s), notice to the plaintiffsand final approval by the Court, we have agreed with counsel for the lead plaintiffsto pay or cause to be paid $52.5 million in settlement of the class actions. Ofthis amount, we expect to pay $34.0 million, and expect that our insurancecarriers will pay the remaining $18.5 million. In consideration of thissettlement payment, counsel for the lead plaintiffs has agreed that thesettlement will include a dismissal of the class actions with prejudice and arelease of claims by the plaintiffs.

**Other Income (Expense)**

Interest income was $12.6million and $9.8 million for the three months ended March 31, 2007 and2006, respectively, an increase of approximately 29%. The increase is primarilydue to higher interest rates earned on investments in 2007. For the threemonths ended March 31, 2007 and 2006, the average annualized interest ratethat we earned on our investments was 5.26% and 4.13%, respectively.

Interest expense was $2.8million and $5.6 million for the three months ended March 31, 2007 and2006, respectively. The expense in both periods is primarily related to theinterest we paid on our 5% convertible subordinated debentures, which we repaidin full upon their maturity on February 15, 2007.

Equity in investee losseswere $272,000 and $258,000 for the three months ended March 31, 2007 and2006, respectively. The loss represents our portion of BioSphere losses.

**Income Taxes**

Income tax expense was$1.4 million and $111,000 for the three months ended March 31, 2007 and2006, respectively. The increase in income tax expense for the three monthsended March 31, 2007 as compared to the three months ended March 31,2006 is primarily due to U.S. Federal and state alternative minimum tax, orAMT, as a result of an increase in net income. Although we had Federal and statetax net operating loss carryforwards of approximately $1,197.3 million as of December 31,2006, the utilization of these loss carryforwards is limited in the calculationof AMT. For the three months ended March 31, 2006, income tax expenseincludes state tax expense and foreign income tax expense. Our historicallosses from operations continue to represent significant negative evidence thatindicates the need for a valuation allowance. Accordingly, a valuationallowance has been established for the full amount of our deferred tax asset. Ifwe determine, based on future profitability, that these deferred tax assets aremore likely than not 

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to berealized, a release of all, or part, of the related valuation allowance couldresult in an immediate material income tax benefit in the period of decreaseand material income tax provisions in future periods.

**Liquidity and Capital Resources**

Our liquidity requirementshave historically consisted of research and development expenses, sales andmarketing expenses, capital expenditures, working capital, debt service andgeneral corporate expenses. Historically, we have funded these requirements andthe growth of our business primarily through convertible subordinated debtofferings, the issuance of common stock, including the exercise of stockoptions, sales of our products and license agreements for our drug compounds.We now expect to fund our liquidity requirements primarily with revenuegenerated from product sales. We also believe we have the ability to meet ourshort-term liquidity needs through the use of our cash and short-terminvestments on hand at March 31, 2007.

Cash, cash equivalents andshort- and long-term investments totaled $830.3 million, or 69% of totalassets, at March 31, 2007, compared to $1.2 billion, or 78% of totalassets, at December 31, 2006.

Net cash provided byoperating activities for the three months ended March 31, 2007 was $92.3 million,which includes net income of $22.5 million. Our net income includes non-cashcharges of $14.8 million, consisting primarily of share-based compensation anddepreciation and amortization expense. Accounts receivable increased by $23.2million primarily due to LUNESTA and XOPENEX Inhalation Solution sales.Inventory decreased by $3.0 million in an effort to reduce the number of daysof inventory on hand. Other current assets increased by $25.3 million, which isprimarily attributable to an increase in prepaid expenses and the insurancereceivable resulting from the preliminary settlement of two class actions.Accounts payable increased by $16.5 million primarily due to timing of vendorpayments. Accrued expenses increased by $50.9 million primarily due to thecharge related to the preliminary settlement of two class actions and increasedsales and marketing costs relating to the commercialization of BROVANA, off setby a decline in accrued interest as a result of the February 2007 paymentin full of our 5% convertible subordinated debentures. Other currentliabilities increased by $32.9 million primarily due to an increase in accrualsfor product revenue rebates related to XOPENEX and LUNESTA product sales.

Net cash provided byinvesting activities for the three months ended March 31, 2007 was $112.9 million,which is primarily attributable to cash provided by net sales of short-and long-term investments of $119.4 million offset by purchases of property andequipment of $6.5 million.

Net cash used in financingactivities for the three months ended March 31, 2007 was $432.8 million.We received proceeds of $7.3 million from issuing common stock upon theexercise of stock options issued under our stock option plans and we used$440.1 million to repay capital lease obligations and long-term debt.

Webelieve our existing cash and the cash flow that we anticipate from operationsand current strategic alliances will be sufficient to support existingoperations through at least 2008. In the longer term, we expect to continue tofund our operations with revenue generated from product sales. Our actualfuture cash requirements and our ability to generate revenue, however, willdepend on many factors, including:

·       LUNESTAsales;

·       XOPENEXInhalation Solution and XOPENEX HFA sales;

·       successfulcommercialization of BROVANA;

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

·       successfulexpansion into foreign markets;

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

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

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

·       achievementof milestones under our strategic alliance arrangements;

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

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

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

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

**Critical Accounting Policies and Estimates**

We identified criticalaccounting policies and estimates in our annual report on Form 10-Kfor the year ended December 31, 2006. These critical accounting policiesrelate to product revenue recognition, royalty revenue recognition, rebate andreturn reserves, patents, intangibles and other assets, accounts receivable andbad debt, income taxes, induced conversion of debt, inventory write-downsand stock-based compensation. These policies require us to make estimates inthe preparation of our financial statements as of a given date. Because of theuncertainty inherent in these matters, our actual results could differ from theestimates we use in applying the critical accounting policies.

A summary of significantaccounting policies and a description of accounting policies that areconsidered critical may be found in Part II, Item 7 of our Annual Reporton Form 10-K for the year ended December 31, 2006 in the “CriticalAccounting Policies and Estimates” section. Other than as described below, ourcritical accounting policies and estimates are as set forth in the Form 10-K.

***Product sales allowances and reserves—******The*** followingtable summarizes activity in each of our productsales allowances and reserve categories for the three months ended March 31,2007:

| ** **                             | ** ** | **Payment  Terms  Discount** | ** ** | **Wholesaler  Fee  for Service** | ** ** | **Government  Rebates and  Contractual  Discounts** | ** ** | **Returns** | ** ** | **Other  Discounts** | ** ** | **Total** | ** ** |
|----------------------------------------|------------|------------------------------|------------|---------------------------------------|------------|----------------------------------------------------------|------------|-------------|------------|----------------------|------------|-----------|------------|
| ** **                             | ** ** | **(in thousands)**           | ** ** |
| **Balance  at December 31, 2006** |       |                         | $          | (4,351                                | )          |                                                     |       | $           | (16,669    | )                    |       |      | $          | (74,249 | ) |   | $ | (23,218 | ) |   | $ | (1,511 | ) |   | $ | (119,998 | ) |
| Current provision:                     |       |                         |       |                                  |       |                                                     |       |        |       |                 |       |      |       |   |   |   |   |   |   |   |   |
| Current year                           |       |                         | (8,225     | )                                     |       |                                                     | (10,150    | )           |       |                 | (65,250    | )         |       | (5,119 | ) |   | (1,407 | ) |   | (90,151 | ) |
| Prior year                             |       |                         | —     |                                  |       |                                                     | —     |        |       |                 | (637       | )         |       | — |   |   | 299 |   |   | (338 | ) |
| Total                                  |       |                         | (8,225     | )                                     |       |                                                     | (10,150    | )           |       |                 | (65,887    | )         |       | (5,119 | ) |   | (1,108 | ) |   | (90,489 | ) |
| Actual:                                |       |                         |       |                                  |       |                                                     |       |        |       |                 |       |      |       |   |   |   |   |   |   |   |   |
| Current year                           |       |                         | 3,932      |                                  |       |                                                     | —     |        |       |                 | 13,984     |      |       | — |   |   | 368 |   |   | 18,284 |   |
| Prior year                             |       |                         | 4,378      |                                  |       |                                                     | 6,404      |        |       |                 | 20,942     |      |       | 6,613 |   |   | 1,005 |   |   | 39,342 |   |
| Total                                  |       |                         | 8,310      |                                  |       |                                                     | 6,404      |        |       |                 | 34,926     |      |       | 6,613 |   |   | 1,373 |   |   | 57,626 |   |
| **Balance at March 31, 2007**     |       |                         | $          | (4,266                                | )          |                                                     |       | $           | (20,415    | )                    |       |      | $          | (105,210 | ) |   | $ | (21,724 | ) |   | $ | (1,246 | ) |   | $ | (152,861 | ) |

