SEPRACOR INC /DE/ - 10-Q Quarterly Report

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 April 30, 2004 was: 85,586,673 shares.

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

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 March 31, 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.

In January 2003, the Financial Accounting Standards Board, or FASB, issued FASB Interpretation No. 46, "Consolidation of Variable Interest Entities", or FIN 46, and, in December 2003, issued a revision to that interpretation. FIN 46R replaces FIN 46 and addresses consolidation by business enterprises of variable interest entities that possess certain characteristics. A variable interest entity, or VIE, is defined as (a) an ownership, contractual or monetary interest in an entity where the ability to influence financial decisions is not proportional to the investment interest or (b) an entity lacking the invested capital sufficient to fund future activities without the support of a third party. FIN 46R establishes standards for determining under what circumstances VIEs should be consolidated with their primary beneficiary, including those to which the usual condition for consolidation does not apply. We adopted FIN 46 in the year ended December 31, 2003, and adopted FIN 46R in the first quarter of 2004, for non-special purpose entities created prior to February 1, 2003. Our adoption of FIN 46R has not had a material effect on our financial statements.

Basic earnings (loss) per share, or EPS, excludes dilution and is computed by dividing income available to common shareholders 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 months ended March 31, 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 months ended March 31, 2004 and 2003 because they would have an anti-dilutive effect due to net losses for such periods. These excluded securities include the following:

(in thousands, except price per share data)		March 31, 2004			March 31, 2003
Number of options			13,987			12,348
Price 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)	March 31, 2004	March 31, 2003
7% convertible subordinated debentures due 2005	—	1,792
5% convertible subordinated debentures due 2007	4,763	4,763
5.75% convertible subordinated notes due 2006	—	7,166
Series A 0% convertible senior subordinated notes due 2008	7,839	—
Series B 0% convertible senior subordinated notes due 2010	16,756	—

	29,358	13,721

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 income and earnings per share if we had applied the fair value recognition provisions of SFAS No. 123 to stock-based employee compensation:

	Three Months Ended March 31,
(in thousands, except per share data)	Three Months Ended March 31,
(in thousands, except per share data)	2004			2003
Net loss attributable to common stockholders	$	(50,441	)	$	(29,759	)
Total stock-based employee compensation expense determined under fair value based method for all awards		(11,038	)		(14,403	)

Pro forma net loss	$	(61,479	)	$	(44,162	)

Amounts per common share:
Basic and diluted—as reported	$	(0.59	)	$	(0.35	)
Basic and diluted—pro forma	$	(0.72	)	$	(0.52	)

(in thousands)	March 31, 2004		December 31, 2003
Raw materials	$	1,887	$	1,062
Work in progress		2,118		1,295
Finished goods		5,602		4,509

	$	9,607	$	6,866

The following schedule details the carrying value of our patents and other intangible assets as of March 31, 2004 and December 31, 2003:

(in thousands)	March 31, 2004			December 31, 2003
Deferred finance costs, gross	$	35,106		$	42,957
Accumulated amortization		(9,556	)		(13,136	)

Deferred finance costs, net	$	25,550		$	29,821

Patents, gross	$	7,223		$	7,223
Accumulated amortization		(2,405	)		(2,231	)

Patents, net	$	4,818		$	4,992

Amortization expense was $1,554,000 and $2,082,000, including amortization expense of $1,380,000 and $1,222,000 related to deferred financing costs for the three months ended March 31, 2004 and 2003, respectively. We currently estimate that our amortization expense will be $4,496,000, $5,990,000, $5,965,000, $4,328,000 and $3,935,000 for the remainder of 2004 and for the years ending December 31, 2005, 2006, 2007 and 2008, respectively.

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

On January 9, 2004, using funds from the 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.

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
(in thousands)	March 31, 2004			March 31, 2003
Comprehensive loss:
Net loss	$	(50,441	)	$	(29,759	)
Net foreign currency translation adjustment		820			(9	)
Net unrealized gain (loss) on available-for-sale securities		3,769			16

Total comprehensive loss	$	(45,852	)	$	(29,752	)

We enter into standard indemnification agreements in our ordinary course of business where 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 defect 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 March 31, 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 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 discovery process will begin shortly.

