**SECURITIES AND EXCHANGE COMMISSION**

**Washington,D.C. 20549**

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**FORM 10-Q**

**(Mark One)**

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

**Forthe Quarterly Period Ended September 30, 2007**

**or**

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

**Forthe transition periodfrom                to                **

**Commissionfile number 0-19410**

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**Sepracor Inc.**

(Exact name of registrantas specified in its charter)

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

 

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

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

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

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

 

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

Thenumber of shares outstanding of the registrant’s class of Common Stock as of October 31,2007 was: 111,702,976 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 September 30, 2007 (Unaudited) and  December 31, 2006                       |   | 3 |
|                                            |   | Consolidated  Statements of Operations for the Three and Nine Months Ended  September 30, 2007 and 2006 (Unaudited) |   | 4 |
|                                            |   | Consolidated  Statements of Cash Flows for the Nine Months Ended September 30, 2007 and  2006 (Unaudited)      |   | 5 |
|                                            |   | Notes  to Condensed Consolidated Interim Financial Statements                                                                 |   | 6 |
| Item  2.                                        |   | Management’s  Discussion and Analysis of Financial Condition and Results of  Operations                                  |   | 16 |
| Item  3.                                        |   | Quantitative  and Qualitative Disclosures About Market Risk                                                                   |   | 35 |
| Item  4.                                        |   | Controls  and Procedures                                                                                                      |   | 35 |
| **Part II—Other  Information**        |   | 36                                                                                                                            |
| Item 1.                                         |   | Legal  Proceedings                                                                                                            |   | 36 |
| Item 1A.                                        |   | Risk Factors                                                                                                                  |   | 40 |
| Item 6.                                         |   | Exhibits                                                                                                                      |   | 64 |
|                                            |   | Signatures                                                                                                                    |   | 65 |
|                                            |   | Exhibit Index                                                                                                            |   | 66 |

 

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

| ** **                                                                                                                                                                                                                                                                            | ** ** | **September 30,  2007** | ** ** | **December 31,  2006** | ** ** |
|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|------------------------------|------------|-----------------------------|------------|
| ** **                                                                                                                                                                                                                                                                            | ** ** | **(Unaudited)**              | ** ** | ** **                  | ** ** |
| **Assets**                                                                                                                                                                                                                                                                            | ** ** |                         | ** ** | ** **                  |       | ** ** | ** ** |
| Current assets:                                                                                                                                                                                                                                                                       |       |                         |       |                        |       |   |   |
| Cash and cash  equivalents                                                                                                                                                                                                                                                            |       |                         | $          | 387,241                     |       |   | $ | 415,411 |   |
| Short-term  investments                                                                                                                                                                                                                                                               |       |                         | 324,777    |                        |       | 568,037 |   |
| Accounts receivable, net                                                                                                                                                                                                                                                              |       |                         | 154,486    |                        |       | 175,103 |   |
| Inventories                                                                                                                                                                                                                                                                           |       |                         | 49,459     |                        |       | 37,087 |   |
| Other assets                                                                                                                                                                                                                                                                          |       |                         | 31,407     |                        |       | 25,390 |   |
| Total current assets                                                                                                                                                                                                                                                                  |       |                         | 947,370    |                        |       | 1,221,028 |   |
| Long-term  investments                                                                                                                                                                                                                                                                |       |                         | 220,284    |                        |       | 182,876 |   |
| Property and equipment,  net                                                                                                                                                                                                                                                          |       |                         | 85,231     |                        |       | 72,811 |   |
| Investment in affiliate                                                                                                                                                                                                                                                               |       |                         | 4,344      |                        |       | 5,107 |   |
| Deferred financing costs  and patents, net                                                                                                                                                                                                                                            |       |                         | 8,566      |                        |       | 11,881 |   |
| Other assets                                                                                                                                                                                                                                                                          |       |                         | 81         |                        |       | 90 |   |
| Total assets                                                                                                                                                                                                                                                                          |       |                         | $          | 1,265,876                   |       |   | $ | 1,493,793 |   |
| **Liabilities and Stockholders’ Equity**                                                                                                                                                                                                                                         | ** ** |                         | ** ** | ** **                  |       | ** ** | ** ** |
| Current liabilities:                                                                                                                                                                                                                                                                  |       |                         |       |                        |       |   |   |
| Accounts payable                                                                                                                                                                                                                                                                      |       |                         | $          | 17,240                      |       |   | $ | 10,751 |   |
| Accrued expenses                                                                                                                                                                                                                                                                      |       |                         | 123,948    |                        |       | 113,099 |   |
| Current portion of notes  payable and capital lease obligation                                                                                                                                                                                                                        |       |                         | 1,199      |                        |       | 385 |   |
| Current portion of  convertible subordinated debt                                                                                                                                                                                                                                     |       |                         | —     |                        |       | 440,000 |   |
| Other current  liabilities                                                                                                                                                                                                                                                            |       |                         | 137,270    |                        |       | 115,877 |   |
| Total current  liabilities                                                                                                                                                                                                                                                            |       |                         | 279,657    |                        |       | 680,112 |   |
| Notes payable and  capital lease obligation                                                                                                                                                                                                                                           |       |                         | 2,225      |                        |       | 693 |   |
| Long-term deferred  revenue                                                                                                                                                                                                                                                           |       |                         | 24,794     |                        |       | — |   |
| Convertible subordinated  debt                                                                                                                                                                                                                                                        |       |                         | 720,820    |                        |       | 720,820 |   |
| Total liabilities                                                                                                                                                                                                                                                                     |       |                         | 1,027,496  |                        |       | 1,401,625 |   |
| Stockholders’ equity:                                                                                                                                                                                                                                                            |       |                         |       |                        |       |   |   |
| Preferred stock, $1.00  par value, 1,000 shares authorized; none outstanding at  September 30, 2007 and December 31, 2006                                                                                                                                              |       |                         | —     |                        |       | — |   |
| Common stock, $.10 par  value, 240,000 shares authorized at September 30, 2007 and December 31,  2006; 111,679 and 110,040 shares issued, 107,418 and 105,779 shares  outstanding, at September 30, 2007 and December 31, 2006,  respectively |       |                         | 11,168     |                        |       | 11,004 |   |
| Treasury stock, at cost  (4,261 shares at September 30, 2007 and December 31, 2006)                                                                                                                                                                                         |       |                         | (232,028   | )                           |       | (232,028 | ) |
| Additional paid-in  capital                                                                                                                                                                                                                                                           |       |                         | 1,848,379  |                        |       | 1,788,417 |   |
| Accumulated deficit                                                                                                                                                                                                                                                                   |       |                         | (1,406,474 | )                           |       | (1,478,065 | ) |
| Accumulated other  comprehensive income                                                                                                                                                                                                                                               |       |                         | 17,335     |                        |       | 2,840 |   |
| Total stockholders’  equity                                                                                                                                                                                                                                                      |       |                         | 238,380    |                        |       | 92,168 |   |
| Total liabilities and stockholders’ equity                                                                                                                                                                                                                                       |       |                         | $          | 1,265,876                   |       |   | $ | 1,493,793 |   |

 

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

3

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

| ** **                                                                    | ** ** | **Three Months Ended** | ** ** | **Nine Months Ended** | ** ** |
|-------------------------------------------------------------------------------|------------|----------------------------------|------------|---------------------------------|------------|
| ** **                                                                    | ** ** | **September 30,  2007**     | ** ** | **September 30,  2006**    | ** ** | **September 30,  2007** | ** ** | **September 30,  2006** | ** ** |
| Revenues:                                                                     |       |                             |       |                            |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Product sales                                                                 |       |                             | $          | 275,024                         |       |   |   | $ | 280,086 |   |   |   | $ | 861,983 |   |   |   | $ | 814,018 |   |   |
| Royalties and license fees                                                    |       |                             | 8,921      |                            |       |   | 9,210 |   |   |   | 31,524 |   |   |   | 25,362 |   |   |
| Total revenues                                                                |       |                             | 283,945    |                            |       |   | 289,296 |   |   |   | 893,507 |   |   |   | 839,380 |   |   |
| Costs and  expenses:                                                          |       |                             |       |                            |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Cost of product sold                                                          |       |                             | 26,226     |                            |       |   | 24,554 |   |   |   | 82,719 |   |   |   | 70,780 |   |   |
| Cost of royalties                                                             |       |                             | 194        |                            |       |   | 327 |   |   |   | 849 |   |   |   | 769 |   |   |
| Research and development                                                      |       |                             | 49,025     |                            |       |   | 35,520 |   |   |   | 135,184 |   |   |   | 121,149 |   |   |
| Selling, marketing and distribution                                           |       |                             | 154,648    |                            |       |   | 151,154 |   |   |   | 538,282 |   |   |   | 523,750 |   |   |
| General and administrative                                                    |       |                             | 20,477     |                            |       |   | 19,285 |   |   |   | 58,666 |   |   |   | 51,880 |   |   |
| Litigation settlement, net                                                    |       |                             | —     |                            |       |   | — |   |   |   | 34,000 |   |   |   | — |   |   |
| Total costs and expenses                                                      |       |                             | 250,570    |                            |       |   | 230,840 |   |   |   | 849,700 |   |   |   | 768,328 |   |   |
| Income from operations                                                        |       |                             | 33,375     |                            |       |   | 58,456 |   |   |   | 43,807 |   |   |   | 71,052 |   |   |
| Other income  (expense):                                                      |       |                             |       |                            |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Interest income                                                               |       |                             | 11,173     |                            |       |   | 12,319 |   |   |   | 34,882 |   |   |   | 33,103 |   |   |
| Interest expense                                                              |       |                             | (88        | )                               |       |   | (5,538 | ) |   |   | (2,958 | ) |   |   | (16,632 | ) |   |
| Equity in investee losses                                                     |       |                             | (37        | )                               |       |   | (212 | ) |   |   | (441 | ) |   |   | (565 | ) |   |
| Other expense                                                                 |       |                             | (621       | )                               |       |   | (9 | ) |   |   | (907 | ) |   |   | (321 | ) |   |
| Income before income taxes                                                    |       |                             | 43,802     |                            |       |   | 65,016 |   |   |   | 74,383 |   |   |   | 86,637 |   |   |
| Income taxes                                                                  |       |                             | 907        |                            |       |   | 585 |   |   |   | 2,792 |   |   |   | 1,126 |   |   |
| Net income after income taxes                                                 |       |                             | $          | 42,895                          |       |   |   | $ | 64,431 |   |   |   | $ | 71,591 |   |   |   | $ | 85,511 |   |   |
| Basic net income per common share                                             |       |                             | $          | 0.40                            |       |   |   | $ | 0.61 |   |   |   | $ | 0.67 |   |   |   | $ | 0.82 |   |   |
| Diluted net income per common share                                           |       |                             | $          | 0.37                            |       |   |   | $ | 0.56 |   |   |   | $ | 0.61 |   |   |   | $ | 0.74 |   |   |
| Shares used in  computing basic and diluted net income per common share: |       |                             |       |                            |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Basic                                                                         |       |                             | 107,318    |                            |       |   | 104,991 |   |   |   | 106,628 |   |   |   | 104,627 |   |   |
| Diluted                                                                       |       |                             | 116,033    |                            |       |   | 115,694 |   |   |   | 116,508 |   |   |   | 115,447 |   |   |

 

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

4

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

| ** **                                                                         | ** ** | **Nine Months Ended** | ** ** |
|------------------------------------------------------------------------------------|------------|---------------------------------|------------|
| ** **                                                                         | ** ** | **September 30,  2007**    | ** ** | **September 30,  2006** | ** ** |
| Cash flows from  operating activities:                                             |       |                            |       |   |   |   |   |   |   |
| Net income                                                                         |       |                            | $          | 71,591 |   |   |   | $ | 85,511 |   |   |
| Adjustments to reconcile  net income to net cash provided by operating activities: |       |                            |       |   |   |   |   |   |   |
| Depreciation and amortization                                                      |       |                            | 15,178     |   |   |   | 15,259 |   |   |
| Equity in investee losses                                                          |       |                            | 441        |   |   |   | 565 |   |   |
| Stock compensation                                                                 |       |                            | 27,926     |   |   |   | 31,371 |   |   |
| Loss (gain) on asset disposal                                                      |       |                            | 218        |   |   |   | (137 | ) |   |
| Changes in operating  assets and liabilities:                                      |       |                            |       |   |   |   |   |   |   |
| Accounts receivable                                                                |       |                            | 20,617     |   |   |   | (47,292 | ) |   |
| Inventories                                                                        |       |                            | (11,119    | ) |   |   | (9,312 | ) |   |
| Other current assets                                                               |       |                            | (5,848     | ) |   |   | (4,426 | ) |   |
| Accounts payable                                                                   |       |                            | 6,426      |   |   |   | 6,288 |   |   |
| Accrued expenses                                                                   |       |                            | 10,699     |   |   |   | (82,945 | ) |   |
| Other liabilities                                                                  |       |                            | 46,188     |   |   |   | 23,855 |   |   |
| Net cash provided  by operating activities                                         |       |                            | 182,317    |   |   |   | 18,737 |   |   |
| Cash flows from  investing activities:                                             |       |                            |       |   |   |   |   |   |   |
| Purchases of short and long-term investments                                       |       |                            | (730,355   | ) |   |   | (915,978 | ) |   |
| Sales and maturities of short and long-term  investments                           |       |                            | 947,885    |   |   |   | 839,405 |   |   |
| Additions to property and equipment                                                |       |                            | (19,739    | ) |   |   | (11,929 | ) |   |
| Proceeds from sales of equipment                                                   |       |                            | —     |   |   |   | 150 |   |   |
| Investment in non-affiliate                                                        |       |                            | —     |   |   |   | (8,939 | ) |   |
| Net cash provided  by (used in) investing activities                               |       |                            | 197,791    |   |   |   | (97,291 | ) |   |
| Cash flows from  financing activities:                                             |       |                            |       |   |   |   |   |   |   |
| Net proceeds from issuance of common stock                                         |       |                            | 32,200     |   |   |   | 18,694 |   |   |
| Repayments of long-term debt and capital  leases                                   |       |                            | (440,877   | ) |   |   | (1,717 | ) |   |
| Net cash provided  by (used in) financing activities                               |       |                            | (408,677   | ) |   |   | 16,977 |   |   |
| Effect of  exchange rate changes on cash and cash equivalents                      |       |                            | 399        |   |   |   | 89 |   |   |
| Net decrease in  cash and cash equivalents                                         |       |                            | (28,170    | ) |   |   | (61,488 | ) |   |
| Cash and cash  equivalents at beginning of period                                  |       |                            | 415,411    |   |   |   | 178,144 |   |   |
| Cash and cash  equivalents at end of period                                        |       |                            | $          | 387,241 |   |   |   | $ | 116,656 |   |   |
| Supplemental schedule of cash flow information:                                    |       |                            |       |   |   |   |   |   |   |
| Cash paid during the period for interest                                           |       |                            | $          | 11,148 |   |   |   | $ | 22,043 |   |   |
| Cash paid during the period for income taxes                                       |       |                            | $          | 3,976 |   |   |   | $ | 234 |   |   |
| Non cash activities:                                                               |       |                            |       |   |   |   |   |   |   |
| Additions to  capital leases                                                       |       |                            | $          | 3,260 |   |   |   | $ | — |   |   |

 

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

5

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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 September 30, 2007 and 2006.

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

The consolidated results of operations for the interimperiods are not necessarily indicative of the results of operations to beexpected for the full fiscal year. These condensed consolidated interimfinancial statements should be read in conjunction with the audited financialstatements for the year ended December 31, 2006, which are contained in ourannual 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: (i) the reported amounts of assets and liabilities, (ii) thedisclosure of contingent assets and liabilities at the dates of the financialstatements and (iii) 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 Optionfor Financial Assets and Financial Liabilities*, or SFAS 159, whichallows entities the option to measure eligible financial instruments andcertain other items at fair value. SFAS 159 is effective for fiscal yearsbeginning after November 15, 2007. We do not expect the adoption of SFAS159 to have a material impact on our consolidated financial statements.

In September 2006, FASBissued SFAS No. 157, *Fair Value Measurements*,or SFAS 157, which defines fair value, establishes a framework for measuringfair value and expands disclosures about fair value measurements. SFAS 157 iseffective for fiscal years beginning after November 15, 2007, and interimperiods within those fiscal years. We do not expect the adoption of SFAS 157 tohave a material impact on our consolidated financial statements.

**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. Potentialcommon shares result from the assumed conversion of convertible subordinateddebt and the assumed exercise of outstanding stock options, the proceeds ofwhich are then assumed to have been used to repurchase outstanding stockoptions using the treasury stock method. Potential common shares are notincluded in the per share calculation when the effect of their inclusion wouldbe anti-dilutive.

6

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For the three and nine months ended September 30,2007 and 2006, the following securities were excluded from the computation ofdiluted EPS because they would have had an anti-dilutive effect:

a.                 Optionsto purchase shares of common stock:

| ** **            | ** ** | **Three Months  Ended  September 30, 2007**                    | ** **      | **Three Months  Ended  September 30, 2006** | ** ** | **Nine Months  Ended  September 30, 2007** | ** ** | **Nine Months  Ended  September 30, 2006** | ** **      |
|-----------------------|------------|-------------------------------------------------------------------------------|-----------------|------------------------------------------------------------|------------|-----------------------------------------------------------|------------|-----------------------------------------------------------|-----------------|
| ** **            | ** ** | **(in thousands, except price per share data)** | ** **      |
| Number of options     |       | 3,569                                                                         |            | 4,175                                                      |       | 4,459                                                     |       | 3,779                                                     |            |
| Price range per share |       | $                                                                             | 22.71 to $87.50 |                                                       | $          | 48.52 to $87.50                                           |       | $                                                         | 38.26 to $87.50 |   | $ | 52.08 to $87.50 |   |
|                       |            |                                                                               |                 |                                                            |            |                                                           |            |                                                           |                 |  |  |  |  |

 

b.                Sharesof common stock reserved for issuance upon conversion of convertiblesubordinated debt:

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

 

We have issued 0%convertible subordinated notes due 2024, which were not convertible into equityas of September 30, 2007 or 2006 or at any time during the nine monthsended September 30, 2007 or 2006. Once these notes become convertible intoequity, shares of common stock will be reserved under the conversion formulafor issuance upon conversion if and when our common stock price exceeds $67.20per share on the NASDAQ Global Select Market. Prior to such occurrence, thenotes are only convertible into cash.

**4.**                 Inventories

Inventoriesconsist of the following:

| ** **     | ** ** | **September 30,  2007** | ** ** | **December 31,  2006** | ** ** |
|----------------|------------|------------------------------|------------|-----------------------------|------------|
| ** **     | ** ** | **(in thousands)**      | ** ** |
| Raw materials  |       |                         | $          | 24,238                      |       |   |   | $ | 21,611 |   |   |
| Finished goods |       |                         | 25,221     |                        |       |   | 15,476 |   |   |
| Total          |       |                         | $          | 49,459                      |       |   |   | $ | 37,087 |   |   |

 

**5.**                 DeferredFinancing and Patents Costs

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

| ** **                       | ** ** | **September 30,  2007** | ** ** | **December 31,  2006** | ** ** |
|----------------------------------|------------|------------------------------|------------|-----------------------------|------------|
| ** **                       | ** ** | **(in thousands)**      | ** ** |
| Deferred  financing costs, gross |       |                         | $          | 20,407                      |       |   |   | $ | 34,440 |   |   |
| Accumulated  amortization        |       |                         | (12,377    | )                           |       |   | (23,215 | ) |   |
| Deferred  financing costs, net   |       |                         | $          | 8,030                       |       |   |   | $ | 11,225 |   |   |
| Patents, gross                   |       |                         | $          | 2,259                       |       |   |   | $ | 2,259 |   |   |
| Accumulated  amortization        |       |                         | (1,723     | )                           |       |   | (1,603 | ) |   |
| Patents, net                     |       |                         | $          | 536                         |       |   |   | $ | 656 |   |   |

 

7

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Thefollowing schedule details our amortization expense related to patents and deferredfinancing costs:

| ** **                                | ** ** | **Three Months Ended** | ** ** | **Nine Months Ended** | ** ** |
|-------------------------------------------|------------|----------------------------------|------------|---------------------------------|------------|
| ** **                                | ** ** | **September 30,  2007**     | ** ** | **September 30,  2006**    | ** ** | **September 30,  2007** | ** ** | **September 30,  2006** | ** ** |
| ** **                                | ** ** | **(in thousands)**          | ** ** |
| Amortization of  deferred financing costs |       |                             | $          | 959                             |       |   |   | $ | 1,435 |   |   |   | $ | 3,195 |   |   |   | $ | 4,305 |   |   |
| Amortization of  patents                  |       |                             | 35         |                            |       |   | 60 |   |   |   | 120 |   |   |   | 186 |   |   |
| Total                                     |       |                             | $          | 994                             |       |   |   | $ | 1,495 |   |   |   | $ | 3,315 |   |   |   | $ | 4,491 |   |   |

 

**6.**                 ConvertibleSubordinated Debt

Convertiblesubordinated debt consists of the following:

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

 

**7.**                 ComprehensiveIncome

Totalcomprehensive income consists of net income, net foreign currency translationadjustment and net unrealized gain (loss) on available-for-sale securities.

| ** **                                                   | ** ** | **Three Months Ended** | ** ** | **Nine Months Ended** | ** ** |
|--------------------------------------------------------------|------------|----------------------------------|------------|---------------------------------|------------|
| ** **                                                   | ** ** | **September 30,  2007**     | ** ** | **September 30,  2006**    | ** ** | **September 30,  2007** | ** ** | **September 30,  2006** | ** ** |
| ** **                                                   | ** ** | **(in thousands)**          | ** ** |
| Comprehensive  income:                                       |       |                             |       |                            |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Net income                                                   |       |                             | $          | 42,895                          |       |   |   | $ | 64,431 |   |   |   | $ | 71,591 |   |   |   | $ | 85,511 |   |   |
| Net foreign  currency translation adjustment                 |       |                             | 1,294      |                            |       |   | 93 |   |   |   | 3,138 |   |   |   | 774 |   |   |
| Net unrealized  gain (loss) on available-for-sale securities |       |                             | 2,491      |                            |       |   | (8 | ) |   |   | 11,357 |   |   |   | (3,872 | ) |   |
| Total comprehensive  income                                  |       |                             | $          | 46,680                          |       |   |   | $ | 64,516 |   |   |   | $ | 86,086 |   |   |   | $ | 82,413 |   |   |

 

**8.**                 LegalProceedings

***Tecastemizole Class Action Complaints***

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

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

Under the terms of the Stipulation of Settlement, in June 2007,we paid into escrow $52.5 million in settlement of the class actions and,in July 2007, received an $18.5 million reimbursement from ourinsurance carriers. We recorded the litigation settlement expense of $34.0million, relating to this matter, during the quarter ended March 31, 2007.