 

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

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

We adopted the Financial Accounting Standards Board,or FASB, interpretation, or FIN, No. 48, “Accounting for Uncertainty in IncomeTaxes,” or FIN 48, on January 1, 2007. The implementation of FIN 48 didnot have a material impact on our consolidated financial statements or resultsof operations. We are currently in the process of conducting a study of ourresearch and development credit carryforwards. This study may result in anadjustment to our research and development credit carryforwards. However, untilthe study is completed and any adjustment is known, no amounts are beingpresented as an uncertain tax position under FIN 48.

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

The foreign jurisdictions where we currently fileincome tax returns are Canada and the Netherlands Antilles. We are currentlyunder examination by Canada Revenue Agency, or CRA, for our Scientific Researchand Experimental Development claims for the years ended December 31, 2003 and2004. There are currently no examinations being conducted by the taxauthorities in the Netherlands Antilles. With limited exceptions, we are nolonger subject to examination in Canada and the Netherlands Antilles for yearsprior to 2003 and 1999, respectively, although carryforward attributes thatwere generated prior to these respective periods may still be adjusted uponexamination if they either have been or will be used in a future period.

We recognize accruedinterest and penalties related to unrecognized tax benefits as a component oftax expense. This policy did not change as a result of the adoption of FIN 48.For the quarter ended March 31, 2007 we did not recognize any accruedinterest and penalties in our consolidated statement of operations or ourconsolidated balance sheet.

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**ContractualObligations**

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

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

**Market Risk**

We are exposed to marketrisk from changes in interest rates and equity prices, which could affect ourfuture results of operations and financial condition. These risks are describedin our annual report on Form 10-K for the year ended December 31,2006. As of May 10, 2007, there have been no material changes to themarket risks described in our annual report on Form 10-K for theyear ended December 31, 2006. Additionally, we do not anticipate anynear-term changes in the nature of our market risk exposures or in ourmanagement’s objectives and strategies with respect to managing such exposures.

**ITEM 4.**                CONTROLSAND PROCEDURES

**Evaluation ofDisclosure Controls and Procedures**

Our management, with theparticipation of our chief executive officer and chief financial officer,evaluated the effectiveness of our disclosure controls and procedures as of March 31,2007. The term “disclosure controls and procedures,” as defined in Rules 13a-15(e) and 15d-15(e) underthe Exchange Act, means controls and other procedures of a company that aredesigned to ensure that information required to be disclosed by a company inthe reports that it files or submits under the Exchange Act is recorded,processed, summarized and reported, within the time periods specified in theSEC’s rules and forms. Disclosure controls and procedures include, withoutlimitation, controls and procedures designed to ensure that informationrequired to be disclosed by a company in the reports that it files or submitsunder the Exchange Act is accumulated and communicated to the company’smanagement, including its principal executive and principal financial officers,as appropriate to allow timely decisions regarding required disclosure. Ourmanagement recognizes that any controls and procedures, no matter how welldesigned and operated, can provide only reasonable assurance of achieving theirobjectives and our management necessarily applies its judgment in evaluatingthe cost-benefit relationship of possible controls and procedures. Based on theevaluation of our disclosure controls and procedures as of March 31, 2007,our chief executive officer and chief financial officer concluded that, as ofsuch date, our disclosure controls and procedures were effective at thereasonable assurance level.

**Change in andEvaluation of Internal Control Over Financial Reporting**

There has been no change in our internal control overfinancial reporting (as defined in Rules 13a-15(f) and 15d-15(f) underthe Exchange Act) during our quarter ended March 31, 2007 that hasmaterially affected, or is reasonably likely to materially affect, our internalcontrol over financial reporting.

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**PART II**

**OTHERINFORMATION**

**ITEM1.**                LEGAL PROCEEDINGS

***Tecastemizole Class ActionComplaints***

On April 20, 2007, weentered into a MOU regarding the settlement of two class actions pending in theCourt naming Sepracor and certain of our current and former officers and onedirector as defendants. As previously disclosed, the class actions, which werefiled on behalf of certain purchasers of our equity and debt securities, or theplaintiffs, allege that the defendants violated the Federal securities laws bymaking false and misleading statements relating to the testing, safety andlikelihood of approval of tecastemizole by the FDA.

Under the terms of theMOU, which outlines certain elements of a settlement that will require theexecution by all parties of definitive settlement agreement(s), notice to theplaintiffs and final approval by the Court, we have agreed with counsel for thelead plaintiffs to pay or cause to be paid $52.5 million in settlement of theclass actions. Of this amount, we expect to pay $34.0 million, and we expectthat our insurance carriers will pay the remaining $18.5 million. Inconsideration of this settlement payment, counsel for the lead plaintiffs hasagreed that the settlement will include a dismissal of the class actions withprejudice and a release of claims by the plaintiffs.

The MOU contains noadmission of wrongdoing. Sepracor and the other defendants have alwaysmaintained and continue to believe that we did not engage in any wrongdoing orotherwise commit any violation of Federal or state securities laws or otherlaws. However, given the potential cost and burden of continued litigation, webelieve the settlement is in our best interests and the best interests of ourstockholders.

We can provide noassurance that we will be able to settle these lawsuits on the terms describedabove or at all. We may not be able to agree on final settlement terms withlead counsel to the plaintiffs and, if we do, the Court may not approve thesettlement, the plaintiffs may appeal or raise objections to the settlement andthe insurers may not contribute to the settlement the amounts to which theyhave agreed. If we are unable to settle these lawsuits, we will need tocontinue to defend against them, which could have a material adverse effect onour financial condition and business. If these matters were concluded in amanner adverse to us, we could be required to pay substantially more in damagesthan the proposed settlement amount. In addition, the costs to us of defendingany litigation 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.

***LevalbuterolHydrochloride Inhalation Solution Abbreviated New Drug Applications***

In September 2005, wereceived notification that the FDA had received an ANDA from Breath Limitedseeking approval of a generic version of our 1.25 mg, 0.63 mg and 0.31 mglevalbuterol hydrochloride inhalation solution. Breath Limited’s submissionincludes a Paragraph IV certification alleging that our patents listed in the FDApublication entitled “Approved Drug Products With Therapeutic Equivalence Evaluations,”commonly referred to as the “Orange Book,” for XOPENEX Inhalation Solution areinvalid, unenforceable or not infringed by Breath Limited’s proposed product.We have filed a civil action against Breath Limited for patent infringement. Wewere notified in January 2006 of a second ANDA seeking approval of ageneric version of our 1.25 mg, 0.63 mg and 0.31 mg levalbuterol hydrochlorideinhalation solution including a Paragraph IV certification, which was submittedto the FDA by Dey, L.P. We have filed a civil action against Dey, L.P. forpatent infringement.

