SECURITIES AND EXCHANGE COMMISSIONWashington, D.C. 20549

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FORM 10-Q

|(Mark One)                                                    |                                                                                         
|------------------------------------------------------------- | ----------------------------------------------------------------------------------------
|ý                                                             | QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 
|For the Quarterly Period Ended June 30, 2004                 
|or                                                           
|o                                                             | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
|For the transition period
from                             to

Commission file number 0-19410

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Sepracor Inc.(Exact name of registrant as specified in its charter)

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

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

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Indicate
by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the
preceding 12 months (or for such shorter period that the registrant was required to file such reports) and (2) has been subject to such filing requirements for the past
90 days. Yes ý    No o

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

The number of shares outstanding of the registrant's class of Common Stock as of July 30, 2004 was: 87,605,171 shares.



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SEPRACOR INC.        INDEX

|Part IFinancial Information |  |                                                                                                            
|---------------------------- |  | -----------------------------------------------------------------------------------------------------------
|Item 1.                      |  | Consolidated Financial Statements (Unaudited)                                                              
|                             |  | Consolidated Balance Sheets as of June 30, 2004 and December 31,
2003 (Unaudited)                          
|                             |  | Consolidated Statements of Operations for the Three and Six Months Ended June 30, 2004 and 2003 (Unaudited)
|                             |  | Consolidated Statements of Cash Flows for the Six Months Ended June 30, 2004 and 2003 (Unaudited)          
|                             |  | Notes to Consolidated Interim Financial Statements                                                         
|Item 2.                      |  | Management's Discussion and Analysis of Financial Condition and Results of Operations                      
|Item 3.                      |  | Quantitative and Qualitative Disclosures About Market Risk                                                 
|Item 4.                      |  | Controls and Procedures                                                                                    
|Part IIOther Information    |  |                                                                                                            
|Item 1.                      |  | Legal Proceedings                                                                                          
|Item 4.                      |  | Submission of Matters to a Vote of Security Holders                                                        
|Item 6.                      |  | Exhibits and Reports on Form 8-K                                                                           
|                             |  | Signatures                                                                                                 
|                             |  | Exhibit Index                                                                                              

2

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SEPRACOR INC.

CONSOLIDATED BALANCE SHEETS

(Unaudited)

(In Thousands)

|                                                                                                                                                                           |  | June 30, 2004 |            | December 31, 2003 |  
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------- |  | ------------- | ---------- | ----------------- | -
|Assets                                                                                                                                                                     |  |               |            |                   |  
|Current assets:                                                                                                                                                            |  |               |            |                   |  
|Cash and cash equivalents                                                                                                                                                  |  | $             | 318,440    |                   | $
|Restricted cash                                                                                                                                                            |  |               | 1,500      |                   |  
|Short-term investments                                                                                                                                                     |  |               | 156,522    |                   |  
|Accounts receivable, net                                                                                                                                                   |  |               | 44,902     |                   |  
|Inventories                                                                                                                                                                |  |               | 15,901     |                   |  
|Other assets                                                                                                                                                               |  |               | 18,172     |                   |  
|                                                                                                                                                                           |  |               |            |                   |  
|Total current assets                                                                                                                                                       |  |               | 555,437    |                   |  
|Long-term investments                                                                                                                                                      |  |               | 59,296     |                   |  
|Property and equipment, net                                                                                                                                                |  |               | 71,280     |                   |  
|Investment in affiliate                                                                                                                                                    |  |               | 2,514      |                   |  
|Patents and deferred financing costs, net                                                                                                                                  |  |               | 28,536     |                   |  
|Other assets                                                                                                                                                               |  |               | 487        |                   |  
|                                                                                                                                                                           |  |               |            |                   |  
|Total assets                                                                                                                                                               |  | $             | 717,550    |                   | $
|                                                                                                                                                                           |  |               |            |                   |  
|Liabilities and Stockholders' Equity (Deficit)                                                                                                                             |  |               |            |                   |  
|Current liabilities:                                                                                                                                                       |  |               |            |                   |  
|Accounts payable                                                                                                                                                           |  | $             | 18,253     |                   | $
|Accrued expenses                                                                                                                                                           |  |               | 110,101    |                   |  
|Current portion of notes payable and capital lease obligation                                                                                                              |  |               | 1,926      |                   |  
|Current portion of convertible subordinated debt                                                                                                                           |  |               |           |                   |  
|Other current liabilities                                                                                                                                                  |  |               | 32,073     |                   |  
|                                                                                                                                                                           |  |               |            |                   |  
|Total current liabilities                                                                                                                                                  |  |               | 162,353    |                   |  
|Notes payable and capital lease obligation                                                                                                                                 |  |               | 3,375      |                   |  
|Long-term deferred revenue                                                                                                                                                 |  |               |           |                   |  
|Other long-term liabilities                                                                                                                                                |  |               | 30,987     |                   |  
|Convertible subordinated debt                                                                                                                                              |  |               | 1,190,000  |                   |  
|                                                                                                                                                                           |  |               |            |                   |  
|Total liabilities                                                                                                                                                          |  |               | 1,386,715  |                   |  
|                                                                                                                                                                           |  |               |            |                   |  
|Stockholders' equity (deficit):                                                                                                                                            |  |               |            |                   |  
|Preferred stock $1.00 par value, 1,000 shares authorized, none outstanding at June 30, 2004 and December 31, 2003                                                          |  |               |           |                   |  
|Common stock, $.10 par value, 240,000 and 240,000 shares authorized; 87,586 and 85,025 shares issued and outstanding, at June 30, 2004 and December 31, 2003, respectively |  |               | 8,759      |                   |  
|Additional paid-in capital                                                                                                                                                 |  |               | 773,855    |                   |  
|Accumulated deficit                                                                                                                                                        |  |               | (1,461,398 | )                 |  
|Accumulated other comprehensive income                                                                                                                                     |  |               | 9,619      |                   |  
|                                                                                                                                                                           |  |               |            |                   |  
|Total stockholders' equity (deficit)                                                                                                                                       |  |               | (669,165   | )                 |  
|                                                                                                                                                                           |  |               |            |                   |  
|Total liabilities and stockholders' equity (deficit)                                                                                                                       |  | $             | 717,550    |                   | $
|                                                                                                                                                                           |  |               |            |                   |  

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

3

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SEPRACOR INC.

CONSOLIDATED STATEMENTS OF OPERATIONS

(Unaudited)

(In Thousands, Except Per Share Amounts)

|                                                                      |                                             | Three Months Ended       |   | Six Months Ended |        
|--------------------------------------------------------------------- | ------------------------------------------- | ------------------------ | - | ---------------- | -------
|
|Revenues:                                                             |                                             |                          |   |                  |        
|                                                                      | Product sales                               |                          | $ | 57,450           |        
|                                                                      | Royalties and other                         |                          |   | 12,517           |        
|                                                                      |                                             |                          |   |                  |        
|                                                                      |                                             | Total revenues           |   |                  | 69,967 
|                                                                      |                                             |                          |   |                  |        
|Costs and expenses:                                                   |                                             |                          |   |                  |        
|                                                                      | Cost of product sold                        |                          |   | 6,821            |        
|                                                                      | Cost of royalties and other                 |                          |   | 109              |        
|                                                                      | Research and development                    |                          |   | 45,077           |        
|                                                                      | Selling, marketing and distribution         |                          |   | 86,355           |        
|                                                                      | General and administrative and patent costs |                          |   | 7,899            |        
|                                                                      |                                             |                          |   |                  |        
|                                                                      |                                             | Total costs and expenses |   |                  | 146,261
|                                                                      |                                             |                          |   |                  |        
|                                                                      | Loss from operations                        |                          |   | (76,294          | )      
|Other income (expense):                                               |                                             |                          |   |                  |        
|                                                                      | Interest income                             |                          |   | 1,424            |        
|                                                                      | Interest expense                            |                          |   | (5,830           | )      
|                                                                      | Loss on redemption of debt                  |                          |   |                 |        
|                                                                      | Equity in investee (losses)                 |                          |   | (358             | )      
|                                                                      | Other income (expense), net                 |                          |   | (71              | )      
|                                                                      |                                             |                          |   |                  |        
|                                                                      | Net loss                                    |                          | $ | (81,129          | )      
|                                                                      |                                             |                          |   |                  |        
|                                                                      | Basic and diluted net loss per common share |                          | $ | (0.93            | )      
|Shares used in computing basic and diluted net loss per common share: |                                             |                          |   |                  |        
|                                                                      | Basic and diluted                           |                          |   | 86,797           |        

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

4

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SEPRACOR INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)

(In Thousands)

|                                                                            |                                                              | Six Months Ended |  
|--------------------------------------------------------------------------- | ------------------------------------------------------------ | ---------------- | -
|
|Cash flows from operating activities:                                       |                                                              |                  |  
|                                                                            | Net loss                                                     |                  | $
|Adjustments to reconcile net loss to net cash used in operating activities: |                                                              |                  |  
|                                                                            | Depreciation and amortization                                |                  |  
|                                                                            | Provision for bad debt                                       |                  |  
|                                                                            | Equity in investee losses                                    |                  |  
|                                                                            | Loss on patent impairment                                    |                  |  
|                                                                            | Loss on redemption of debt                                   |                  |  
|Changes in operating assets and liabilities:                                |                                                              |                  |  
|                                                                            | Accounts receivable                                          |                  |  
|                                                                            | Inventories                                                  |                  |  
|                                                                            | Other current assets                                         |                  |  
|                                                                            | Accounts payable                                             |                  |  
|                                                                            | Accrued expenses                                             |                  |  
|                                                                            | Other current liabilities                                    |                  |  
|                                                                            | Other liabilities                                            |                  |  
|                                                                            |                                                              |                  |  
|                                                                            | Net cash used in operating activities                        |                  |  
|                                                                            |                                                              |                  |  
|Cash flows from investing activities:                                       |                                                              |                  |  
|                                                                            | Purchases of short and long-term investments                 |                  |  
|                                                                            | Sales and maturities of short and long-term investments      |                  |  
|                                                                            | Additions to property and equipment                          |                  |  
|                                                                            | Change in other assets                                       |                  |  
|                                                                            |                                                              |                  |  
|                                                                            | Net cash used in investing activities                        |                  |  
|                                                                            |                                                              |                  |  
|Cash flows from financing activities:                                       |                                                              |                  |  
|                                                                            | Redemption of convertible subordinated notes                 |                  |  
|                                                                            | Net proceeds from issuance of common stock                   |                  |  
|                                                                            | Proceeds from sale of convertible subordinated debt          |                  |  
|                                                                            | Costs associated with sale of convertible subordinated debt  |                  |  
|                                                                            | Settlement of call spread options                            |                  |  
|                                                                            | Repayments of long-term debt and capital leases              |                  |  
|                                                                            |                                                              |                  |  
|                                                                            | Net cash provided by (used in) financing activities          |                  |  
|                                                                            |                                                              |                  |  
|                                                                            | Effect of exchange rate changes on cash and cash equivalents |                  |  
|                                                                            |                                                              |                  |  
|                                                                            | Net decrease in cash and cash equivalents                    |                  |  
|                                                                            | Cash and cash equivalents at beginning of period             |                  | $
|                                                                            |                                                              |                  |  
|                                                                            | Cash and cash equivalents at end of period                   |                  | $
|                                                                            |                                                              |                  |  
|Non cash activities:                                                        |                                                              |                  |  
|                                                                            | Additions to capital leases                                  |                  |  

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

5

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NOTES TO CONSOLIDATED INTERIM FINANCIAL STATEMENTS

1. Basis of Presentation

The accompanying consolidated interim financial statements are unaudited and have been prepared on a basis substantially consistent with the audited financial
statements. Certain information and footnote disclosures normally included in our annual financial statements have been condensed or omitted. The year-end consolidated condensed balance
sheet data was derived from audited financial statements but does not include all disclosures required by generally accepted accounting principles. The consolidated interim financial statements, in
the opinion of our management, reflect all adjustments (consisting of normal recurring accruals) necessary for a fair presentation of the results for the interim periods ended June 30, 2004 and
2003. Certain prior amounts have been reclassified to conform to current year presentation.