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

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 March 31, 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 April 30, 2004, we announced 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, which becomes effective on July 1, 2004, we will only be responsible for providing sample coverage for ASTELIN under a fee-based compensation program. If we meet the sample coverage requirement for the three months ended September 30, 2004, we will earn $1,000,000. In addition, effective October 1, 2004, both parties have the unilateral right to terminate the agreement without cause. If the agreement is terminated by either party, we will receive a termination payment from MedPointe of $6,950,000, less any amount we earned prior to October 1, 2004 related to the sample coverage.

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.

We are a research-based pharmaceutical company dedicated to treating and preventing human disease through the discovery, development and commercialization of innovative pharmaceutical compounds. We select compounds for development that have the potential to offer improvements over existing therapies with respect to efficacy, side effect profile, dosage forms and, in some cases, the opportunity for additional indications. We market and sell XOPENEX, 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.

On February 27, 2004, we received an "approvable" letter from the United States Food and Drug Administration, or FDA, for 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. Contingent upon approval from the FDA, we would expect the recommended dosing to achieve sleep maintenance to be 2 mg or 3 mg for adult patients and 2 mg for elderly patients, and for elderly patients whose primary complaint is difficulty falling asleep, we would expect the recommended dosing to be 1 mg. The FDA has not requested additional clinical or

preclinical trials for final approval. Based on discussions with the FDA we expect the FDA to characterize our resubmission as a class II resubmission, which will be reviewed by the FDA within a six month period. As a result we are currently planning on an end of 2004 product launch. We are currently expanding our sales force in anticipation of marketing ESTORRA to primary care physicians and psychiatrists, the principal prescribers of sleep medications. If the FDA delays or denies final approval of our NDA for ESTORRA, then commercialization of ESTORRA may be delayed or terminated, which could have a material adverse effect on our business.

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.

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 three months ended March 31, 2004.

Product revenues were $85,056,000 and $72,156,000 for the three months ended March 31, 2004 and 2003, respectively, an increase of approximately 18%. The increase for the three-month period ended March 31, 2004 as compared with the same period in 2003 is due primarily to an increase in unit volume sales of XOPENEX of approximately 20%, offset by a decrease in the net selling price per unit of XOPENEX of approximately 2%. The decrease in the net selling price per unit of XOPENEX is due primarily to an increase in sales rebates and allowances of approximately 7%, which are accounted for as a reduction to gross product sales, offset by a gross unit price increase of approximately 5%. The increase in sales rebates and allowances is due primarily to an increase in supplemental Medicaid and Medicare allowances of approximately 171% that are impacted materially by our sales of 1.25 mg XOPENEX product as the rebate per unit on this dosage is higher than the rebate per unit on our other dosages of XOPENEX. Gross unit sales of our 1.25 mg XOPENEX product increased by approximately 64% for the three months ended March 31, 2004 as compared with the same period in 2003. We believe that the increase in total XOPENEX unit volume 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.

Royalties and other revenues were $14,422,000 and $12,350,000 for the three months ended March 31, 2004 and 2003, respectively, an increase of approximately 17%. The increase for the three months ended March 31, 2004 as compared with the same period in 2003 is primarily due to an increase in royalties earned, particularly in Japan, on sales of ALLEGRA® under our agreement with Aventis. Offsetting the increase in royalties earned on sales of ALLEGRA is a decrease in royalties earned on sales of CLARINEX® under our agreement with Schering-Plough Corporation. Royalties earned on sales of CLARINEX continue to be adversely impacted by the availability of other allergy drugs without a prescription. Included in other revenues for the three months ended March 31, 2004 are co-promotion revenue of $902,000 received from MedPointe for our co-promotion of ASTELIN® and $219,000 of other MedPointe related revenue as compared with $0 for the three months ended March 31, 2003.