In April 2006, wewere notified of an ANDA seeking approval of a generic version of our 1.25 mg,0.63 mg and 0.31 mg levalbuterol hydrochloride inhalation solution including aParagraph IV certification, 

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whichwas submitted to the FDA by Watson Laboratories, Inc. Watson’s ParagraphIV certification was limited to our patent that expires in 2021 and coverscertain levalbuterol hydrochloride inhalation solutions, including XOPENEXInhalation Solution. We have decided not to file a civil action against WatsonLaboratories, Inc. for patent infringement at this time.

In August 2006, wereceived notification that the FDA had received an ANDA, including a Paragraph IVcertification, from Dey, L.P. seeking approval of a generic version of our 1.25mg/0.5 mL levalbuterol hydrochloride inhalation solution concentrate. We havefiled a civil action against Dey, L.P. for patent infringement.

Should we successfullyenforce our patents, ANDA approval will not occur until the expiration of theapplicable patents. Otherwise, the FDA will stay its approval of the relevantANDA until 30 months following the date we received notice of such ANDA oruntil 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 prevent the generic companies,for the full term of our patents, from marketing their generic version ofXOPENEX Inhalation Solution. Introduction of a generic copy of XOPENEXInhalation Solution before the expiration of our patents would have a materialadverse effect on our business.

***BROVANA PatentInfringement Claim***

On April 5, 2007, wewere served with a complaint filed by Dey alleging that BROVANATM (arformoteroltartrate) Inhalation Solution infringes or will induce infringement of a singleU.S. patent for which Dey owns all rights, title and interest. We have filed ananswer and counterclaim to this complaint, however it is too early to make a reasonableassessment as to the likely outcome or impact of this litigation. We are unableto reasonably estimate any possible range of loss related to this lawsuit dueto its uncertain resolution.

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

We announced in June 2006,that the SEC is conducting an informal inquiry into our stock option grants andstock option granting practices. A special committee of our outside directors,with the assistance of outside legal counsel and outside accounting specialists,reviewed the stock option grants to our officers, directors and employees from1996 to June 2006 under our various stock option plans in effect duringthis period. Our finance department also reviewed the stock option grants andstock option practices from 1996 to June 2006. Their review resulted inthe restatement of our financial statements for the quarters ended March 31,June 30 and September 30, 2005, the quarter ended March 31, 2006and the year ended December 31, 2005, 2004 and 2003. Representatives fromthe U.S. Attorneys Office have been present at meetings that our outsidecounsel have had with the SEC. While the U.S. Attorneys Office has notinitiated an investigation, we cannot be certain that it will not. In October 2006,the IRS commenced an audit into our 2005 and 2004 U.S. Federal income taxreturns and has requested, among other things, certain information relating toour stock option grants and granting practices. The SEC and/or any othergovernmental agency that may initiate a formal investigation may reachdifferent conclusions and, if so, we could be subject to monetary damages,fines and penalties, and our officers and/or directors would be prohibited fromserving as officers and directors of any public company and could be subject tocriminal penalties and/or disgorgement.

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We have accepted serviceof three stockholder derivative complaints relating to certain of our stockoption grants that were filed in the Superior Court, Middlesex County,Commonwealth of Massachusetts, naming Sepracor as nominal defendant and alsonaming as defendants certain current members of our board of directors andcertain of our current and former employees. The complaints allege purportedbreaches of fiduciary duties and unjust enrichment in connection with certainstock option grants made by us between June 1998 and May 2001. Thecomplaints seek monetary damages in unspecified amounts, equitable andinjunctive relief, including disgorgement of profits obtained by certaindefendants and other relief as determined by the Court. On September 12,2006, the three complaints were consolidated into one action, and on September 22,2006, the action was transferred to the Business Litigation Session of theSuperior Court, Suffolk County, Commonwealth of Massachusetts. On October 19,2006, plaintiffs filed a consolidated complaint alleging breaches of fiduciaryduty and unjust enrichment in connection with certain stock option grants wemade between December 1995 and April 2003. On November 20, 2006,we moved to dismiss the Consolidated Amended Complaint and a hearing onthe motion was held on March 20, 2007. No decision on this motion has beenrendered at this time.

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

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

***LUNESTA TrademarkClaim***

In September 2006,Tharos Laboratories, Inc. filed suit against us in the United StatesDistrict Court, District of Utah, Central Division, alleging trademarkinfringement, dilution, unfair competition, false advertising and falsedesignation of origin arising out of our use of our silk moth design inconnection with LUNESTA® (eszopiclone). Tharos seeks unspecifiedmonetary damages and an injunction of our use of the silk moth design. In October 2006,we filed a motion to dismiss Tharos’ claims. On February 9, 2007, thecourt granted our motion in respect of the state unfair competition claims anddenied it in respect of Tharos’ other claims. We are unable to reasonablyestimate any possible range of loss related to this lawsuit due to itsuncertain resolution.

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

**ITEM1A.**        RISK FACTORS

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

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

***We have a historyof net losses and we may not be able to generate revenues sufficient to achieveand maintain profitability on a quarterly and annual basis.***

Until the quarter ended December 31,2005, we had incurred net losses each quarter since our inception. It ispossible we will not be able to achieve profitability again or maintainprofitability on a quarterly or annual basis. We expect to continue to incursignificant operating expenditures to further develop and commercialize ourproducts and product candidates and in order to allow us to otherwise expandour product portfolio through drug discovery efforts. As a result, we will needto generate significant revenues in future periods to achieve and maintainprofitability. We cannot assure you that we will achieve significant revenuesor that we will ever achieve profitability again. Even if we do achieveprofitability again, we may not be able to maintain profitability for anysubstantial period of time. If revenues grow more slowly than we anticipate orif operating expenses exceed our expectations or cannot be adjustedaccordingly, our business, results of operations and financial condition willbe materially and adversely affected. In addition, if we are unable to achieveor maintain profitability on a quarterly or annual basis, the market price ofour common stock may decline.

***Almost all of ourrevenues are derived from sales of LUNESTA and XOPENEX Inhalation Solution andour future success depends on the continued commercial success of theseproducts.***

Approximately 91% of ourtotal revenues for the three months ended March 31, 2007 and 94% of ourtotal revenues for the twelve months ended December 31, 2006 resulted fromsales of LUNESTA and XOPENEX Inhalation Solution, and we expect that sales fromthese two products will continue to represent a significant majority of ourrevenues for the coming year. In April 2005, we commercially introducedLUNESTA as a new product in a highly and increasingly competitive market, andwe cannot be certain that it will achieve continued commercial success. Inaddition, we do not have long-term sales contracts with our customers, and werely on purchase orders for sales of LUNESTA and XOPENEX Inhalation Solution.Reductions, delays or cancellations of orders for LUNESTA or XOPENEX InhalationSolution could adversely affect our operating results. If sales of LUNESTA andXOPENEX Inhalation Solution do not continue to increase, we may not havesufficient revenues to achieve our business plan or repay our outstanding debt,and our business will not be successful. In December 2005, we commerciallyintroduced XOPENEX HFA and in April 2007, we commercially introducedBROVANA. We cannot be certain that either XOPENEX HFA or BROVANA will achievecommercial success.