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

The
consolidated results of operations for the interim periods are not necessarily indicative of the results of operations to be expected for the fiscal year. These consolidated interim
financial statements should be read in conjunction with the audited financial statements for the year ended December 31, 2003, which are contained in our annual report on
Form 10-K for the year ended December 31, 2003, filed with the Securities and Exchange Commission.

The
preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the following:
(1) the reported amounts of assets and liabilities, (2) the disclosure of contingent assets and liabilities at the dates of the financial statements and (3) the reported amounts
of revenues and expenses during the reporting periods. Actual results could differ from those estimates.

2. Basic and Diluted Net Loss Per Common Share

Basic earnings (loss) per share, or EPS, excludes dilution and is computed by dividing net income by the weighted-average number of common shares outstanding for
the period. Diluted EPS is based upon the weighted average number of common shares outstanding during the period plus the additional weighted average common equivalent shares during the period. Common
equivalent shares are not included in the per share calculations where the effect of their inclusion would be anti-dilutive. Common equivalent shares result from the assumed conversion of
preferred stock, convertible subordinated debt and the assumed exercise of outstanding stock options, the proceeds of which are then assumed to have been used to repurchase outstanding stock options
using the treasury stock method. Purchased call options are also not included in the per share calculations because including them would be anti-dilutive.

For
the three and six months ended June 30, 2004 and 2003, basic and diluted net loss per common share is computed based on the weighted-average number of common shares
outstanding during the period because the effect of common stock equivalents would be anti-dilutive. Certain securities were not included in the computation of diluted earnings per share
for the three and six

6

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months
ended June 30, 2004 and 2003 because they would have an anti-dilutive effect due to net losses for such periods. These excluded securities include the following:

Options
to purchase shares of common stock:

(in thousands, except price per share data)

June 30, 2004

June 30, 2003Number of options


12,189


12,698Price range per share

$
2.63 to $87.50

$
2.50 to $87.50


Shares
of common stock reserved for issuance upon conversion of convertible subordinated debt:

(in thousands)

June 30, 2004

June 30, 20037% convertible subordinated debentures due 2005



1,7925% convertible subordinated debentures due 2007

4,763

4,7635.75% convertible subordinated notes due 2006



7,1660% Series A convertible senior subordinated notes due 2008

7,839

0% Series B convertible senior subordinated notes due 2010

16,756

29,358

13,721


3. Accounting for Stock-Based Compensation

We have elected to follow Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees", or APB 25, and related interpretations,
in accounting for our stock-based compensation plans, rather than the alternative fair value accounting method provided for under FASB Statement of Financial Accounting Standards No. 123,
"Accounting for Stock-Based Compensation", or SFAS No. 123. Under APB 25, when the exercise price of options granted under these plans equals the market price of the underlying stock on the
date of grant, no compensation expense is recognized.

The
following table illustrates the effect on net loss and loss per share if we had applied the fair value recognition provisions of SFAS No. 123 to stock-based employee
compensation:

Three Months
Ended June 30,

Six Months
Ended June 30,(in thousands, except per share data)2004

2003

2004

2003Net loss attributable to common stockholders

$
(81,129
)
$
(33,791
)
$
(131,570
)
$
(63,550
)Total stock-based employee compensation expense determined under fair value based method for all awards


(11,757
)

(14,977
)

(22,795
)

(29,380
)Pro forma net loss

$
(92,886
)
$
(48,768
)
$
(154,365
)
$
(92,930
)Amounts per common share:Basic and dilutedas reported

$
(0.93
)
$
(0.40
)
$
(1.53
)
$
(0.75
)Basic and dilutedpro forma

$
(1.07
)
$
(0.58
)
$
(1.79
)
$
(1.10
)


7

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4. Inventories

Inventories consist of the following:

(in thousands)

June 30, 2004

December 31, 2003Raw materials

$
2,954

$
1,062Work in progress


1,858


1,295Finished goods


11,089


4,509$
15,901

$
6,866


5. Patents and Deferred Financing Costs

The following schedule details the carrying value of our patents and deferred financing costs as of June 30, 2004 and December 31, 2003:

(in thousands)

June 30, 2004

December 31, 2003Deferred finance costs, gross

$
35,147

$
42,957Accumulated amortization


(10,882
)

(13,136
)Deferred finance costs, net

$
24,265

$
29,821Patents, gross

$
6,679

$
7,223Accumulated amortization


(2,408
)

(2,231
)Patents, net

$
4,271

$
4,992


The
following schedule details our amortization expense related to patents and deferred financing costs:

Three Months
Ended June 30,

Six Months
Ended June 30,(in thousands)2004

2003

2004

2003Amortization of deferred finance costs

$
1,326

$
1,222

$
2,706

$
2,444Amortization of patents


174


943


348


1,829Total amortization

$
1,500

$
2,165

$
3,054

$
4,273


We
currently estimate that our amortization expense will be $2,973,000, $5,943,000, $5,917,000, $4,283,000 and $3,893,000 for the remainder of 2004 and for the years ending
December 31, 2005, 2006, 2007 and 2008, respectively.

During
the second quarter of 2004, we recorded a charge of approximately $374,000 related to the impairment of all patents related to ticalopride (formerly known as (+)- norcisapride).
This impairment of patents related to our termination, during the second quarter of 2004, of all plans for development of ticalopride. This charge is included in research and development expense in
the consolidated statements of operations for the three and six months ended June 30, 2004.

8

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6. Convertible Subordinated Debt

Convertible subordinated debt, including current portion, consists of the following:

(in thousands)

June 30, 2004

December 31, 20035.75% convertible subordinated notes due 2006

$


$
430,0005% convertible subordinated debentures due 2007


440,000


440,0000% Series A convertible senior subordinated notes due 2008


250,000


200,0000% Series B convertible senior subordinated notes due 2010


500,000


400,000Total

$
1,190,000

$
1,470,000


On
January 9, 2004, using funds from our December 2003 issuance of 0% convertible senior subordinated notes, we redeemed the remaining outstanding $430,000,000 principal
amount of our 5.75% convertible subordinated notes due 2006 for an aggregate redemption price of $433,709,000, including approximately $3,709,000 in accrued interest. As a result of this redemption,
we recorded a loss of approximately $7,022,000 related to the write-off of deferred financing costs in the first quarter of 2004.

On
January 15, 2004, pursuant to an option granted to the initial purchasers of our 0% convertible senior subordinated notes, we issued an additional $50,000,000 of 0%
Series A convertible senior
subordinated notes due 2008 and $100,000,000 of 0% Series B convertible senior subordinated notes due 2010. These notes have the same terms and conditions as our previously issued 0% notes. Net
of issuance costs, our proceeds were approximately $145,875,000.

7. Equity

During the second quarter of 2004, pursuant to the call spread option agreements we entered into in December 2003, we settled 1,639,832 call spread options
for cash in the amount of $50,006,000. The settled options expired at various dates beginning on May 12, 2004 and ending on June 9, 2004. We recorded the full amount of the call spread
option settlement as an increase to additional paid-in capital. Our remaining outstanding call spread options expire at various dates through 2005 and we have the option to settle the
remaining outstanding call spread options in either net shares or in cash.

8. Comprehensive Loss

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

|                                                            |  | Three Months Ended |         | Six Months Ended |  
|----------------------------------------------------------- |  | ------------------ | ------- | ---------------- | -
|
|Comprehensive loss:                                         |  |                    |         |                  |  
|Net loss                                                    |  | $                  | (81,129 | )                | $
|Net foreign currency translation adjustment                 |  |                    | 5       |                  |  
|Net unrealized gain (loss) on available-for-sale securities |  |                    | (7,182  | )                |  
|                                                            |  |                    |         |                  |  
|Total comprehensive loss                                    |  | $                  | (88,306 | )                | $
|                                                            |  |                    |         |                  |  

9

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9. Commitments and Contingencies

We enter into indemnification agreements in our ordinary course of business pursuant to which we indemnify and hold harmless certain parties against claims,
liabilities and losses brought by a third party to the extent that the claims arise out of (1) injury or death to person or property caused by defects in our product or product candidates,
(2) negligence in the manufacture or distribution of our product or product candidates or (3) a material breach by us. We have no liabilities recorded for these guarantees at
June 30, 2004. If liabilities were incurred, we have insurance policies covering product liabilities, which should mitigate, but may not eliminate, losses.

We
have agreements whereby we indemnify our officers and directors for certain events or occurrences while the officer or director is, or was, serving at our request in such capacity.
The term of the indemnification period is for the officer's or director's lifetime. The maximum potential amount of future payments we could be required to make under these indemnification agreements
is unlimited; however, we believe the fair value of these indemnification agreements is minimal.

The
Securities and Exchange Commission is conducting an investigation into trading in our securities, including trading by certain of our officers and employees during the period from
January 1, 1998 through December 31, 2001. We have cooperated fully with the investigation and will continue to do so.

We
and several of our current and former officers and a current director are named as defendants in several purported class action complaints which have been filed on behalf of certain
persons who purchased our common stock and/or debt securities during different time periods, beginning on various dates, the earliest being May 17, 1999, and all ending on March 6, 2002.
These complaints allege
violations of the Securities Exchange Act of 1934, as amended, and the rules and regulations promulgated thereunder by the Securities and Exchange Commission. Primarily they allege that the defendants
made certain materially false and misleading statements relating to the testing, safety and likelihood of approval of tecastemizole (formerly SOLTARA) by the United States Food and Drug
Administration, or FDA. On April 11, 2003, two consolidated amended complaints were filed, one on behalf of the purchasers of our common stock and the other on behalf of the purchasers of our
debt securities. These consolidated amended complaints reiterate the allegations contained in the previously filed complaints and define the alleged class periods as May 17, 1999 through
March 6, 2002. We filed a motion to dismiss both consolidated amended complaints on May 27, 2003. On March 11, 2004, the court, while granting in part the motion to dismiss, did
allow much of the case to proceed. The parties are currently engaged in discovery.

We
are unable to reasonably estimate any possible range of loss related to these lawsuits due to their uncertain resolution.

10. Ross Agreement Amendment

On March 25, 2004, we announced an amendment to our agreement with the Ross Products Division of Abbott Laboratories, or Ross, for the
co-promotion of XOPENEX® brand levalbuterol HCl inhalation solution. Under the terms of the amendment, our agreement with Ross will terminate effective December 31,
2004. Ross will continue to co-promote XOPENEX through December 31, 2004. Under the terms of the amendment, we will make residual payments to Ross of $30,000,000 on or before
December 31, 2005 and $3,000,000 on or before December 31, 2006. We charged the present value of these payments, approximately $30,671,000, to selling, marketing and distribution expense
in the first quarter of 2004 and this amount is included on the balance sheet in other long-term liabilities as of June 30, 2004. The difference between the payment amounts and the
present value will be

10

---



accreted
to interest expense at a rate of $317,000 per quarter through the end of 2005 and then $28,000 per quarter in 2006.