On September 6, 2007,the Court granted final approval of the Stipulation of Settlement and entered afinal judgment consistent with the Stipulation of Settlement. The settlement isnow final and the total settlement amount has been released from escrow. Pursuantto the final judgment entered by the Court, the Court dismissed the classactions with prejudice and the plaintiffs are deemed to have released allrelated claims against us.

***Litigation Related to Generic Competition and PatentInfringement***

**LevalbuterolHydrochloride Inhalation Solution Abbreviated New Drug Applications**

In September 2005, we received notification thatthe FDA had received an Abbreviated New Drug Application, or ANDA, from BreathLimited, or Breath, seeking approval of a generic version of our 1.25 mg/3mL, 0.63 mg/3 mL and 0.31 mg/3 mL XOPENEX® (levalbuterol hydrochloride) InhalationSolution. Breath’s submission includes a Paragraph IV certification allegingthat our patents listed in the FDA publication entitled *Approved Drug Products With Therapeutic EquivalenceEvaluations*, commonly referred to as the “Orange Book,” for thesethree dosages of XOPENEX Inhalation Solution are invalid, unenforceable or notinfringed by the generic version for which Breath is seeking approval. In October 2005,we filed a civil action against Breath for patent infringement and a non-jurytrial is scheduled to begin on July 14, 2008 in the United States DistrictCourt for the District of Massachusetts, No. CV:06-10043.

In January 2006, we received notification thatthe FDA had received an ANDA from Dey, L.P., seeking approval of a genericversion of our 1.25 mg/3 mL, 0.63 mg/3 mL, and 0.31 mg/3 mL XOPENEXInhalation Solution. Dey, L.P.’s submission includes a Paragraph IVcertification alleging that our patents listed in the Orange Book for thesethree dosages of XOPENEX Inhalation Solution are invalid, unenforceable, or notinfringed by the generic version for which Dey, L.P. is seeking approval. In February 2006,we filed a civil action against Dey, L.P. for patent infringement and the caseis pending in the United States District Court for the District of Delaware,C.A. No. 06-113.

In August 2006, we received notification that theFDA had received an ANDA from Dey, L.P. seeking approval of a generic versionof our 1.25 mg/0.5 mL XOPENEX Inhalation Solution concentrate. Dey,L.P.’s submission includes a Paragraph IV certification alleging that ourpatents listed in the Orange Book for 1.25 mg/0.5 mL XOPENEXInhalation Solution concentrate are invalid, unenforceable, or not infringed bythe generic version for which Dey, L.P. is seeking approval. In September 2006,we filed a civil action against Dey, L.P. for patent infringement in the UnitedStates District Court for the District of Delaware, C.A. No. 06-604.In September 2006, both civil actions we filed against Dey, L.P. wereconsolidated into a single suit. No trial date has been set.

In May 2007, we received notification that theFDA had received an ANDA from Barr Laboratories, Inc., or Barr, seekingapproval of a generic version of our 1.25 mg/3 mL, 0.63 mg/3 mL and 0.31 mg/3mL XOPENEX Inhalation Solution. Barr’s submission includes a Paragraph IVcertification alleging that our patents listed in the Orange Book for thesethree dosages of XOPENEX Inhalation 

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Solution are invalid,unenforceable or not infringed by the generic version for which Barr is seekingapproval. In July 2007, we filed a civil action against Barr for patentinfringement and the case is pending in the United States District Court forthe District of Delaware, C.A. No. 07-438. No trial date has beenset.

The filing of an action for patent infringement underthe Hatch-Waxman Act invokes an automatic 30-month stay of the FDA’sauthority to grant final marketing approval to those companies that file anANDA containing a Paragraph IV certification against one or more of our XOPENEXInhalation Solution patents. The first filer of an ANDA with a Paragraph IVcertification is potentially entitled to a 180-day period ofsemi-exclusivity during which the FDA cannot approve subsequently filed ANDAs. The180-day semi-exclusivity period would begin to run only upon firstcommercial marketing by the first filer. There are, however, also certainevents that could cause the first filer to forfeit the 180-daysemi-exclusivity period, which we refer to as a forfeiture event.

For our 1.25 mg/3 mL, 0.63/3 mL, and 0.31/3 mL XOPENEXInhalation Solution, we believe that Breath is the first filer and potentiallyentitled to 180-days of semi-exclusivity against subsequent ANDA filersfor those three dosages. The 30-month stay against Breath’s ANDA isscheduled to expire on or about March 7, 2008. Upon expiration of that 30-monthstay, the FDA could grant final approval and Breath could then commence an “atrisk” distribution of its generic levalbuterol product for those dosagesnotwithstanding our patents and notwithstanding that the court’s decision as tothe merits of the litigation will not have been rendered, unless we were ableto obtain an injunction prohibiting such distribution. However, if a forfeitureevent occurs and the FDA determines that Breath has forfeited the 180-daysemi-exclusivity period for those three dosages, other ANDA filers who havebeen granted final approval by the FDA could commence an “at risk” launch uponexpiration of the 30-month stay. For those three dosages, the 30-monthstays against Dey L.P. and Barr expire on or about July 9, 2008 and November 30,2009, respectively.

For our 1.25 mg/0.5 mL XOPENEX InhalationSolution concentrate, we believe that Dey L.P. is the first filer andpotentially entitled to 180-days of semi-exclusivity for thatconcentration. The 30 month stay against Dey L.P.’s ANDA for that concentrationexpires on or about February 14, 2009.

Although we could seekrecovery of any damages sustained in connection with any activities conductedby a party that infringe a valid and enforceable claim in our patents, whetherwe are ultimately entitled to such damages would be determined by the court inconnection with our ongoing legal proceedings with each party desiring tolaunch generic levalbuterol hydrochloride products. If any of these partieswere to commence selling a generic alternative to our XOPENEX InhalationSolution product prior to the resolution of these ongoing legal proceedings, orthere is a court determination that the products these companies wish to marketdo not infringe our patents, or that our patents are invalid or unenforceable,it would have a material adverse effect on our business, financial conditionand results of operations. In addition, our previously issued guidanceregarding our projected financial results may no longer be accurate and wewould have to revise such guidance.

**DesloratadineAbbreviated New Drug Applications**

In June 2007, we received notification that theFDA had received an ANDA from Glenmark Pharmaceuticals, Ltd. and GlenmarkPharmaceuticals, Inc., USA, which we refer to collectively as Glenmark,seeking approval of a generic version of Schering-Plough Corporation, orSchering-Plough’s, 5 mg tablets of CLARINEX® (desloratadine). Glenmark’s submissionincludes a Paragraph IV certification alleging that our patents thatSchering-Plough (as licensee of such patents) listed in the Orange Book for itsCLARINEX are invalid, unenforceable or not infringed by the generic version forwhich Glenmark is seeking approval. In July 2007, we and the University ofMassachusetts, co-owners of 

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certain patents listed inthe Orange Book, filed a civil action in the United States District Court forthe District of New Jersey against Glenmark for patent infringement, C.A. No. 07-3385.

In July 2007, we received notification that theFDA had received an ANDA from Sun Pharmaceutical Industries, Ltd., or Sun,seeking approval of a generic version of Schering-Plough’s 5 mg tablets ofCLARINEX. Sun’s submission includes a Paragraph IV certification alleging thatour patents listed by Schering-Plough (as licensee of such patents) in theOrange Book for CLARINEX are invalid, unenforceable, or are not infringed bythe generic version for which Sun is seeking approval. In September 2007,we and the University of Massachusetts filed a civil action in the UnitedStates District Court for the District of New Jersey against Sun for patentinfringement, C.A. No. 07-4213.

In August 2007, we received notification that theFDA had received an ANDA from Orchid Chemicals & Pharmaceuticals Ltd.,or Orchid, seeking approval of a generic version of Schering-Plough’s 5 mgtablets, and 2.5 and 5 mg orally disintegrating tablets of CLARINEX. Orchid’ssubmission includes a Paragraph IV certification alleging that our patentslisted by Schering-Plough (as licensee of such patents) in the Orange Book forCLARINEX are invalid, unenforceable or not infringed by the generic version forwhich Orchid is seeking approval. In October 2007, we and the Universityof Massachusetts filed a civil action in the United States District Court forthe District of New Jersey against Orchid for patent infringement, C.A. No. 07-4623.

In September 2007, we received notification thatthe FDA had received ANDAs from Mylan Pharmaceuticals, Inc., or Mylan,Lupin Limited, or Lupin, and Perrigo R & D Company, or Perrigo,seeking approval of a generic version of Schering-Plough’s 5 mg tablets ofCLARINEX, and from Dr. Reddy’s Laboratories, or Dr. Reddy’s, seekingapproval of a generic version of Schering-Plough’s 2.5/120 mg tablets ofCLARINEX-D 12 hour desloratadine and pseudoephedrine extended release tablets. Thesubmissions by these parties include Paragraph IV certifications alleging thatcertain patents listed by Schering-Plough (as licensee of such patents) in theOrange Book for CLARINEX are invalid, unenforceable or not infringed by thegeneric versions for which these parties are seeking approval. In October 2007,we and the University of Massachusetts filed civil actions in the United StatesDistrict Court for the District of New Jersey against Mylan, Lupin, Perrigo andDr. Reddy’s for patent infringement, C.A. No. 3:07-cv-05017,C.A. No. 3:07-cv-05265, C.A. No. 3:07-cv-05136 and C.A. No. 3:07-cv-05001,respectively.

In October 2007, we received notification thatthe FDA had received an ANDA from Anchen Pharmaceuticals, Inc., or Anchen,seeking approval of a generic version of Schering-Plough’s 2.5/120 mg tabletsof CLARINEX-D 12 hour desloratadine and pseudoephedrine extended releasetablets. Anchen’s submission includes a Paragraph IV certification allegingthat our patents listed by Schering-Plough (as licensee of such patents) in theOrange Book for CLARINEX are invalid, unenforceable or not infringed by thegeneric version for which Anchen is seeking approval. We are currentlycontemplating filing a civil action against Anchen for patent infringement.

We believe that all ofthese ANDAs are subject to a statutory stay of approval until June 21,2009 based on previous litigation commenced by Schering-Plough against theseparties in separate civil actions involving another patent.

***BROVANAPatent Infringement Claim***

In April 2007, we were served with a Complaintfiled in the United States District Court for the Southern District of NewYork, C.A. No. 1:07-cv-2353, by Dey, L.P. and Dey, Inc.,referred to collectively as Dey, alleging that manufacture and sale of BROVANA® (arformoteroltartrate) Inhalation Solution infringes or will induce infringement of a singleU.S. patent for which Dey owns all rights, title and interest. In April 2007,we filed an Answer and Counterclaim to this Complaint seeking to invalidate theoriginally asserted patent and a second related patent. In May 2007, Deyfiled a reply asserting infringement of the 

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second patent. Under thecurrent trial scheduling order, trial will begin no earlier than December 12,2008. It is too early to make a reasonable assessment as to the likely outcomeor impact of this litigation. We are unable to reasonably estimate any possiblerange of loss or liability related to this lawsuit due to its uncertainresolution.

Patent litigation involvescomplex legal and factual questions. We can provide no assurance concerning theoutcome or the duration of any patent related lawsuits. If we, or third partiesfrom whom we receive royalties, are not successful in enforcing our respectivepatents, the companies seeking to market generic versions of our drugs and thedrugs of our licensees will not be excluded, for the full term of therespective patents, from marketing their generic versions of our products orthird party products for which we have licensed rights to our patents.Introduction of generic copies of any of our products or third party productsfor which we have licensed rights to our patents before the expiration of ourpatents would have a material adverse effect on our business, financialcondition and results of operations.

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

We announced in June 2006 that the SEC isconducting an informal inquiry into our stock option grants and stock optiongranting practices. A special committee of our outside directors, with theassistance of outside legal counsel and outside accounting specialists,reviewed the stock option grants to our officers, directors and employees from1996 to June 2006 under our various stock option plans in effect duringthis period. Our finance department also reviewed the stock option grants andstock option practices from 1996 to June 2006. Their review resulted inthe restatement of our financial statements for the quarters ended March 31,June 30 and September 30, 2005, the quarter ended March 31, 2006and the years ended December 31, 2005, 2004 and 2003. The specialcommittee has concluded that there is no evidence of fraud, illegal activity oran intent to mislead or deceive with respect to our stock option grantingpractices or the specific grants that have resulted in the restatement of ourfinancial statements. The special committee also determined that the board ofdirectors and/or compensation committee generally intended to award the optionson the date specified in the grants, although they were not aware of theaccounting consequences. Representatives from the U.S. Attorneys Officeattended some of the earlier meetings that our outside counsel had with theSEC. While the U.S. Attorneys Office has not initiated an investigation, wecannot be certain that it will not. The SEC and/or any other governmentalagency that may initiate a formal investigation may reach different conclusionsand, if so, we could be subject to monetary damages, fines and penalties, andour officers and/or directors could be prohibited from serving as officers anddirectors of any public company and could be subject to criminal penaltiesand/or disgorgement.

From June to October 2006, six stockholderderivative complaints were commenced against us (as a nominal defendant) andcertain of our current and former officers and directors. Three of thesecomplaints were filed in the Superior Court, Middlesex County, Commonwealth ofMassachusetts (later transferred to the Business Litigation Session of theSuperior Court, Suffolk County, Commonwealth of Massachusetts) and three werefiled in the United States District Court for the District of Massachusetts. Allstate court complaints were later consolidated into one state court action, andall Federal court complaints were consolidated into one Federal court action.It was alleged in both actions that the individual defendants breached theirfiduciary duties and were unjustly enriched in connection with certain stockoption grants; violations of Federal securities laws were alleged in the Federalaction as well. The complaints sought monetary damages in unspecified amounts,equitable and injunctive relief, including disgorgement of profits obtained bycertain defendants and other relief as determined by the court. On November 20,2006, we moved to dismiss the state court action, and on March 20, 2007 ahearing was held on the motion. No decision on the motion has been rendered atthis time. The Federal court action has been stayed pending resolution of thestate court motion to dismiss.

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In October 2007, theparties to both the state and Federal action reached a settlement that providesfor the dismissal of both actions, subject to the approval of the court. Thesettlement resolves all claims and includes no finding of wrongdoing on thepart of any of the defendants and no cash payment other than attorneys’ fees. Aspart of the settlement, we have agreed to adopt and implement stock optiongrant and other procedures that reflect developing best practices. Apreliminary hearing on the fairness of the settlement and the adequacy of thestockholder notice was held on November 6, 2007 by the state court, with afinal fairness hearing likely to be held in January 2008. The settlement willnot be final and effective until final approval by the state court and entry ofdismissal with prejudice by the Federal court.

***LUNESTA Trademark Claim***

In September 2006,Tharos Laboratories, Inc., or Tharos, filed suit against us in the UnitedStates District Court, District of Utah, Central Division, 2:06-cv-00757,alleging trademark infringement, dilution, unfair competition, falseadvertising and false designation of origin arising out of our use of our silkluna moth design in connection with LUNESTA® (eszopiclone).Tharos seeks unspecified monetary damages and to enjoin our use of the silkluna moth design. In October 2006, we filed a Motion to Dismiss Tharos’claims. On February 9, 2007, the court granted our motion in respect ofthe state unfair competition claims and denied it in respect of Tharos’ otherclaims. On March 6, 2007, we filed an Answer to Tharos’ Complaint. Inaddition, we filed counterclaims against Tharos for cancellation of Tharos’alleged trademark and for false advertising. We continue to defend ourtrademark in this litigation but we are unable at this stage to predict itsultimate resolution. In October 2007, we reached a preliminary agreementin principle with Tharos to settle this litigation, and final settlement issubject to the parties entering into a written settlement agreement.

***Other Legal Proceedings***

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, financial condition or results of operations.

**9.**                 Commitmentsand Contingencies

We announced in June 2006that the SEC is conducting an informal inquiry into our stock option grants andstock option granting practices. A special committee of our outside directors,with the assistance of outside legal counsel and outside accountingspecialists, reviewed the stock option grants to our officers, directors andemployees from 1996 to June 2006 under our various stock option plans ineffect during this period. Our finance department also reviewed the stockoption grants and stock option practices from 1996 to June 2006. Theirreview resulted in the restatement of our financial statements for the quartersended March 31, June 30 and September 30, 2005, the quarterended March 31, 2006 and the years ended December 31, 2005, 2004 and2003. The special committee has concluded that there is no evidence of fraud,illegal activity or an intent to mislead or deceive with respect to our stockoption granting practices or the specific grants that have resulted in therestatement of our financial statements. The special committee also determinedthat the board of directors and/or compensation committee generally intended toaward the options on the date specified in the grants, although they were notaware of the accounting consequences. Representatives from the U.S. AttorneysOffice attended some of the earlier meetings that our outside counsel had withthe SEC. While the U.S. Attorneys Office has not initiated an investigation, wecannot be certain that it will not. The SEC and/or any other governmentalagency that may initiate a formal investigation may reach different conclusionsand, if so, we could be subject to monetary damages, fines and penalties, andour officers and/or directors could be prohibited from serving as officers anddirectors of any public company and could be subject to criminal penaltiesand/or disgorgement.

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**10.**          IncomeTaxes

Deferred tax assets and liabilities are recognized forthe estimated future tax consequences attributable to tax benefit carryforwardsand to differences between the financial statement amounts of assets andliabilities and their respective tax basis. Deferred tax assets and liabilitiesare measured using enacted tax rates in effect for the year in which thedifferences are expected to reverse. A valuation allowance is established if,based on management’s review of both positive and negative evidence, it is morelikely than not that all or a portion of the deferred tax asset will not be realized.Given our limited history of profitability, and the possible adverse impact toour XOPENEX Inhalation Solution sales if an “at risk” generic launch were tooccur or we are unable to successfully defend our patents rights, managementcontinues to conclude a valuation allowance is required for the full amount ofthe deferred tax asset. If in the future, we determine based on our futureprofitability, that these deferred tax assets are more likely than not to berealized, a release of all, or part, of the related valuation allowance couldresult in an immediate material income tax benefit in the period of decreaseand material income tax provisions in future periods.

We adopted the FASB Interpretation, or FIN, No. 48, *Accounting for Uncertainty in Income Taxes*, or FIN 48 in January 2007.The implementation 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 reasonably estimate that our unrecognized tax benefits position will notchange significantly within the next twelve months.