Cost of product sold was $8,860,000 and $6,949,000 for the three months ended March 31, 2004 and 2003, respectively, an increase of approximately 28%. Cost of product sales as a percentage of product sales was approximately 10% for both the three months ended March 31, 2004 and 2003. The increase for the three months ended March 31, 2004 as compared with the same period in 2003 is primarily due to the increase in product sales of 18% and, to a lesser extent to a reduction in the cost of products sold of $771,000 in the three months ended March 31, 2003 due to a favorable outcome of a quality control issue. This was partially offset by a lower manufacturing cost per unit, which resulted from an increase in the number of units of XOPENEX produced in the three months ended March 31, 2004 as compared with the same period in 2003.

Cost of royalties and other revenues was $240,000 and $256,000 for the three months ended March 31, 2004 and 2003, respectively, a decrease of approximately 6%. 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 March 31, 2004 as compared with the same period in 2003 resulted from the decrease in royalties we earned on sales of CLARINEX.

Research and development expenses were $37,296,000 and $53,183,000 for the three months ended March 31, 2004 and 2003, respectively, a decrease of approximately 30%. The decrease for the three months ended March 31, 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 XOPENEX hydrofluoroalkane metered-dose inhaler, or HFA MDI, and arformoterol programs.

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 two product candidates in Phase III clinical trials and one NDA submitted in January 2003 and currently under FDA review. The successful development of our product candidates is highly uncertain. Product

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 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 March 31, 2004. The "Estimate of Completion of Phase" column contains forward-looking statements regarding timing of completion of product development phases. Completion of product development, if successful, culminates in the submission of an NDA to the FDA. The actual timing of completion of phases 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 March 31, 2004, and the three product candidates listed accounted for approximately 87% of our direct project research and development spending during this period.

Product Candidate	Indication	Phase of Development	Estimate of Completion of Phase
Arformoterol	Respiratory—COPD	Phase III	2004	*
XOPENEX HFA MDI	Respiratory—Asthma	Phase III	2004
ESTORRA (eszopiclone)	Insomnia	NDA	2004	**

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 March 31, 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.

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, accurate and meaningful estimates of the ultimate cost to bring our product candidates to FDA approved status is extremely difficult. 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. The table below estimates the cost ranges to bring our active phase III product candidates to an NDA filing:

XOPENEX HFA MDI		$15 to $20 million (based on an expected NDA submission in the second quarter of 2004)
Aformoterol		$27 to $32 million (based on an expected NDA submission in the first quarter of 2005)

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

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 expenses were $84,434,000 and $35,681,000 for the three months ended March 31, 2004 and 2003, respectively, an increase of approximately 137%. Of the 137% increase, 86% 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 an amendment to the agreement in March 2004, we agreed to terminate the XOPENEX co-promotion agreement with Ross effective December 31, 2004. The remaining increase of 51% is primarily due to increased XOPENEX sales commission expense paid to internal sales representatives and to Ross in 2004 as a result of the increase in sales of XOPENEX for the three months ended March 31, 2004. Additionally, during 2004, we implemented our sales force expansion for, and have incurred increased marketing and training expenses related to, ESTORRA, which we expect to commercialize in 2004, if we receive final approval from the FDA.

General and administrative and patent expenses were $7,034,000 and $5,842,000 for the three months ended March 31, 2004 and 2003, respectively, an increase of approximately 20%. The increase for the three months ended March 31, 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.

Interest income was $1,255,000 and $1,931,000 for the three months ended March 31, 2004 and 2003, respectively. The decrease for the three months ended March 31, 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 earned on investments in 2004.

Interest expense was $6,124,000 and $13,657,000 for the three months ended March 31, 2004 and 2003, respectively. The decrease for the three months ended March 31, 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 quarter of 2004 was $655,000,000 as compared to the average outstanding balance in the first quarter of 2003 of approximately $981,870,000.

Loss on debt redemption was $7,022,000 and $0 for the three months ended March 31, 2004 and 2003, respectively. The loss in the three months ended March 31, 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 debentures.

Equity in investee (losses) were ($147,000) and ($625,000) for the three months ended March 31, 2004 and 2003, respectively. The loss for the three-month periods ended March 31, 2004 and 2003 represents our portion of BioSphere losses.