11. MedPointe Agreement Amendment

On April 30, 2004, we entered into an amendment to our agreement with MedPointe Inc., or MedPointe, for the co-promotion of
ASTELIN® brand azelastine HCl for the treatment of allergic rhinitis. Under the terms of the amendment, effective July 1, 2004 our sales force is only responsible for providing
ASTELIN samples to doctors. Effective October 1, 2004, both parties have the unilateral right to terminate the agreement without cause. As of the amendment date, we
began recognizing revenue at the fair value of services as those services are performed. If the agreement is terminated by either party, we will receive a payment from MedPointe of $6,950,000, less
any amount received prior to the termination related to the sample coverage.

11

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ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

This quarterly report on Form 10-Q contains, in addition to historical information, forward-looking statements within the meaning of
Section 21E of the Securities Exchange Act of 1934, as amended. These forward-looking statements involve risks and uncertainties and are not guarantees of future performance. Our actual results
could differ significantly from the results we discuss in these forward-looking statements. See the section entitled "Factors Affecting Future Operating Results" below for a discussion of important
factors that could cause our actual results to differ materially from the results we discuss in our forward-looking statements.

Executive Overview

We are a research-based pharmaceutical company dedicated to treating and preventing human disease through discovery, development and commercialization of
innovative pharmaceutical compounds. We select compounds for development that have potential to offer improvements over existing therapies with respect to efficacy, side-effect profile,
dosage forms and, in some cases, opportunity for additional indications. We market and sell XOPENEX inhalation solution, currently our only commercialized product, directly through our sales force and
through a co-promotion agreement. We have entered into out-licensing arrangements with respect to several other compounds. We expect to commercialize any additional products
that we successfully develop through our sales force, through co-promotion agreements and/or through out-licensing partnerships.

Significant 2004 Developments

On July 15, 2004, we announced that the United States Food and Drug Administration, or FDA, had accepted our resubmission of our New Drug Application, or
NDA, for ESTORRA brand eszopiclone for the treatment of insomnia characterized by difficulty falling asleep, and/or difficulty maintaining sleep during the night and early morning. We
received an "approvable" letter from the FDA on February 27, 2004 for the original NDA for ESTORRA. The FDA has classified our resubmission as a Class 2 resubmission. Under the
Prescription Drug User Fee Act, or PDUFA, the
FDA is expected to complete its review of a Class 2 resubmission within a six-month period beginning on the date that the resubmission was received. As a result of this
Class 2 designation, the PDUFA date, the date by which the FDA is expected to review and act on an NDA submission, for our ESTORRA NDA is December 15, 2004 and we are currently planning
on a January 2005 product launch, contingent upon approval from the FDA. We have expanded our sales force in anticipation of marketing ESTORRA to primary care physicians and psychiatrists, the
principal prescribers of sleep medications. Contingent upon approval from the FDA, we expect the recommended dosing to achieve sleep onset and maintenance to be 2 mg or 3 mg for adult patients, 2 mg
for elderly patients with sleep maintenance difficulties, and 1 mg for sleep onset in elderly patients whose primary complaint is difficulty falling asleep. The FDA has not requested additional
clinical or preclinical trials for final approval. If the FDA delays or denies final approval of our NDA for ESTORRA, then our plans for commercialization of ESTORRA may be delayed or terminated,
which would have a material adverse effect on our business.

On
July 15, 2004, we announced that the FDA had accepted for formal review, our NDA for XOPENEX HFA (levalbuterol tartrate HFA) Inhalation Aerosol, a
hydrofluoroalkane, or HFA, metered-dose inhaler, or MDI. The FDA has notified us that the PDUFA date for our NDA for XOPENEX HFA MDI is March 12, 2005. On May 12, 2004, we
submitted our NDA to the FDA for XOPENEX HFA MDI for the treatment or prevention of bronchospasm in adults, adolescents and children 4 years of age and older with reversible obstructive airway
disease, such as asthma and chronic obstructive pulmonary disease, or COPD. MDIs are hand-held, pressurized canisters that deliver inhaled medications directly to the lungs. Our MDI
development program included approximately

12

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1,870 pediatric
and adult subjects and 54 studies (preclinical and clinical). In 2003, we completed our Phase III studies of XOPENEX HFA. In each of the three, large-scale, pivotal Phase III
trials that we conducted, the XOPENEX HFA MDI was well tolerated and met the targeted efficacy endpoints in both adults and children with asthma. In the primary airway function measure, FEV1 (a test
of lung function that measures the amount of air forcefully exhaled in one second), the XOPENEX HFA MDI produced statistically and clinically significant improvements relative to placebo
(p<0.001). If the FDA delays or denies approval of our NDA for XOPENEX HFA MDI, then commercialization of this product candidate could be delayed or terminated, which would have a material
adverse effect on our business.

On
July 13, 2004, we announced a conditional amendment to our agreement with Aventis relating to eszopiclone, which we are developing as ESTORRA. The amendment is subject to the
successful completion of the proposed business combination between Aventis and Sanofi-Synthelabo. Under the conditional amended agreement, we would have the right to read and reference Aventis'
regulatory filings related to zopiclone outside of the United States for the purpose of development and regulatory registration of eszopiclone outside of the U.S., and Aventis would assign to us the
foreign counterparts to the U.S. patent covering eszopiclone and its therapeutic use. Also, as part of the amendment, we would permit Aventis to assign our obligation to pay a royalty on sales of
eszopiclone in the U.S. to a third party. Under the original agreement, we have exclusively licensed Aventis' preclinical, clinical and post-marketing surveillance data package relating to
zopiclone, its isomers and metabolites, to develop, make, use and sell eszopiclone in the U.S. Zopiclone is marketed by Aventis in
approximately 80 countries worldwide under the brand names of IMOVANE® and AMOBAN®.

During
the second quarter of 2004, pursuant to the call spread option agreements we entered into in December 2003, we settled 1,639,832 call spread options for cash in the amount
of $50,006,000. The settled options expired at various dates beginning on May 12, 2004 and ending on June 9, 2004. We recorded the full amount of the call spread option settlement as an
increase to additional paid-in capital. Our remaining outstanding call spread options expire at various dates through 2005 and we have the option to settle the remaining outstanding call
spread options in either net shares or in cash.

On
April 30, 2004, we entered into an amendment to our agreement with MedPointe Inc., or MedPointe, for the co-promotion of ASTELIN brand azelastine HCl for the
treatment of allergic rhinitis. Under the terms of the amendment, effective July 1, 2004 our sales force is only responsible for providing ASTELIN samples to doctors. Effective
October 1, 2004, both parties have the unilateral right to terminate the agreement without cause. As of the amendment date, we began recognizing revenue at the fair value of services as those
services are performed. If the agreement is terminated by either party, we will receive a payment from MedPointe of $6,950,000, less any amount received prior to the termination related to the sample
coverage.

On
March 25, 2004, we announced an amendment to our agreement with the Ross Products Division of Abbott Laboratories, or Ross, for the co-promotion of XOPENEX brand
levalbuterol HCl inhalation solution. Under the terms of the amendment, our agreement with Ross will terminate effective December 31, 2004. Ross will continue to co-promote XOPENEX
through December 31, 2004. Under the terms of the amendment, we will make residual payments to Ross of $30,000,000 on or before December 31, 2005 and $3,000,000 on or before
December 31, 2006. We charged the present value of these payments, approximately $30,671,000, to selling, marketing and distribution expense in the first quarter of 2004 and this amount is
included on the balance sheet in other long-term liabilities as of June 30, 2004. The difference between the payment amounts and the present value will be accreted to interest
expense at a rate of $317,000 per quarter through the end of 2005 and then $28,000 per quarter in 2006.

On
January 15, 2004, pursuant to an option granted to the initial purchasers of our 0% convertible senior subordinated notes, we issued an additional $50,000,000 of 0%
Series A convertible senior

13

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subordinated
notes due 2008 and $100,000,000 of 0% Series B convertible senior subordinated notes due 2010. These notes have the same terms and conditions as our previously issued 0% notes. Net
of issuance costs, our proceeds were approximately $145,875,000.

On
January 9, 2004, we completed the redemption of $430,000,000 aggregate principal amount of our 5.75% convertible subordinated notes due November 15, 2006. We redeemed
the 5.75% notes, pursuant to their terms, at 100% of the principal amount, plus accrued but unpaid interest from November 15, 2003 to, but excluding, the redemption date. The total aggregate
redemption price for the 5.75% notes was approximately $433,709,000, including approximately $3,709,000 of accrued interest. The 5.75% notes that we redeemed represented all of our remaining
outstanding 5.75% notes.

Critical Accounting Policies

We identified critical accounting policies in our annual report on Form 10-K for the year ended December 31, 2003. These critical
accounting policies relate to product revenue recognition, royalty revenue recognition, rebate and return reserves, patents, intangibles and other assets, accounts receivable and bad debt, induced
conversion of debt and inventory write-downs. These policies require us to make estimates in the preparation of our financial statements as of a given date. Because of the uncertainty inherent in
these matters, our actual results could differ from the estimates we use in applying the critical accounting policies. Within the context of these critical accounting policies, we are not currently
aware of any reasonably likely events or circumstances that would result in us reporting materially different amounts. Additionally, no changes to these critical accounting policies have taken place
in the six months ended June 30, 2004.

Three Month Periods ended June 30, 2004 and 2003

Revenues

Product revenues were $57,450,000 and $61,350,000 for the three months ended June 30, 2004 and 2003, respectively, a decrease of approximately 6%. The
decrease in product revenue is primarily attributable to an approximate 7% reduction in the net selling price per unit of XOPENEX, offset by a 1% increase in XOPENEX unit volume sales. The 7% net
selling price per unit reduction is due primarily to approximately 12% higher sales rebates, including supplemental rebates and additional discounting, that are accounted for as a reduction in gross
product sales, offset by a gross unit price increase of approximately 8%. The increase in rebates is primarily attributable to an increase in Medicaid rebates that we provided in return for the
inclusion of XOPENEX on certain states' Medicaid preferred drug lists. The 1% increase in unit volume sales is significantly less than the increase in unit volume sales during prior recent periods. We
believe this decrease in unit volume sales growth is primarily attributable to (1) an atypically mild allergy season, which resulted in reduced unit volume sales growth for respiratory drugs
generally during the period and (2) a temporary disruption of our sales force due to the ESTORRA hiring efforts, which resulted in new or different sales representatives making more than a
majority of the XOPENEX sales calls during the period and an approximate 19% reduction in
the number of XOPENEX sales calls made during the three-month period ended June 30, 2004 as compared to the same period in 2003.

Royalties
and other revenues were $12,517,000 and $15,105,000 for the three months ended June 30, 2004 and 2003, respectively, a decrease of approximately 17%. The decrease for
the three months ended June 30, 2004 as compared with the same period in 2003 is primarily due to a decrease in royalties earned on sales of CLARINEX® under our agreement with
Schering-Plough, and to a lesser extent, due to a decrease in royalties earned on sales of ALLEGRA® under our agreement with Aventis. Royalties earned from these products continue to be
adversely affected by decreased sales volume resulting from the availability of other allergy drugs without a prescription. The decrease in royalty revenue is partially offset by other MedPointe
related revenue of $2,774,000 for the three

14

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months
ended June 30, 2004, which consists primarily of revenue related to the fair value of services performed pursuant to our ASTELIN agreement, as compared with other MedPointe related
revenue of $219,000 for the three months ended June 30, 2003.