With respect to XOPENEXInhalation Solution, three companies have filed ANDAs with the FDA seekingto market a generic version of levalbuterol hydrochloride inhalation solution.We have commenced patent litigation against two of these companies and we havedecided not to commence litigation against the third at this time. A findingthat the products these companies wish to market do not infringe our patents orthat our patents are invalid or unenforceable will likely lead to theintroduction of generic levalbuterol inhalation solution. If this occurs, salesof XOPENEX Inhalation Solution will be adversely affected.

In addition, Medicarereimbursement rates for XOPENEX Inhalation Solution have been favorable since January 2005,but we cannot be certain these favorable rates will continue. In December 2006,the Centers for Medicare and Medicaid Services, or CMS, commenced a NationalCoverage Analysis, or NCA, to determine when use of nebulized levalbuterol intreating COPD in the Medicare population is reasonable and necessary. We expectthe NCA process to be concluded before the end of 2007. We estimate thatapproximately 25 to 30 percent of our XOPENEX Inhalation Solution units soldare subject to reimbursement under Medicare Part B, and if the NCA resultsin significant restrictions on uses of nebulized levalbuterol, revenue fromsales of XOPENEX Inhalation Solution could be materially adversely affected.

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We filed a healthcarecommon procedure coding system application, commonly referred to as a J Codeapplication, for BROVANA Inhalation Solution in January 2007 and it wasaccepted by CMS as part of the 2008 coding cycle review. In April 2007, CMSannounced that its preliminary determination on the BROVANA J Code applicationwas favorable and CMS recommended that BROVANA be awarded a unique J Code. The finaldecision on the BROVANA J Code application is expected in November 2007. If BROVANAis awarded a unique J Code by CMS in November 2007, it would become effectiveon January 1, 2008. In April 2007, CMS informed us that the scope of theNCA includes BROVANA. Coverage provided for BROVANA under any permanent J Codeawarded for the product would be as established by the NCA. Prior to January 1,2008, we expect providers to submit claims for reimbursement of BROVANA under amiscellaneous J Code. Coverage for BROVANA under this miscellaneous J Coderemains under review by the Durable Medical Equipment Program SafeguardContractor or DME-PSCs.

With respect to BROVANA,Dey has filed a patent infringement complaint alleging that BROVANA infringesor will induce infringement of a U.S. patent for which they own all rights,title and interest. We believe we have strong defenses to the allegations madein the complaint and intend to vigorously defend against this action, however,it is too early to make a reasonable assessment as to the likely outcome orimpact of this litigation. If we are not successful in defending against thisaction, our ability to continue to commercialize of BROVANA could be materiallyadversely affected.

Wecannot be certain that we will be able to continue to successfullycommercialize our products or that any of our products will continue to beaccepted in their markets. Specifically, the following factors, among others,could affect the level of success and market acceptance of XOPENEX InhalationSolution, XOPENEX HFA, BROVANA and/or LUNESTA:

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

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

·       thelevel and effectiveness of our sales and marketing efforts;

·       anyunfavorable publicity regarding these products or similar products;

·       litigationor threats of litigation with respect to these products;

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

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

·       anychanges in government and other third-party payor reimbursement policiesand practices; and

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

Any adverse developmentswith respect to the sale of LUNESTA or XOPENEX Inhalation Solution couldsignificantly reduce revenues and have a material adverse effect on our abilityto maintain profitability and achieve our business plan.

***We have significant debt and we may not be able tomake principal payments when due.***

As of March 31, 2007,our total debt was approximately $721.0 million. None of our 0% Series Anotes due December 2008, our 0% Series B notes due December 2010nor our 0% notes due October 2024 restricts us or our subsidiaries’ability to incur additional indebtedness, including debt that ranks senior tothe notes. The 0% notes due 2024 are senior to the Series A notes due 2008and Series B notes due 2010. Additional indebtedness that we incur may incertain circumstances rank senior to or on parity with this debt. Our abilityto satisfy our obligations will depend upon our future performance, which issubject to many factors, including factors beyond our control. The conversionprices for the 0% Series A notes due 

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2008 and0% Series B notes due 2010 are $31.89 and $29.84, respectively. On April 30,2007, the closing sale price of our common stock was $53.68. If the marketprice for our common stock does not exceed the conversion price, the holders ofour outstanding convertible debt may not convert their securities into commonstock. For example, the holders of our 5% debentures did not convert suchdebentures into common stock, and on February 15, 2007, the maturity datefor the 5% debentures, we repaid the entire principal amount of $440.0 million,plus $11.0 million of accrued interest in cash. Our 0% notes due 2024 areconvertible into cash at various times upon the occurrence of certain eventsand, if applicable, shares of our common stock at a conversion price ofapproximately $67.20, at the option of the holders under certain circumstances.We may not be able to make the required cash payments upon conversion of the 0% notesdue 2024.

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

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

As of March 31, 2007,we had approximately $721.0 million of outstanding debt that could beconverted into common stock. In order to reduce future payments due atmaturity, we may, from time to time, depending on market conditions, repurchaseadditional outstanding convertible debt for cash; exchange debt for shares ofour common stock, warrants, preferred stock, debt or other consideration; or acombination of any of the foregoing. If we exchange shares of our capital stock,or securities convertible into or exercisable for our capital stock, foroutstanding convertible debt or use proceeds from the issuance of convertibledebt to fund redemption of outstanding convertible debt with a higherconversion ratio, the number of shares that we might issue as a result of suchexchanges would significantly exceed the number of shares originally issuableupon conversion of such debt and, accordingly, such exchanges would result inmaterial dilution to holders of our common stock. We cannot assure you that wewill repurchase or exchange any additional outstanding convertible debt.

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

Our financial statementshave been prepared in accordance with accounting principles generally acceptedin the United States. The preparation of these financial statements requires usto make estimates and judgments that affect the reported amounts of our assets,liabilities, net revenues and expenses, the amounts of charges accrued by usand related disclosure of contingent assets and liabilities. We base ourestimates on historical experience and on various other assumptions that webelieve to be reasonable under the circumstances. We cannot assure you,however, that our estimates, or the assumptions underlying them, will not bematerially different from actual results. For example, our royalty revenue isrecognized based upon our estimates of our collaboration partners’ sales duringthe period and, if these sales estimates are greater than the actual sales thatoccur during the period, our net income would be reduced. This, in turn, couldadversely affect our stock price.

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

We mayrequire additional funds for our research and product development programs,operating expenses, repayment of debt, the pursuit of regulatory approvals,license or acquisition opportunities and 

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the expansion of our production, sales and marketingcapabilities. Historically, we have satisfied our funding needs throughcollaboration arrangements with corporate partners, sales of product, andequity and debt financings. These funding sources may not be available to uswhen needed in the future, and, if available, they may not be on termsacceptable to us. Insufficient funds could require us to delay, scale back oreliminate certain of our research and product development programs and/orcommercialization efforts or to enter into license agreements with thirdparties to commercialize products or technologies that we would otherwisedevelop or commercialize ourselves. Our cash requirements may vary materiallyfrom those now planned because of factors including:

·       patentdevelopments;

·       licensingor acquisition opportunities;

·       drugdiscovery efforts;

·       relationshipswith collaboration partners;

·       theFDA regulatory process;

·       expansioninto foreign markets;

·       litigationand government inquiries and investigations;

·       ourcapital requirements; and

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

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

On April 20, 2007, weentered into a MOU, regarding the settlement of two class actions, pending inthe Court, naming Sepracor and certain of our current and former officers andone director as defendants. As previously disclosed, the class actions, whichwere filed on behalf of certain purchasers of our equity and debt securities,or the plaintiffs, allege that the defendants violated the Federal securitieslaws by making false and misleading statements relating to the testing, safetyand likelihood of approval of tecastemizole by the FDA.