In January 2003, the FASB issued FIN No. 46, "Consolidation of Variable Interest Entities" and, in December 2003, issued a revision to that interpretation. FIN No. 46R replaces FIN No. 46 and addresses consolidation by business enterprises of variable interest entities that possess certain characteristics. A variable interest entity, or VIE, is defined as (a) an ownership, contractual or monetary interest in an entity where the ability to influence financial decisions is not proportional to the investment interest, or (b) an entity lacking the invested capital sufficient to fund future activities without the support of a third party. FIN No. 46R establishes standards for determining under what circumstances VIEs should be consolidated with their primary beneficiary, including those to which the usual condition for consolidation does not apply. We adopted FIN No. 46 in the year ended December 31, 2003, and adopted FIN No. 46R in the first quarter of 2004, for non-special purpose entities created prior to February 1, 2003. Our adoption of FIN No. 46R has not had a material effect on our financial statements.

Cash, cash equivalents and short- and long-term investments totaled $530,272,000 at March 31, 2004, compared to $840,388,000 at December 31, 2003.

The net cash used in operating activities for the three months ended March 31, 2004 was $27,729,000. The net cash used in operating activities includes a net loss of $50,441,000 adjusted by non-cash charges of $11,457,000, which includes a loss on early debt extinguishment of $7,022,000. Accounts receivable decreased by $7,588,000 due primarily to the decreased sales of XOPENEX during March 2004 as compared to December 2003 due to customary seasonal fluctuations. Inventory increased by $2,741,000 due to shifts in product mix as well as in anticipation of production down time as our contract manufacturer qualifies upgraded production equipment. On a combined basis, accounts payable and accrued expenses decreased by $27,507,000 primarily due to lower research and development costs. Other current liabilities increased by $3,530,000 primarily due to additional accruals for product revenue rebates and return reserves related to XOPENEX revenues. Other liabilities increased by $30,452,000 primarily due to an accrual for $30,671,000, which represents the present value of a termination payment we will make to Ross.

The net cash provided by investing activities for the three months ended March 31, 2004 was $17,683,000. Cash was provided by net sales and maturities of short- and long-term investments of $20,098,000. We also made purchases of property and equipment of $2,351,000.

The net cash used in financing activities for the three months ended March 31, 2004 was $283,654,000. 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 also received proceeds of $4,344,000 from the issuance of common stock upon the exercise of stock options issued under our stock option plans. We used $164,000 to repay capital lease obligations and long-term debt.

We currently generate cash from the sale of XOPENEX, 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:

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, or 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. We cannot assure that, if required, we would be able to raise the additional funds on favorable terms, if at all.

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

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:

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 will cause our expectations to change. However, while we may elect to update these forward-looking 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 $50.4 million for the three months ended March 31, 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 products and 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, submitting 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:

We received an "approvable" letter from the FDA for ESTORRA on February 27, 2004; however, we cannot be certain that the FDA will approve the ESTORRA NDA.

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. We intend to resubmit the NDA and, assuming we satisfactorily respond to the issues raised by the FDA, we expect to receive approval during 2004. However, we cannot be certain that we will satisfactorily respond to the issues raised by the FDA or that the FDA will grant us approval during 2004, if at all. If the FDA delays or denies approval of our NDA for ESTORRA, or any other NDA that we file in the future, then commercialization of ESTORRA 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. If the trials are successful, we would be responsible for submitting an NDA to the FDA for XOPENEX HFA MDI. If 3M is unable to manufacture a XOPENEX HFA MDI formulation, or our clinical trials are unsuccessful, we may be unable to proceed with the development of XOPENEX HFA MDI. 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.