Costs of Revenues

Cost of product sold was $6,821,000 and $6,964,000 for the three months ended June 30, 2004 and 2003, respectively. Cost of product sold as a percentage of
product sales was approximately 12% and 11% for the three months ended June 30, 2004 and 2003, respectively. The increase in cost of product sold as a percentage of product sales for the three
months ended June 30, 2004 as compared with the same period in 2003 is primarily due to the decrease in the net selling price of XOPENEX during the period. Unit volume sales of XOPENEX
increased by approximately 1% for the three months ended June 30, 2004 as compared to the three months ended June 30, 2003, with per unit cost of product sold remaining relatively flat
during the periods.

Cost
of royalties and other revenues was $109,000 and $444,000 for the three months ended June 30, 2004 and 2003, respectively, a decrease of approximately 75%. Our cost of
royalties and other revenues consists primarily of an obligation to a third-party as a result of royalties we receive from Schering-Plough Corporation based upon its sales of CLARINEX. The decrease
for the three months ended June 30, 2004 as compared with the same period in 2003 resulted from the decrease in royalties we earned on sales of CLARINEX.

Research and Development

Research and development expenses were $45,077,000 and $48,255,000 for the three months ended June 30, 2004 and 2003, respectively, a decrease of
approximately 7%. The decrease for the three months ended June 30, 2004 as compared with the same period in 2003 is primarily due to our reduced spending on our tecastemizole and (S)-oxybutynin
programs. We discontinued our development of tecastemizole in December 2003, and we have elected not to fund the (S)-oxybutynin clinical program at this time. Our decreased spending in these
programs was partially offset by our increased spending on our arformoterol program and the XOPENEX HFA MDI program. We submitted an NDA for XOPENEX HFA MDI to the FDA in May 2004, which was
accepted for filing on July 15, 2004.

Drug
development and approval in the United States is a multi-step process regulated by the FDA. The process begins with the filing of an Investigational New Drug
Application, or IND, which, if successful, allows the opportunity for study in humans, or clinical study, of the potential new drug. Clinical development typically involves three phases of study:
Phases I, II and III. The most significant costs in clinical development are in the Phase III clinical trials as they tend to be the longest and largest studies in the drug development process.
Following successful completion of Phase III clinical trials, an NDA must be submitted to, and accepted by, the FDA, and the FDA must approve the NDA prior to commercialization of the drug. As further
discussed below, we currently have one product candidate in Phase III clinical trials and two NDAs submitted and currently under FDA review. The successful development of our product candidates is
highly uncertain. Completion dates and completion costs can vary significantly for each product candidate and are difficult to predict. The lengthy process of seeking FDA approvals, and the subsequent
compliance with applicable statutes and regulations, require the expenditure of substantial resources. Any failure by us to obtain, or any delay in obtaining, regulatory approvals could materially
adversely affect our business. We cannot assure you that we will obtain any approval required by the FDA on a timely basis, if at all.

For
additional discussion of the risks and uncertainties associated with completing development of potential product candidates, see "Factors Affecting Future Operating Results".

Below
is a summary of our product candidates representing 10% or more of our direct project research and development spending during the three months ended June 30, 2004. The
"Estimate of

15

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Completion
of Stage" column contains forward-looking statements regarding timing of completion of product development stages. Completion of product development, if successful, culminates in the
submission of an NDA to the FDA. The actual timing of completion of stages could differ materially from the estimates provided in the table. The table is sorted by highest to lowest spending amounts
for the three months ended June 30, 2004, and the three product candidates listed accounted for approximately 80% of our direct project research and development spending during this period.

|Product Candidate     |  | Indication         |  | Stage of
Development |  | Estimate of
Completion of Stage |    
|--------------------- |  | ------------------ |  | -------------------- |  | ------------------------------- | ---
|ESTORRA (eszopiclone) |  | Insomnia           |  | NDA Review           |  | 2004                            | *  
|Arformoterol          |  | RespiratoryCOPD   |  | Phase III            |  | 2004                            | ** 
|XOPENEX HFA MDI       |  | RespiratoryAsthma |  | NDA Review           |  | 2005                            | ***

---

Below
is expenditure information related to our product candidates representing 10% or more of our direct project research and development spending during the three months ended
June 30, 2004 and 2003, respectively, as well as the costs incurred to date on these projects. The costs in this analysis include only direct costs and do not include certain indirect labor,
overhead or other costs which benefit multiple projects. As a result, fully loaded research and development cost summaries by project are not presented.

|(in thousands)        |  | Project costs for the
three months
ended June 30, 2004 |        | Project costs to
date through
June 30, 2004 |   | Project costs for the
three months
ended June 30, 2003 |  | Project costs to
date through
June 30, 2003
|--------------------- |  | ------------------------------------------------------ | ------ | ------------------------------------------- | - | ------------------------------------------------------ |  | -------------------------------------------
|ESTORRA (eszopiclone) |  | $                                                      | 14,113 |                                             | $ | 155,380                                                |  | $                                          
|Arformoterol          |  |                                                        | 8,161  |                                             |   | 134,821                                                |  |                                            
|XOPENEX HFA MDI       |  |                                                        | 4,181  |                                             |   | 123,214                                                |  |                                            

Due
to the length of time necessary to develop a product, the uncertainties related to the ability to obtain governmental approval for commercialization and the difficulty in estimating
costs of projects, it is difficult to make accurate and meaningful estimates of the 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, the costs of product candidates which are in stages earlier than Phase III. We estimate the
cost range to bring our one active Phase III product candidate, arformoterol, to an NDA filing as $22,000,000 to $27,000,000 based on an expected NDA submission in the first half of 2005.

Delays
in meeting expected NDA submission dates may adversely impact our business due to (1) potential lost revenues due to competition and market changes and
(2) additional expenditures if a project timeline is extended in order to conduct additional studies.

The
uncertainties related to completion of development, regulatory approval and timing of commercialization make it difficult to estimate when, if ever, our product candidates will
generate revenue and cash flows. We do not expect to receive net cash inflows from any of our major research and development projects until a product candidate becomes a profitable commercial product.

16

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Selling, Marketing and Distribution

Selling, marketing and distribution expenses were $86,355,000 and $36,817,000 for the three months ended June 30, 2004 and 2003, respectively, an increase
of approximately 135%. The increase is primarily due to our sales force expansion and increased marketing costs related to our preparation for commercialization of ESTORRA, which we expect to launch
in January 2005 if we receive final approval from the FDA. During the three months ended June 30, 2004, we hired approximately 800 sales representatives and incurred significant
recruiting and training costs related to these individuals.

General and Administrative

General and administrative and patent expenses were $7,899,000 and $5,763,000 for the three months ended June 30, 2004 and 2003, respectively, an increase
of approximately 37%. The increase for the three months ended June 30, 2004 as compared with the same period in 2003 is primarily due to payroll and related expenses resulting from an increase
in headcount related to permanent and temporary employees and contracted service providers to support the expected commercialization of ESTORRA.

Other Income (Expense)

Interest income was $1,424,000 and $1,874,000 for the three months ended June 30, 2004 and 2003, respectively. The decrease for the three months ended
June 30, 2004 as compared with the same period in 2003 is due primarily to lower interest rates earned on our cash and short- and long-term investment balances in 2004.

Interest
expense was $5,830,000 and $13,654,000 for the three months ended June 30, 2004 and 2003, respectively. The decrease for the three months ended June 30, 2004 as
compared with the same period in 2003 is due to lower outstanding average balances on our interest-bearing debt. The average outstanding balance on our interest-bearing debt for the second quarter of
2004 was $440,000,000 as compared to the average outstanding balance in the second quarter of 2003 of approximately $981,870,000.

Equity
in investee (losses) were ($358,000) and ($217,000) for the three months ended June 30, 2004 and 2003, respectively. The loss for the three-month periods ended
June 30, 2004 and 2003 represents our portion of BioSphere losses.

Six Month Periods ended June 30, 2004 and 2003

Revenues

Product revenues were $142,506,000 and $133,506,000 for the six months ended June 30, 2004 and 2003, respectively, an increase of approximately 7%. The
increase in product revenue is due to an approximate 11% increase in unit volume sales of XOPENEX, offset by an approximate 4% decrease in the net selling price per unit of XOPENEX. The 4% decrease in
the net selling price per unit is due primarily to approximately 9% higher sales rebates, including supplemental rebates and additional discounting, that are accounted for as a reduction in gross
product sales, offset by a gross unit price increase of approximately 5%. The increase in rebates is primarily attributable to an increase in Medicaid rebates that we provided in return for the
inclusion of XOPENEX on certain states' Medicaid preferred drug lists. We believe that the 11% increase in unit volume sales is due to market share increases that can be attributed to increased demand
for XOPENEX as a result of positive experiences reported by patients and physicians and our targeted marketing to high volume prescribers. However, the 11% increase in unit volume sales is
significantly less than the increase in unit volume sales during recent prior periods. We believe this decrease in unit volume sales growth is primarily attributable to: (1) an atypically mild
allergy season, which resulted in reduced unit volume sales growth

17

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for
respiratory drugs generally during the period and (2) a temporary disruption of our sales force due to the ESTORRA hiring efforts, which resulted in new or different sales representatives
making more of the XOPENEX sales calls during the six-month period ended June 30, 2004 as compared to the same period in 2003 and an approximate 13% reduction in the number of XOPENEX sales
calls made during the six-month period ended June 30, 2004 as compared to the same period in 2003.

Royalties
and other revenues were $26,939,000 and $27,455,000 for the six months ended June 30, 2004 and 2003, respectively, a decrease of approximately 2%. The decrease for the
six months ended June 30, 2004 as compared with the same period in 2003 is primarily due to a decrease in royalties earned on sales of CLARINEX under our agreement with Schering-Plough, and to
a lesser extent, due to a decrease in royalties earned on sales of ALLEGRA under our agreement with Aventis. Royalties earned from these products continue to be adversely affected by decreased sales
volume resulting from the availability of other allergy drugs without a prescription. The decrease in royalty revenue is partially offset by (1) other MedPointe related revenue of $2,993,000
for the six months ended June 30, 2004, which consists primarily of revenue related to the fair value of services performed pursuant to our ASTELIN agreement, as compared with other MedPointe
related revenue of $219,000 for the six months ended June 30, 2003, and (2) co-promotion revenue of $902,000 for the six months ended June 30, 2004 received from
MedPointe for our co-promotion of ASTELIN as compared with $0 for the six months ended June 30, 2003.

Costs of Revenues

Cost of product sold was $15,681,000 and $13,913,000 for the six months ended June 30, 2004 and 2003, respectively, an increase of approximately 13%. Cost
of product sales as a percentage of product sales was approximately 11% and 10% for the six months ended June 30, 2004 and 2003, respectively. The increase for the six months ended
June 30, 2004 as compared with the same period in 2003 is primarily due to the increase in product sales of 7% and, to a lesser extent, to a reduction in the cost of products sold of $771,000
in the six months ended June 30, 2003 due to a favorable outcome of a quality control issue. This was partially offset by a lower manufacturing cost per unit, as a result of manufacturing
efficiencies that resulted from an increase in the number of units of XOPENEX produced in the six months ended June 30, 2004 as compared with the same period in 2003.