Under the terms of theMOU, which outlines certain elements of a settlement that will require theexecution by all parties of definitive settlement agreement(s), notice to theplaintiffs and final approval by the Court, we have agreed with counsel for thelead plaintiffs to pay or cause to be paid $52.5 million in settlement of theclass actions. Of this amount, we expect to pay $34.0 million, and we expectthat our insurance carriers will pay the remaining $18.5 million. Inconsideration of this settlement payment, counsel for the lead plaintiffs hasagreed that the settlement will include a dismissal of the class actions withprejudice and a release of claims by the plaintiffs.

The MOU contains noadmission of wrongdoing. Sepracor and the other defendants have alwaysmaintained and continue to believe that we did not engage in any wrongdoing orotherwise commit any violation of Federal or state securities laws or otherlaws. However, given the potential cost and burden of continued litigation, webelieve the settlement is in our best interests and the best interests of ourstockholders.

We can provide noassurance that we will be able to settle these lawsuits on the terms describedabove or at all. We may not be able to agree on final settlement terms withlead counsel to the plaintiffs and, if we do, the Court may not approve thesettlement, the plaintiffs may appeal or raise objections to the settlement andthe insurers may not contribute to the settlement the amounts to which theyhave agreed. If we are unable to settle these lawsuits we will need to continueto defend against them, which could have a material adverse effect on ourfinancial condition and business. If these matters were concluded in a manneradverse to us, we could be required to pay substantially more in damages thanthe proposed 

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settlementamount. In addition, the costs to us of defending any litigation or otherproceeding, even if resolved in our favor, could be substantial. Suchlitigation could also substantially divert the attention of our management andour resources in general. Uncertainties resulting from the initiation andcontinuation of any litigation or other proceedings could harm our ability tocompete in the marketplace.

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

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

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

***We have civillitigation pending that relates to our stock option granting practices, and wecannot predict the ultimate outcome of this litigation.***

We and certain of ourdirectors and officers are defendants in several derivative actions relating toour stock option granting practices. The complaints allege purported breachesof fiduciary duties and unjust enrichment in connection with certain stockoption 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. These actions are inpreliminary stages and we cannot predict the ultimate outcome or impact of thislitigation.

***Fluctuations in the demand for products, the successand timing of clinical trials, regulatory approvals, product introductions,collaboration arrangements and any termination of development efforts willcause fluctuations in our quarterly operating results, which could causevolatility in our stock price.***

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

·       timingand extent of product sales and market penetration;

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

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

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·       timingand success of product introductions;

·       introductionof competitive products into the market;

·       resultsof clinical trials with respect to products under development;

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

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

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

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

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

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

·       timingand success of expansion into foreign markets;

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

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

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

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

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

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

·       non-cumulativevoting for directors;

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

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

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

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

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

***The price of our common stock historically has beenvolatile, which could cause you to lose part or all of your investment.***

The market price of ourcommon stock, like that of the common stock of many other pharmaceutical andbiotechnology companies, may be highly volatile. In addition, the stock markethas experienced extreme price and volume fluctuations. This volatility hassignificantly affected the market prices of securities of many pharmaceuticaland biotechnology companies for reasons frequently unrelated to ordisproportionate to the operating performance of the specific companies. Thesebroad market fluctuations may adversely affect the market price of our commonstock. Prices for our common stock are determined in the marketplace and may beinfluenced by many factors, including variations in our financial results andinvestors’ perceptions of us, and changes in recommendations by securitiesanalysts as well as their perceptions of general economic, industry and marketconditions.

**Risks Related toCommercialization**

***We face intense competition and our competitors havegreater resources and capabilities than we have.***

We face intense competition in the sale of our currentproducts, and expect to face intense competition in the sale of any futureproducts we sell. If we are unable to compete effectively, our financialcondition and results of operations could be materially adversely affectedbecause we may not achieve our product revenue objectives and because we mayuse our financial resources to seek to differentiate ourselves from our competition.Large and small companies, academic institutions, governmental agencies andother public and private organizations conduct research, seek patentprotection, develop and acquire products, establish collaborative arrangementsfor product development and sell or license products in competition with us.Many of our competitors and potential competitors have substantially greaterresources, manufacturing and sales and marketing capabilities, research anddevelopment staff and production facilities than we have. The fields in whichwe compete are subject to rapid and substantial technological change. Ourcompetitors may be able to respond more quickly to new or emerging technologiesor to devote greater resources to the development, manufacture and marketing ofnew products and/or technologies than we can. As a result, any products and/ortechnologies that we develop may become obsolete or noncompetitive before wecan recover expenses incurred in connection with their development.

In the sleep disorder market, LUNESTA faces intensecompetition from established products such as AMBIEN®, SONATA®, AMBIEN CRTM andROZEREMTM. We expect that LUNESTA will face increasing competition from otherpotentially competitive therapies, such as a generic version of AMBIEN, whichwas introduced in April of 2007, and therapies in clinical development andunder FDA review for the treatment of insomnia. To continue to besuccessful in the market with LUNESTA, we must continue to demonstrate thatLUNESTA’s safety and efficacy features are superior to those of competingbranded and generic products, some of which may be less expensive than LUNESTA.

In the asthma and COPD markets, XOPENEX InhalationSolution, a short-acting beta-agonist, faces competition from generic albuteroland DUONEB®.Albuterol has been available generically for many years, is well establishedand sells at prices substantially lower than XOPENEX Inhalation Solution.DUONEB offers combination therapy of albuterol with ipratropium bromide. Tocontinue to be successful in the marketing of XOPENEX Inhalation Solution, wemust continue to demonstrate that the efficacy and safety features of the drugoutweigh its higher price relative to generic albuterol.

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Albuterol MDIs have been on the market for many yearsand are well established. In the asthma market, we face competition fromchlorofluorocarbons, or CFC-containing albuterol MDIs and branded HFA albuterolMDIs such as PROAIR® HFA,VENTOLIN® HFA andPROVENTIL® HFA.With the cessation of CFC albuterol MDI production, we expect that competitionfrom branded HFA MDIs will increase substantially. There are currently nogeneric short-acting beta-agonist HFA MDIs available. To be successful in themarketing of XOPENEX HFA, we must demonstrate that the efficacy and safetyfeatures of the drug outweigh its higher price as compared to generic CFCalbuterol MDIs and that these attributes differentiate the product from otherHFA MDIs on the market.

BROVANA competes in the COPD market, as it does nothave an asthma indication. Competitive products include all nebulized productsused in the treatment of COPD including albuterol, ATROVENT® (ipratropium bromide) and DUONEB. Even thoughBROVANA is a nebulized product, it also faces competition from long-actingbeta-agonists and anticholinergics delivered by MDI and dry powder inhaler, or DPI,including SEREVENT®,SPIRIVA® and FORADIL®. BROVANA alsocompetes with combination therapy products used for COPD including ADVAIR® (salmeterol and fluticasone) and soon to becommercialized SYMBICORT® (formoterol and budesonide). We are also awareof products in clinical development for treatment of COPD that, if approved,will compete with BROVANA. To be successful in the marketing of BROVANA, wemust demonstrate that patients with COPD who use a nebulizer will benefit byadding BROVANA as adjunctive therapy.

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

***We may be unable to successfully commercializeproducts 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 arrangements, manufacturing processes and arrangements, producesufficient inventory and/or properly prepare our sales force. If we are unableto successfully commercialize a product promptly after receipt of an approvalletter, our business and financial position may be materially adverselyaffected due to reduced revenue from product sales during the period or periodsthat commercialization is delayed and the shortening of any lead time to marketwe may have had over our competitors. In addition, the exclusivity period,which is the time during which the FDA will prevent generic pharmaceuticalcompanies from introducing a generic copy of the product, begins to run uponFDA approval and, therefore, to the extent we are unable to successfullycommercialize a product promptly after receipt of an approval letter, ourlong-term product sales and revenues could be adversely affected.