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. 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 and the maintenance and protection of patents, 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 slightly in 2004 due to the continued adverse impact on sales of these prescription allergy drugs resulting from the availability of competitor 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

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

Sales of XOPENEX represent a majority of our revenues; if sales of XOPENEX 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 three months ended March 31, 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. If the FDA grants final marketing approval for our ESTORRA NDA, we do not expect to launch ESTORRA until late 2004 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 at least the third quarter of 2004. We do not have long-term sales contracts with our customers and we rely on purchase orders for sales of XOPENEX. Reductions, delays or cancellations of orders for XOPENEX could adversely affect our operating results. If sales of XOPENEX 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 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 agreement, 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 the attempt by us or our collaborative development partners to receive regulatory approval 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. If the FDA delays or denies approval of our NDA for ESTORRA, or delays or denies acceptance or approval of any other NDA that we file in the future, then commercialization of ESTORRA 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 expect to incur 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 also expect to rely primarily on a sales force to market ESTORRA, if it is approved by the FDA. We have incurred significant expense in expanding our sales force and expect to incur additional expense as we further expand. With respect to products under development, we expect to incur significant costs in expanding our sales force before the products have

been approved for marketing. For example, although we do not expect to receive marketing approval from the FDA for ESTORRA until late 2004, if at all, we have already expanded our sales force in anticipation of receiving such marketing approval. In addition, if we enter into co-promotion arrangements or market and sell additional products directly, we will need to 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. 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.

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 March 31, 2004, our total long-term debt excluding the current portion, was approximately $1.2 billion and our stockholders' equity (deficit) was ($660.7 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

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 three months ended March 31, 2004, net cash used in operating activities was approximately $27.7 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 March 31, 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

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.

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 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 discovery process will begin shortly.

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

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 and investors' perceptions of us, changes in recommendations by securities analysts as well as their perceptions of general economic, industry and market conditions.

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 May 6, 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.

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.

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 discovery process will begin shortly.

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

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.

(Mark One)
ý	QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the Quarterly Period Ended March 31, 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

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)

Part I—Financial Information
Item 1.	Consolidated Financial Statements (Unaudited)
	Consolidated Balance Sheets as of March 31, 2004 and December 31, 2003 (Unaudited)	3
	Consolidated Statements of Operations for the Three Months Ended March 31, 2004 and 2003 (Unaudited)	4
	Consolidated Statements of Cash Flows for the Three Months Ended March 31, 2004 and 2003 (Unaudited)	5
	Notes to Consolidated Interim Financial Statements	6
Item 2.	Management's Discussion and Analysis of Financial Condition and Results of Operations	11
Item 3.	Quantitative and Qualitative Disclosures About Market Risk	30
Item 4.	Controls and Procedures	30
Part II—Other Information
Item 1.	Legal Proceedings	30
Item 6.	Exhibits and Reports on Form 8-K	31
	Signatures	32
	Exhibit Index	33

	March 31, 2004			December 31, 2003
Assets
Current assets:
Cash and cash equivalents	$	412,082		$	705,802
Restricted cash		1,500			1,500
Short-term investments		67,411			71,913
Accounts receivable, net		43,003			50,591
Inventories		9,607			6,866
Other assets		21,366			17,580

Total current assets		554,969			854,252
Long-term investments		49,279			61,173
Property and equipment, net		69,678			66,428
Investment in affiliate		2,872			3,019
Patents and other intangible assets, net		30,368			34,813
Other assets		605			540

Total assets	$	707,771		$	1,020,225

Liabilities and Stockholders' Equity (Deficit)
Current liabilities:
Accounts payable	$	15,278		$	12,324
Accrued expenses		96,757			127,218
Current portion of notes payable and capital lease obligation		1,109			129
Current portion of convertible subordinated debt		—			430,000
Other current liabilities		32,287			28,757

Total current liabilities		145,431			598,428
Notes payable and capital lease obligation		2,389			789
Long-term deferred revenue		—			219
Other long-term liabilities		30,671			—
Convertible subordinated debt		1,190,000			1,040,000

Total liabilities		1,368,491			1,639,436

Stockholders' equity (deficit):
Preferred stock $1.00 par value, 1,000 shares authorized, none outstanding at March 31, 2004 and December 31, 2003		—			—
Common stock, $.10 par value, 240,000 and 240,000 shares authorized; 85,425 and 85,025 shares issued and outstanding, at March 31, 2004 and December 31, 2003, respectively		8,542			8,503
Additional paid-in capital		694,211			689,907
Accumulated deficit		(1,380,269	)		(1,329,828	)
Accumulated other comprehensive income		16,796			12,207