Cost
of royalties and other revenues was $349,000 and $700,000 for the six months ended June 30, 2004 and 2003, respectively, a decrease of approximately 50%. Our cost of
royalties and other revenues consists primarily of an obligation to a third-party as a result of royalties we receive from Schering-Plough Corporation based upon its sales of CLARINEX. The decrease
for the six months ended June 30, 2004 as compared with the same period in 2003 resulted from the decrease in royalties we earned on sales of CLARINEX.

Research and Development

Research and development expenses were $82,373,000 and $101,438,000 for the six months ended June 30, 2004 and 2003, respectively, a decrease of
approximately 19%. The decrease for the six months ended June 30, 2004 as compared with the same period in 2003 is partially due to our decreased spending on ESTORRA brand eszopiclone, for
which we submitted an NDA to the FDA in January 2003. The decrease is also due to our reduced spending on our tecastemizole and (S)-oxybutynin programs. We discontinued our development of
tecastemizole in December 2003, and we have elected not to fund the (S)-oxybutynin clinical program at this time. Our decreased spending in these programs was partially offset by our increased
spending on the arfomoterol program and XOPENEX HFA MDI program. We submitted an NDA for XOPENEX HFA MDI to the FDA in May 2004, which was accepted for filing in July 2004.

18

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Below
is a summary of our product candidates representing 10% or more of our direct project research and development spending during the six months ended June 30, 2004. The
"Estimate of Completion of Stage" column contains forward-looking statements regarding timing of completion of product development stages. Completion of product development, if successful, culminates
in the submission of an NDA to the FDA. The actual timing of completion of stages could differ materially from the
estimates provided in the table. The table is sorted by highest to lowest spending amounts for the six months ended June 30, 2004, and the three product candidates listed accounted for
approximately 83% of our direct project research and development spending during this period.

|Product Candidate     |  | Indication         |  | Stage of
Development |  | Estimate of
Completion of Stage |    
|--------------------- |  | ------------------ |  | -------------------- |  | ------------------------------- | ---
|ESTORRA (eszopiclone) |  | Insomnia           |  | NDA Review           |  | 2004                            | *  
|Arformoterol          |  | RespiratoryCOPD   |  | Phase III            |  | 2004                            | ** 
|XOPENEX HFA MDI       |  | RespiratoryAsthma |  | NDA Review           |  | 2005                            | ***

---

Below
is expenditure information related to our product candidates representing 10% or more of our direct project research and development spending during the six months ended
June 30, 2004 and 2003, respectively, as well as the costs incurred to date on these projects. The costs in this analysis include only direct costs and do not include certain indirect labor,
overhead or other costs which benefit multiple projects. As a result, fully loaded research and development cost summaries by project are not presented.

|(in thousands)        |  | Project costs for the
six months
ended June 30, 2004 |        | Project costs to
date through
June 30, 2004 |   | Project costs for the
six months ended June 30, 2003 |  | Project costs to
date through
June 30, 2003
|--------------------- |  | ---------------------------------------------------- | ------ | ------------------------------------------- | - | ---------------------------------------------------- |  | -------------------------------------------
|ESTORRA (eszopiclone) |  | $                                                    | 19,650 |                                             | $ | 155,380                                              |  | $                                          
|Arformoterol          |  |                                                      | 16,697 |                                             |   | 134,821                                              |  |                                            
|XOPENEX HFA MDI       |  |                                                      | 12,451 |                                             |   | 123,214                                              |  |                                            

Due
to the length of time necessary to develop a product, the uncertainties related to the ability to obtain governmental approval for commercialization and the difficulty in estimating
costs of projects, it is difficult to make accurate and meaningful estimates of the 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, the costs of product candidates which are in stages earlier than Phase III. We estimate the cost range to bring our one active Phase III product candidate, arformoterol,
to an NDA filing as $22,000,000 to $27,000,000 based on an expected NDA submission in the first half of 2005.

Delays
in meeting expected NDA submission dates may adversely impact our business due to (1) potential lost revenues due to competition and market changes and
(2) additional expenditures if a project timeline is extended in order to conduct additional studies.

19

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For
additional discussion of the risks and uncertainties associated with completing development of potential product candidates, see "Factors Affecting Future Operating Results".

The
uncertainties related to completion of development, regulatory approval and timing of commercialization make it difficult to estimate when, if ever, our product candidates will
generate revenue and cash flows. We do not expect to receive net cash inflows from any of our major research and development projects until a product candidate becomes a profitable commercial product.

Selling, Marketing and Distribution

Selling, marketing and distribution expenses were $170,789,000 and $72,498,000 for the six months ended June 30, 2004 and 2003, respectively, an increase
of approximately 136%. Of the 136% increase, 31% is due to an accrual for $30,671,000, which represents the present value of the termination payments totaling $33,000,000 that we will make to Ross
pursuant to a March 2004 amendment to our XOPENEX co-promotion agreement with Ross in which we agreed to terminate the agreement effective December 31, 2004. The remaining
increase of 105% is primarily due to our sales force expansion and increased marketing costs related to our preparation for commercialization of
ESTORRA, which we expect to launch in January 2005 if we receive final approval from the FDA. During the six months ended June 30, 2004, we hired approximately 800 sales representatives
and incurred significant recruiting and training costs related to these individuals. Additionally, as a result of the increase in sales of XOPENEX for the six months ended June 30, 2004 as
compared with the same period in 2003, we incurred increased sales commission expense paid to internal sales representatives and to Ross.

General and Administrative

General and administrative and patent expenses were $14,933,000 and $11,605,000 for the six months ended June 30, 2004 and 2003, respectively, an increase
of approximately 29%. The increase for the six months ended June 30, 2004 as compared with the same period in 2003 is primarily due to payroll and related expenses resulting from an increase in
headcount related to permanent and temporary employees and contracted service providers to support the expected commercialization of ESTORRA.

Other Income (Expense)

Interest income was $2,679,000 and $3,805,000 for the six months ended June 30, 2004 and 2003, respectively. The decrease for the six months ended
June 30, 2004 as compared with the same period in 2003 is due primarily to lower average cash and short- and long-term investment balances available for investment and a slight
decrease in the interest rate earned on investments in 2004.

Interest
expense was $11,954,000 and $27,311,000 for the six months ended June 30, 2004 and 2003, respectively. The decrease for the six months ended June 30, 2004 as
compared with the same period in 2003 is due to lower outstanding average balances on our interest-bearing debt. The average outstanding balance on our interest-bearing debt for the first half of 2004
was $655,000,000 as compared to the average outstanding balance in the first half of 2003 of approximately $981,870,000.

Loss
on debt redemption was $7,022,000 and $0 for the six months ended June 30, 2004 and 2003, respectively. The loss in the six months ended June 30, 2004 resulted from
our redemption of the remaining outstanding $430,000,000 face value of our 5.75% convertible subordinated notes due 2006 for aggregate cash consideration of $430,000,000, excluding accrued interest.
The loss represents the write-off of $7,022,000 of deferred financing costs related to the notes.

20

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Equity
in investee (losses) were ($505,000) and ($842,000) for the six months ended June 30, 2004 and 2003, respectively. The loss for the six-month periods ended
June 30, 2004 and 2003 represents our portion of BioSphere losses.

Liquidity and Capital Resources

Cash, cash equivalents and short- and long-term investments totaled $535,758,000 at June 30, 2004, compared to $840,388,000 at
December 31, 2003.

The
net cash used in operating activities for the six months ended June 30, 2004 was $92,057,000. The net cash used in operating activities includes a net loss of $131,570,000
adjusted by non-cash charges of $16,862,000, which includes a loss on early debt extinguishment of $7,022,000. Accounts receivable decreased by $5,689,000 due primarily to the decreased
sales of XOPENEX during June 2004 as compared to December 2003 due to customary seasonal fluctuations. Inventory increased by $9,035,000 due to lower than expected sales volume, shifts
in product mix, and inventory build-up in anticipation of production down time as our contract manufacturer upgrades production equipment. On a combined basis, accounts payable and accrued
expenses decreased by $11,188,000 primarily due to lower research and development costs. Other current liabilities increased by $3,316,000 primarily due to additional accruals for product revenue
rebates and return reserves related to XOPENEX revenues. Other liabilities increased by $30,768,000 primarily due to an accrual for $30,987,000, which represents the present value of a termination
payment we will make to Ross.

The
net cash used in investing activities for the six months ended June 30, 2004 was $91,481,000. Cash was used for net sales and maturities of short- and long-term
investments of $86,119,000. We also made purchases of property and equipment of $5,415,000.

The
net cash used in financing activities for the six months ended June 30, 2004 was $203,986,000. We used $433,709,000 to redeem the remaining outstanding $430,000,000 face value
of our 5.75% subordinated notes due 2006 at face value plus accrued interest. We received proceeds of $150,000,000, offset by $4,125,000 of issuance costs, from the issuance of 0% convertible senior
subordinated notes. We received proceeds of $50,006,000 from the settlement of a portion of our call spread options. We also received proceeds of $34,198,000 from the issuance of common stock upon the
exercise of stock options issued under our stock option plans. We used $356,000 to repay capital lease obligations and long-term debt.

We
currently generate cash from the sale of XOPENEX inhalation solution, from royalties on sales generated by our license agreements, primarily the agreements related to ALLEGRA and
CLARINEX, and from our co-promotion arrangement with MedPointe. We believe our existing cash and the anticipated cash flow from our current strategic alliances and operations will be
sufficient to
support existing operations through 2005. In the longer term, we expect to fund our operations with revenue generated from product sales. Our actual future cash requirements and our ability to
generate revenue, however, will depend on many factors, including:



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If
our assumptions underlying our beliefs regarding future revenues and expenses change, or if unexpected opportunities or needs arise, we may seek to raise additional cash by selling
debt or equity securities or borrowing money from a bank. However, we may not be able to raise such funds on favorable terms, if at all.

Based
on our current operating plan, we believe that we will not be required to raise additional capital to fund the repayment of our outstanding convertible debt when due. If we are not
able to commercialize ESTORRA, it is likely that our business would be materially and adversely affected and that we would be required to raise additional funds in order to repay our outstanding
convertible debt. In addition, if we are not able to commercialize XOPENEX HFA MDI, we may be required to raise additional funds. There can be no assurance that, if required, we would be able to raise
the additional funds on favorable terms, if at all.

Off-Balance Sheet Arrangements

We do not have any off-balance sheet arrangements, other than operating leases in the ordinary course of business, or variable interest entities or
activities that include non-exchange traded contracts accounted for at fair value.

Contractual Obligations

Our contractual obligations disclosure in our annual report on Form 10-K for the year ended December 31, 2003 has not materially changed
since we filed that report, except for:



Factors Affecting Future Operating Results

Certain of the information contained in this report, including information with respect to the expected timing of completion of phases of development of our drugs
under development, the safety, efficacy and potential benefits of our drugs under development, the timing and results of regulatory filings and the scope and duration of patent protection with respect
to these products and information with respect to the other plans and strategies for our business and the business of our subsidiaries and certain of our affiliates, consists of forward-looking
statements. The forward-looking statements contained in this report represent our expectations as of the date of this report. Subsequent events may cause our expectations to change. However, while we
may elect to update these forward-looking

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statements,
we specifically disclaim any intention or obligation to do so. Important factors that could cause our actual results to differ materially from the forward-looking statements include the
following:

We have never been profitable and we may not be able to generate revenues sufficient to achieve profitability.

