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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

FORM 10-Q

Commission file number 0-19410

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

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

        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 November 1, 2004 was: 105,086,396 shares.

SEPRACOR INC.

INDEX

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SEPRACOR INC.

CONSOLIDATED BALANCE SHEETS

(Unaudited)

(In Thousands)

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

3

SEPRACOR INC.

CONSOLIDATED STATEMENTS OF OPERATIONS

(Unaudited)

(In Thousands, Except Per Share Amounts)

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

4

SEPRACOR INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)

(In Thousands)

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

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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 September 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. Recent Accounting Pronouncements

        In September 2004, the Emerging Issues Task Force, or EITF, of the Financial Accounting Standards Board, or FASB, reached consensus on EITF Issue No. 04-8, "The Effect of Contingently Convertible Debt on Diluted Earnings per Share", or EITF No. 04-8. Under the EITF's conclusion, contingently convertible shares attached to a debt instrument are to be included in the calculation of diluted earnings per share regardless of whether or not the contingency has been met. The EITF consensus supersedes the accounting under Statement of Financial Accounting Standards No. 128, "Earnings Per Share," and accordingly, we will be required to adopt the provisions of EITF No. 04-8 for our 0% convertible subordinated notes due 2024 when effective, which is expected to be for the year ending December 31, 2004, including the retroactive restatement of all diluted earnings per share calculations for all periods presented. Based on a review of the provisions of EITF No. 04-8, we have determined that the adoption will have no effect on our current or prior year diluted earnings per share, as inclusion of any contingently convertible shares would be anti-dilutive.

3. 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

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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 nine months ended September 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 nine months ended September 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:

a.

Options to purchase shares of common stock:

b.

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

        The 0% convertible subordinated notes due 2024 are not convertible at the present time. If the notes were currently convertible, no shares of common stock would need to be reserved under the conversion formula for issuance upon conversion until our stock price exceeds $67.20 per share.

4. 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.

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        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:

5. Inventories

        Inventories consist of the following:

6. Patents and Deferred Financing Costs

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

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

        We currently estimate that our amortization expense will be $1,049,000, $4,248,000, $4,222,000, $2,588,000 and $2,231,000 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 is 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 nine months ended September 30, 2004.

        During September 2004, we converted $177,200,000 and $351,980,000 aggregate principal amount of our 0% Series A convertible senior subordinated notes due 2008, or 0% Series A notes due 2008, and 0% Series B convertible senior subordinated notes due 2010, or 0% Series B notes due 2010, respectively, into an aggregate of 5,556,104 and 11,797,483 shares of our common stock, respectively. As a result of the conversions, deferred financing costs related to the converted 0% Series A notes due 2008 and 0% Series B notes due 2010 of $4,244,000 and $8,846,000, respectively, were netted against the amount of debt converted into equity.

        On September 22, 2004, we issued $500,000,000 in principal amount of 0% convertible senior subordinated notes due 2024, or 0% notes due 2024. As part of the sale of the 0% notes due 2024, we incurred offering costs of $14,190,000 which have been recorded as deferred financing costs and are being amortized over the 20 year term of the 0% notes due 2024.

7. Convertible Subordinated Debt

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

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        On January 9, 2004, using funds from our December 2003 issuance of 0% Series A notes due 2008 and Series B notes due 2010, 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% Series A notes due 2008 and 0% Series B notes due 2010, we issued an additional $50,000,000 of 0% Series A notes due 2008 and $100,000,000 of 0% Series B notes due 2010. These notes have the same terms and conditions as our previously issued 0% Series A notes due 2008 and 0% Series B notes due 2010. Net of issuance costs, our proceeds were approximately $145,875,000. The issuance costs have been recorded as deferred financing costs and are being amortized over 4 and 6 years, respectively, the remaining term of the debt.

        During September 2004, certain holders agreed, in separately negotiated transactions, to convert $177,200,000 and $351,980,000 in aggregate principal amount of their 0% Series A notes due 2008 and 0% Series B notes due 2010, respectively, into an aggregate of 5,556,104 and 11,797,483 shares of our common stock, respectively. As an inducement to convert their notes, we paid the holders of the 0% Series A notes due 2008 and 0% Series B notes due 2010 aggregate cash payments of $23,868,250 and $45,899,900, respectively. These amounts are recorded as a loss on conversion of convertible notes. Deferred financing costs related to the converted 0% Series A notes due 2008 and 0% Series B notes due 2010 of $4,244,000 and $8,846,000, respectively, were netted against the amount of debt converted into equity.