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

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

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

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

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

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

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

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

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**Risks Related tothe Regulatory Environment**

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

The FDA and similarforeign agencies must approve for commercialization any pharmaceutical productsdeveloped by us or our development partners. These agencies impose substantialrequirements on drug manufacturing and marketing. Any unanticipated preclinicaland clinical studies we are required to undertake could result in a significantincrease in the cost of advancing our products to commercialization. Inaddition, failure by us or our collaborative development partners to obtainregulatory approval on a timely basis, or at all, or the attempt by us or ourcollaborative development partners to receive regulatory approval to achievelabeling objectives, could prevent or adversely affect the timing of commercialintroduction of, or our ability to market and sell, our products.

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

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

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

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

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

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

·       wemay not receive regulatory approval for our product candidates;

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

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

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

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

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

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

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

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

·       productsmay not be shown to be safe and efficacious.

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

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

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

There have been, there are, and we expect there willcontinue to be, state and Federal legislative and/or administrative proposalsthat could limit the amount that state or Federal governments will pay toreimburse the cost of pharmaceutical products. The Medicare Prescription DrugImprovement and Modernization Act of 2003, or MMA, which was signed into law inDecember 2003, contains provisions that permit reductions in governmentreimbursement for drugs. The full impact of the MMA and its regulatoryrequirements on our business is not yet known. However, we believe thatlegislative or administrative acts that reduce reimbursement for our productscould adversely affect our business. In addition, private insurers, such asmanaged care organizations, may adopt their own coverage restrictions or demandprice concessions in response to legislation. Reduction in reimbursement forour products could have a material adverse effect on our results of operations.Also, the increasing emphasis on managed care in the U.S. may put increasingpressure on the price and usage of our products, which may adversely affectproduct sales. Further, when a new drug product is approved, governmentaland/or private reimbursement for that product is uncertain, as is the amountfor which that product will be reimbursed and to the extent of coverage for theproduct. We cannot predict availability or amount of reimbursement for ourapproved products or product candidates and current reimbursement policies formarketed products may change at any time.

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

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plans influencingprescription decisions for a larger segment of the population. In addition,certain states have proposed, and certain other states have adopted, variousprograms to control prices for their seniors’ and low-income drug programs,including price or patient reimbursement constraints, restrictions on access tocertain products, importation from other countries, such as Canada, and bulkpurchasing of drugs.

In March 2006, the DME-PSCs issued a draftlocal coverage determination, or LCD, under which Medicare reimbursement forXOPENEX Inhalation Solution would be reduced to the level of reimbursement forgeneric albuterol under Medicare Part B, which is substantially less thanthe current level of reimbursement for XOPENEX Inhalation Solution. In December 2006,the CMS commenced an NCA on XOPENEX Inhalation Solution to determine when useof nebulized levalbuterol for treating COPD in the Medicare population isreasonable and necessary. The comments to the NCA remain under review by CMSand we expect the NCA process to be concluded before the end of 2007. In March 2007,Tricenturion announced that they would not pursue the LCD while the CMS reviewof the NCA is ongoing. We anticipate that the final national coveragedetermination that results from the NCA will take precedence over any LCDsthat have been implemented or are under consideration for XOPENEX InhalationSolution. We estimate that approximately 25 to 30 percent of our XOPENEXInhalation Solution units sold are subject to reimbursement under Medicare Part B.If the NCA results in significant restrictions on the use of nebulizedlevalbuterol, revenue from these sales of XOPENEX Inhalation Solution would bematerially adversely affected.

We filed a J Code application, for BROVANA InhalationSolution in January 2007 and it was accepted by CMS as part of the 2008 codingcycle review. In April 2007, CMS announced that its preliminary determinationon the BROVANA J Code application was favorable and CMS recommended thatBROVANA be awarded a unique J Code. The final decision on the BROVANA JCode application is expected in November 2007. If BROVANA is awarded a unique JCode by CMS in November 2007, it would become effective on January 1, 2008. InApril 2007, CMS informed us that the scope of the NCA includes BROVANA.Coverage provided for BROVANA under any permanent J Code awarded for theproduct would be as established by the NCA. If the NCA results in significantrestrictions on the use of BROVANA, revenue from the sales of BROVANA could bematerially adversely affected. Prior to January 1, 2008, we expect providers tosubmit claims for reimbursement of BROVANA under a miscellaneous J Code.Coverage for BROVANA under this miscellaneous J Code remains under review by theDME-PSCs.

Some states have adopted PDLs for their Medicaidprograms and more states may adopt this practice. Medicaid PDLs indicate whichdrugs a provider is permitted under the Medicaid program to prescribe withoutfirst seeking prior authorization from the state Medicaid agency. If our drugsare not included on Medicaid PDLs, use of our drugs in the Medicaid program maybe adversely affected. In some states that have adopted PDLs, we have been, andmay continue to be, required to provide substantial supplemental rebates tostate Medicaid authorities in order for our drugs to be included on the PDL.

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

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***We will spend considerable time and money complyingwith Federal and state laws and regulations and, if we are unable to fullycomply with such laws and regulations, we could face substantial penalties.***

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

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

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

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

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

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

·       stateand foreign law equivalents of the foregoing;

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

·       statelaws that prohibit practice of medicine by non-physicians and fee-splittingarrangements between physicians and non-physicians, as well as state lawequivalents to the Federal Medicare and Medicaid Anti-Kickback Laws, which maynot be limited to government reimbursed items or services.

If our past or presentoperations are found to be in violation of any of the laws described above orother governmental regulations to which we or our customers are subject, we maybe subject to the applicable penalty associated with the violation, includingcivil and criminal penalties, damages, fines, exclusion from Medicare andMedicaid programs and curtailment or restructuring of our operations. Similarly,if our customers are found non-compliant with applicable laws, they may besubject to sanctions, which could also have a negative impact on us. Inaddition, if we are required to obtain permits or licenses under these lawsthat we do not already possess, we may become subject to substantial additionalregulation or incur significant expense. Any penalties, damages, fines,curtailment or restructuring of our operations would adversely affect ourability to operate our business and our financial results. The risk of ourbeing found in violation of these laws is increased by the fact that many ofthem have not been fully interpreted by the regulatory authorities or thecourts and their provisions are open to a variety of 

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interpretations.Any action against us for violation of these laws, even if we successfullydefend against it, could cause us to incur significant legal expenses, divertour management’s attention from operating our business and damage ourreputation.

***If our Medicaid rebate program practices areinvestigated, the costs could be substantial and could divert the attention ofmanagement.***

We are a participant in the Medicaid rebate programestablished by the Omnibus Budget Reconciliation Act of 1990. Under theMedicaid rebate program, we pay a minimum primary rebate of 15.1% on allutilization of our products by Medicaid beneficiaries. Congress is consideringlegislation that may raise the minimum rebate level that we must pay to stateMedicaid programs. In addition, this primary rebate may be higher if we providediscounts to commercial customers that are greater than the statutorilymandated minimum. Also, several state Medicaid programs have implemented PDLs.Products placed on a state Medicaid program’s PDL are not subject torestrictions on their utilization such as prior authorization before use. Tosecure a place on a given state PDL, we provide discounts to the state Medicaidprogram in the form of supplemental rebates. Both the Federal government andstate and local governments have initiated investigations and lawsuitsconcerning the rebate practices of many pharmaceutical companies to ensurecompliance with these rebate programs. We were recently named as a defendant,together with numerous other companies, in one such suit. While we believe ourcalculations of rebates and discounts are accurate and based on reasonableassumptions and judgments, as a result of an investigation or lawsuit we may berequired to pay additional rebates and/or discounts on sales made in priorperiods or be subject to fines and other penalties. In addition, aninvestigation or lawsuit concerning our rebate practices could be costly, coulddivert the attention of our management from our core business and could damageour reputation.