We have not been profitable since inception, and it is possible that we will not achieve profitability. We incurred net losses on a consolidated basis of
approximately $131.6 million for the six months ended June 30, 2004 and $135.9 million for the year ended December 31, 2003. We expect to continue to incur significant
operating and capital expenditures. As a result, we will need to generate significant revenues to achieve and maintain profitability. We cannot assure you that we will achieve significant revenues or
that we will ever achieve profitability. Even if we do achieve profitability, we cannot assure you that we will be able to sustain or increase profitability on a quarterly or annual basis in the
future. If revenues grow more slowly than we anticipate or if operating expenses exceed our expectations or cannot be adjusted accordingly, our business, results of operations and financial condition
will be materially and adversely affected.

If we or our development partners fail to successfully develop our principal product candidates, we will be unable to commercialize the product candidates and our
ability to become profitable will be adversely affected.

Our ability to achieve profitability will depend in large part on successful development and commercialization of our principal products under development.
Failure to successfully commercialize our marketed products or our products under development may have a material adverse effect on our business. Before we commercialize any product candidate, we will
need to successfully develop the product candidate by completing successful clinical trials, submit an NDA for the product candidate that is accepted by the FDA and receive FDA approval to market the
candidate. If we fail to successfully develop a product candidate and/or the FDA delays or denies approval of any submitted NDA or any NDA that we submit in the future, then commercialization of our
products under development may be delayed or terminated, which could have a material adverse effect on our business.

A
number of problems may arise during the development of our product candidates, including:



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We received an "approvable" letter from the FDA for ESTORRA on February 27, 2004 and on July 15, 2004 we announced that the FDA accepted our resubmission of our NDA for
ESTORRA. In addition, on July 15, 2004, we announced that the FDA had accepted for formal review, our NDA for XOPENEX HFA MDI. However, we cannot be certain that the FDA will approve the
ESTORRA NDA or the NDA for XOPENEX HFA MDI.

Our
success significantly depends on our continued ability to develop and market new products. There can be no assurance that we will be able to develop and introduce new products in a
timely manner or that new products, if developed, will achieve market acceptance. In addition, our growth is dependent on our continued ability to penetrate new markets where we have limited
experience and competition is intense. There can be no assurance that the markets we serve will grow in the future, that our existing and new products will meet the requirements of these markets, that
our products will achieve customer acceptance in these markets, that competitors will not force prices to an unacceptably low level or take market share from us, or that we can achieve or maintain
profits in these markets.

Although we have received an "approvable" letter from the FDA for our NDA for ESTORRA brand eszopiclone, we may not receive approval to commercialize ESTORRA.

The FDA issues an "approvable" letter when it believes it can approve an NDA if the applicant submits specific additional information or agrees to specific
conditions. In order to receive approval, the applicant must satisfy the requests made and/or answer the questions posed by the FDA, through a resubmission of the NDA. On February 27, 2004, we
received an "approvable" letter from the FDA for our ESTORRA NDA and on July 15, 2004 we announced that the FDA accepted our resubmission of our NDA for ESTORRA. However, we cannot be certain
that we satisfactorily responded to the issues raised by the FDA or that the FDA will grant us approval during 2004, if at all. In addition, on July 15, 2004, we announced that the FDA had
accepted for filing, our NDA for XOPENEX HFA MDI. If the FDA delays or denies approval of our NDA for ESTORRA or XOPENEX HFA MDI, or any other NDA that we file in the future, then commercialization of
ESTORRA, XOPENEX HFA MDI or our other products under development, may be delayed or terminated, which would have a material adverse effect on our business.

If any third-party collaborator is not successful in development of our product candidates, we may not realize the potential commercial benefits of the
arrangement and our results of operations could be adversely affected.

We have entered into a collaboration agreement with 3M Drug Delivery Systems Division for the scale-up and manufacturing of XOPENEX HFA MDI, and we
may enter into additional development collaboration agreements in the future. Under our agreement with 3M, 3M is responsible for manufacturing an MDI formulation of XOPENEX. We are responsible for
conducting clinical trials using the 3M-manufactured formulation. Based on the results of the trials, we submitted an NDA to the FDA for XOPENEX HFA MDI in May 2004 and the NDA was accepted for
filing by the FDA in July 2004. If 3M, or any future development or commercialization collaborator, does not devote sufficient time and resources to its collaboration arrangement with us,
breaches or terminates its agreement with us, fails to perform its obligation to us in a timely manner or is unsuccessful in its development and/or commercialization efforts, we may not realize the
potential commercial benefits of the arrangement and our results of operations may be adversely affected. In addition, if regulatory approval of XOPENEX HFA MDI or any other product candidate under
development by, or in collaboration with, a partner is delayed, denied or includes limitations on indicated uses for which the product may be marketed, we may not realize, or may be delayed in
realizing, the potential commercial benefits of the arrangement.

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The royalties we receive under collaboration arrangements could be delayed, reduced or terminated if our collaboration partners terminate, or fail to perform
their obligations under, their agreements with us, if our collaboration partners are unsuccessful in their sales efforts, or if we lose certain patent rights.

We have entered into collaboration arrangements pursuant to which we license patents to pharmaceutical companies and our revenues under these collaboration
arrangements consist primarily of royalties on sales of products in countries where we hold patents. Payments and royalties under these arrangements depend in large part on the commercialization
efforts of our collaboration partners in countries where we hold patents, including sales efforts which we cannot control. If any of our collaboration partners does not devote sufficient time and
resources to its collaboration arrangement with us or focuses its efforts in countries where we do not hold patents, we may not realize the potential commercial benefits of the arrangement, our
revenues under these arrangements may be less than anticipated and our results of operations may be adversely affected. If any of our collaboration partners was to breach or terminate its agreement
with us or fail to perform its obligations to us in a timely manner, the royalties we receive under the collaboration agreement could decrease or cease. Any failure or inability by us to perform, or
any breach by us in our performance of, our obligations under a collaboration agreement could reduce or extinguish the royalties and benefits to which we are otherwise entitled under the agreement. If
the patents covering the products upon which we receive royalties expire or are held invalid or unenforceable, generic versions of these products may be introduced, which would decrease sales of the
royalty-bearing product or terminate our right to receive
royalties. Any delay or termination of these types could have a material adverse effect on our financial condition and results of operations because we may lose technology rights and milestone or
royalty payments from collaboration partners and/or revenue from product sales, if any, could be delayed, reduced or terminated.

The approval of the sale of certain medications without a prescription may adversely affect our business.

In May 2001, an advisory panel to the FDA recommended that the FDA allow certain popular allergy medications to be sold without a prescription. In
November 2002, the FDA approved CLARITIN®, an allergy medication, to be sold without a prescription. In the future, the FDA may also allow the sale of other allergy medications
without a prescription. The sale of CLARITIN and/or, if allowed, the sale of other allergy medications without a prescription, may have a material adverse effect on our business because the market for
prescription drugs, including ALLEGRA and CLARINEX, for which we receive royalties on sales, has been and may continue to be adversely affected. We expect revenues from royalties earned on both
CLARINEX and ALLEGRA to decrease in 2004 due to the continued adverse impact on sales of these prescription allergy drugs resulting from the availability of competing allergy drugs without a
prescription.

We will be required to expend significant resources for research, development, testing and regulatory approval of our drugs under development and these drugs may
not be developed successfully.

We develop and commercialize proprietary products for the primary care and specialty markets. Most of our drug candidates are still undergoing clinical trials or
are in the early stages of development. Our drugs may not provide greater benefits or fewer side effects than other drugs used to treat the same condition and our research efforts may not lead to the
discovery of new drugs with benefits over existing treatments or development of new therapies. All of our drugs under development will require significant additional research, development, preclinical
and/or clinical testing, regulatory

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approval
and a commitment of significant additional resources prior to their commercialization. Our potential products may not:



Sales of XOPENEX inhalation solution represent a majority of our revenues; if sales of XOPENEX inhalation solution do not continue to increase, we may not have
sufficient revenues to achieve our business plan and our business will not be successful.

All of our revenues from product sales for the six months ended June 30, 2004 and the years ended December 31, 2003 and 2002 and substantially all
of our product revenues for the year ended December 31, 2001, resulted from sales of XOPENEX inhalation solution. If the FDA grants final marketing approval for our ESTORRA NDA, we do not
expect to launch ESTORRA until the first quarter of 2005, at the earliest. Accordingly, we expect that sales of XOPENEX will represent all of our product sales and a majority of our total revenues
through 2004. We do not have long-term sales contracts with our customers and we rely on purchase orders for sales of XOPENEX inhalation solution. Reductions, delays or cancellations of
orders, as well as decreases in the average selling price and increases in rebates and allowances for XOPENEX could adversely affect our operating results. If sales of XOPENEX inhalation solution do
not continue to increase, we may not have sufficient revenues to achieve our business plan and our business will not be successful.

XOPENEX
competes primarily against generic albuterol in the asthma market. XOPENEX is more expensive than generic albuterol. We must continue to demonstrate to physicians and other
health care
professionals that the benefits of XOPENEX justify the higher price. If XOPENEX does not continue to compete successfully against competitive products, our business will not be successful.

If we fail to adequately protect or enforce our intellectual property rights, then we could lose revenue under our collaborative agreements or lose sales to
generic versions of our products.

Our success depends in part on our ability to obtain, maintain and enforce patents, and protect trade secrets. Our ability to commercialize any drug successfully
will largely depend upon our ability to obtain and maintain patents of sufficient scope to prevent third parties from developing similar or competitive products. In the absence of patent and trade
secret protection, competitors may adversely affect our business by independently developing and marketing substantially equivalent products and technology. It is also possible that we could incur
substantial costs if we are required to initiate litigation against others to protect or enforce our intellectual property rights.

We
have filed patent applications covering composition of, methods of making and methods of using, single-isomer or active-metabolite forms of various compounds for specific
applications. Our revenues under collaboration agreements with pharmaceutical companies depend in part on the existence and scope of issued patents. We may not be issued patents based on patent
applications already filed or that we file in the future and if patents are issued, they may be insufficient in scope to cover the products licensed under these collaboration agreements. We do not
receive royalty revenue from sales of products licensed under collaboration agreements in countries where we do not have a

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patent
for such products. The issuance of a patent in one country does not ensure the issuance of a patent in any other country. Furthermore, the patent position of companies in the pharmaceutical
industry generally involves complex legal and factual questions, and recently has been the subject of much litigation. Legal standards relating to the scope and validity of patent claims are evolving.
Any patents we have obtained, or obtain in the future, may be challenged, invalidated or circumvented. Moreover, the United States Patent and Trademark Office, which we refer to as the PTO, may
commence interference proceedings involving our patents or patent applications. Any challenge to, or invalidation or circumvention of, our patents or patent applications would be costly, would require
significant time and attention of our management and could have a material adverse effect on our business.

Should
a generic drug company submit an Abbreviated New Drug Application, or ANDA, to the FDA seeking approval of a generic version of XOPENEX, we would expect to enforce patents against
the generic drug company. However, the resulting patent litigation would involve complex legal and factual questions, and we may not be able to exclude a generic company, for the full term of our
patents, from marketing a generic version of XOPENEX. Introduction of a generic copy of XOPENEX before the expiration of our patents could have a material adverse effect on our business.