Total stockholders' equity (deficit)		(660,720	)		(619,211	)

Total liabilities and stockholders' equity (deficit)	$	707,771		$	1,020,255

		Three Months Ended
		March 31, 2004			March 31, 2003
Cash flows from operating activities:
	Net loss	$	(50,441	)	$	(29,759	)
Adjustments to reconcile net loss to net cash used in operating activities:
	Depreciation and amortization		4,288			4,726
	Equity in investee losses		147			625
	Loss on redemption of debt		7,022			—
Changes in operating assets and liabilities:
	Accounts receivable		7,588			106
	Inventories		(2,730	)		94
	Other current assets		(3,801	)		(416	)
	Accounts payable		2,953			7,408
	Accrued expenses		(26,738	)		(4,843	)
	Other current liabilities		3,531			1,380
	Other liabilities		30,452			—

	Net cash used in operating activities		(27,729	)		(20,679	)

Cash flows from investing activities:
	Purchases of short and long-term investments		(62,042	)		(87,982	)
	Sales and maturities of short and long-term investments		82,140			77,604
	Additions to property and equipment		(2,351	)		(1,211	)
	Change in other assets		(64	)		—

	Net cash provided by (used in) investing activities		17,683			(11,589	)

Cash flows from financing activities:
	Redemption of convertible subordinated debentures		(433,709	)		—
	Net proceeds from issuance of common stock		4,344			35
	Proceeds from sale of convertible subordinated debt		150,000			—
	Costs associated with sale of convertible subordinated debt		(4,125	)
	Repayments of long-term debt and capital leases		(164	)		(258	)

	Net cash used in financing activities		(283,654	)		(223	)

	Effect of exchange rate changes on cash and cash equivalents		(20	)		2

	Net decrease in cash and cash equivalents		(293,720	)		(32,489	)
	Cash and cash equivalents at beginning of period	$	705,802		$	375,438

	Cash and cash equivalents at end of period	$	412,082		$	342,949

Non cash activities:
	Additions to capital leases		2,659			—

			Three Months Ended
			March 31, 2004			March 31, 2003
Revenues:
	Product sales		$	85,056		$	72,156
	Royalties and other			14,422			12,350

		Total revenues		99,478			84,506

Costs and expenses:
	Cost of product sold			8,860			6,949
	Cost of royalties and other			240			256
	Research and development			37,296			53,183
	Selling, marketing and distribution			84,434			35,681
	General and administrative and patent costs			7,034			5,842

		Total costs and expenses		137,864			101,911

	Loss from operations			(38,386	)		(17,405	)
Other income (expense):
	Interest income			1,255			1,931
	Interest expense			(6,124	)		(13,657	)
	Loss on redemption of debt			(7,022	)		—
	Equity in investee (losses)			(147	)		(625	)
	Other income (expense), net			(17	)		(3	)

	Net loss		$	(50,441	)	$	(29,759	)

	Basic and diluted net loss per common share		$	(0.59	)	$	(0.35	)
Shares used in computing basic and diluted net loss per common share:
	Basic and diluted			85,214			84,350

(in thousands)	Project costs for the three months ended March 31, 2004		Project costs to date through March 31, 2004		Project costs for the three months ended March 31, 2003		Project costs to date through March 31, 2003
Arformoterol	$	8,536	$	126,660	$	5,197	$	78,609
XOPENEX HFA MDI		8,270		119,033		3,873		61,269
ESTORRA (eszopiclone)		5,537		141,267		6,632		122,156

		10.1†		Amendments No. 1, 2 and 3, dated January 19, 2000, January 1, 2001 and March 19, 2004, to the Co-Promotion Agreement between Abbott Laboratories, Inc. and the Registrant.
		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.

		SEPRACOR INC.
Date: May 6, 2004		By:	/s/ TIMOTHY J. BARBERICH Timothy J. Barberich Chairman and Chief Executive Officer (Principal Executive Officer)