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

In May 2001, an advisory panel to the FDArecommended that the FDA allow certain popular allergy medications to be soldwithout a prescription. In November 2002, the FDA approved CLARITIN®, an allergy medication, to besold without a prescription. In the future, the FDA may also allow sale ofother allergy medications without a prescription. The sale of CLARITIN and /or,if allowed, the sale of other allergy medications without a prescription, mayhave a material adverse effect on our business because the market forprescription drugs, including CLARINEX, for which we receive royalties onsales, has been and may continue to be, adversely affected.

**RisksRelated to Our Intellectual Property**

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

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

We have filed patentapplications covering composition of, methods of making, and/or methods of using,our 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 

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notreceive royalty revenue from sales of products licensed under collaborationagreements in countries where we do not have a patent for such products. Theissuance of a patent in one country does not ensure the issuance of a patent inany other country. Furthermore, the patent position of companies in thepharmaceutical industry generally involves complex legal and factual questions,and has been and remains the subject of much litigation. Legal standardsrelating to scope and validity of patent claims are evolving. Any patents wehave obtained, or obtain in the future, may be challenged, invalidated orcircumvented. Moreover, the United States Patent and Trademark Office maycommence interference proceedings involving our patents or patent applications.Any challenge to, or invalidation or circumvention of, our patents or patentapplications would be costly, would require significant time and attention ofour management and could have a material adverse effect on our business. Inaddition, if we are not successful in enforcing our patents, we will not beable to prevent others from introducing generic versions of our products.

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

XOPENEX brand levalbuterol HCl Inhalation Solution iscurrently the subject of patent invalidity claims. The FDA has received ANDAsfrom Breath Limited, Dey, L.P. and Watson Laboratories, Inc. seekingmarketing approval for generic copies of our XOPENEX Inhalation Solutionproducts. These submissions include Paragraph IV certifications allegingthat our patents listed in the Orange Book for XOPENEX Inhalation Solution areinvalid, unenforceable or not infringed by the submitter’s proposed product. Wehave filed civil actions against Breath Limited and Dey, L.P. for patentinfringement. Should we successfully enforce our patents, the FDA will notapprove the ANDA until expiration of the applicable patents. Otherwise, the FDAwill stay its approval of the relevant ANDA until 30 months following thedate we received notice of such ANDA or until a court decides that our patentsare invalid, unenforceable or not infringed, whichever is earlier. Patentlitigation involves complex legal and factual questions. We can provide noassurance concerning the outcome or the duration of the lawsuits. Anyconclusion of these matters in a manner adverse to us would have a materialadverse effect on our financial condition and business. If we are notsuccessful in enforcing our patents, we will not be able to prevent the genericcompany, for the full term of our patents, from marketing their generic versionof XOPENEX Inhalation Solution. Introduction of a generic copy of XOPENEXInhalation Solution before the expiration of our patents would have a materialadverse effect on our business.

The costs to us of these proceedings, even if resolvedin our favor, could be substantial. Such litigation could also substantiallydivert the attention of our management and other key personnel from our corebusiness and our resources in general. Uncertainties resulting from theinitiation and continuation of this and any other litigation proceedings couldharm our ability to compete in the marketplace.

In June 2006, we were notified that TevaPharmaceutical Industries Limited and Teva UK Limited, referred to collectivelyas Teva, have filed a claim naming us as defendant in the United Kingdom’s HighCourt of Justice, Chancery Division, Patents Court. The claim alleges that ourtwo patents relating to fexofenandine, which we have licensed to sanofi-aventisin connection with its sale of ALLEGRA, are invalid, and seeks to have theminvalidated. Sanofi-aventis is defending this action. If patent-basedexclusivity for ALLEGRA is lost in the United Kingdom or in any otherjurisdiction where a similar action is brought, our rights to receive royaltyrevenue in any such jurisdiction will terminate.

In August 2006, we were notified that severalANDAs containing Paragraph IV certifications had been received by the FDAseeking approval of generic versions of certain of Schering-Plough’s CLARINEXproducts. If and while a generic version of a CLARINEX product is marketed inthe U.S. without Schering-Plough’s consent, Schering-Plough will have noobligation to pay royalties to us on the U.S. sales of CLARINEX products.

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

Our success depends in part on our ability to operatewithout infringing upon proprietary rights of others, including patent and trademarkrights. Third parties, typically drug companies, hold patents or patentapplications covering compositions, methods of making and uses, covering thecomposition of matter for some of the drug candidates for which we have patentsor patent applications. Third parties also hold patents relating to drugdelivery technology that may be necessary for development or commercializationof some of our drug candidates. In each of these cases, unless we have orobtain a license agreement, we generally may not commercialize the drugcandidates until these third-party patents expire or are declared invalidor unenforceable by the courts. Licenses may not be available to us onacceptable terms, if at all. 

Others may file suit against us alleging that ourproducts or product candidates infringe patents they hold. Even if resolved inour favor, any patent infringement litigation would be costly, would requiresignificant time and attention of our management, could prevent us fromcommercializing our products for a period of time and could require us to paysignificant damages and could have a material adverse effect on our business.If the matter is not resolved in our favor, we could be required to paysignificant damages and/or be prevented from commercializing our product andour business could be materially adversely affected. On April 5, 2007, wewere served with a complaint filed by Dey, alleging that BROVANA infringes orwill induce infringement of a single U.S. patent for which Dey owns all rights,title and interest. We have filed an answer and counterclaim to this complaintand believe we have strong defenses to the allegations made in the complaint,however, it is too early to make a reasonable assessment as to the likelyoutcome or impact of this litigation.

If any of our trademarks,or our use of any of our trademarks on our products, is challenged, we may beforced to rename the affected product or product candidate, which could becostly and time consuming, and would result in the loss of any brand equity associatedwith the product name. In September 2006, Tharos Laboratories, Inc.filed suit against us in the United States District Court, District of Utah,Central Division, alleging trademark infringement, dilution, unfaircompetition, false advertising, and false designation of origin arising out ofour use of our silk moth design in connection with LUNESTA. Tharos seeksunspecified monetary damages and an injunction of our use of the silk mothdesign. In October 2006, we filed a motion to dismiss Tharos’ claims. On February 9,2007, the court granted our motion in respect of the state unfair competitionclaims and denied it in respect of Tharos’ other claims. We are unable toreasonably estimate any possible range of loss related to this lawsuit due toits uncertain resolution.

**Risks Related toOur Dependence on Third Parties**

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

We have entered into a collaboration agreement with 3Mfor the scale-up and manufacturing of XOPENEX HFA 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. Wecommercially introduced XOPENEX HFA in December 2005. If 3M, or any futuredevelopment or commercialization collaborator, does not devote sufficient timeand resources to its collaboration arrangement with us, breaches or terminatesits agreement with us, fails to perform its obligations to us in a timelymanner or is unsuccessful in its development and/or commercialization efforts,we may not realize the potential commercial benefits of the arrangement and ourresults of operations may be adversely affected. In addition, if regulatoryapproval or commercialization of any product candidate under development by orin collaboration with a partner is delayed or limited, we may not realize, ormay be delayed in realizing, the potential commercial benefits of thearrangement.