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

Our success depends in part on our ability to operate without infringing upon the proprietary rights of others. Third parties, typically drug companies, hold
patents or patent applications covering compositions, methods of making and uses, covering the composition of matter for most of the drug candidates for which we have patents or patent applications.
Third parties also hold patents relating to drug delivery technology that may be necessary for the development or commercialization of some of our drug candidates. In each of these cases, unless we
have or obtain a license, we generally may not commercialize the drug candidates until these third-party patents expire or are declared invalid or unenforceable by the courts. Licenses may not be
available to us on acceptable terms, if at all. In addition, it would be costly for us to contest the validity of a third-party patent or defend any claim that we infringe a third-party patent.
Moreover, litigation involving third-party patents may not be resolved in our favor. Such contests and litigation would be costly, would require significant time and attention of our management, could
prevent us from commercializing our products, could require us to pay significant damages and could have a material adverse effect on our business.

If our products do not receive government approval, then we will not be able to commercialize them.

The FDA and similar foreign agencies must approve the marketing and sale of pharmaceutical products developed by us or our development partners. These agencies
impose substantial requirements on the manufacture and marketing of drugs. Any unanticipated preclinical and clinical studies we are required to undertake could result in a significant increase in the
funds we will require to advance our products to commercialization. In addition, the failure by us or our collaborative development partners to obtain regulatory approval on a timely basis, or at all,
or failure of an attempt by us or our collaborative development partners to receive regulatory approval or to achieve labeling objectives, could prevent or adversely affect the timing of the
commercial introduction of, or our ability to market and sell, our products.

In
February 2004, we received an "approvable" letter from the FDA for our NDA for ESTORRA, and in July 2004, we announced that the FDA accepted our resubmission of our NDA
for ESTORRA. In addition, in July 2004, we announced that the FDA had accepted for filing our NDA for XOPENEX HFA MDI. If the FDA delays or denies approval of our NDA for ESTORRA or XOPENEX HFA
MDI, or delays or denies acceptance or approval of any other NDA that we file in the future, then

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commercialization
of ESTORRA, XOPENEX HFA MDI, or our other products under development may be delayed or terminated, which could have a material adverse effect on our business.

The
regulatory process to obtain marketing approval requires clinical trials of a product to establish its safety and efficacy. Problems that may arise during clinical trials include:



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

The development and commercialization of our product candidates could be delayed or terminated if we are unable to enter into collaboration agreements in the
future or if any future collaboration agreement is subject to lengthy government review.

Development and commercialization of some of our product candidates may depend on our ability to enter into additional collaboration agreements with
pharmaceutical companies to fund all or part of the costs of development and commercialization of these product candidates. We may not be able to enter into collaboration agreements and the terms of
the collaboration agreements, if any, may not be favorable to us. The inability to enter into collaboration agreements could delay or preclude the development, manufacture and/or marketing of some of
our drugs and could have a material adverse effect on our financial condition and results of operations because:



We
are required to file a notice under the Hart-Scott-Rodino Antitrust Improvements Act of 1976, as amended, which we refer to as the HSR Act, for certain agreements
containing exclusive license grants and to delay the effectiveness of any such exclusive license until the expiration or earlier termination of the notice and waiting period under the HSR Act. If the
expiration or termination of the notice and waiting period under the HSR Act is delayed because of lengthy government review, or if the Federal Trade Commission or Department of Justice successfully
challenges such a license, development and commercialization could be delayed or precluded and our business could be adversely affected.

We have limited sales and marketing experience and we have incurred significant expenses in expanding our sales force. Our limited sales and marketing experience
may restrict our success in commercializing additional products.

We currently have limited marketing and sales experience. If we successfully develop and obtain regulatory approval for the products we are currently developing,
we may: (1) market and sell them through our sales force, (2) license some of them to large pharmaceutical companies and/or (3) market and sell them through other arrangements,
including co-promotion arrangements. We have established a sales force to market XOPENEX. We have incurred significant expenses in expanding our sales force

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because
we expect to rely primarily on our sales force to market ESTORRA, if it is approved by the FDA. In addition, if we enter into co-promotion arrangements or market and sell
additional products directly, we may need to further expand our sales force.

Our
ability to realize significant revenues from direct marketing and sales activities depends on our ability to attract and retain qualified sales personnel in the pharmaceutical
industry and competition for these persons is intense. If we are unable to attract and retain qualified sales personnel, we will not be able to successfully expand our marketing and sales force on a
timely or cost effective basis. We may also need to enter into additional co-promotion arrangements with third parties where our own sales force is neither well situated nor large enough
to achieve maximum penetration in the market. We may not be successful in entering into any co-promotion arrangements, and the terms of any co-promotion arrangements may not be
favorable to us.

If we do not maintain current Good Manufacturing Practices, then the FDA could refuse to approve marketing applications. We do not have the capability to
manufacture in sufficient quantities all of the products that may be approved for sale, and developing and obtaining this capability will be time consuming and expensive.

The FDA and other regulatory authorities require that our products be manufactured according to their Good Manufacturing Practices regulations. The failure by us,
our collaborative development partners or third-party manufacturers to maintain current Good Manufacturing Practices compliance and/or our failure to scale up our manufacturing processes could lead to
refusal by the FDA to approve marketing applications. Failure in either respect could also be the basis for action by the FDA to withdraw approvals previously granted and for other regulatory action.

Failure
to increase our manufacturing capabilities may mean that even if we develop promising new products, we may not be able to produce them. We currently operate a manufacturing
plant, which is compliant with current Good Manufacturing Practices, that we believe can produce commercial quantities of the active pharmaceutical ingredient for XOPENEX and support the production of
our other product candidates in amounts needed for our clinical trials. However, we will not have the capability to manufacture in sufficient quantities all of the products that may be approved for
sale. Accordingly, we will be required to spend money to expand our current manufacturing facility, build an additional manufacturing facility or contract the production of these drugs to third-party
manufacturers.

Our reliance on a third-party manufacturer could adversely affect our ability to meet our customers' demands.

Cardinal Health, Inc. is currently the sole finished goods manufacturer of our product, XOPENEX inhalation solution. If Cardinal Health experiences delays or
difficulties in producing, packaging or delivering XOPENEX, we could be unable to meet our customers' demands for XOPENEX, which could lead to customer dissatisfaction and damage to our reputation.
Furthermore, if we are required to change manufacturers, we will be required to verify that the new manufacturer maintains facilities and procedures that comply with quality standards and with all
applicable regulations and guidelines. The delays associated with the verification of a new manufacturer could negatively affect our ability to produce XOPENEX in a timely manner or within budget.

Our
contract manufacturers may possess technology related to the manufacture of our compounds that such manufacturer owns independently. This would increase our reliance on such
manufacturer or require us to obtain a license from such manufacturer in order to have another third party manufacture our products.

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If we or our collaboration partners fail to obtain an adequate level of reimbursement for our future products or services by third-party payors, there may be no
commercially viable markets for our products or services.

The availability and amounts of reimbursement by governmental and other third-party payors affects the market for any pharmaceutical product or service. These
third-party payors continually attempt to contain or reduce the costs of health care by challenging the prices charged for medical products and services. In certain foreign countries, including the
countries of the European Union, the pricing of prescription pharmaceuticals is subject to governmental control. We may not be able to sell our products profitably if reimbursement is unavailable or
limited in scope or amount.

In
both the United States and certain foreign jurisdictions, there have been a number of legislative and regulatory proposals to change the health care system. Further proposals are
likely. The potential for adoption of these proposals affects or will affect our ability to raise capital, obtain additional collaboration partners and market our products. We expect to experience
pricing pressure for our existing products and any future products for which marketing approval is obtained due to the trend toward managed health care, the increasing influence of health maintenance
organizations and additional legislative proposals.

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

We may be subjected to product liability claims that arise through the testing, manufacturing, marketing and sale of human health care products. These claims
could expose us to significant liabilities that could prevent or interfere with our product commercialization efforts. Product liability claims could require us to spend significant time and money in
litigation or to pay significant damages. Although we maintain product liability insurance coverage for both the clinical trials and commercialization of our products, it is possible that we will not
be able to obtain further product liability insurance on acceptable terms, if at all, and that our insurance coverage may not provide adequate coverage against all potential claims.

If our Medicaid rebate program practices are investigated, the costs of responding to the investigation could be substantial and could divert the attention of
management.

We are a participant in the Medicaid rebate program established by the Omnibus Budget Reconciliation Act of 1990, and under amendments of that law that became
effective in 1993. Under the Medicaid rebate program, we pay a rebate for each unit of our product reimbursed by Medicaid, and the amount of the rebate for each product is set by law. We are also
required to pay certain statutorily defined rebates on Medicaid purchases for reimbursement on prescription drugs under state Medicaid plans. Both the federal government and state governments have
initiated investigations into the rebate practices of many pharmaceutical companies to ensure compliance with these rebate programs. If our rebate practices are investigated, the costs of compliance
with any such investigations could be substantial and could divert the attention of our management.

We have significant long-term debt and we may not be able to make interest or principal payments when due.

As of June 30, 2004, our total long-term debt excluding the current portion, was approximately $1.2 billion and our stockholders' equity
(deficit) was ($669.2 million). None of the 5% convertible subordinated debentures due 2007, the 0% Series A notes due 2008 nor the 0% Series B notes due 2010 restricts our
ability or our subsidiaries' ability to incur additional indebtedness, including debt that ranks senior to the notes. The Series A notes and the Series B notes are senior to our 5%
debentures. Additional indebtedness that we incur may in certain circumstances rank senior to or on parity with the

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notes.
Our ability to satisfy our obligations will depend upon our future performance, which is subject to many factors, including factors beyond our control. The conversion prices for the 5%
debentures, 0% Series A notes and 0% Series B notes are $92.38, $31.89, and $29.84, respectively. If the market price for our common stock does not exceed the conversion price, the
holders of our outstanding convertible debt may not convert their securities into common stock.

Historically,
we have had negative cash flow from operations. For the six months ended June 30, 2004, net cash used in operating activities was approximately $92.1 million.
Our annual debt service through 2006, assuming no additional 5% debentures are converted, redeemed, repurchased or exchanged, is approximately $22.0 million. Unless we are able to generate
sufficient operating cash flow to service our outstanding debt, we will be required to raise additional funds or default on our obligations under the debentures and notes. If we are not able to
commercialize ESTORRA, it is likely that our business would be materially and adversely affected and that we would be required to raise additional funds in order to repay our outstanding convertible
debt. In addition, if we are not able to commercialize
XOPENEX HFA MDI, we may be required to raise additional funds. There can be no assurance that, if required, we would be able to raise the additional funds on favorable terms, if at all.

Our exchanges of debt into shares of common stock would result in additional dilution.

As of June 30, 2004, we had approximately $1.2 billion of outstanding convertible debt. In order to reduce future payments due at maturity and, in
the case of our 5% debentures, future cash interest payments, we may, from time to time, depending on market conditions, repurchase additional outstanding convertible debt for cash; exchange debt for
shares of our common stock, warrants, preferred stock, debt or other consideration; or a combination of any of the foregoing. If we exchange shares of our capital stock, or securities convertible into
or exercisable for our capital stock, for outstanding convertible debt or use the proceeds from the issuance of convertible debt to fund the redemption of outstanding convertible debt with a higher
conversion ratio, the number of shares that we might issue as a result of such exchanges would significantly exceed the number of shares originally issuable upon conversion of such debt and,
accordingly, such exchanges would result in material dilution to holders of our common stock. We cannot assure you that we will repurchase or exchange any additional outstanding convertible debt.

If the estimates we make, and the assumptions on which we rely, in preparing our financial statements prove inaccurate, our actual results may vary from these
reflected in our projections and accruals.