We file tax returns in the U.S. Federal jurisdictionand in various state, local and foreign jurisdictions. During the fourthquarter of 2006, the Internal Revenue Service, or IRS, commenced an audit ofour 2005 and 2004 U.S. Federal income tax returns, which was formally concludedduring the third quarter of 2007. We are no longer subject to IRS examinationfor years prior to 2004, although carryforward attributes that were generatedprior to 2004 may still be adjusted upon examination by the IRS if they eitherhave been or will be used in a future period. We receive inquiries from variousstates during the year, some of those inquiries include an audit of statereturns previously filed. With limited exceptions, we are no longer subject tostate or local examinations for years prior to 2003, however, carryforwardattributes that were generated prior to 2003 may still be adjusted uponexamination by state or local tax authorities if they either have been or willbe 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, 2005,2004 and 2003. There are currently no examinations being conducted by the taxauthorities in the Netherlands Antilles. With limited exceptions, we are nolonger subject to examination in Canada and the Netherlands Antilles for yearsprior to 2003 and 1999, respectively, although carryforward attributes thatwere generated prior to these respective periods may still be adjusted uponexamination if they either have been or will be used in a future period.

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

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**11.**          SubsequentEvents

In October 2007,we announced that we had decided to reduce our sales force by approximately 300positions. The decision was based on our recently completed evaluation of thestructure, sizing and allocation of our direct sales force and is intended toresult in cost savings in fiscal year 2008. We communicated our decision to ouremployees, including our sales force, on October 30, 2007. A finaldecision regarding which employees will be affected has not been made, howeverwe expect to complete the sales force reduction prior to December 31,2007.

As a result of this sales force reduction, we expectto record charges of between $10 and $12 million in the fourth quarter of2007. We currently expect these charges to consist of approximately $7.5 to $9.0 million relating to employee severance benefits and approximately $2.5 to$3.0 million relating to other charges, including employee relocation expensesand automobile lease termination fees.

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**ITEM2.**                MANAGEMENT’SDISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

**Cautionary Statement Regarding Forward-LookingStatements**

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-basedpharmaceutical company focused on discovering, developing and commercializingdifferentiated products that address large and growing markets and unmetmedical needs and can be marketed to primary care physicians and certainspecialists through our sales force.

Wecurrently manufacture and sell four products:

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

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

·       BROVANA® (arformoterol tartrate) as a long-term,twice-daily maintenance treatment of bronchoconstriction in patients withchronic obstructive pulmonary disease, or COPD, including chronic bronchitisand emphysema; and

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

We market and sell XOPENEXInhalation Solution, XOPENEX HFA, BROVANA and LUNESTA directly through oursales force. We have entered into out-licensing arrangements with respect tothe sale of eszopiclone outside of the United States, Canada and Mexico andwith respect to several other compounds. We expect to commercialize anyadditional products that we may successfully develop or acquire through oursales force, co-promotion agreements and/or out-licensing partnerships.

Criticalnear-term success factors for us include our ability to:

·       continueto increase our LUNESTA revenues, despite increasing competition;

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

·       continueto increase our XOPENEX HFA revenues;

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

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

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

Our long-term successdepends in large part on our ability to successfully develop, acquire and commercializenew product candidates.

We expect that sales ofLUNESTA and XOPENEX Inhalation Solution will represent the majority of ourtotal revenues in 2007. We do not have long-term sales contracts with ourcustomers, and we rely primarily on purchase orders for sales of our products.Reductions, delays or cancellations of orders for LUNESTA, XOPENEX InhalationSolution, XOPENEX HFA or BROVANA could adversely affect our operating results.If sales of LUNESTA, XOPENEX Inhalation Solution, XOPENEX HFA and/or BROVANA donot meet our expectations, we may not have sufficient revenues to achieve ourbusiness 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 continue to increase as compared to 2006 as we incurincreasing sales and marketing costs, related to anticipated product revenuegrowth, as well as expenses related to the restructuring of our sales force. Weexpect research and development expenses to continue to increase as compared to2006 as we continue to invest in research and development activities relatingto additional studies for LUNESTA and BROVANA, and continued development of ourPhase I and Phase II drug candidates, as well as increased drug discoveryefforts. As part of our business strategy for the remainder of 2007 and thefuture, we expect to consider and, as appropriate, consummate acquisitionsand/or licensing of other technologies, product candidates, approved productsand/or businesses.

**Significant 2007 Developments**

In November 2007, weannounced that the Centers for Medicare and Medicaid Services, or CMS,established a product-specific billing code for BROVANA under the Medicare PartB benefit, which becomes effective on January 1, 2008. In April 2007, weannounced the commercial availability of BROVANA for the treatment of COPD.

In October 2007, weannounced that we had decided to reduce our sales force by approximately 300positions. The decision was based on our recently completed evaluation of thestructure, sizing and allocation of our direct sales force and is intended toresult in cost savings in fiscal year 2008. We expect to complete the salesforce reduction prior to December 31, 2007.

In October 2007, theparties to both the state and Federal derivative actions brought against us (asa nominal defendant) and certain of our current and former officers anddirectors related to certain stock option grants and alleged violations of Federalsecurities laws, reached a settlement that provides for the dismissal of bothactions, subject to the approval of the court. The settlement resolves allclaims and includes no finding of wrongdoing on the part of any of thedefendants and no cash payment other than attorneys’ fees. As part of thesettlement, we have agreed to adopt and implement stock option grant and otherprocedures that reflect developing best practices. A preliminary hearing on thefairness of the settlement and the adequacy of the stockholder notice was heldon November 6, 2007 by the state court, with a final fairness hearing likely tobe held in January 2008. The settlement will not be final and effective untilfinal approval by the state court and entry of dismissal with prejudice by the Federalcourt.

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In October 2007, weannounced that Mark Iwicki was elected to the newly created position ofExecutive Vice President, Chief Commercial Officer.

In September 2007, weentered into an agreement with Glaxo Group Limited, or GSK, an affiliate ofGlaxoSmithKline, for the commercialization of our eszopiclone product, which wemarket as LUNESTA in the United States, for all markets worldwideexcluding the United States, Canada, Mexico and Japan. Our eszopiclone productwill be marketed by GSK in its territory primarily as LUNIVIA® brand eszopiclone for the treatment ofinsomnia. Under this agreement, we received an initial payment of $20 millionand are entitled to receive additional payments upon accomplishment of variousmilestones. If all milestones are met, GSK will be obligated to pay us $155million in aggregate license and milestone payments. We are also entitled toreceive double-digit royalties that escalate upon increased product sales, and compensationfor supplying the product to GSK pursuant to a supply agreement that isexpected to be entered into by the parties.

In July 2007, weannounced that we had submitted a Marketing Authorization Application, or MAA,to the European regulatory authorities for LUNIVIA for the treatment ofinsomnia. Approval of the MAA, which is the European Union equivalent of a NewDrug Application, or NDA, in the United States, would allow authorization tomarket LUNIVIA in the European Union. Pursuant to our agreement with GSK, weare responsible for supporting the MAA until final approval, or such earlierdate mutually agreed upon by the parties, and GSK is responsible for supportingthe MAA thereafter.

In July 2007, we alsoannounced that we had entered into an agreement with Eisai Co. Ltd., or Eisai,for the development and commercialization of our eszopiclone product, marketedas LUNESTA in the United States. Under this agreement, Eisai will beresponsible for completing remaining clinical trials necessary for attainingmarketing approval from the Japanese regulatory authorities and, contingent onobtaining regulatory approval, commercialization of the product in Japan. Wereceived an initial milestone payment and will be entitled to receivesubsequent payments upon accomplishment of various development, regulatory andpricing milestones, as well as royalties on product sales. We will also beresponsible for, and will receive compensation in connection with, themanufacture and supply of bulk tablets and/or active ingredient.

In June 2007, weannounced that CMS determined that, based on its interpretation of thestatutory language of the Medicare Prescription Drug Improvement andModernization Act of 2003, or MMA, it was required to discontinue the uniquereimbursement codes for XOPENEX Inhalation Solution and generic albuterol,which had been in place since January 2005, and bundled these productstogether in a newly created reimbursement code. As a result of this codingchange, reimbursement for XOPENEX Inhalation Solution and generic albuterol isnow based on the blended weighted average selling price for the two products,resulting in reimbursement for XOPENEX Inhalation Solution that is considerablylower than the published selling price for the product distribution channel. Thenew reimbursement rate became effective on July 1, 2007 and is subject tochange quarterly based upon the respective contribution of commercial sales ofXOPENEX Inhalation Solution and generic albuterol to the quarterly blendedweighted average selling price calculation for the newly created reimbursementcode. This quarterly average selling price calculation is mandated by the MMA. Revenuesfrom the sale of XOPENEX Inhalation Solution have been, and we expect willcontinue to be, adversely affected on a comparable basis as a result of thischange.

In June 2007, wefiled in the United States District Court for the District of Massachusetts, orthe Court, a Stipulation of Settlement regarding two securities class actionlawsuits, or class actions, pending in 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 of 

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tecastemizoleby the FDA. The Stipulation of Settlement contains no admission of wrongdoing.Sepracor and the other defendants have always maintained and continue tobelieve that we did not engage in any wrongdoing or otherwise commit anyviolation of Federal or state securities laws or other laws. However, given thepotential cost and burden of continued litigation, we believe the settlement isin our best interests and the best interests of our stockholders. Under theterms of the Stipulation of Settlement, in June 2007 we paid into escrow$52.5 million in settlement of the class actions and, in July 2007,received an $18.5 million reimbursement from our insurance carriers. Werecorded the litigation settlement expense of $34.0 million, relating to thismatter, during the quarter ended March 31, 2007. In September 2007,the Court granted final approval of the Stipulation of Settlement and entered afinal judgment consistent with the Stipulation of Settlement. The settlement isnow final and the total settlement amount has been released from escrow. Pursuantto the final judgment entered by the Court, the Court dismissed the classactions with prejudice and the plaintiffs are deemed to have released allclaims against us.

In May 2007, weannounced that Adrian Adams, President and Chief Operating Officer of Sepracor,was elected to the role of President and Chief Executive Officer. Mr. Adamsassumed the Chief Executive Officer role from Timothy J. Barberich, who wassimultaneously elected Executive Chairman of the Board of Directors.

In April 2007, wewere served with a Complaint filed in the United States District Court for theSouthern District of New York, C.A. No. 1:07-cv-2353, by Dey,L.P. and Dey, Inc., referred to collectively as Dey, alleging that themanufacture and sale of BROVANA infringes or will induce infringement of asingle U.S. patent for which Dey owns all rights, title and interest. In April 2007,we filed an Answer and Counterclaim to this Complaint seeking to invalidate theoriginally asserted patent and a second related patent. In May 2007, Deyfiled a reply asserting infringement of the second patent Under the currenttrial scheduling order, trial will begin no earlier than December 12,2008. It is too early to make a reasonable assessment as to the likely outcomeor impact of this litigation. We are unable to reasonably estimate any possiblerange of loss or liability related to this lawsuit due to its uncertainresolution.

In March 2007, weannounced that W. James O’Shea had resigned as our President and ChiefOperating Officer and was elected Vice Chairman. Mr. O’Shea ceased actingin this capacity on August 31, 2007. In addition, we announced that,effective March 1, 2007, our board had elected Adrian Adams to thepositions of President and Chief Operating Officer and Andrew I. Koven to thepositions of Executive Vice President, General Counsel and Secretary. Theboard, upon the recommendation of the nominating and corporate governancecommittee, also elected Mr. Adams to the Board of Directors, as a Class IIdirector. Douglas E. Reedich, Senior Vice President, Legal Affairs, plansto leave Sepracor but will remain in this position for a 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 Periods ended September 30, 2007 and2006**

**Revenues**

Product sales were $275.0million and $280.1 million for the three months ended September 30, 2007and 2006, respectively, a decrease of approximately 2%.

Sales of XOPENEXInhalation Solution were $94.4 million and $125.4 million for the three monthsended September 30, 2007 and 2006, respectively, a decrease ofapproximately 25%. The decrease was primarily due to a decrease in the numberof units sold of approximately 15%, and a 12% decrease in the net selling priceas a result of a higher rate of sales discounts and allowances during the threemonths ended September 30, 2007, primarily related to an increase inMedicare Part B government rebates as a result of the CMS bundlingdecision, which created a new reimbursement code for XOPENEX Inhalation 

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Solution.The decrease in net selling price was partially offset by (i) a grossprice increase that occurred in July 2007, and, (ii) a decrease inwholesaler fee-for-service charges resulting from credits earned due to thegross price increase. In the three months ended September 30, 2006, wereversed a $4.1 million reserve related to TRICARE Pharmacy Benefits Programgovernment rebate, which was based on a U.S. Federal Court of Appeals ruling in September 2006 that pharmaceuticalmanufacturers are not required to reimburse on drugs purchased through theTRICARE Program. Adjustments recorded to gross sales are furtherdisclosed below under the heading “Analysis of gross sales to net sales.”

Salesof XOPENEX HFA were $17.3 million and $13.1 million for the three monthsended September 30, 2007 and 2006, respectively, an increase ofapproximately 32%.The increase is duein part to a 47% increase in the net selling price, which is primarily relatedto fewer units sold in the three months ended September 30, 2007 under agovernment contract with the Departmentof Veterans Affairs, or VA, as compared to the same period in 2006. Thisincrease in net selling price was partially offset by a decrease in the numberof units sold of approximately 10% and an increase in Medicaid governmentrebates, as well as an increase in product coupons distributed. Adjustmentsrecorded to gross sales are further disclosed below under the heading “Analysisof gross sales to net sales.”

Sales of BROVANA were $2.4million and $0 for the three months ended September 30, 2007 and 2006,respectively. We introduced BROVANA commercially in April 2007.Adjustments recorded to gross sales are disclosed below under the heading “Analysisof gross sales to net sales.”

Sales of LUNESTA were$160.9 million and $141.6 million for the three months ended September 30,2007 and 2006, respectively, an increase of approximately 14%. The increase isprimarily the result of a 19% increase in the gross selling price, whichyielded an increase of approximately 10% in the net selling price due to ahigher rate of sales discounts and allowances, particularly with respect toMedicare Part D government rebates and managed care commercial discounts. Theincrease was also the result of an increase in the number of units sold ofapproximately 3%. In the three months ended September 30, 2006, wereversed a $4.1 million reserve related to TRICARE Pharmacy Benefits Programgovernment rebate, which was based on a U.S. Federal Court of Appeals ruling in September 2006 that pharmaceuticalmanufacturers are not required to reimburse on drugs purchased through theTRICARE Program. Adjustments recorded to gross sales are furtherdisclosed below under the heading “Analysis of gross sales to net sales.”

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***Analysis of gross sales to net sales—******We***recordproduct sales net of the following significant categories of product salesallowances: payment term discounts, wholesaler fee-for service, government andcommercial rebates and discounts, returns and other discounts. Calculating eachof these items involves significant estimates and judgments and requires us touse information from external sources. We recompute these amounts each quarterand, historically, our estimates have not materially differed from actualresults. *The*followingtable presents the adjustments deducted from gross sales to arrive at netsales:

| ** **                                           | ** ** | **For the Three Months Ended September 30,** | ** ** |
|------------------------------------------------------|------------|----------------------------------------------------------------------------|------------|
| ** **                                           | ** ** | **2007**                                                                   | ** ** | **% of  Sales** | ** ** | **2006** | ** ** | **% of  Sales** | ** ** | **$  Change** | ** ** | **%  Change** | ** ** |
| ** **                                           | ** ** | **(dollars in thousands)**                                       | ** ** |
| Gross sales                                          |       | $                                                                          | 372,412    |   | 100.0 | % | $ | 349,015 |   | 100.0 | % | $ | 23,397 |   |   | 7 | % |   |
| Adjustments to gross  sales:                         |       |                                                                       |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Payment term discounts                               |       | 7,474                                                                      |       | 2.0 | % | 7,010 |   | 2.0 | % | 464 |   |   | 7 | % |   |
| Wholesaler fee-for-service                           |       | 7,012                                                                      |       | 1.9 | % | 11,487 |   | 3.3 | % | (4,475 | ) |   | (39 | )% |   |
| Government and commercial rebates and discounts |       | 68,630                                                                     |       | 18.4 | % | 45,325 |   | 13.0 | % | 23,305 |   |   | 51 | % |   |
| Returns                                              |       | 8,231                                                                      |       | 2.2 | % | 4,141 |   | 1.2 | % | 4,090 |   |   | 99 | % |   |
| Other (includes product introduction discounts)      |       | 6,041                                                                      |       | 1.6 | % | 966 |   | 0.3 | % | 5,075 |   |   | 525 | % |   |
| Sub-total  adjustments                               |       | 97,388                                                                     |       | 26.1 | % | 68,929 |   | 19.8 | % | 28,459 |   |   | 41 | % |   |
| Net sales                                            |       | $                                                                          | 275,024    |   | 73.9 | % | $ | 280,086 |   | 80.2 | % | $ | (5,062 | ) |   | (2 | )% |   |

 

The increase inadjustments to gross sales as a percentage of gross sales for the three monthsended September 30, 2007 as compared to the three months ended September 30,2006 primarily reflects an overall increase in government and commercialrebates and discounts as a result of (i) an increase in discounts giventhrough the Medicare Part B program that we offered on the sales ofXOPENEX Inhalation Solution, (ii) an increase in Medicaid discounts thatwe offered on the sales of LUNESTA, XOPENEX Inhalation Solution and XOPENEXHFA, (iii) an increase in discounts given through the Medicare Part Dprogram that we offered on the sales of LUNESTA. In the three months ended September 30,2006, we reversed $8.3 million of reserves related to TRICARE Pharmacy BenefitsProgram government rebate,of which $4.2 million related to XOPENEX franchise sales and $4.1 millionrelated to LUNESTA sales. The reversal was based on a U.S. Federal Court ofAppeals ruling in September 2006 that pharmaceutical manufacturers are notrequired to reimburse on drugs purchased through the TRICARE Program. Inaddition, adjustments to gross sales increased as a result of higher amountsreserved for LUNESTA and XOPENEX Inhalation Solution product returns based onhigher actual returns, and an increase in discounts we offered through voucherand coupon programs on the sales of XOPENEX HFA. Partially offsetting theseincreases in adjustments to gross sales as a percentage of gross sales was a decrease in governmentdiscounts as a result of fewer XOPENEX HFA units sold in the three months endedSeptember 30, 2007 under a government contract with the VA as compared to the same period in2006. Wholesaler fee-for-service charges also decreased primarily related tocredits earned due to a XOPENEX Inhalation Solution gross price increase in July 2007.

Royalties and license feeswere $8.9 million and $9.2 million for the three months ended September 30,2007 and 2006, respectively, a decrease of approximately 3%.

Royalties earned on thesales of ALLEGRA® (fexofenadine HCl), under our agreementwith sanofi-aventis, increased to $3.7 million for the three months ended September 30,2007 compared to $3.0 million for the same period in 2006 due to increasedsales in Japan.

Royalties earned on sales of CLARINEX® (desloratadine),under our agreement with Schering-Plough Corporation, or Schering-Plough, were$2.5 million for the three months ended September 30, 

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2007 compared to $4.1million for the same period in 2006. Royalties for the three months ended September 30,2006 included a true-up of the second-quarter 2006 estimate of approximately$900,000.

Royalties earned on sales of XYZAL®/XUSALTM (levocetirizine) underour agreement with UCB Pharma SA, Belgium, or UCB, increased slightly to $2.5million for the three months ended September 30, 2007 as compared to $2.1million for the same period in 2006.

License fees recognized on our GSK and Eisaiagreements for the commercialization of our eszopiclone product were $206,000and $0 for the three months ended September 30, 2007 and 2006,respectively.

A number of the patents weown and license to third parties for which we receive these royalties are thesubject of patent infringement, invalidation or revocation claims. We canprovide no assurance concerning the outcome or the duration of any patentrelated lawsuits. If we, or third parties from whom we receive royalties, arenot successful in enforcing our respective patents, the companies seeking tomarket generic versions of our drugs and the drugs of our licensees will not beexcluded from marketing their generic versions of these products. Introductionof generic copies of any of these products before the expiration of our patentsor the patents of our licensees could have a material adverse effect on ourbusiness, financial condition and/or results of operations.

**Costs of Revenues**

Cost of products sold was $26.2 million and $24.6million for the three months ended September 30, 2007 and 2006,respectively, an increase of approximately 7%.

Cost of XOPENEX Inhalation Solution sold as apercentage of XOPENEX Inhalation Solution gross sales was approximately 7% forboth the three months ended September 30, 2007 and 2006. The cost ofXOPENEX Inhalation Solution sold was slightly higher in the three months endedSeptember 30, 2007 compared to the same period in 2006 when taking intoconsideration the July 2007 gross price increase.

Cost of XOPENEX HFA sold as a percentage of XOPENEXHFA gross sales was approximately 14% for both the three months endedSeptember 30, 2007 and 2006. Included in the costs of XOPENEX HFA sold isa royalty paid on net sales of XOPENEX HFA to 3M Company, or 3M, our third-partyfinished goods manufacturer of the product.