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

We have entered into licensing arrangements pursuantto which we license patents to pharmaceutical companies and our revenues underthese licensing arrangements consist primarily of royalties on sales ofproducts. Payments and royalties under these arrangements depend in large parton the commercialization efforts of our licensing partners in countries wherewe hold patents, including sales efforts and enforcement of patents, which wecannot control. If any of our licensing partners does not devote sufficienttime and resources to its licensing arrangement with us or focuses its effortsin countries where we do not hold patents, we may not realize the potentialcommercial benefits of the arrangement, our revenues under these arrangementsmay be less than anticipated and our results of operations may be adverselyaffected. If any of our licensing partners was to breach or terminate itsagreement with us or fail to perform its obligations to us in a timely manner,the royalties we receive under the licensing agreement could decrease or cease.If we are unable or fail to perform, or breach in our performance of, ourobligations under a licensing agreement, the royalties and benefits to which weare otherwise entitled under the agreement could be reduced or eliminated. Anydelay or termination of this type could have a material adverse effect on ourfinancial condition and results of operations because we may lose technology rightsand milestone or royalty payments from licensing partners and/or revenues fromproduct sales, if any, could be delayed, reduced or terminated.

In June 2006, we werenotified that Teva had filed a claim in the United Kingdom alleging that ourtwo patents relating to fexofenandine, which we have licensed to sanofi-aventisin connection with its sale of ALLEGRA, are invalid, and seeks to have theminvalidated. Sanofi-aventis is defending this action. If patent-basedexclusivity for ALLEGRA is lost in the United Kingdom or in any otherjurisdiction where a similar action is brought our rights to receive royaltyrevenue in any such jurisdiction will terminate. In addition, in August 2006,we were notified that several ANDAs containing Paragraph IV certifications hadbeen received by the FDA seeking approval of generic versions of certain ofSchering-Plough’s CLARINEX products. If and while a generic version of aCLARINEX product is marketed in the U.S. without Schering-Plough’s consent,Schering-Plough will have no obligation to pay royalties to us on the U.S.sales of CLARINEX products.

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

We currently operate a manufacturing plant that we believecan meet our commercial requirements of the active pharmaceutical ingredientfor XOPENEX Inhalation Solution and XOPENEX HFA, partially fulfill ourcommercial requirements of the active pharmaceutical ingredient for LUNESTA,and support production of our product candidates in amounts needed for ourclinical trials. We do not, however, have the capability to manufacture at ourmanufacturing facility all of our requirements for the active ingredients ofour currently approved products, and we have no facilities for manufacturingpharmaceutical dosage forms or finished drug products. Developing and obtainingthis capability would be time consuming and expensive. Unless and until wedevelop this capability, we will rely substantially, and in some cases, entirely,on third-party manufacturers. Cardinal Health, Inc. is currently thesole finished goods manufacturer of our XOPENEX Inhalation Solution andBROVANA, Patheon Inc. is the sole manufacturer of LUNESTA and 3M is thesole manufacturer and supplier of XOPENEX HFA. Certain components of XOPENEXHFA are available from only a single source. If Cardinal Health, Patheon, 3M,or any of our sole-source component suppliers experiences delays ordifficulties in producing, packaging or delivering XOPENEX Inhalation Solution,XOPENEX HFA, BROVANA or LUNESTA, as the case may be, we could be unable to meetour customers’ demands for such products, which could lead to customerdissatisfaction and damage to our reputation. Furthermore, if we are requiredto change manufacturers, 

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we will be required toverify that the new manufacturer maintains facilities and procedures thatcomply with quality standards and with all applicable regulations andguidelines, including FDA guidelines. The delays associated with the verificationof a new manufacturer for XOPENEX Inhalation Solution, XOPENEX HFA, BROVANA orLUNESTA could negatively affect our ability to produce such products in atimely 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.

**Risks Related toGrowth of Our Business**

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

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

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

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

·       manufacturedor produced economically;

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

·       complementaryto our existing product portfolio; or

·       widelyaccepted in the marketplace.

Proposing, negotiating and implementing aneconomically viable acquisition is a lengthy and complex process. Othercompanies, including those with substantially greater financial, marketing andsales resources, may compete with us for the acquisition of product candidatesand approved products. We may not be able to acquire the rights to additionalproduct candidates and approved products on terms that we find acceptable, orat all.

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***We may undertake strategic acquisitions in the futureand any difficulties from integrating such acquisitions could adversely affectour stock price, operating results and results of operations.***

We may acquire additional businesses and products thatcomplement or augment our existing business. We have limited acquisitionexperience and may not be able to integrate any acquired business or productsuccessfully or operate any acquired business profitably. Integrating any newlyacquired business or product could be expensive and time-consuming. Integrationefforts often take a significant amount of time, place a significant strain onmanagerial, operational and financial resources and could prove to be moredifficult or expensive than we predict. The diversion of our management’sattention and any delay or difficulties encountered in connection with anyfuture acquisitions we may consummate could result in the disruption of ouron-going business or inconsistencies in standards, controls, procedures andpolicies that could negatively affect our ability to maintain relationshipswith customers, suppliers, collaborators, employees and others with whom wehave business dealings. Moreover, we may need to raise additional funds throughpublic or private debt or equity financing to acquire any businesses orproducts, which may result in dilution for stockholders or the incurrence ofindebtedness.

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

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

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

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

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

·       revenuefrom product sales could be delayed; or

·       wemay elect not to commercialize the drugs.

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

**ITEMS 2-5.**                              NONE

**ITEM6.**                EXHIBITS
| 10.1 |   | Employment Agreement by and between the Registrant  and Adrian Adams dated March 1, 2007.                                                                 |
|------|--------|----------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 10.2 |   | Executive Retention Agreement by and between the  Registrant and Adrian Adams dated March 1, 2007.                                                        |
| 10.3 |   | Employment Agreement by and between the Registrant  and Andrew I. Koven dated March 1, 2007.                                                              |
| 10.4 |   | Executive Retention Agreement by and between the  Registrant and Andrew I. Koven dated March 1, 2007.                                                     |
| 10.5 |   | Transition and Severance Agreement by and between  the Registrant and W. James O’Shea dated March 1, 2007.                                           |
| 10.6 |   | Letter Agreement by and between the Registrant and  Douglas E. Reedich dated March 1, 2007.                                                               |
| 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**

Pursuant to therequirements of the Securities Exchange Act of 1934, the registrant has dulycaused this report to be signed on its behalf by the undersigned thereunto dulyauthorized.
|                         | **SEPRACOR  INC.** |
|-------------------------|--------------------|
| Date: May 10, 2007 | By:                | /s/  TIMOTHY J. BARBERICH |
|                    |               | Timothy J.  Barberich |
|                    |               | *Chairman  and Chief Executive Officer  (Principal Executive Officer)* |
| Date: May 10, 2007 | 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** |
|------------------|------------|----------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------|
| 10.1             |       | Employment Agreement by  and between the Registrant and Adrian Adams dated March 1, 2007.                                                            |
| 10.2             |       | Executive Retention  Agreement by and between the Registrant and Adrian Adams dated March 1,  2007.                                                       |
| 10.3             |       | Employment Agreement by  and between the Registrant and Andrew I. Koven dated March 1, 2007.                                                              |
| 10.4             |       | Executive Retention  Agreement by and between the Registrant and Andrew I. Koven dated  March 1, 2007.                                                    |
| 10.5             |       | Transition and Severance  Agreement by and between the Registrant and W. James O’Shea dated  March 1, 2007.                                          |
| 10.6             |       | Letter Agreement by and  between the Registrant and Douglas E. Reedich dated March 1, 2007.                                                          |
| 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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