Our financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America. The preparation of these
financial statements requires us to make estimates and judgments that affect the reported amounts of our assets, liabilities, revenues and expenses, the amounts of charges accrued by us and related
disclosure of contingent assets and liabilities. We base our estimates on historical experience and on various other assumptions that we believe to be reasonable under the circumstances. There can be
no assurance, however, that our estimates, or the assumptions underlying them, will be correct. For example, our royalty revenue is recognized based upon our estimates of our collaboration partners'
sales during the period and, if these sales estimates are greater than the actual sales that occur during the period, our net income would be reduced. This, in turn, could adversely affect our stock
price.

If sufficient funds to finance our business are not available to us when needed or on acceptable terms, then we may be required to delay, scale back, eliminate or
alter our strategy for our programs.

We may require additional funds for our research and product development programs, operating expenses, repayment of debt, the pursuit of regulatory approvals,
license or acquisition opportunities and the expansion of our production, sales and marketing capabilities. Historically, we have satisfied

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our
funding needs through collaboration arrangements with corporate partners and equity and debt financings. These funding sources may not be available to us when needed in the future, and, if
available, they may not be on terms acceptable to us. Insufficient funds could require us to delay, scale back or eliminate certain of our research and product development programs or to enter into
license agreements with third parties to commercialize products or technologies that we would otherwise develop or commercialize ourselves. Our cash requirements may vary materially from those now
planned because of factors including:



We expect to face intense competition and our competitors have greater resources and capabilities than we have. Developments by others may render our products or
technologies obsolete or noncompetitive.

We expect to encounter intense competition in the sale of our current and future products. If we are unable to compete effectively, our financial condition and
results of operations could be materially adversely affected because we may use our financial resources to seek to differentiate ourselves from our competition and because we may not achieve our
product revenue objectives. Many of our competitors and potential competitors, which include pharmaceutical and biotechnology companies, have substantially greater resources, manufacturing and
marketing capabilities, research and development staff and production facilities than we have. The fields in which we compete are subject to rapid and substantial technological change. Our competitors
may be able to respond more quickly to new or emerging technologies or to devote greater resources to the development, manufacture and marketing of new products and/or technologies than we can. As a
result, any products and/or technologies that we develop may become obsolete or noncompetitive before we can recover expenses incurred in connection with their development.

In
the asthma market, XOPENEX faces competition from generic albuterol. Albuterol has existed for many years, is well established and sells at prices substantially less than XOPENEX. To
continue to be successful in the marketing of XOPENEX, we must continue to demonstrate that the efficacy and safety features of the drug outweigh its higher cost. In the sleep disorder market, if
ESTORRA brand eszopiclone is approved, we will face intense competition from established products, such as AMBIEN® and SONATA®. There are also other potentially competitive
therapies that are in late-stage clinical development for the treatment of insomnia.

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

We and several of our current and former officers and a current director are named as defendants in several purported class action complaints which have been
filed on behalf of certain persons who purchased our common stock and/or debt securities during different time periods, beginning on various dates, the earliest being May 17, 1999, and all
ending on March 6, 2002. These complaints allege violations of the Securities Exchange Act of 1934 and the rules and regulations promulgated thereunder by the Securities and Exchange
Commission. Primarily they allege that the defendants made certain materially false and misleading statements relating to the testing, safety and likelihood of FDA

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approval
of SOLTARA. On April 11, 2003, two consolidated amended complaints were filed, one on behalf of the purchasers of our common stock and the other on behalf of the purchasers of our debt
securities. These consolidated amended complaints reiterate the allegations contained in the previously filed complaints and define the alleged class periods as May 17, 1999 through
March 6, 2002. We filed a motion to dismiss both consolidated amended complaints on May 27, 2003. On March 11, 2004, the court, while granting in part the motion to dismiss, did
allow much of the case to proceed. The parties are currently engaged in discovery.

We
can provide no assurance as to the outcome of these lawsuits. Any conclusion of these matters in a manner adverse to us would have a material adverse effect on our financial position
and results of operations; however, we are unable to reasonably estimate any possible range of loss due to the uncertain resolution of these matters. In addition, the costs to us of defending any
litigation or other proceeding, even if resolved in our favor, could be substantial. Such litigation could also substantially divert the attention of our management and our resources in general.
Uncertainties resulting from the initiation and continuation of any litigation or other proceedings could harm our ability to compete in the marketplace.

Fluctuations in the demand for products, the success and timing of collaboration arrangements and regulatory approval, any termination of development efforts,
expenses and the results of operations of our subsidiaries will cause fluctuations in our quarterly operating results, which could cause volatility in our stock price.

Our quarterly operating results are likely to fluctuate significantly, which could cause our stock price to be volatile. These fluctuations will depend on
factors, which include:



We have various mechanisms in place to discourage takeover attempts, which may reduce or eliminate our stockholders' ability to sell their shares for a premium in
a change of control transaction.

Various provisions of our certificate of incorporation and by-laws and of Delaware corporate law may discourage, delay or prevent a change in control
or takeover attempt of our company by a third party that is opposed by our management and board of directors. Public stockholders who might desire to participate in such a transaction may not have the
opportunity to do so. These anti-takeover

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provisions
could substantially impede the ability of public stockholders to benefit from a change of control or change in our management and board of directors. These provisions include:



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

The Securities and Exchange Commission is conducting an inquiry into the trading of our securities that could divert the attention of our management and our
resources generally.

The Securities and Exchange Commission is conducting an investigation into the trading in our securities, including trading by officers and employees during the
period from January 1, 1998 through December 31, 2001. Uncertainties resulting from this inquiry could substantially divert the attention of our management and our resources in general.
We can provide no assurance as to the outcome of this inquiry. Any conclusion of these matters in a manner adverse to us or our officers or employees could harm our ability to compete in the
marketplace and have a material adverse effect on our business. In addition, the costs to us to respond to the inquiry, even if the outcome is favorable, could be substantial. Such inquiry could also
substantially divert the attention of our management and our resources in general.

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

The market price of our common stock, like that of the common stock of many other pharmaceutical and biotechnology companies, may be highly volatile. In addition,
the stock market has experienced extreme price and volume fluctuations. This volatility has significantly affected the market prices of securities of many pharmaceutical and biotechnology companies
for reasons frequently unrelated to or disproportionate to the operating performance of the specific companies. These broad market fluctuations may adversely affect the market price of our common
stock. Prices for our common stock will be determined in the marketplace and may be influenced by many factors, including variations in our financial results, changes in recommendations by securities
analysts, investors' perceptions of us and general economic, industry and market conditions.

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ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Market Risk

We are exposed to market risk from changes in interest rates and equity prices, which could affect our future results of operations and financial condition. These
risks are described in our annual report on Form 10-K for the year ended December 31, 2003. As of August 9, 2004, there have been no material changes to the market
risks described in our annual report on Form 10-K for the year ended December 31, 2003. Additionally, we do not anticipate any near-term changes in the nature of
our market risk exposures or in our management's objectives and strategies with respect to managing such exposures.

ITEM 4. CONTROLS AND PROCEDURES

Evaluation of Disclosure Controls and Procedures.Our management, with the participation of our Chief Executive Officer, or
CEO, and Chief Financial Officer, or CFO, evaluated the effectiveness of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the
Securities Exchange Act) as of June 30, 2004. In designing and evaluating our disclosure controls and procedures, our management recognized that any controls and procedures, no matter how well
designed and operated, can provide only reasonable assurance of achieving their objectives, and our management necessarily applied its judgment in evaluating the cost-benefit relationship
of possible controls and procedures. Based on this evaluation, our CEO and CFO concluded that, as of June 30, 2004, our disclosure controls and procedures were (1) designed to ensure
that material information relating to us, including our consolidated subsidiaries, is made known to our CEO and CFO by others within those entities, particularly during the period in which this report
was being prepared and (2) effective, in that they provide reasonable assurance that information required to be disclosed by us in the reports that we file or submit under the Securities
Exchange Act is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission's rules and forms.

Changes in Internal Controls.No change in our internal controls over financial reporting (as defined in
Rules 13a-15(f) and 15d-15(f) under the Securities Exchange Act) occurred during the fiscal quarter ended June 30, 2004 that has materially affected, or is
reasonably likely to materially affect, our internal controls over financial reporting.

PART II  OTHER INFORMATION

ITEM 1. LEGAL PROCEEDINGS

The Securities and Exchange Commission is conducting an investigation into trading in our securities, including trading by certain of our officers and employees
during the period from January 1, 1998 through December 31, 2001. We have, and will continue to, cooperate fully with the investigation.

We
and several of our current and former officers and a current director are named as defendants in several purported class action complaints which have been filed on behalf of certain
persons who purchased our common stock and/or debt securities during different time periods, beginning on various dates, the earliest being May 17, 1999, and all ending on March 6, 2002.
These complaints allege violations of the Exchange Act and the rules and regulations promulgated thereunder by the Securities and Exchange Commission. Primarily they allege that the defendants made
certain materially false and misleading statements relating to the testing, safety and likelihood of FDA approval of SOLTARA. On April 11, 2003, two consolidated amended complaints were filed,
one on behalf of the purchasers of our common stock and the other on behalf of the purchasers of our debt securities. These consolidated amended complaints reiterate the allegations contained in the
previously filed complaints and define

35

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the
alleged class periods as May 17, 1999 through March 6, 2002. We filed a motion to dismiss both consolidated amended complaints on May 27, 2003. On March 11, 2004, the
court, while granting in part the motion to dismiss, did allow much of the case to proceed. The parties are currently engaged in discovery.

We
are unable to reasonably estimate any possible range of loss related to these lawsuits due to their uncertain resolution.

ITEMS 2-3. NONE

ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

Our annual meeting of stockholders was held on May 19, 2004. The following represents the results of the voting on proposals submitted to a vote of
stockholders at the annual meeting:

For

Withheld AuthorityDigby W. Barrios

71,628,229

1,631,512Alan A. Steigrod

72,359,897

899,843




For

Against

Abstain40,628,392

13,393,069

58,390


For

Against

Abstain72,223,311

1,009,552

26,877


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ITEM 5. NONE

ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K

| |  | 10.1 |  | The Registrant's 2000 Stock Incentive Plan, as amended                                                                                            
| |  | ---- |  | --------------------------------------------------------------------------------------------------------------------------------------------------
| |  | 31.1 |  | Certification of Chief Executive Officer pursuant to Rule 13a-14(a)/Rule 15d-14(a) of the Securities Exchange Act of 1934, as amended.            
| |  | 31.2 |  | Certification of Chief Financial Officer pursuant to Rule 13a-14(a)/Rule 15d-14(a) of the Securities Exchange Act of 1934, as amended.            
| |  | 32.1 |  | Certification of Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
| |  | 32.2 |  | Certification of Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

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SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned
thereunto duly authorized.

|                     |  | SEPRACOR INC.
|-------------------- |  | -------------
|Date: August 9, 2004 |  | By:          
|Date: August 9, 2004 |  | By:          

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Exhibit Index

|Exhibit No. |  | Description                                                                                                                                       
|----------- |  | --------------------------------------------------------------------------------------------------------------------------------------------------
|10.1        |  | The Registrant's 2000 Stock Incentive Plan, as amended.                                                                                           
|31.1        |  | Certification of Chief Executive Officer pursuant to Rule 13a-14(a)/Rule 15d-14(a) of the Securities Exchange Act of 1934, as amended.            
|31.2        |  | Certification of Chief Financial Officer pursuant to Rule 13a-14(a)/Rule 15d-14(a) of the Securities Exchange Act of 1934, as amended.            
|32.1        |  | Certification of Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
|32.2        |  | Certification of Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

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