Cost of BROVANA sold as a percentage of BROVANA grosssales was approximately 14% for the three months ended September 30, 2007.We introduced BROVANA commercially in April 2007.

Cost of LUNESTA sold as a percentage of LUNESTA grosssales was approximately 6% and 5% for the three months ended September 30,2007 and 2006, respectively, with the largest portion being the royalty paid onnet sales of LUNESTA to a third party. The increase is primarily due to ahigher cost per unit of units sold in the three months ended September 30,2007 compared to the same period in 2006, as the cost of LUNESTA units sold wasnot impacted by certain capitalized product manufacturing costs, until the endof 2006.

Cost of royalties earnedwas $194,000 and $327,000 for the three months ended September 30, 2007and 2006, respectively, a decrease of approximately 41%. The cost of royaltiesin both periods relates to an obligation to a third party as a result ofroyalties we earn from Schering-Plough based on its sales of CLARINEX.This decrease in third-party obligations is due to the decrease in royaltiesearned during the three months ended September 30, 2007 as compared withthe same period in 2006.

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**Research andDevelopment**

Research and development expenses were $49.0 millionand $35.5 million for the three months ended September 30, 2007 and 2006,respectively, an increase of approximately 38%. The increase is primarily dueto greater spending on our BROVANA Phase IV program, our drug discoveryefforts, further research and development expenses for our Phase I and Phase IIprograms and an increase in non-project-specific personnel-related expenses.

Drug development andapproval in the United States is a multi-step process regulated by the FDA. Theprocess begins with the filing of an investigational new drug application, orIND, which, if successful, allows the opportunity for study in humans, orclinical study, of the potential new drug. Clinical development typicallyinvolves three phases of study: Phase I, II and III. The most significantcosts in clinical development are in Phase III clinical trials, as they tend tobe the longest and largest studies in the drug development process. Followingsuccessful completion of Phase III clinical trials, an NDA must be submittedto, and accepted by, the FDA, and the FDA must approve the NDA, prior tocommercialization of the drug. We may elect either on our own, or at therequest of the FDA, to conduct further studies that are referred to as PhaseIIIB and IV studies, which if conducted, could cause us to incur substantialcosts. Phase IIIB studies are initiated and either completed or substantiallycompleted while the NDA is under FDA review. These studies are conducted underan IND. Phase IV studies, also referred to as post-marketing studies, arestudies that are initiated and conducted after the FDA has approved a productfor marketing. Phase IV studies may be requested by the FDA either before orafter the FDA has approved an NDA. These studies may also be independentlyinitiated by the company for which an NDA has been approved. The FDA and thecompanies conducting post-marketing studies use them to gather additionalinformation about a product’s safety, efficacy or optimal use.

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

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

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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 September 30, 2007. The “Estimateof Completion of Phase” column contains forward-looking statementsregarding expected timing of completion of product development phases.Completion of product development, if successful, culminates in the submissionof an NDA to the FDA; however, there can be no assurance that the FDA willaccept for filing, or approve, any NDA. The actual timing of completion ofphases could differ materially from the estimates provided in the table. In thetable below, the three commercial products and the two product candidateslisted accounted for approximately 76% of our direct project research anddevelopment spending for the three months ended September 30, 2007. Noother product candidate accounted for more than 8% 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  II  |                           |       |                                                  | 2008       |   |   |
| SEP-227162                                      |       | 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 September 30,2007 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, stock 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  September 30, 2007** | ** ** | **Project costs to  date through  September 30, 2007** | ** ** | **Project costs for  the three  months ended  September 30, 2006** | ** ** | **Project costs to  date through  September 30, 2006** | ** ** |
|--------------------------------------|------------|--------------------------------------------------------------------------------------------------|------------|---------------------------------------------------------------------------------|------------|--------------------------------------------------------------------------------------------------|------------|---------------------------------------------------------------------------------|------------|
| ** **                           | ** ** | **(in thousands)**                                                                          | ** ** |
| LUNESTA  (eszopiclone)               |       |                                                                                             | $          | 4,890                                                                           |       |                                                                                             |       | $                                                                               | 236,439    |   |   |   | $ | 3,958 |   |   |   | $ | 214,502 |   |   |
| XOPENEX HFA  (levalbuterol tartrate) |       |                                                                                             | $          | 1,870                                                                           |       |                                                                                             |       | $                                                                               | 174,089    |   |   |   | $ | 2,343 |   |   |   | $ | 167,547 |   |   |
| BROVANA  (arformoterol tartrate)     |       |                                                                                             | $          | 3,605                                                                           |       |                                                                                             |       | $                                                                               | 184,948    |   |   |   | $ | 2,237 |   |   |   | $ | 169,465 |   |   |
| SEP-225289                           |       |                                                                                             | $          | 3,278                                                                           |       |                                                                                             |       | $                                                                               | 20,843     |   |   |   | $ | 1,835 |   |   |   | $ | 11,105 |   |   |
| SEP-227162                           |       |                                                                                             | $          | 4,344                                                                           |       |                                                                                             |       | $                                                                               | 16,495     |   |   |   | $ | 2,089 |   |   |   | $ | 6,462 |   |   |

 

Due to the length of timenecessary to develop a product, uncertainties related to the ability to obtaingovernmental approval for commercialization, and difficulty in estimating costsof projects, it is difficult to make accurate and meaningful estimates ofthe ultimate cost to bring our product candidates to FDA-approved status.We do not believe it is possible to estimate, with any degree of accuracy, thecosts of product candidates that are in stages earlier than Phase III.Accordingly, because all of our product candidates are in Phase I or Phase IIdevelopment, we have not provided any such estimates.

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**Selling, Marketingand Distribution**

Selling, marketing anddistribution expenses were $154.6 million and $151.2 million for the threemonths ended September 30, 2007 and 2006, respectively, an increase ofapproximately 2%. This increase is primarily the result of an increase insalary and other compensation related expenses, offset by an overall decreasein marketing, advertising and promotional expenses. The decrease in marketing,advertising and promotional expenses consisted of a reduction in costs tosupport LUNESTA, which was partially offset by an increase in costs to supportBROVANA, which was commercially introduced in April 2007.

**General andAdministrative**

General and administrativecosts were $20.5 million and $19.3 million for the three months ended September 30,2007 and 2006, respectively, an increase of approximately 6%. The increase isprimarily the result of an increase in personnel-related expenses.

**Other Income(Expense)**

Interest income was $11.2 million and $12.3 millionfor the three months ended September 30, 2007 and 2006, respectively, adecrease of approximately 9%. The decrease is primarily due to lower averagebalances of cash and short- and long-term investments in the thirdquarter of 2007. For the three months ended September 30, 2007 and 2006,the average annualized interest rate that we earned on our investments was5.10% and 5.09%, respectively.

Interest expense was $88,000 and $5.5 million for thethree months ended September 30, 2007 and 2006, respectively, a decreaseof approximately 98%. The expense in the three months ended September 30,2006 is primarily related to the interest we paid on our 5% convertiblesubordinated debentures, which we repaid in full upon their maturity on February 15,2007.

Equity in investee losseswere $37,000 and $212,000 for the three months ended September 30, 2007and 2006, respectively, a decrease of approximately 83%. The loss representsour portion of BioSphere losses.

**Income Taxes**

Income tax expense was$907,000 and $585,000 for the three months ended September 30, 2007 and2006, respectively. The increase in income tax expense for the three monthsended September 30, 2007 as compared to the three months endedSeptember 30, 2006 is primarily due to foreign income taxes, as well asU.S. Federal and state alternative minimum tax, or AMT. Although we had Federaland state tax net operating loss carryforwards as of December 31, 2006,the utilization of these loss carryforwards is limited in the calculation ofAMT. For the three months ended September 30, 2007 and 2006, income taxexpense includes Federal, state and foreign income tax expense. Given our limited history of profitability,and the possible adverse impact to our XopenexInhalation Solution sales if an “at risk” generic launch were to occuror we are unable to successfully defend our patents rights, managementcontinues to conclude a valuation allowance is required for the full amount ofour deferred tax asset. If in the future, we determine based on our futureprofitability, that these deferred tax assets are more likely than not to berealized, a release of all, or part, of the related valuation allowance couldresult in an immediate material income tax benefit in the period of decreaseand material income tax provisions in future periods.

**Nine Month Periodsended September 30, 2007 and 2006**

**Revenues**

Product sales were $862.0 million and $814.0 millionfor the nine months ended September 30, 2007 and 2006, respectively, anincrease of approximately 6%.

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Sales of XOPENEX Inhalation Solution were $351.8million for the nine months ended September 30, 2007 as compared to $375.2million for the same period in 2006, a decrease of approximately 6%. Thedecrease is primarily due to a 1% decrease in number of units sold and a 5%decrease in the net selling price as a result of a higher rate of salesdiscounts and allowances during the nine months ended September 30, 2007,primarily related to an increase in Medicare Part B government rebates asa result of the CMS bundling decision, which created a new reimbursement codefor XOPENEX Inhalation Solution, and an increase in Medicaid government rebates.The decrease in net selling price was partially offset by (i) a grossprice increase that occurred in July 2007, and (ii) a decrease inwholesaler fee-for-service charges resulting from credits earned due to thegross price increase. In the nine months ended September 30, 2006, wereversed a $3.1 million reserve related to TRICARE Pharmacy Benefits Programgovernment rebate, which was based on a U.S. Federal Court of Appeals ruling inSeptember 2006 that pharmaceutical manufacturers are not required toreimburse on drugs purchased through the TRICARE Program. Adjustments recordedto gross sales are further disclosed below under the heading “Analysis of grosssales to net sales.”

Sales of XOPENEX HFA were $50.1 million for the ninemonths ended September 30, 2007 as compared to $20.0 million for the sameperiod in 2006, an increase of approximately 150%.The increase is due to a 75% increase in the number of unitssold, and a 43% increase in the net selling price, which is primarily relatedto fewer units sold in the nine months ended September 30, 2007 under agovernment contract with the VA as compared to the same period in 2006. This increase in netselling price was adversely affected by an increase in Medicaid government rebates,as well as an increase in managed care commercial discounts. Adjustmentsrecorded to gross sales are further disclosed below under the heading “Analysisof gross sales to net sales.”

Sales of BROVANA were $8.0 million for the nine monthsended September 30, 2007, as compared to $0 for the same period in 2006.We introduced BROVANA commercially in April 2007. Adjustments recorded togross sales are disclosed below under the heading “Analysis of gross sales tonet sales.”

Sales of LUNESTA were $452.1 million and $418.8million for the nine months ended September 30, 2007 and 2006,respectively, an increase of approximately 8%. The increase is primarily theresult of a 13% increase in the gross selling price, which yielded an increaseof approximately 7% in the net selling price due to a higher rate of salesdiscounts and allowances, particularly with respect to Medicare Part Dgovernment rebates and managed care commercial discounts. Partially offsettingthese increases in sales discounts and allowances was a decrease in wholesalerfee-for-service charges primarily related to credits earned due to the grossprice increase in June 2007. In the nine months ended September 30, 2006,we reversed a $2.6 million reserve related to TRICARE Pharmacy Benefits Programgovernment rebate, which was based on a U.S. Federal Court of Appeals ruling in September 2006 that pharmaceuticalmanufacturers are not required to reimburse on drugs purchased through theTRICARE Program. Adjustments recorded to gross sales are furtherdisclosed below under the heading “Analysis of gross sales to net sales.”

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

| ** **                                           | ** ** | **For the Nine Months Ended September 30,** | ** ** |
|------------------------------------------------------|------------|---------------------------------------------------------------------------|------------|
| ** **                                           | ** ** | **2007**                                                                  | ** ** | **% of  sales** | ** ** | **2006** | ** ** | **% of  sales** | ** ** | **$  Change** | ** ** | **%  Change** | ** ** |
| ** **                                           | ** ** | **(dollars in thousands)**                                      | ** ** |
| Gross sales                                          |       | $                                                                         | 1,121,158  |   | 100.0 | % | $ | 987,722 |   | 100.0 | % | $ | 133,436 |   |   | 14 | % |   |
| Adjustments to  gross sales:                         |       |                                                                      |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Payment term discounts                               |       | 22,440                                                                    |       | 2.0 | % | 20,309 |   | 2.1 | % | 2,131 |   |   | 10 | % |   |
| Wholesaler fee for service                           |       | 20,874                                                                    |       | 1.9 | % | 27,339 |   | 2.8 | % | (6,465 | ) |   | (24 | )% |   |
| Government and commercial rebates and discounts |       | 186,264                                                                   |       | 16.6 | % | 108,930 |   | 11.0 | % | 77,334 |   |   | 71 | % |   |
| Returns                                              |       | 17,181                                                                    |       | 1.5 | % | 14,691 |   | 1.5 | % | 2,490 |   |   | 17 | % |   |
| Other (includes product introduction discounts)      |       | 12,416                                                                    |       | 1.1 | % | 2,435 |   | 0.2 | % | 9,981 |   |   | 410 | % |   |
| Sub-total  adjustments                               |       | 259,175                                                                   |       | 23.1 | % | 173,704 |   | 17.6 | % | 85,471 |   |   | 49 | % |   |
| Net sales                                            |       | $                                                                         | 861,983    |   | 76.9 | % | $ | 814,018 |   | 82.4 | % | $ | 47,965 |   |   | 6 | % |   |

 

The increase in adjustments to gross sales as apercentage of gross sales for the nine months ended September 30, 2007 ascompared to the nine months ended September 30, 2006 primarily reflects anoverall increase in government and commercial rebates and discounts as a resultof (i) an increase in Medicaid discounts that we offered on the sales ofXOPENEX HFA, XOPENEX Inhalation Solution and LUNESTA, (ii) an increase indiscounts given through Medicare Part B program that we offered on thesales of XOPENEX Inhalation Solution as a result of the CMS bundling decision,which created a new reimbursement code for XOPENEX Inhalation Solution, (iii) anincrease in discounts given through Medicare Part D program that weoffered on the sales of LUNESTA, (iv) an increase in managed carecommercial discounts we offered on the sales of LUNESTA and XOPENEX HFA, and (v) adecrease in XOPENEX HFA units sold under a government contract with the VA inthe nine months ended September 30, 2007 as compared to the same period in2006. Partially offsetting these increases in adjustments to gross sales as apercentage of gross sales was adecrease in wholesaler fee-for-service charges primarily related to creditsearned due to LUNESTA and XOPENEX Inhalation Solution gross price increasesduring 2007.

Royalties and license fees were $31.5 million and$25.4 million for the nine months ended September 30, 2007 and 2006,respectively, an increase of approximately 24%.

Royalties earned on the sales of ALLEGRA (fexofenadineHCl), under our agreement with sanofi-aventis, increased to $15.8 million forthe nine months ended September 30, 2007 compared to $11.7 million for thesame period in 2006, resulting primarily from increased sales in Japan.

Royalties earned on sales of CLARINEX (desloratadine),under our agreement with Schering-Plough were $10.6 million for the nine monthsended September 30, 2007 compared to $9.6 million for the same periodin 2006.

Royalties earned on sales of XYZAL/XUSAL(levocetirizine) under our agreement with UCB, increased to $4.9 million forthe nine months ended September 30, 2007 as compared to $4.1 million forthe same period in 2006.

Licenses fees recognizedon our GSK and Eisai agreements for the commercialization of our eszopicloneproduct was $206,000 and $0 for the three months ended September 30, 2007and 2006, respectively.

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A number of the patents weown and license to third parties for which we receive these royalties are thesubject of patent infringement, invalidation or revocation claims. We canprovide no assurance concerning the outcome or the duration of any patentrelated lawsuits. If we, or third parties from whom we receive royalties, arenot successful in enforcing our respective patents, the companies seeking tomarket generic versions of our drugs and the drugs of our licensees will not beexcluded from marketing their generic versions of these products. Introductionof generic copies of any of these products before the expiration of our patentsor the patents of our licensees could have a material adverse effect on ourbusiness, financial condition and/or results of operations.

**Costs of Revenues**

Cost of products sold was $82.7 million and $70.8million for the nine months ended September 30, 2007 and 2006,respectively, an increase of approximately 17%.

Cost of XOPENEX Inhalation Solution sold as apercentage of XOPENEX Inhalation Solution gross sales was approximately 7% and8% for the nine months ended September 30, 2007 and 2006, respectively.The decrease in the cost as a percentage of gross sales is primarily due tolower manufacturing costs during the nine months ended September 30, 2007as compared to the same period in 2006.

Cost of XOPENEX HFA sold as a percentage of XOPENEXHFA gross sales was approximately 15% and 14% for the nine months endedSeptember 30, 2007 and 2006, respectively. Included in the costs ofXOPENEX HFA sold is a royalty paid on net sales of XOPENEX HFA to 3M, ourthird-party finished goods manufacturer of the product. The increase in thecost as a percentage of gross sales is primarily due to lower manufacturingvolumes resulting in a higher per unit cost on the units sold in the ninemonths ended September 30, 2007 as compare to the same period in 2006.

Cost of BROVANA sold as a percentage of BROVANA grosssales was approximately 18% for the nine months ended September 30, 2007.We introduced BROVANA commercially in April 2007.

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

Cost of royalties earnedwas $849,000 and $769,000 for the nine months ended September 30, 2007 and2006, respectively, an increase of approximately 10%. The cost of royalties inboth periods relates to an obligation to a third party as a result of royaltieswe earn from Schering-Plough based upon its sales of CLARINEX. This increase inthird-party obligations is due to the increase in royalties earned during thenine months ended September 30, 2007 as compared with the same period in2006.

**Research andDevelopment**

Research and development expenses were $135.2 millionand $121.1 million for the nine months ended September 30, 2007 and 2006,respectively, an increase of approximately 12%. The increase is primarily dueto greater spending on our BROVANA Phase IV program, further research anddevelopment expenses for our Phase I and Phase II programs, as well as anincrease in non-project-specific personnel-related expenses. These increaseswere offset by a decrease in spending on our XOPENEX HFA MDI formulation.

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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 nine months ended September 30, 2007. The “Estimateof Completion of Phase” column contains forward-looking statements regardingexpected timing of completion of product development phases. Completion ofproduct development, if successful, culminates in the submission of an NDA tothe FDA; however, there can be no assurance that the FDA will accept forfiling, or approve, any NDA. The actual timing of completion of phases coulddiffer materially from the estimates provided in the table. In the table below,the three commercial products and the two product candidates listed accounted forapproximately 82% of our direct project research and development spending forthe nine months ended September 30, 2007. No other product candidateaccounted for more than 6% of our direct research and development spending inthis 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  II  |                           |       |                                            | 2008       |   |   |
| SEP-227162                                      |       | 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 nine months ended September 30,2007 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, stock 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 nine  months ended  September 30, 2007** | ** ** | **Project costs to  date through  September 30, 2007** | ** ** | **Project costs for  the nine  months ended  September 30, 2006** | ** ** | **Project costs to  date through  September 30, 2006** | ** ** |
|--------------------------------------|------------|-------------------------------------------------------------------------------------------------|------------|---------------------------------------------------------------------------------|------------|-------------------------------------------------------------------------------------------------|------------|---------------------------------------------------------------------------------|------------|
| ** **                           | ** ** | **(in thousands)**                                                                         | ** ** |
| LUNESTA  (eszopiclone)               |       |                                                                                            | $          | 16,416                                                                          |       |                                                                                            |       | $                                                                               | 236,439    |   |   |   | $ | 14,780 |   |   |   | $ | 214,502 |   |   |
| XOPENEX HFA  (levalbuterol tartrate) |       |                                                                                            | $          | 4,791                                                                           |       |                                                                                            |       | $                                                                               | 174,089    |   |   |   | $ | 10,756 |   |   |   | $ | 167,547 |   |   |
| BROVANA  (arformoterol tartrate)     |       |                                                                                            | $          | 11,017                                                                          |       |                                                                                            |       | $                                                                               | 184,948    |   |   |   | $ | 7,887 |   |   |   | $ | 169,465 |   |   |
| SEP-225289                           |       |                                                                                            | $          | 7,733                                                                           |       |                                                                                            |       | $                                                                               | 20,843     |   |   |   | $ | 7,036 |   |   |   | $ | 11,105 |   |   |
| SEP-227162                           |       |                                                                                            | $          | 8,354                                                                           |       |                                                                                            |       | $                                                                               | 16,495     |   |   |   | $ | 4,716 |   |   |   | $ | 6,462 |   |   |

 

Due to the length of timenecessary to develop a product, uncertainties related to the ability to obtaingovernmental approval for commercialization, and difficulty in estimating costsof projects, it is difficult to make accurate and meaningful estimates of theultimate cost to bring our product candidates to FDA approved status. We do notbelieve it is possible to estimate, with any degree of accuracy, the costs ofproduct candidates that are in stages earlier than Phase III. Accordingly,because all of our product candidates are in Phase I or Phase IIdevelopment, we have not provided any such estimates.