        On September 22, 2004, we issued $500,000,000 in principal amount of 0% convertible senior subordinated notes due 2024, or 0% notes due 2024. The 0% notes due 2024 are convertible into cash and, if applicable, shares of our common stock, at the option of the holder upon certain specified circumstances, at an initial price of $67.20 per share, subject to adjustment.

        Holders may convert the notes into cash and, if applicable, shares of our common stock at a conversion rate of 14.8816 shares of common stock per $1,000 principal amount of notes (which is equal to a conversion price of approximately $67.20 per share), subject to adjustment, before the close of business on the business day immediately preceding October 15, 2024 only under the following circumstances:

•

during any fiscal quarter beginning after December 31, 2004, if the closing sale price of our common stock for at least 20 trading days in the 30 consecutive trading days ending on the last day of the preceding fiscal quarter is more than 130% of the conversion price per share of common stock on the last day of such preceding quarter;



•

during the five business day period following any five consecutive trading day period (the "measurement period") in which the trading price per note on each day of that measurement period is less than 98% of the closing sale price of our common stock multiplied by the conversion rate on each such day;



•

if the notes have been called for redemption;



•

upon the occurrence and continuance of specified corporate transactions; and

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•

in connection with a transaction or event constituting a fundamental change occurring on or prior to October 20, 2009.

        Upon conversion of the notes, if the adjusted conversion value of the notes is less than or equal to the principal amount of the notes, then we will convert the notes for an amount in cash equal to the adjusted conversion value of the notes. If the adjusted conversion value of the notes is greater than the principal amount of the notes, then we will convert the notes into whole shares of our common stock for an amount equal to the adjusted conversion value of the notes less the principal amount of the notes, plus an amount in cash equal to the principal amount of the notes plus the cash value of any fractional shares of our common stock. The notes do not bear interest. On or after October 20, 2009, we have the option to redeem for cash all or part of the notes at any time at a redemption price equal to 100% of the principal amount of the notes to be redeemed. We may be required by the note holders to repurchase for cash all or part of the notes on October 15 of 2009, 2014 and 2019 at a repurchase price equal to 100% of the principal amount of the notes to be repurchased. We may be required to repurchase for cash all or part of the notes upon a change in control of our company or a termination of trading of our common stock on the NASDAQ or similar markets at a repurchase price equal to 100% of the principal amount of the notes to be repurchased. The initial purchaser has an option to purchase an additional $100,000,000 in principal amount of 0% notes due 2024 until November 29, 2004 pursuant to the Purchase Agreement between the initial purchaser and us, dated September 17, 2004, as amended. In connection with the sale of the notes, we incurred offering costs of approximately $14,190,000 which have been recorded as deferred financing costs and are being amortized over 20 years, the term of the notes.

8. Equity

        During the second quarter of 2004, pursuant to the call spread option agreements we entered into in December 2003, we settled 4,919,496 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. We currently expect to settle these call spread options for cash, although the amount we receive upon settlement, if any, will vary based on the price of our common stock on the option expiration dates. Proceeds from a cash settlement of these options are calculated based on the difference between our stock price and the option price if our stock price is below the cap price or the difference between the cap price and the option price if our stock price exceeds the cap price. Any cash received in settlement of the remaining call spread options will be recorded as additional paid-in capital.

        The following table sets forth the potential proceeds from our remaining call spread options if settled in cash using the closing price of our common stock on November 1, 2004 of $45.94:

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        On September 22, 2004, we purchased 1,933,000 shares of our common stock for approximately $100,321,000, including transaction costs of $394,000. The shares are being held in treasury at cost and may be issued in connection with our employee stock purchase plan and other corporate purposes.

9. Comprehensive Loss

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

10. 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 not incurred a liability on these guarantees at September 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 with the investigation and plan to 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

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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.

11. 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 September 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.

12. MedPointe Agreement Amendment

        On October 1, 2004, we terminated our co-promotion agreement with MedPointe, Inc., or MedPointe, for the co-promotion of ASTELIN® brand azelastine HCl for the treatment of allergic rhinitis. Such termination was not for cause and was undertaken in accordance with the terms of the agreement, which had been amended as of April 30, 2004. Pursuant to the terms of the amended agreement, as of July 1, 2004, our sales force was only responsible for providing ASTELIN samples to doctors and, as of October 1, 2004, both parties had the right to unilaterally terminate the agreement without cause. In connection with our termination of the agreement, we are entitled to receive a payment from MedPointe of $6,950,000, less any amount earned for sample coverage services provided for ASTELIN prior to the October 1, 2004 termination of the agreement. As of September 30, 2004, we had earned all $6,950,000 by providing sample coverage and that amount has been recognized as other revenue.