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**Selling, Marketing and Distribution**

Selling, marketing anddistribution expenses were $538.3 million and $523.8 million for the ninemonths ended September 30, 2007 and 2006, respectively, an increase ofapproximately 3%. The increase is primarily attributable to an increase insalary and other compensation related expense as a result of hiring 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 offset by a decrease inmarketing, advertising and promotional expenses primarily related to costs tosupport LUNESTA.

**General and Administrative**

General and administrativecosts were $58.7 million and $51.9 million for the nine months ended September 30,2007 and 2006, respectively, an increase of approximately 13%. The increase isprimarily the result of increased legal fees largely related to patentlitigation, as well as expenses associated with our XOPENEX Inhalation SolutionMedicare Part B reimbursement matter.

**Litigation Settlement**

Litigation settlementexpense was $34.0 million and $0 for the nine months ended September 30,2007 and 2006, respectively. In June 2007, we filed in the Court aStipulation of Settlement regarding two class actions pending in the Courtnaming Sepracor and certain of our current and former officers and one directoras defendants. As previously disclosed, the class actions alleged that the defendantsviolated the Federal securities laws by making false and misleading statementsrelating to the testing, safety and likelihood of approval of tecastemizole bythe FDA. Under the terms of the Stipulation of Settlement, in June 2007,we paid into escrow $52.5 million in settlement of the class actions and, in July 2007,received an $18.5 million reimbursement from our insurance carriers. Thesettlement is now final and the total settlement amount has been released fromescrow. We recorded the litigation settlement expense of $34.0 millionrelating to this matter during the quarter ended March 31, 2007.

**Other Income (Expense)**

Interest income was $34.9million and $33.1 million for the nine months ended September 30, 2007 and2006, respectively, an increase of approximately 5%. The increase is primarilydue to higher interest rates earned on investments in 2007. Our monthly averagecash and investment balance was approximately $894.5 million and $948.1 millionfor the nine months ended September 30, 2007 and 2006, respectively. Forthe nine months ended September 30, 2007 and 2006, the average annualizedinterest rate that we earned on our investments was 5.20% and 4.66%,respectively.

Interest expense was $3.0million and $16.6 million for the nine months ended September 30, 2007 and2006, respectively, a decrease of approximately 82%. The expense in bothperiods is primarily related to the interest we paid on our 5% convertiblesubordinated debentures, which we repaid in full upon their maturity on February 15,2007.

Equity in investee losseswere $441,000 and $565,000 for the nine months ended September 30, 2007and 2006, respectively, a decrease of approximately 22%. The loss representsour portion of BioSphere losses.

**Income Taxes**

Income tax expense was$2.8 million and $1.1 million for the nine months ended September 30, 2007and 2006, respectively. The increase in income tax expense for the nine monthsended September 30, 2007 as compared to the nine months endedSeptember 30, 2006 is primarily due to U.S. Federal and state AMT andforeign taxes as a result of an increase in net income. Although we had Federaland state tax net 

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operatingloss carryforwards as of December 31, 2006, the utilization of these losscarryforwards is limited in the calculation of AMT. For the nine months endedSeptember 30, 2007 and 2006, income tax expense includes Federal, stateand foreign income tax expense. Given our limited history of profitability, and the possible adverseimpact to our Xopenex InhalationSolution sales if an “at risk” generic launch were to occur or we are unable tosuccessfully defend our patents rights, management continues to concludea valuation allowance is required for the full amount of our deferred taxasset. If in the future, we determine based on our 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.

**Liquidity andCapital Resources**

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

Cash, cash equivalents and short- and long-terminvestments totaled $932.3 million, or 74% of total assets, at September 30,2007, compared to $1.2 billion, or 78% of total assets, at December 31,2006.

Net cash provided by operating activities for the ninemonths ended September 30, 2007 was $182.3 million, which includesnet income of $71.6 million. Our net income includes non-cash charges of $43.7million, consisting primarily of stock compensation and depreciation andamortization expense. Accounts receivable decreased by $20.6 million primarilydue to timing of product sales. Inventory on hand increased by $11.1 million asa result of efforts to increase the number of days inventory on hand of XOPENEXHFA. Other current assets increased by $5.8 million, which is primarilyattributable to an increase in prepaid expenses off set by a decline ininterest receivable. Accounts payable increased by $6.4 million primarilydue to timing of vendor payments. Accrued expenses increased by $10.7 millionprimarily due to (i) the timing of personnel-related expenses, (ii) increasedlegal and research and development expenses, (iii) increased expensesrelating to the expansion of commercial production lines primarily associatedwith BROVANA, and (iv) a decline in accrued interest as a result of the February 2007payment in full of our 5% convertible subordinated debentures. Other currentliabilities increased by $46.2 million primarily due to an increase indeferred revenues and reserves for product revenue rebates.

Net cash provided by investing activities for the ninemonths ended September 30, 2007 was $197.8 million, which isprimarily attributable to cash provided by net sales of short- and long-terminvestments of $217.5 million offset by purchases of property and equipment of$19.7 million.

Net cash used in financing activities for the ninemonths ended September 30, 2007 was $408.7 million. We receivedproceeds of $32.2 million from issuing common stock upon the exercise of stockoptions issued under our stock option plans and we used $440.9 million to repaylong-term debt and capital lease obligations.

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We believe our existingcash and the cash flow that we anticipate from operations and current strategicalliances will be sufficient to support existing operations through at least2008. In the longer term, we expect to continue to fund our operations withrevenue generated from product sales. Our actual future cash requirements andour ability to generate revenue, however, will depend on many factors,including:

·       LUNESTAsales;

·       XOPENEXInhalation Solution and XOPENEX HFA sales;

·       BROVANAsales;

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

·       successfulexpansion into foreign markets;

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

·       whetherour debt, particularly debt due in 2008, will be paid in cash rather thanconverted into common stock pursuant to the terms of such debt;

·       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, including litigation related to genericcompetition and/or the informal Securities and Exchange Commission, or SEC,inquiry, or the “at risk” launch of generic versions of our product.

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

Based on our current operating plan, we believe thatwe will not be required to raise additional capital to fund the repayment ofour outstanding convertible debt when due; however, we may choose to do so. Ifwe are not able to successfully continue to grow our revenue and properlymanage our expenses, if sales of LUNESTA do not increase, if sales of XOPENEXInhalation Solution in other markets do not offset the reduction in revenuesresulting from the change in Medicare Part B reimbursement for theproduct, or if we do not prevail against those manufacturers seeking to marketa generic version of our XOPENEX Inhalation Solution product, it is likely thatour business would be materially and adversely affected and that we would berequired to raise additional funds in order to repay our outstandingconvertible debt. We cannot assure that, if required, we would be able to raisethe additional funds on favorable terms, if at all.

In addition, we will, from time to time, consider theacquisition of, or investment in, complementary businesses, products, productcandidates and technologies, which may affect our liquidity requirements orcause us to raise additional funds which we may not be able to do on favorableterms, if at all.

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**Critical AccountingPolicies and Estimates**

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

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

***Revenue******Recognition, Multiple Element Arrangements—******We***haveentered into collaborative agreements with other pharmaceutical companies forthe development and commercialization of our eszopiclone product outside of theUnited States, Canada and Mexico. These agreements are in the form of licenseagreements that call for nonrefundable upfront payments, milestone payments onachieving significant milestones, and royalty payments on sales if and when thecompound receives marketing approval.

Our revenue recognition policy for all multiplerevenue-generating arrangements are in accordance with the guidance provided inthe SEC’s Staff Accounting Bulletin, or SAB, No. 101, *RevenueRecognition in Financial Statements*, as amended by SAB No. 104,*Revenue Recognition*, and Emerging IssuesTask Force, or EITF, Issue No. 00-21, *RevenueArrangements with Multiple Deliverables*.

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

| ** **                              | ** ** | **Payment  Terms  Discount** | ** ** | **Wholesaler  Fee  for Service** | ** ** | **Government  and  Commercial  Rebates and  Discounts** | ** ** | **Returns** | ** ** | **Other  Discounts** | ** ** | **Total** | ** ** |
|-----------------------------------------|------------|------------------------------|------------|---------------------------------------|------------|--------------------------------------------------------------|------------|-------------|------------|----------------------|------------|-----------|------------|
| ** **                              | ** ** | **(in thousands)**      | ** ** |
| **Balance  at December 31, 2006**  |       | $                            | (4,351     | )                                     |       | $                                                            | (16,669    | )           |       |                 | $          | (74,249   | )          |   | $ | (23,218 | ) | $ | (1,511 | ) | $ | (119,998 | ) |
| Current provision:                      |       |                         |       |                                  |       |                                                         |       |        |       |                 |       |      |       |   |   |   |   |
| Current year                            |       | (22,440                      | )          |                                  | (21,331    | )                                                            |       |        | (185,627   | )                    |       | (17,181   | )          | (12,856 | ) | (259,435 | ) |
| Prior year                              |       | —                       |       |                                  | 457        |                                                         |       |        | (637       | )                    |       | —    |       | 440 |   | 260 |   |
| Total                                   |       | (22,440                      | )          |                                  | (20,874    | )                                                            |       |        | (186,264   | )                    |       | (17,181   | )          | (12,416 | ) | (259,175 | ) |
| Actual:                                 |       |                         |       |                                  |       |                                                         |       |        |       |                 |       |      |       |   |   |   |   |
| Current year                            |       | 19,209                       |       |                                  | 15,504     |                                                         |       |        | 97,620     |                 |       | 517       |       | 9,558 |   | 149,219 |   |
| Prior year                              |       | 4,378                        |       |                                  | 14,123     |                                                         |       |        | 56,813     |                 |       | 20,552    |       | 589 |   | 89,644 |   |
| Total                                   |       | 23,587                       |       |                                  | 29,627     |                                                         |       |        | 154,433    |                 |       | 21,069    |       | 10,147 |   | 238,863 |   |
| **Balance at September 30,  2007** |       | $                            | (3,204     | )                                     |       | $                                                            | (7,916     | )           |       |                 | $          | (106,080  | )          |   | $ | (19,330 | ) | $ | (3,780 | ) | $ | (140,310 | ) |

 

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

***Provision for Income Taxes—***Deferredtax assets and liabilities are recognized for the estimated future taxconsequences attributable to tax benefit carryforwards and to differencesbetween the financial 

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statement amounts ofassets and liabilities and their respective tax basis. Deferred tax assets andliabilities are measured using enacted tax rates in effect for the year inwhich the differences are expected to reverse. A valuation allowance isestablished if, based on management’s review of both positive and negativeevidence, it is more likely than not that all or a portion of the deferred taxasset will not be realized. Given our limited history of profitability, and the possible adverseimpact to our Xopenex InhalationSolution sales if an “at risk” generic launch were to occur or we are unable tosuccessfully defend our patents rights, management continues to concludea valuation allowance is required for the full amount of the deferred taxasset. If in the future, we determine based on our 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 the Financial Accounting Standards BoardInterpretation, or FIN, No. 48, *Accountingfor Uncertainty in Income Taxes*, or FIN 48, in January 2007.The implementation 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 reasonably estimate that our unrecognized tax benefits position will notchange significantly within the next twelve months.

We file tax returns in the U.S. Federal jurisdictionand in various state, local and foreign jurisdictions. During the fourthquarter of 2006, the Internal Revenue Service, or IRS, commenced an audit ofour 2005 and 2004 U.S. Federal income tax returns, which was formally concludedduring the third quarter of 2007. We are no longer subject to IRS examinationfor years prior to 2004, although carryforward attributes that were generatedprior to 2004 may still be adjusted upon examination by the IRS if they eitherhave been or will be used in a future period. We receive inquiries from variousstates during the year, some of those inquiries include an audit of statereturns previously filed. With limited exceptions, we are no longer subject tostate or local examinations for years prior to 2003, however, carryforwardattributes that were generated prior to 2003 may still be adjusted uponexamination by state or local tax authorities if they either have been or willbe 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, 2005,2004 and 2003. There are currently no examinations being conducted by the taxauthorities in the Netherlands Antilles. With limited exceptions, we are nolonger subject to examination in Canada and the Netherlands Antilles for yearsprior to 2003 and 1999, respectively, although carryforward attributes thatwere generated prior to these respective periods may still be adjusted uponexamination if they either have been or will be used in a future period.

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

**ContractualObligations**

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

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**ITEM3.****                QUANTITATIVE ANDQUALITATIVE DISCLOSURES ABOUT 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 November 8, 2007, there have been no material changes to themarket risks described in our annual report on Form 10-K for theyear ended December 31, 2006. Additionally, we do not anticipate anynear-term changes in the nature of our market risk exposures or in 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 September 30,2007. The term “disclosure controls and procedures,” as defined in Rules 13a-15(e) and 15d-15(e) underthe Exchange Act, means controls and other procedures of a company that aredesigned to ensure that information required to be disclosed by a company inthe reports that it files or submits under the Exchange Act is recorded,processed, summarized and reported, within the time periods specified in theSEC’s rules and forms. Disclosure controls and procedures include, withoutlimitation, controls and procedures designed to ensure that informationrequired to be disclosed by a company in the reports that it files or submitsunder the Exchange Act is accumulated and communicated to the company’smanagement, including its principal executive and principal financial officers,as appropriate to allow timely decisions regarding required disclosure. Ourmanagement recognizes that any controls and procedures, no matter how welldesigned and operated, can provide only reasonable assurance of achieving theirobjectives and our management necessarily applies its judgment in evaluatingthe cost-benefit relationship of possible controls and procedures. Based on theevaluation of our disclosure controls and procedures as of September 30,2007, our Chief Executive Officer and Chief Financial Officer concluded that,as of such date, our disclosure controls and procedures were effective at thereasonable assurance level.

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

There has been no change in our internal control overfinancial reporting (as defined in Rules 13a-15(f) and 15d-15(f) underthe Exchange Act) during our quarter ended September 30, 2007 that hasmaterially affected, or is reasonably likely to materially affect, our internalcontrol over financial reporting.

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**PART II**

**OTHER INFORMATION**

**ITEM 1.**                LEGALPROCEEDINGS

***Tecastemizole Class Action Complaints***

In June 2007, we filed in the Court, aStipulation of Settlement regarding two class actions, pending in the Courtnaming Sepracor and certain of our current and former officers and one directoras defendants. As previously disclosed, the class actions, which were filed onbehalf of the plaintiffs, alleged that the defendants violated the Federal securitieslaws by making false and misleading statements relating to the testing,safety and likelihood of approval of tecastemizole by the FDA.

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

Under the terms of the Stipulation of Settlement, in June 2007,we paid into escrow $52.5 million in settlement of the class actions and,in July 2007, received an $18.5 million reimbursement from ourinsurance carriers. We recorded the litigation settlement expense of $34.0million, relating to this matter, during the quarter ended March 31, 2007.

On September 6, 2007,the Court granted final approval of the Stipulation of Settlement and entered afinal judgment consistent with the Stipulation of Settlement. The settlement isnow final and the total settlement amount has been released from escrow. Pursuantto the final judgment entered by the Court, the Court dismissed the classactions with prejudice and the plaintiffs are deemed to have released allrelated claims against us.

***Litigation Related to Generic Competition and Patent Infringement***

**LevalbuterolHydrochloride Inhalation Solution Abbreviated New Drug Applications**

In September 2005, we received notification thatthe FDA had received an ANDA, from Breath Limited, or Breath, seeking approvalof a generic version of our 1.25 mg/3 mL, 0.63 mg/3 mL and 0.31 mg/3 mLXOPENEX® (levalbuterol hydrochloride) InhalationSolution. Breath’s submission includes a Paragraph IV certification allegingthat our patents listed in the FDA publication entitled *Approved Drug Products With Therapeutic EquivalenceEvaluations*, commonly referred to as the “Orange Book,” for thesethree dosages of XOPENEX Inhalation Solution are invalid, unenforceable or notinfringed by the generic version for which Breath is seeking approval. In October 2005,we filed a civil action against Breath for patent infringement and a non-jurytrial is scheduled to begin on July 14, 2008 in the United States DistrictCourt for the District of Massachusetts, No. CV:06-10043.

In January 2006, we received notification thatthe FDA had received an ANDA from Dey, L.P., seeking approval of a genericversion of our 1.25 mg/3 mL, 0.63 mg/3 mL, and 0.31 mg/3 mL XOPENEX InhalationSolution. Dey, L.P.’s submission includes a Paragraph IV certification allegingthat our patents listed in the Orange Book for these three dosages of XOPENEXInhalation Solution are invalid, unenforceable, or not infringed by the genericversion for which Dey, L.P. is seeking approval. In February 2006, wefiled a civil action against Dey, L.P. for patent infringement and the case ispending in the United States District Court for the District of Delaware, C.A. No. 06-113.

In August 2006, we received notification that theFDA had received an ANDA from Dey, L.P. seeking approval of a generic versionof our 1.25 mg/0.5 mL XOPENEX Inhalation Solution concentrate. 

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Dey, L.P.’ssubmission includes a Paragraph IV certification alleging that our patentslisted in the Orange Book for 1.25 mg/0.5 mL XOPENEX InhalationSolution concentrate are invalid, unenforceable, or not infringed by thegeneric version for which Dey, L.P. is seeking approval. In September 2006,we filed a civil action against Dey, L.P. for patent infringement in the UnitedStates District Court for the District of Delaware, C.A. No. 06-604.In September 2006, both civil actions we filed against Dey, L.P. wereconsolidated into a single suit. No trial date has been set.

In May 2007, we received notification that theFDA had received an ANDA from Barr Laboratories, Inc., or Barr, seekingapproval of a generic version of our 1.25 mg/3 mL, 0.63 mg/3 mL and 0.31 mg/3mL XOPENEX Inhalation Solution. Barr’s submission includes a Paragraph IVcertification alleging that our patents listed in the Orange Book for thesethree dosages of XOPENEX Inhalation Solution are invalid, unenforceable or notinfringed by the generic version for which Barr is seeking approval. In July 2007,we filed a civil action against Barr for patent infringement and the case ispending in the United States District Court for the District of Delaware, C.A. No. 07-438.No trial date has been set.

The filing of an action for patent infringement underthe Hatch-Waxman Act invokes an automatic 30-month stay of the FDA’sauthority to grant final marketing approval to those companies that file anANDA containing a Paragraph IV certification against one or more of our XOPENEXInhalation Solution patents. The first filer of an ANDA with a Paragraph IVcertification is potentially entitled to a 180-day period ofsemi-exclusivity during which the FDA cannot approve subsequently filed ANDAs. The180-day semi-exclusivity period would begin to run only upon firstcommercial marketing by the first filer. There are, however, also certainevents that could cause the first filer to forfeit the 180-daysemi-exclusivity period, which we refer to as a forfeiture event.

For our 1.25 mg/3 mL, 0.63/3 mL, and 0.31/3 mL XOPENEXInhalation Solution, we believe that Breath is the first filer and potentiallyentitled to 180-days of semi-exclusivity against subsequent ANDA filersfor those three dosages. The 30-month stay against Breath’s ANDA isscheduled to expire on or about March 7, 2008. Upon expiration of that 30-monthstay, the FDA could grant final approval and Breath could then commence an “atrisk” distribution of its generic levalbuterol product for those dosagesnotwithstanding our patents and notwithstanding that the court’s decision as tothe merits of the litigation will not have been rendered, unless we were ableto obtain an injunction prohibiting such distribution. However, if a forfeitureevent occurs and the FDA determines that Breath has forfeited the 180-daysemi-exclusivity period for those three dosages, other ANDA filers who havebeen granted final approval by the FDA could commence an “at risk” launch uponexpiration of the 30-month stay. For those three dosages, the 30-monthstays against Dey L.P. and Barr expire on or about July 9, 2008 and November 30,2009, respectively.

For our 1.25 mg/0.5 mL XOPENEX InhalationSolution concentrate, we believe that Dey L.P. is the first filer andpotentially entitled to 180-days of semi-exclusivity for thatconcentration. The 30 month stay against Dey L.P.’s ANDA for that concentrationexpires on or about February 14, 2009.

Although we could seekrecovery of any damages sustained in connection with any activities conductedby a party that infringe a valid and enforceable claim in our patents, whetherwe are ultimately entitled to such damages would be determined by the court inconnection with our ongoing legal proceedings with each party desiring tolaunch generic levalbuterol hydrochloride products. If any of these partieswere to commence selling a generic alternative to our XOPENEX InhalationSolution product prior to the resolution of these ongoing legal proceedings, orthere is a court determination that the products these companies wish to marketdo not infringe our patents, or that our patents are invalid or unenforceable,it would have a material adverse effect on our business, financial conditionand results of operations. In addition, our previously issued guidanceregarding our projected financial results may no longer be accurate and wewould have to revise such guidance.

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**DesloratadineAbbreviated New Drug Applications**

In June 2007, we received notification that theFDA had received an ANDA from Glenmark Pharmaceuticals, Ltd. and GlenmarkPharmaceuticals, Inc., USA, which we refer to collectively as Glenmark,seeking approval of a generic version of Schering-Plough’s 5 mg tablets ofCLARINEX. Glenmark’s submission includes a Paragraph IV certification allegingthat our patents that Schering-Plough (as licensee of such patents) listed inthe Orange Book for its CLARINEX are invalid, unenforceable or not infringed bythe generic version for which Glenmark is seeking approval. In July 2007,we and the University of Massachusetts, co-owners of certain patents listed inthe Orange Book, filed a civil action in the United States District Court forthe District of New Jersey against Glenmark for patent infringement, C.A. No. 07-3385.

In July 2007, we received notification that theFDA had received an ANDA from Sun Pharmaceutical Industries, Ltd., or Sun,seeking approval of a generic version of Schering-Plough’s 5 mg tablets ofCLARINEX. Sun’s submission includes a Paragraph IV certification alleging thatour patents listed by Schering-Plough (as licensee of such patents) in theOrange Book for CLARINEX are invalid, unenforceable, or are not infringed bythe generic version for which Sun is seeking approval. In September 2007,we and the University of Massachusetts filed a civil action in the UnitedStates District Court for the District of New Jersey against Sun for patentinfringement, C.A. No. 07-4213.

In August 2007, we received notification that theFDA had received an ANDA from Orchid Chemicals & Pharmaceuticals Ltd.,or Orchid, seeking approval of a generic version of Schering-Plough’s 5 mgtablets, and 2.5 and 5 mg orally disintegrating tablets of CLARINEX. Orchid’ssubmission includes a Paragraph IV certification alleging that our patentslisted by Schering-Plough (as licensee of such patents) in the Orange Book forCLARINEX are invalid, unenforceable or not infringed by the generic version forwhich Orchid is seeking approval. In October 2007, we and the Universityof Massachusetts filed a civil action in the United States District Court forthe District of New Jersey against Orchid for patent infringement, C.A. No. 07-4623.

In September 2007, we received notification thatthe FDA had received ANDAs from Mylan Pharmaceuticals, Inc., or Mylan,Lupin Limited, or Lupin, and Perrigo R & D Company, or Perrigo,seeking approval of a generic version of Schering-Plough’s 5 mg tablets ofCLARINEX, and from Dr. Reddy’s Laboratories, or Dr. Reddy’s, seekingapproval of a generic version of Schering-Plough’s 2.5/120 mg tablets ofCLARINEX-D 12 hour desloratadine and pseudoephedrine extended release tablets. Thesubmissions by these parties include Paragraph IV certifications alleging thatcertain patents listed by Schering-Plough (as licensee of such patents) in theOrange Book for CLARINEX are invalid, unenforceable or not infringed by thegeneric versions for which these parties are seeking approval. In October 2007,we and the University of Massachusetts filed civil actions in the United StatesDistrict Court for the District of New Jersey against Mylan, Lupin, Perrigo andDr. Reddy’s for patent infringement, C.A. No. 3:07-cv-05017, C.A. No. 3:07-cv-05265,C.A. No. 3:07-cv-05136 and C.A. No. 3:07-cv-05001, respectively.

In October 2007, we received notification thatthe FDA had received an ANDA from Anchen Pharmaceuticals, Inc., or Anchen,seeking approval of a generic version of Schering-Plough’s 2.5/120 mg tabletsof CLARINEX-D 12 hour desloratadine and pseudoephedrine extended releasetablets. Anchen’s submission includes a Paragraph IV certification allegingthat our patents listed by Schering-Plough (as licensee of such patents) in theOrange Book for CLARINEX are invalid, unenforceable or not infringed by thegeneric version for which Anchen is seeking approval. We are currentlycontemplating filing a civil action against Anchen for patent infringement.

We believe that all ofthese ANDAs are subject to a statutory stay of approval until June 21,2009 based on previous litigation commenced by Schering-Plough against theseparties in separate civil actions involving another patent.

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**BROVANA PatentInfringement Claim**

In April 2007, we were served with a Complaintfiled in the United States District Court for the Southern District of NewYork, C.A. No. 1:07-cv-2353, by Dey, alleging that manufactureand sale of BROVANA® (arformoterol tartrate) Inhalation Solutioninfringes or will induce infringement of a single U.S. patent for which Deyowns all rights, title and interest. In April 2007, we filed an Answer andCounterclaim to this Complaint seeking to invalidate the originally assertedpatent and a second related patent. In May 2007, Dey filed a replyasserting infringement of the second patent. Under the current trial schedulingorder, trial will begin no earlier than December 12, 2008. It is too earlyto make a reasonable assessment as to the likely outcome or impact of thislitigation. We are unable to reasonably estimate any possible range of loss orliability related to this lawsuit due to its uncertain resolution.

Patent litigation involvescomplex legal and factual questions. We can provide no assurance concerning theoutcome or the duration of any patent related lawsuits. If we, or third partiesfrom whom we receive royalties, are not successful in enforcing our respectivepatents, the companies seeking to market generic versions of our drugs and thedrugs of our licensees will not be excluded, for the full term of therespective patents, from marketing their generic versions of our products orthird party products for which we have licensed rights to our patents.Introduction of generic copies of any of our products or third party productsfor which we have licensed rights to our patents before the expiration of ourpatents would have a material adverse effect on our business, financialcondition and results of operations.

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

We announced in June 2006 that the SEC isconducting an informal inquiry into our stock option grants and stock optiongranting practices. A special committee of our outside directors, with theassistance of outside legal counsel and outside accounting specialists,reviewed the stock option grants to our officers, directors and employees from1996 to June 2006 under our various stock option plans in effect duringthis period. Our finance department also reviewed the stock option grants andstock option practices from 1996 to June 2006. Their review resulted inthe restatement of our financial statements for the quarters ended March 31,June 30 and September 30, 2005, the quarter ended March 31, 2006and the years ended December 31, 2005, 2004 and 2003. The specialcommittee has concluded that there is no evidence of fraud, illegal activity oran intent to mislead or deceive with respect to our stock option grantingpractices or the specific grants that have resulted in the restatement of ourfinancial statements. The special committee also determined that the board ofdirectors and/or compensation committee generally intended to award the optionson the date specified in the grants, although they were not aware of theaccounting consequences. Representatives from the U.S. Attorneys Officeattended some of the earlier meetings that our outside counsel had with theSEC. While the U.S. Attorneys Office has not initiated an investigation, wecannot be certain that it will not. The SEC and/or any other governmentalagency that may initiate a formal investigation may reach different conclusionsand, if so, we could be subject to monetary damages, fines and penalties, andour officers and/or directors could be prohibited from serving as officers anddirectors of any public company and could be subject to criminal penaltiesand/or disgorgement.

From June to October 2006, six stockholderderivative complaints were commenced against us (as a nominal defendant) andcertain of our current and former officers and directors. Three of thesecomplaints were filed in the Superior Court, Middlesex County, Commonwealth ofMassachusetts (later transferred to the Business Litigation Session of theSuperior Court, Suffolk County, Commonwealth of Massachusetts) and three werefiled in the United States District Court for the District of Massachusetts. Allstate court complaints were later consolidated into one state court action, andall Federal court complaints were consolidated into one Federal court action.It was alleged in both actions that the individual defendants breached theirfiduciary duties and were unjustly enriched in connection with certain stockoption grants; violations of Federal securities laws were alleged in the Federalaction as well. The 

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complaints sought monetarydamages in unspecified amounts, equitable and injunctive relief, includingdisgorgement of profits obtained by certain defendants and other relief asdetermined by the court. On November 20, 2006, we moved to dismiss thestate court action, and on March 20, 2007 a hearing was held on the motion.No decision on the motion has been rendered at this time. The Federal courtaction has been stayed pending resolution of the state court motion to dismiss.

In October 2007, theparties to both the state and Federal action reached a settlement that providesfor the dismissal of both actions, subject to the approval of the court. Thesettlement resolves all claims and includes no finding of wrongdoing on thepart of any of the defendants and no cash payment other than attorneys’ fees. Aspart of the settlement, we have agreed to adopt and implement stock optiongrant and other procedures that reflect developing best practices. Apreliminary hearing on the fairness of the settlement and the adequacy of thestockholder notice was held on November 6, 2007 by the state court, with afinal fairness hearing likely to be held in January 2008. The settlement willnot be final and effective until final approval by the state court and entry ofdismissal with prejudice by the Federal court.

***LUNESTA Trademark Claim***

In September 2006,Tharos Laboratories, Inc., or Tharos, filed suit against us in the UnitedStates District Court, District of Utah, Central Division, 2:06-cv-00757,alleging trademark infringement, dilution, unfair competition, falseadvertising and false designation of origin arising out of our use of our silkluna moth design in connection with LUNESTA. Tharos seeks unspecified monetarydamages and to enjoin our use of the silk luna moth design. In October 2006,we filed a Motion to Dismiss Tharos’ claims. On February 9, 2007, thecourt granted our motion in respect of the state unfair competition claims anddenied it in respect of Tharos’ other claims. On March 6, 2007, we filedan Answer to Tharos’ Complaint. In addition, we filed counterclaims againstTharos for cancellation of Tharos’ alleged trademark and for false advertising.We continue to defend our trademark in this litigation but we are unable atthis stage to predict its ultimate resolution. In October 2007, we reacheda preliminary agreement in principle with Tharos to settle this litigation, andfinal settlement is subject to the parties entering into a written settlementagreement.

***Other Legal Proceedings***

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, financial condition or results of operations.

**ITEM 1A.**        RISKFACTORS

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

**Risks Related toOur Financial Results and Our Common Stock**

***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 

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developand commercialize our products and product candidates and in order to allow usto otherwise expand our product portfolio through drug discovery and businessdevelopment efforts. As a result, we will need to generate significant revenuesin future periods to achieve and maintain profitability. We cannot provideassurance that we will be able to maintain profitability for any substantialperiod of time. If revenues grow more slowly than we anticipate or if operatingexpenses exceed our expectations or cannot be adjusted accordingly, ourbusiness, results of operations and financial condition will be materially andadversely affected. In addition, if we are unable to achieve or maintainprofitability on a quarterly or annual basis, the market price of our commonstock 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 as well as XOPENEX HFA and BROVANA.***

Approximately 90% of our total revenues for the ninemonths ended September 30, 2007 resulted from sales of LUNESTA and XOPENEXInhalation Solution, and we expect that sales from these two products willcontinue to represent a significant majority of our revenues for the comingyear. In April 2005, we commercially introduced LUNESTA as a new productin a highly and increasingly competitive market, and we cannot be certain thatit will achieve continued commercial success. In addition, we do not havelong-term sales contracts with our customers, and we rely primarily on purchaseorders for sales of LUNESTA and XOPENEX Inhalation Solution. Reductions, delaysor cancellations of orders for LUNESTA or XOPENEX Inhalation Solution couldadversely affect our operating results. Additionally, revenues from the sale ofXOPENEX Inhalation Solution have been, and we expect will continue to be,adversely affected on a comparable basis as a result of a change in theMedicare Part B reimbursement rate. If sales of LUNESTA do not increaseand if sales of XOPENEX Inhalation Solution in other markets do not offset thereduction in revenues resulting from the change in Medicare Part Breimbursement for the product, or if we do not prevail against thosemanufactures seeking to market a generic version of our XOPENEX InhalationSolution product, we may not have sufficient revenues to achieve our businessplan or repay our outstanding debt, and our business will not be successful.

In December 2005, we commercially introducedXOPENEX HFA and in April 2007, we commercially introduced BROVANA. Wecannot be certain that either XOPENEX HFA or BROVANA will achieve commercialsuccess.

With respect to XOPENEX Inhalation Solution, Breath,Dey, L.P., Barr and Watson Laboratories, Inc., or Watson, have filed ANDAsincluding Paragraph IV certifications with the FDA seeking to market ageneric version of levalbuterol hydrochloride inhalation solution before ourpatents expire. We have commenced patent infringement litigation againstBreath, Dey, L.P., and Barr, but we have decided not to commence litigationagainst Watson at this time as its Paragraph IV certification is limited to apatent that expires in 2021. The filing of a lawsuit for patent infringementunder the Hatch-Waxman Act results in an automatic 30-month stay of theFDA’s authority to grant marketing approval to these companies. The 30-monthstay against Breath’s ANDA is scheduled to expire for our 1.25 mg/3 mL, 0.63mg/3 mL and 0.31 mg/3 mL XOPENEX Inhalation Solution on or about March 7,2008. Upon expiration of that 30-month stay, the FDA could grant finalapproval and Breath could then commence an “at risk” distribution of itsgeneric levalbuterol product for those dosages notwithstanding our patents andnotwithstanding that the court’s decision as to the merits of the litigationwill not have been rendered, unless we were able to obtain an injunctionprohibiting such distribution. However, if a forfeiture event occurs and theFDA determines that Breath has forfeited the 180-day semi-exclusivityperiod for those three dosages, other ANDA filers who have been granted finalapproval by the FDA could commence an “at risk” launch upon expiration of the 30-monthstay. For those three dosages, the 30-month stays against Dey L.P. andBarr expire on or about July 9, 2008 and November 30, 2009,respectively. If any of these parties were to commence selling a genericalternative to our XOPENEX Inhalation Solution product 

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prior to the resolution ofthese ongoing legal proceedings, or there is a court determination that theproducts these companies wish to market do not infringe our patents, or thatour patents are invalid or unenforceable, it would have a material adverseeffect on our business, financial condition and/or results of operations. Inaddition, our previously issued guidance regarding our projected financialresults may no longer be accurate and we would have to revise such guidance.

With respect to BROVANA, in April 2007, we wereserved with a Complaint filed in the United States District Court for theSouthern District of New York, C.A. No. 1:07-cv-2353, by Deyalleging that the manufacture and sale of BROVANA infringes or will induceinfringement of a single U.S. patent for which Dey owns all rights, title andinterest. In April 2007, we filed an Answer and Counterclaim to thisComplaint seeking to invalidate the originally asserted patent and a secondrelated patent. In May 2007, Dey filed a reply asserting infringement ofthe second patent. Under the current trial scheduling order, trial will beginno earlier than December 12, 2008. 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 or liability related to thislawsuit due to its uncertain resolution.

We cannot becertain that we will be able to continue to successfully commercialize LUNESTAand/or XOPENEX Inhalation Solution or that any of our products will continue tobe accepted in their markets. Specifically, the following factors, amongothers, could affect the level of success and market acceptance of XOPENEXInhalation Solution, XOPENEX HFA, BROVANA and/or LUNESTA:

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

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

·       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 or the “at risk” launch of genericversions of our products;

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

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

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

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

Any adverse developments with respect to the sale ofLUNESTA or XOPENEX Inhalation Solution could significantly reduce revenues andhave a material adverse effect on our ability to maintain profitability andachieve our business plan.

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

Since January 2005 and through June 2007,Medicare reimbursed XOPENEX Inhalation Solution pursuant to a uniquereimbursement code. In March 2006, the Durable Medical Equipment ProgramSafeguard Contractors, or DME-PSCs, the entities responsible for overseeing theMedicare Part B prescription drug benefit for respiratory products,announced their intention to implement a Least Costly Alternative, or LCA,reimbursement action for XOPENEX Inhalation Solution that, if it had beenimplemented, would have reduced the reimbursement paid for XOPENEX InhalationSolution to that of generic racemic albuterol. In December 2006, CMScommenced a National Coverage Analysis, or NCA, to determine when use ofnebulized levalbuterol in treating COPD in the Medicare population isreasonable and necessary. While the NCA for XOPENEX Inhalation Solution waspending, the DME-PSCs announced that the proposed LCA would be stayed. On June 20,2007, CMS announced its preliminary coverage determination, stating that, basedon its review of the available data and comments submitted, it was unable todetermine the criteria for when XOPENEX Inhalation Solution would beappropriate to use by the Medicare population and would instead defer thisdetermination to the DME-PSCs. As part of its coverage determination, CMSaffirmed that the use of nebulized beta-adrenergic agonists (such as XOPENEXInhalation Solution and BROVANA) in the treatment of lung disease in the homeis medically necessary; such a determination is needed before CMS or the DME-PSCscan establish the coverage criteria for a given prescription drug under theMedicare Part B benefit. The final coverage determination was made in September 2007and was identical to the preliminary coverage determination. Should theDME-PSCs establish overly restrictive coverage criteria for either XOPENEXInhalation Solution or BROVANA, or again seek to impose an LCA on XOPENEXInhalation Solution, we may no longer be able to sell these products profitablyin the Medicare Part B market and revenues for these products may bematerially adversely affected.

In May 2007, CMS announced that, based on itsinterpretation of the statutory language of the MMA, it was required todiscontinue the unique reimbursement codes for XOPENEX Inhalation Solution andgeneric albuterol, which had been in place since January 2005, and bundledthese products together in a newly created reimbursement code. As a result ofthis coding change, reimbursement for XOPENEX Inhalation Solution and genericalbuterol is now based on the blended weighted average selling price for thetwo products, resulting in reimbursement for XOPENEX Inhalation Solution thatis considerably lower than the product’s published selling price for theproduct distribution channel. The new reimbursement rate became effective on July 1,2007 and is subject to change quarterly based upon the respective contributionof commercial sales of XOPENEX Inhalation Solution and generic albuterol to thequarterly blended weighted average selling price calculation for the newlycreated reimbursement code. This quarterly average selling price calculation ismandated by the MMA. Revenues from the sale of XOPENEX Inhalation Solution havebeen, and we expect will continue to be, adversely affected on a comparablebasis as a result of this change.

The bundling action also resulted in an unintendedincrease in Medicare Part B reimbursement for generic albuterol,significantly higher than the product’s average selling price (as publiclyreported by the Medicare Part B program), creating the potential forinappropriate reimbursement incentives to influence the dispensing decisions ofproviders. In July 2007, the U.S. House of Representatives released draftlegislation as part of the State Children’s Health Insurance Program, or SCHIP,reauthorization that includes language addressing the Medicare Part Breimbursement scenario that may potentially impact physician prescribingdecisions based upon financial incentives. The draft legislation provides thatXOPENEX Inhalation Solution and generic albuterol will be paid at the lower oftheir respective stand-alone average selling prices or the blended XOPENEXInhalation Solution/generic albuterol average selling price. The draftlegislation was not part of the SCHIP reauthorization bill passed by Congressand 

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vetoed by President Bushin September 2007. The language remains part of the Medicare Physician FeeSchedule corrections legislation currently pending in the House ofRepresentatives and we are working to include comparable language in sisterlegislation being developed by the Senate. For generic albuterol, this willlower the reimbursement Medicare pays for the product to its stand-aloneaverage selling price. For XOPENEX Inhalation Solution, reimbursement willcontinue to be paid at the blended XOPENEX Inhalation Solution/genericalbuterol average selling price. Medicare Part B reimbursement rates areupdated quarterly. The effective date of the legislation, if passed, isexpected to be January 1, 2008, but could be later if the law is notpassed and signed by President Bush prior to the end of 2008. The impact ofthis potential legislative action on XOPENEX Inhalation Solution revenues inthe Medicare market in 2008 is not yet known.

We estimate that as muchas 25% of our XOPENEX Inhalation Solution units sold are subject toreimbursement under Medicare Part B. We have been actively contractingwith home health care and retail pharmacy providers in an effort to ensure thecontinued availability of XOPENEX Inhalation Solution to Medicare Part Bbeneficiaries with reversible obstructive airway disease. If the contractingstrategy for XOPENEX Inhalation Solution is not successful in maintaining asmuch of the current unit sales levels for the product in Medicare ascommercially feasible, if the reimbursement scenario that may potentiallyimpact physician prescribing decisions for generic albuterol is not changedand/or if the DME-PSCs impose restrictive coverage policies on XOPENEXInhalation Solution, revenue from sales of XOPENEX Inhalation Solution will beadversely affected and our financial condition and results from operations willbe impaired.

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

As of September 30, 2007, our total debt wasapproximately $721 million. None of our 0% Series A notes due December 2008,our 0% Series B notes due December 2010 nor our 0% notes due October 2024restricts us or our subsidiaries’ ability to incur additional indebtedness,including debt that ranks senior to the notes. The 0% notes due 2024 are seniorto the Series A notes due 2008 and Series B notes due 2010.Additional indebtedness that we incur may in certain circumstances rank seniorto or on parity with this debt. Our ability to satisfy our obligations willdepend upon our future performance, which is subject to many factors, includingfactors beyond our control. The conversion prices for the 0% Series Anotes due 2008 and 0% Series B notes due 2010 are $31.89 and $29.84,respectively. On October 31, 2007, the closing sale price of our commonstock was $27.54. If the market price for our common stock does not exceed theconversion price, the holders of our outstanding convertible debt may decidenot to convert their securities into common stock. For example, the holders ofour 5% debentures did not convert such debentures into common stock, and on February 15,2007, the maturity date for the 5% debentures, we repaid in cash the entireprincipal amount of $440.0 million, plus $11.0 million of accrued interest. Our0% notes due 2024 are convertible into cash and, if applicable, shares of ourcommon stock at a conversion price of approximately $67.20, at the option ofthe holders in October 2009, 2014, 2019 and 2024, as well as under certain circumstances.We may not be able to make the required cash payments upon conversion ofthe 0% notes due 2024.

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

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***If we exchange debt for shares of common stock, therewill be additional dilution to holders of our common stock.***

As of September 30,2007, we had approximately $721 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 capitalstock, or securities convertible into or exercisable for our capital stock, foroutstanding convertible debt or use proceeds from the issuance of convertibledebt to fund redemption of outstanding convertible debt with a higherconversion ratio, the number of shares that we might issue as a result of suchexchanges would significantly exceed the number of shares originally issuableupon conversion of such debt and, accordingly, such exchanges would result inmaterial dilution to holders of our common stock. We cannot assure you that wewill repurchase or exchange any additional outstanding convertible debt.

***If the estimates wemake, or the assumptions on which we rely, in preparing our financialstatements prove inaccurate, our actual results may vary from 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. In addition, weestimate product sales allowances, including payment term discounts, governmentand commercial rebates and returns and other discounts. If actual amountsdiffer from these estimates, net income could be adversely affected. Each, inturn, could adversely affect our financial condition, results from operationsand stock price.

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

We may requireadditional funds for our research and product development programs, operatingexpenses, repayment of debt, the pursuit of regulatory approvals, license oracquisition opportunities and the expansion of our production, sales andmarketing capabilities. Historically, we have satisfied our funding needsthrough collaboration arrangements with corporate partners, sales of products,and equity and debt financings. These funding sources may not be available tous when needed in the future, and, if available, they may not be on termsacceptable to us. Insufficient funds could require us to delay, scale back,eliminate or alter certain of our research and product development programsand/or commercialization 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;

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·       expansioninto foreign markets;

·       litigationand government inquiries and investigations;

·       ourcapital requirements; and

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

***Our stock option granting practices are the subject ofan informal inquiry by the SEC.***

As we announced on June 2, 2006, the SEC isconducting an informal inquiry into our stock option grants and stock option practicesand a special committee of our outside directors oversaw a review of our stockoption granting practices and the documentation relating to such grants.Representatives from the U.S. Attorneys office attended some of the earliermeetings that our outside legal counsel had with the SEC. While the U.S.Attorneys Office has not initiated an investigation, we cannot be certain thatit will not. As a result of the SEC inquiry 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 ourcurrent and former directors and officers are defendants in a state and a Federalderivative action relating to our stock option granting practices. Thecomplaints allege purported breaches of fiduciary duties and unjust enrichmentin connection with certain stock option grants made by us between June 1998and May 2001. The complaints sought monetary damages in unspecifiedamounts, equitable and injunctive relief, including disgorgement of profitsobtained by certain defendants and other relief as determined by the court. In October 2007,we reached a settlement with the parties to the derivative actions, subject tothe approval of the court. The settlement resolves all claims and includes nofinding of wrongdoing on the part of any of the defendants and no cash paymentother than attorneys’ fees. As part of the settlement, we have agreed to adoptand implement stock option grant and other procedures that reflect developingbest practices. However, the settlement will not be final and effective untilfinal approval by the state court and entry of dismissal with prejudice in the Federalcourt and, if it does not become final, we could be required to pay monetarydamages and/or provide other relief.

***Fluctuations in thedemand for our products, the success and timing of clinical trials, regulatoryapprovals, product introductions, collaboration and licensing arrangements, anytermination of development efforts and other material events will causefluctuations in our quarterly operating results, which could cause volatilityin our stock price.***

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

·       timingand extent of product sales and market penetration;

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

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

·       timingand success of product introductions;

·       changesin third-party reimbursement policies;

·       introductionof competitive products into the market;

·       resultsof clinical trials with respect to products under development;

·       afinding that our patents are invalid or unenforceable or that generic versionsof our products do not infringe our products or the “at risk” launch of genericversions of our products;

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

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

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

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

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

·       timingand success of expansion into foreign markets;

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

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

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

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

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

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

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

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

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

The market price of ourcommon stock, like that of the common stock of many other pharmaceutical andbiotechnology companies, has been highly volatile. In addition, the stockmarket has experienced extreme price and volume fluctuations. The volatilityand market prices of securities of many pharmaceutical and biotechnologycompanies have been significantly affected for reasons frequently unrelated toor disproportionate to the operating performance of the specific companies.These broad market fluctuations may adversely affect the market price of ourcommon stock. Prices for our common stock are determined in the marketplace andmay be influenced by many factors, including variations in our financialresults and investors’ perceptions of us, and changes in recommendations bysecurities analysts as well as their perceptions of general economic, industryand market conditions.

**Risks Related toCommercialization**

***We face intense competition and many of ourcompetitors have greater 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 financial conditionand results of operations could be materially adversely affected because we maynot achieve our product revenue objectives and because we may use our financialresources to seek to differentiate ourselves from our competition. Large andsmall companies, academic institutions, governmental agencies and other publicand private organizations conduct research, seek patent protection, develop andacquire products, establish collaborative arrangements for product developmentand sell or license products in competition with us. Many of our competitorsand potential competitors have substantially greater resources, manufacturingand sales and marketing capabilities, research and development staff andproduction facilities than we have. The fields in which we compete are subjectto rapid and substantial technological change. Our competitors may be able torespond more quickly to new or emerging technologies or to devote greaterresources to the development, manufacture and marketing of new products and/or technologiesthan we can. As a result, any products and/or technologies that we develop maybecome obsolete or noncompetitive before we can recover expenses incurred inconnection with their development.

In the insomnia market, LUNESTA faces intense competitionfrom established products such as AMBIEN® (zolpidem tartrate), SONATA® (zalepon), AMBIEN CR® (zolpidem tartrate extended release) andROZEREMTM (ramelteon). We expect that LUNESTA will face increasing competitionfrom other potentially competitive therapies, such as a generic version ofAMBIEN, which was introduced in April 2007, a generic version of AMBIENCR, which could be introduced as early as March 2009, and therapies inclinical development and under FDA review for the treatment of insomnia.To continue to be successful in the market with LUNESTA, we must continue todemonstrate that LUNESTA’s safety and efficacy features are superior to thoseof competing branded and generic products, some of which may be less expensivethan LUNESTA.

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In the asthma and COPD markets, XOPENEX InhalationSolution, a short-acting beta-agonist, faces competition from generic albuteroland DUONEB® (ipratropium bromide and albuterol sulfate).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. Ageneric version of DUONEB has recently been commercially introduced withadditional generic entrants expected to follow. To be successful in themarketing of XOPENEX Inhalation Solution, we must continue to demonstrate thatthe efficacy and safety features of the drug outweigh its higher price relativeto generic albuterol and other competing products. In addition, as aconsequence of the ongoing commercialization of BROVANA, prescription levelsfor XOPENEX Inhalation Solution**maybe adversely affected to the extent that a significant number of physiciansprescribe BROVANA as a substitute product for their patients who are currentlytaking or would be prescribed XOPENEX Inhalation Solution. Such substitutioncould have an adverse effect on sales of XOPENEX Inhalation Solution and/or thegrowth of the combined revenue generated from the sale of XOPENEX Inhalation Solutionand BROVANA. We may also face competition in the event of commercialintroduction of a generic alternative to our XOPENEX Inhalation Solutionproduct.

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

BROVANA competes in the COPD market, as it does nothave an asthma indication. Competitive products include all nebulized productsused in the treatment of COPD including albuterol, XOPENEX Inhalation Solution,ATROVENT® (ipratropium bromide), DUONEB, genericalbuterol/ipratropium bromide combination products, and nebulized PerforomistTM(formoterol fumarate) Inhalation Solution, which was commercially introduced inOctober 2007. Even though BROVANA is a nebulized product, it also facescompetition from long-acting beta-agonists and anticholinergics delivered byMDI and dry-powder inhaler, including SEREVENT® DISKUS® (salmeterol xinafoate inhalation powder),SPIRIVA® HandiHaler® (tiotropiumbromide inhalation powder) and FORADIL® (formoterol fumarate inhalation powder). BROVANAalso competes with combination therapy products used for COPD including ADVAIR® (salmeterol and fluticasone) and recentlycommercialized SYMBICORT® (formoterol and budesonide). To be successfulin the marketing of BROVANA, we must demonstrate that patients with COPD whouse a nebulizer will benefit by adding BROVANA as adjunctive therapy.

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

***We may be unable tosuccessfully commercialize products for which we receive approval from the FDAor similar foreign agencies.***

Commercialization of a product for which we havereceived an approval letter from the FDA or similar foreign agency could bedelayed for a number of reasons, some of which are outside of our control,including delays in delivery of the product due to importation regulationsand/or problems with our distribution channels or delays in the issuance ofapprovals from, or the completion of, required 

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procedures by agenciesother than the FDA, such as the United States Drug Enforcement Administration.In addition, commercialization of approved products may be delayed by ourfailure to timely finalize distribution arrangements, manufacturing processesand arrangements, produce sufficient inventory and/or properly prepare oursales force. If we are unable to successfully commercialize a product promptlyafter receipt of an approval letter, our business and financial position may bematerially adversely affected due to reduced revenue from product sales duringthe period or periods that commercialization is delayed and the shortening ofany lead time to market we may have had over our competitors. In addition, theexclusivity period, which is the time during which the FDA or similar foreignagency will prevent generic pharmaceutical companies from introducing a genericcopy of the product, begins to run upon approval and, therefore, to the extentwe are unable to successfully commercialize a product promptly after receipt ofan approval letter, our long-term product sales and revenues could be adverselyaffected.

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

***We recentlyannounced our intention to reduce the size of our direct sales force. This andany future reduction in sales force could prevent us from achieving anticipatedrevenues and attracting and retaining qualified sales personnel and couldnegatively impact our financial condition and results of operations.***

We sell our products, XOPENEX Inhalation Solution,XOPENEX HFA, BROVANA and LUNESTA, primarily through our direct sales force. On October 30,2007, we announced our intention to reduce our direct sales force byapproximately 300 positions. Although we expect the sales force reduction toresult in lower expenses, we may not realize the anticipated cost-savings. Thissales force reduction could result in temporary lack of focus and reducedproductivity among our sales personnel and, if our sales organization does notdevote the time and resources necessary to attain sales projections, we may notbe able to achieve anticipated revenues and our financial condition andoperating results could be harmed. In addition, the sales force reduction maymake it more difficult for us to attract and retain the qualified sales peoplenecessary to maintain current sales levels and/or to support potential salesgrowth and sales of any additional products we may commercialize in the future.

We have in the past, andmay again in the future, incur significant expense to expand our sales force. Thissales force expansion has, in some instances, been in anticipation of receivingmarketing approval for products under development and/or expected sales growth.If, in the future, we expand our sales force too rapidly or do not receiveexpected marketing approvals or attain anticipated sales growth, we may beforced to again reduce our sales force, which could negatively impact ourfinancial condition and results of operations.

***We sell ourproducts primarily through a direct sales force, and if we are not successfulin attracting and retaining qualified sales personnel, we may not be successfulin commercializing our products.***

We have established asales force to market XOPENEX Inhalation Solution, XOPENEX HFA, BROVANA andLUNESTA. Our ability to realize significant revenues from direct marketing andsales activities depends on our ability to attract and retain qualified salespersonnel. Competition for these persons is intense and our recently announcedsales force reduction could harm our ability to attract and retain qualifiedsales personnel. 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 

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maximumpenetration in the market. We may not be successful in entering into anyco-promotion or other such arrangements, and the terms of any co-promotion orother such arrangements may not be favorable to us.

***If we or our third-partymanufacturers do not comply with current Good Manufacturing Practices, or GMP,regulations, then the FDA could refuse to approve marketing applications orforce us to recall or withdraw 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 GMP regulationscould lead to delay in our development programs or refusal by the FDA or otherregulatory authorities to approve marketing applications. Following marketingapproval of a product, failure in either respect could also impede commercialintroduction or on-going distribution of the product and/or be the basis foraction by the FDA or other regulatory authorities to withdraw approvalspreviously granted, to recall products and for other regulatory action.

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

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

***Buying patterns ofour wholesalers may vary from time to time, which could have a material impacton our financial condition, cash flows and results of operations.***

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

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

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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 tosuccessfully develop and receive regulatory approval for product candidates, wewill be unable to commercialize the product candidates and future sales andearnings growth will be substantially hampered.***

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

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

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

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

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

·       wemay not receive regulatory approval for our product candidates;

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

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

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

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

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***If the FDA, orsimilar foreign agency, delays or denies approval of any NDA, or foreignequivalent, that we file, then commercialization of the product subject to thefiling will be delayed or terminated, which could have a material adverseeffect on our business.***

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

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

·       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, operatingrestrictions and criminal prosecution.

***Our sales depend onpayment and reimbursement from third-party payors, and a reduction inpayment rate or reimbursement could result in decreased use or sales of ourproducts.***

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. Legislative or administrativeacts that reduce reimbursement for our products could adversely affect ourbusiness. In addition, private insurers, such as managed care organizations,may adopt their own coverage restrictions or demand price concessions inresponse to legislation or administrative action. Reduction in reimbursementfor our products could have a material adverse effect on our results ofoperations. Also, the increasing emphasis on managed care in the United Statesmay put increasing pressure on the price and usage of our products, which mayadversely affect product sales. Further, when a new drug product is approved,governmental and/or private reimbursement for that product is uncertain, as isthe amount for which that product will be reimbursed and the extent of coveragefor the product. We cannot predict availability or amount of reimbursement forour approved products or product candidates and current reimbursement policiesfor marketed 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 administer the Medicare drug benefit, leading to managedcare and private health plans influencing prescription decisions for a largersegment of the population. In addition, certain states have proposed, andcertain other states have adopted, various programs to control prices for theirseniors’ 

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and low-income drugprograms, including price or patient reimbursement constraints, restrictions onaccess to certain products, importation from other countries, such as Canada,and bulk purchasing of drugs.

Since January 2005 and through June 2007,Medicare reimbursed XOPENEX Inhalation Solution pursuant to a uniquereimbursement code. In March 2006, the DME-PSCs, the entities responsiblefor overseeing the Medicare Part B prescription drug benefit forrespiratory products, announced their intention to implement an LCA,reimbursement action for XOPENEX Inhalation Solution that, if it had beenimplemented, would have reduced the reimbursement paid for XOPENEX InhalationSolution to that of generic racemic albuterol. In December 2006, CMScommenced an NCA, to determine when use of nebulized levalbuterol in treatingCOPD in the Medicare population is reasonable and necessary. While the NCA forXOPENEX Inhalation Solution was pending, the DME-PSCs announced that the proposedLCA would be stayed. On June 20, 2007, CMS announced its preliminarycoverage determination, stating that, based on its review of the available dataand comments submitted, it was unable to determine the criteria for whenXOPENEX Inhalation Solution would be appropriate to use by the Medicarepopulation and would instead defer this determination to the DME-PSCs. As partof its coverage determination, CMS affirmed that the use of nebulizedbeta-adrenergic agonists (such as XOPENEX Inhalation Solution and BROVANA) inthe treatment of lung disease in the home is medically necessary; such adetermination is needed before CMS or the DME-PSCs can establish the coveragecriteria for a given prescription drug under the Medicare Part B benefit.The final coverage determination was made in September 2007 and wasidentical to the preliminary coverage determination. Should the DME-PSCsestablish overly restrictive coverage criteria for either XOPENEX InhalationSolution or BROVANA, or again seek to impose an LCA on XOPENEX InhalationSolution, we may no longer be able to sell these products profitably in theMedicare Part B market and revenues for these products may be materiallyadversely affected.

In May 2007, CMS announced that, based on itsinterpretation of the statutory language of the MMA, it was required todiscontinue the unique reimbursement codes for XOPENEX Inhalation Solution andgeneric albuterol, which had been in place since January 2005, and bundledthese products together in a newly created reimbursement code. As a result ofthis coding change, reimbursement for XOPENEX Inhalation Solution and genericalbuterol is now based on the blended weighted average selling price for thetwo products, resulting in reimbursement for XOPENEX Inhalation Solution thatis considerably lower than the product’s published selling price for theproduct distribution channel. The new reimbursement rate became effective on July 1,2007 and is subject to change quarterly based upon the respective contributionof commercial sales of XOPENEX Inhalation Solution and generic albuterol to thequarterly blended weighted average selling price calculation for the newlycreated reimbursement code. This quarterly average selling price calculation ismandated by the MMA. Revenues from the sale of XOPENEX Inhalation Solution havebeen, and we expect will continue to be, adversely affected on a comparablebasis as a result of this change.

The bundling action also resulted in an unintendedincrease in Medicare Part B reimbursement for generic albuterol,significantly higher than the product’s average selling price (as publiclyreported by the Medicare Part B program), creating the potential forinappropriate reimbursement incentives to influence the dispensing decisions ofproviders. In July 2007, the U.S. House of Representatives released draftlegislation as part of the SCHIP reauthorization that includes languageaddressing the Medicare Part B reimbursement scenario that may potentiallyimpact physician prescribing decisions based upon financial incentives. Thedraft legislation provides that XOPENEX Inhalation Solution and genericalbuterol will be paid at the lower of their respective stand-alone averageselling prices or the blended XOPENEX Inhalation Solution/generic albuterolaverage selling price. The draft legislation was not part of the SCHIPreauthorization bill passed by Congress and vetoed by President Bush in September 2007.The language remains part of the Medicare Physician Fee Schedule correctionslegislation currently pending in the House of Representatives and we areworking to include comparable language in sister legislation being 

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developed by the Senate.For generic albuterol, this will lower the reimbursement Medicare pays for theproduct to its stand-alone average selling price. For XOPENEX InhalationSolution, reimbursement will continue to be paid at the blended XOPENEX/genericalbuterol average selling price. Medicare Part B reimbursement rates areupdated quarterly. The effective date of the legislation, if passed, is expectedto be January 1, 2008, but could be later if the law is not passed andsigned by President Bush prior to the end of 2008. The impact of this potentiallegislative action on XOPENEX Inhalation Solution revenues in the Medicaremarket in 2008 is not yet known.

We estimate that as much as 25% of our XOPENEXInhalation Solution units sold are subject to reimbursement under Medicare Part B.We have been actively contracting with home health care and retail pharmacyproviders in an effort to ensure the continued availability of XOPENEXInhalation Solution to Medicare Part B beneficiaries with reversibleobstructive airway disease. If the contracting strategy for XOPENEX InhalationSolution is not successful in maintaining as much of the current unit saleslevels for the product in Medicare as commercially feasible, if thereimbursement scenario that may potentially impact physician prescribingdecisions for generic albuterol is not corrected legislatively, and/or if theDME-PSCs impose restrictive coverage policies on XOPENEX Inhalation Solution,revenue from sales of XOPENEX Inhalation Solution will be adversely affectedand our financial condition and results from operations will be impaired.

In April 2007, CMS informed us that the scope of theNCA includes BROVANA. As stated above, CMS announced that it was deferring itscoverage determination, including any determination for long-actingbeta-agonists like BROVANA, to the DME-PSCs. On June 13, 2007, the DME-PSCspublished an article detailing the coverage criteria for BROVANA. Unlessotherwise modified by the DME-PSCs, the coverage criteria established forBROVANA in the above-referenced article will remain in effect under theproduct-specific billing code that was recently awarded for the product. Wehave initiated a contracting strategy with retail and home health care pharmacyproviders for BROVANA that is intended to ensure the availability of theproduct for Medicare patients. If the contracting strategy for BROVANA is not successfulor if the coverage policies established by the DME-PSCs for the product areviewed by physicians and providers as too restrictive, revenue growth fromsales of BROVANA in the Medicare market will be materially adversely affected.

As we enter into agreements to license our productsfor commercialization outside of the United States, we may be subject topricing decisions made by regulatory bodies and private insurers around theworld. Such pricing decisions may affect royalty rates and payments made to usunder those agreements, or decisions whether or not to commercialize ourproducts in the applicable jurisdiction. Efforts to obtain pricing decisionsare often the responsibility of the third party licensee and we cannot predictthe success of any third party in obtaining desirable pricing, or how theactions of such third party or any regulatory body or private insurer willaffect the ultimate commercial benefits of those transactions.

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

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

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

·       FederalMedicare and Medicaid Anti-Kickback laws, which prohibit persons from knowinglyand willfully soliciting, offering, receiving or providing remuneration,directly or indirectly, in cash or in kind, to induce either referral of anindividual, or furnishing or arranging for a good or service, for 

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

·       otherMedicare and Medicaid laws and regulations that establish requirements forcoverage and payment for our products, including the amount of such payments;

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

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

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

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

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

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

·       Foodand Drug Administration Amendments Act of 2007;

·       DeficitReduction Act of 2005;

·       stateand foreign law equivalents of the foregoing; and

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

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

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

We are a participant inthe Medicaid rebate program established by the Omnibus Budget ReconciliationAct of 1990. Under the Medicaid rebate program, we are obligated to pay atleast a 

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minimumprimary rebate of 15.1% of the average manufacturers price on all utilizationof our products by Medicaid beneficiaries**.**Inaddition, this primary rebate may be higher if we provide discounts tocommercial customers that are greater than the statutorily mandated minimum.Also, several state Medicaid programs have implemented Preferred Drug Lists, orPDLs, and more states may adopt this practice. Products placed on a stateMedicaid program’s PDL are not subject to restrictions on their utilizationsuch as prior authorization before use. If our drugs are not included onMedicaid PDLs, use of our drugs in the Medicaid program may be adverselyaffected. In some states that have adopted PDLs, we have been, and may continueto be, required to provide substantial supplemental rebates to state Medicaidauthorities in order for our drugs to be included on the PDL.

Both the Federalgovernment and state and local governments have initiated investigations andlawsuits concerning the rebate practices of many pharmaceutical companies toensure compliance with these rebate programs. We were recently named as adefendant, together with numerous other companies, in one such suit. Theformulas for determining these rebates and discounts are set by law, are basedon a number of different factors, and can be complicated. We recompute theseamounts each quarter based on our up-to-date knowledge of the statutoryrequirements and believe our calculations are accurate and based on reasonableassumptions and judgments. However, as a result of an investigation or lawsuitwe may be required to pay additional rebates and/or discounts on sales made inprior periods 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 ofsale of certain medications without a prescription may adversely affect ourbusiness.***

In May 2001, anadvisory panel to the FDA recommended that the FDA allow certain popularallergy medications to be sold without a prescription. In November 2002, theFDA approved CLARITIN®,an allergy medication, to be sold without a prescription. In the future, theFDA may also allow sale of other allergy medications without a prescription.The sale of CLARITIN and/or, if allowed, the sale of other allergy medicationswithout a prescription, may have a material adverse effect on our businessbecause the market for prescription drugs, including CLARINEX, ALLEGRA, andXYZAL/XUSAL forwhich we receive royalties on sales, has been and may continue to be, adverselyaffected.

**Risks Related 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 inlarge part on our ability to obtain, maintain and enforce patents, and protecttrade secrets. Our ability to commercialize any drug successfully will largelydepend upon our ability to obtain and maintain patents of sufficient scope toprevent third parties from developing substantially equivalent products. In theabsence of patent and trade secret protection, competitors may adversely affectour business by independently developing and marketing substantially equivalentproducts. It is also possible that we could incur substantial costs if we arerequired to initiate litigation against others to protect or enforce ourintellectual property rights.

We have filed patentapplications covering composition of, methods of making, and/or methods ofusing, our drugs and drug candidates. Our revenues under collaborationagreements with pharmaceutical companies depend in part on the existence andscope of issued patents. We may not be issued patents based on patentapplications already filed or that we file in the future and if patents areissued, they may be insufficient in scope to cover the products licensed underthese collaboration agreements. Generally, we do not receive royalty revenuefrom sales of products licensed under collaboration agreements in countrieswhere we do not have a patent for such products. The issuance of a patent inone country does not ensure the issuance of a patent in any other country.Furthermore, the patent position of companies in the 

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pharmaceuticalindustry generally involves complex legal and factual questions, and has beenand remains the subject of much litigation. Legal standards relating to scopeand validity of patent claims are evolving. Any patents we have obtained, orobtain in the future, may be challenged, invalidated or circumvented. Moreover,the United States Patent and Trademark Office may commence interferenceproceedings involving our patents or patent applications. Any challenge to, orinvalidation or circumvention of, our patents or patent applications would becostly, would require significant time and attention of our management andcould have a material adverse effect on our business. In addition, if we arenot successful in enforcing our patents, we will not be able to prevent othersfrom 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 InhalationSolution is currently the subject of patent infringement litigation. The FDAhas received ANDAs from Breath, Dey, L.P., Watson and Barr seeking marketingapproval for generic versions of our XOPENEX Inhalation Solution products.These submissions include Paragraph IV certifications alleging that ourpatents listed in the Orange Book for XOPENEX Inhalation Solution are invalid,unenforceable or not infringed by the submitter’s proposed product. We havecommenced patent infringement litigation against Breath, Dey, L.P., and Barr,but we have decided not to commence litigation against Watson at this time asits Paragraph IV certification is limited to a patent that expires in 2021**.**The filing of a lawsuit for patent infringement under theHatch-Waxman Act results in an automatic 30-month stay of the FDA’s authorityto grant marketing approval to these companies. The 30-month stay againstBreath’s ANDA is scheduled to expire for our 1.25 mg/3 mL, 0.63 mg/3 mL and0.31 mg/3 mL XOPENEX Inhalation Solution on or about March 7, 2008. Uponexpiration of that 30-month stay, the FDA could grant final approval and Breathcould then commence an “at risk” distribution of its generic levalbuterolproduct for those dosages notwithstanding our patents and notwithstanding thatthe court’s decision as to the merits of the litigation will not have beenrendered, unless we were able to obtain an injunction prohibiting suchdistribution. However, if a forfeiture event occurs and the FDA determines thatBreath has forfeited the 180-day semi-exclusivity period for those threedosages, other ANDA filers who have been granted final approval by the FDAcould commence an “at risk” launch upon expiration of the 30-month stay. Forthose three dosages, the 30-month stays against Dey L.P. and Barr expire on orabout July 9, 2008 and November 30, 2009, respectively. If any ofthese parties were to commence selling a generic alternative to our XOPENEXInhalation Solution product prior to the resolution of these ongoing legalproceedings, or there is a court determination that the products thesecompanies wish to market do not infringe our patents, or that our patents areinvalid or unenforceable, it would have a material adverse effect on ourbusiness, financial condition and results of operations. In addition, ourpreviously issued guidance regarding our projected financial results may nolonger be accurate and we would have to revise such guidance.

Certain of ScheringPlough’s CLARINEX products for which we receive sales royalties are currentlythe subject of patent infringement litigation. In 2007, the FDA received ANDAsfrom (i) Glenmark, Sun, Orchid, Mylan, Dr. Reddy’s, Lupin and Perrigoseeking approval of a generic version of CLARINEX 5 mg tablets,(ii) Orchid seeking approval of a generic version of CLARINEX 2.5 mg and 5mg orally disintegrating tablets, and (iii) Dr. Reddy’s and Anchenseeking approval of Schering Plough’s 2.5/120 mg tablets of CLARINEX-D 12 hourdesloratadine and pseudoephedrine extended release tablets. The submissions in2007 include Paragraph IV certifications alleging that our patents, whichSchering Plough (as licensee of such patents) listed in the Orange Book forthese products, are invalid, unenforceable or not infringed by the submitter’sproposed product. We and the University of Massachusetts, co-owners of certainpatents listed in the Orange Book, filed civil actions against these parties,with the exception of Anchen, for patent infringement. We are currentlycontemplating filing a civil action against Anchen for patent infringement. Webelieve that all of these ANDAs are subject to a statutory stay of approvaluntil 

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June 21,2009 based on previous litigation commenced by Schering-Plough against theseparties in separate civil actions involving another patent. 

In June 2006, we werenotified that Teva Pharmaceutical Industries Limited and Teva UK Limited,referred to collectively as Teva, filed a claim naming us as defendant in theUnited Kingdom’s High Court of Justice, Chancery Division, Patents Court. Theclaim alleged that our two patents relating to fexofenandine hydrocloride,which we have licensed to sanofi-aventis in connection with its sale ofALLEGRA, were invalid and sought to have them invalidated. InOctober 2007, the court determined that certain claims of our patents areinvalid and granted an order allowing the invalid claims to be deleted and bothpatents to be maintained in amended form. No appeal was filed and the decisionis final. We do not believe this decision will adversely affect royalties wereceive for ALLEGRA in the United Kingdom. If a similar action is brought andpatent based exclusivity for ALLEGRA is lost in the United Kingdom or in anyother jurisdiction, our rights to receive royalty revenue in any suchjurisdiction will terminate.

In June 2007, wereceived notification that Teva filed an Action for Revocation of our Europeanpatent for levocetirizine in the High Chancery Court in the United Kingdombased on alleged invalidity of our granted patent and their intent to market ageneric levocetirizine product that would infringe our granted patent. InJuly 2007, we received notification that Teva Pharmaceutical IndustriesLimited filed a Nullification Request for our European patent forlevocetirizine in the German Federal Patent Court. Our levocetirizine patent isexclusively licensed to UCB in connection with its sale of XYZAL/XUSAL. We haveretained counsel for the Action for Revocation in the United Kingdom and we arein process of retaining counsel for the Nullification Action in Germany.

Should the courts upholdour foreign patents, companies seeking to market generic versions of our drugs andthe drugs of our licensees will be deterred from market entry until theexpiration of the applicable patent(s). 

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

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

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

Our success depends inpart on our ability to operate without infringing upon proprietary rights ofothers, including patent and trademark rights. Third parties, typically drugcompanies, hold patents or patent applications covering compositions, methodsof making and uses, covering the composition of matter for some of the drugcandidates for which we have patents or patent applications. Third parties alsohold patents relating to drug delivery technology that may be necessary fordevelopment or commercialization of some of our drug candidates. In each ofthese cases, unless we have or obtain a license agreement, we generally may notcommercialize the drug candidates until these third-party patents expire orare declared invalid or unenforceable by the courts. Licenses may not beavailable to us on acceptable terms, if at all.

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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 pay significantdamages and/or be prevented from commercializing our product and our businesscould be materially adversely affected. In April 2007, we were served witha Complaint filed by Dey, alleging that the manufacture and sale of BROVANAinfringes or will induce infringement of a single U.S. patent for which Deyowns all rights, title and interest. In April 2007, we filed an Answer andCounterclaim to this Complaint seeking to invalidate the originally assertedpatent and a second related patent. In May 2007, Dey filed a replyasserting infringement of the second patent Under the current trial schedulingorder, trial will begin no earlier than December 12, 2008. It is too earlyto make a reasonable assessment as to the likely outcome or impact of thislitigation. We are unable to reasonably estimate any possible range of loss orliability related to this lawsuit due to its uncertain resolution.

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

**Risks Related to Our Dependence on Third Parties**

***If any third-party collaborator is notsuccessful in development or commercialization of our products and productcandidates, we may not realize the potential commercial benefits of thearrangement and our results of operations could be adversely affected.***

We have entered into acollaboration agreement with 3M for the manufacturing of XOPENEX HFA. Underthis agreement, 3M is responsible for manufacturing an MDI formulation ofXOPENEX. We commercially introduced XOPENEX HFA in December 2005. We havealso entered into agreements with Eisai and GSK for development andcommercialization of our eszopiclone product, marketed as LUNESTA in the U.S.Under the Eisai agreement, Eisai will be responsible for completing remainingclinical trials necessary for attaining marketing approval from the Japaneseregulatory authorities and, contingent on regulatory approval,commercialization of the product in Japan. Under the GSK agreement, GSK isresponsible for the development and commercialization of the product for allmarkets worldwide, excluding the United States, Canada, Mexico and Japan.

If 3M, Eisai, GSK or anyfuture development or commercialization collaborator do not devote sufficienttime and resources to its collaboration arrangement with us, breaches orterminates its agreement with us, fails to perform its obligations to us in atimely manner or is unsuccessful in its development and/or commercializationefforts, we may not realize the potential commercial benefits of thearrangement and our results of operations may be adversely affected. Inaddition, if regulatory approval or commercialization of any product candidateunder development by or in collaboration with a partner is 

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

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

We have entered intolicensing arrangements pursuant to which we license patents to pharmaceuticalcompanies and our revenues under these licensing arrangements consist primarilyof royalties on sales of products. Payments and royalties under thesearrangements depend in large part on the commercialization efforts of ourlicensing partners in countries where we hold patents, including sales effortsand enforcement of patents, which we cannot control. If any of our licensingpartners do not devote sufficient time and resources to its licensingarrangement with us or focuses its efforts in countries where we do not holdpatents, we may not realize the potential commercial benefits of thearrangement, our revenues under these arrangements may be less than anticipatedand our results of operations may be adversely affected. If any of ourlicensing partners was to breach or terminate its agreement with us or fail toperform its obligations to us in a timely manner, the royalties we receiveunder the licensing agreement could decrease or cease. If we are unable or failto perform, or breach in our performance of, our obligations under a licensingagreement, the royalties and benefits to which we are otherwise entitled underthe agreement could be reduced or eliminated. Any delay or termination of thistype could have a material adverse effect on our financial condition andresults of operations because we may lose technology rights and milestone orroyalty payments from licensing partners and/or revenues from product sales, ifany, could be delayed, reduced or terminated.

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

We currently operate amanufacturing plant that we believe can meet our commercial requirements of theactive pharmaceutical ingredient for XOPENEX Inhalation Solution and XOPENEXHFA, partially fulfill our commercial requirements of the active pharmaceuticalingredient for LUNESTA, and support production of our product candidates inamounts needed for our clinical trials. We do not, however, have the capabilityto manufacture at our manufacturing facility all of our requirements for theactive ingredients of our currently approved products, and we have nofacilities for manufacturing pharmaceutical dosage forms or finished drugproducts. Developing and obtaining this capability would be time consuming andexpensive. Unless and until we develop this capability, we will relysubstantially, and in some cases, entirely, on third-party manufacturers.Catalent Pharma Solutions, LLC, or Catalent, formerly Cardinal Health, Inc.,and Holopack International Corporation, or Holopack, are currently our onlyfinished goods manufacturers of our XOPENEX Inhalation Solution. Catalent iscurrently the sole finished goods manufacturer of BROVANA, Patheon Inc.,or Patheon, is the sole manufacturer of LUNESTA, and 3M is the solemanufacturer and supplier of XOPENEX HFA. Certain components of XOPENEX HFA areavailable from only a single source. If Catalent, Holopack, Patheon, 3M, or anyof our sole-source component suppliers experiences delays or difficulties inproducing, packaging or delivering XOPENEX Inhalation Solution, XOPENEX HFA orits components, BROVANA or LUNESTA, as the case may be, we could be unable tomeet our customers’ demands for such products, which could lead to lost sales,customer dissatisfaction and damage to our reputation. Furthermore, if we arerequired to change manufacturers, we will be required to verify that the newmanufacturer maintains facilities and procedures that comply with qualitystandards and with all applicable regulations and guidelines, including FDAguidelines. The delays associated with the verification of a new manufacturerfor XOPENEX Inhalation Solution, XOPENEX HFA or its components, BROVANA orLUNESTA could adversely affect our ability to produce such products in a timelymanner or within budget.

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

**Risks Related to Growth of Our Business**

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

We are currentlycommercializing four products. However, all of our product candidates are inthe early stages of development. In order to increase the likelihood that wewill be able to successfully develop and/or commercialize additional drugs, weintend to acquire and develop additional product candidates and/or approvedproducts. The success of this growth strategy depends upon our ability tocorrectly establish criteria for such acquisitions and successfully identify,select and acquire product candidates and/or products that meet such criteria.We will be required to integrate any acquired product candidates into ourresearch and development operations and any acquired products into our salesand marketing operations. Managing the development and/or commercialization ofa new product involves numerous other financial and operational risks,including difficulties allocating resources between existing and acquiredassets and attracting and retaining qualified employees to develop and/or sellthe product.

Any product candidate weacquire may require additional research and development efforts prior tocommercial sale, including extensive preclinical and/or clinical testing andapproval by the FDA and corresponding foreign regulatory authorities. Allproduct candidates are prone to the risks of failure inherent in pharmaceuticalproduct development, including the possibility that the product candidate willnot be safe and effective or approved by regulatory authorities.

Inaddition, we cannot be assured that any products that we develop or acquirewill be:

·       manufacturedor produced economically;

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

·       complementaryto our existing product portfolio; or

·       widelyaccepted in the marketplace.

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

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

We may acquire additionalbusinesses and products that complement or augment our existing business. Wehave limited acquisition experience and may not be able to integrate anyacquired business or product successfully or operate any acquired businessprofitably. Integrating any newly acquired business or product could beexpensive and time-consuming. Integration efforts often place a significantstrain on managerial, operational and financial resources and could prove to bemore difficult or expensive than we predict. The diversion of our management’sattention and any delay or difficulties encountered in 

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connectionwith any future acquisitions we may consummate could result in the disruptionof our on-going business or inconsistencies in standards, controls, proceduresand policies that could adversely 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 toacquire businesses or product candidates or to enter into other significanttransactions, we conduct business, legal and financial due diligence with thegoal of identifying and evaluating material risks involved in the transaction.Despite our efforts, we ultimately may be unsuccessful in ascertaining orevaluating all such risks and, as a result, might not realize the intendedadvantages of the transaction. If we fail to realize the expected benefits fromacquisitions we may consummate in the future, whether as a result ofunidentified risks, integration difficulties, regulatory setbacks or otherevents, our business, results of operations and financial condition could beadversely affected. If we acquire product candidates, we will also need to makecertain assumptions about, among other things, development costs, thelikelihood of receiving regulatory approval and the market for such productcandidates. Our assumptions may prove to be incorrect, which could cause us tofail to realize the anticipated benefits 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.***

Developmentand commercialization of some of our product candidates may depend on ourability to enter into additional collaboration agreements with pharmaceuticalcompanies to fund all or part of the costs of development and commercializationof these product candidates. We may not be able to enter into collaborationagreements and the terms of the collaboration agreements, if any, may not befavorable to us. Inability to enter into collaboration agreements could delayor preclude development, manufacture and/or marketing of some of our drugs andcould have a material adverse effect on our financial condition and results ofoperations because:

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

·       revenuefrom product sales could be delayed; or

·       wemay elect not to commercialize the drugs.

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

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**ITEMS2-5.**                              NONE

**ITEM6.**                EXHIBITS
| 10.1  |   | Amended  and Restated Transition and Severance Agreement by and between the Registrant  and W. James O’Shea dated September 7, 2007.                           |
|-------|--------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 10.2  |   | Employment  Agreement by and between the Registrant and Mark Iwicki dated October 15,  2007.                                                                        |
| 10.3  |   | Executive  Retention Agreement by and between the Registrant and and Mark Iwicki dated  October 15, 2007.                                                           |
| 10.4* |   | Development,  License and Commercialization Agreement dated September 11, 2007 by and  between Registrant and Glaxo Group Limited, an affiliate of GlaxoSmithKline. |
| 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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*                    Confidentialtreatment has been requested as to certain portions, which portions have beenfiled separately with the Securities and Exchange Commission.

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**SIGNATURES**

Pursuantto the requirements of the Securities Exchange Act of 1934, the registrant hasduly caused this report to be signed on its behalf by the undersigned thereuntoduly authorized.
|                              | **SEPRACOR INC.** |
|------------------------------|-------------------|
| Date:  November 8, 2007 | By:               | /s/  ADRIAN ADAMS |
|                         |              | Adrian Adams |
|                         | * *          | *President  and Chief Executive Officer  (Principal Executive Officer)* |
| Date:  November 8, 2007 | By:               | /s/  ROBERT F. SCUMACI |
|                         |              | Robert F. Scumaci |
|                         | * *          | *Executive  Vice President, Corporate Finance,  Administration and Technical Operations,  and Treasurer  (Principal Accounting Officer)* |

 

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**Exhibit Index**

| Exhibit No. | ** ** | ** **                                                                                                                                                                   | ** ** | **Description** |
|------------------|------------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------|
| 10.1             |       | Amended and Restated  Transition and Severance Agreement by and between the Registrant and W. James  O’Shea dated September 7, 2007.                               |
| 10.2             |       | Employment Agreement by  and between the Registrant and Mark Iwicki dated October 15, 2007.                                                                             |
| 10.3             |       | Executive Retention  Agreement by and between the Registrant and Mark Iwicki dated October 15,  2007.                                                                   |
| 10.4*            |       | Development, License and  Commercialization Agreement dated September 11, 2007 by and between the  Registrant and Glaxo Group Limited, an affiliate of GlaxoSmithKline. |
| 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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*                    Confidentialtreatment has been requested as to certain portions, which portions have beenfiled separately with the Securities and Exchange Commission.

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