13. Subsequent Event

        We have agreed to purchase, in a private placement, 4,000 shares of BioSphere Series A Convertible Preferred Stock and warrants to purchase 200,000 shares of BioSphere common stock from BioSphere for an aggregate purchase price of $4,000,000. The completion of the private placement is subject to the execution of definitive agreements and is expected to close on or about November 9, 2004. We will continue to account for our investment in BioSphere under the equity method.

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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 October 22, 2004 we commenced notifying drug wholesalers, hospitals and pharmacies of a manufacturer-initiated voluntary Class III recall of one component of our XOPENEX product line, XOPENEX Inhalation Solution Concentrate (1.25mg/0.5mL), which we had introduced in August 2004. The recall, which affects only XOPENEX Concentrate and no other components of our XOPENEX product line, was necessitated by packaging process validation issues relating to the automated process of placing the finished vials into a foil pouch. We have suspended manufacture and sale of XOPENEX Concentrate until the issues giving rise to the recall have been fully addressed.

        On October 1, 2004, we terminated our co-promotion agreement with MedPointe, Inc., or MedPointe, for the co-promotion of ASTELIN brand azelastine HCl for the treatment of allergic rhinitis. Such termination was not for cause and was undertaken in accordance with the terms of the agreement, which had been amended as of April 30, 2004. Pursuant to the terms of the amended agreement, as of July 1, 2004, our sales force was only responsible for providing ASTELIN samples to doctors and, as of October 1, 2004, both parties had the right to unilaterally terminate the agreement without cause. In connection with our termination of the agreement, we are entitled to receive a payment from MedPointe of $6,950,000, less any amount earned for sample coverage services provided for ASTELIN prior to the October 1, 2004 termination of the agreement. As of September 30, 2004, we had earned all $6,950,000 by providing sample coverage and that amount has been recognized as other revenue.

        On September 22, 2004, we issued $500,000,000 in principal amount of 0% convertible senior subordinated notes due 2024, or 0% notes due 2024. In connection with the sale of these notes, we incurred offering costs of approximately $14,190,000. The net proceeds to us after offering costs were approximately $485,810,000. We used $100,321,000 of the proceeds from the issuance of these notes to purchase 1,933,200 shares of our common stock. The initial purchaser has an option to purchase an additional $100,000,000 in principal amount of 0% notes due 2024 until November 29, 2004 pursuant to the Purchase Agreement between the initial purchaser and us, dated September 17, 2004, as amended.

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        During September 2004, certain holders of our 0% Series A convertible senior subordinated notes due 2008, or 0% Series A notes due 2008, and 0% Series B convertible senior subordinated notes due 2010, or 0% Series B notes due 2010, agreed, in separately negotiated transactions, to convert $177,200,000 and $351,980,000 in aggregate principal amount of their 0% Series A notes due 2008 and 0% Series B notes due 2010, respectively, into an aggregate of 5,556,104 and 11,797,483 shares of our common stock, respectively. As an inducement to convert their notes, we paid the holders of the 0% Series A notes due 2008 and 0% Series B notes due 2010 aggregate cash payments of $23,868,250 and $45,899,900, respectively.

        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 this 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, or the date by which the FDA is expected to review and act on the NDA submission for our ESTORRA NDA, is December 15, 2004. We are currently planning for 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 eszopiclone, or the trademark we propose to use in connection with the product, then our plans for commercialization of ESTORRA would 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 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. The amendment became effective upon the completion of the business combination between Aventis and Sanofi-Synthelabo. Under the amended agreement, we 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 will assign to

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us the foreign counterparts to the U.S. patent covering eszopiclone and its therapeutic use. Also as part of the amendment, we permitted 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 4,919,496 call spread options for cash which resulted in payments to us 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. The next series of call spread options expire in December 2004 and are valued at $74,603,000, based on the closing price of our common stock on November 1, 2004, which was $45.94. We currently expect to settle these call spread options for cash, although the amount we receive upon settlement, if any, will vary based on the price of our common stock on the option expiration dates. Any cash received in settlement of the remaining call spread options will be recorded as additional paid-in capital.

        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 September 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% Series A notes due 2008 and 0% Series B notes due 2010, we issued an additional $50,000,000 of 0% Series A notes due 2008 and $100,000,000 of 0% Series B notes due 2010. These notes have the same terms and conditions as our previously issued 0% Series A notes due 2008 and 0% Series B notes due 2010. 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

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uncertainty inherent in these matters, our actual results could differ from the estimates we use in applying the critical accounting policies. No changes to these critical accounting policies have taken place since December 31, 2003.

Three Month Periods ended September 30, 2004 and 2003

Revenues

        Product revenues were $60,122,000 and $53,097,000 for the three months ended September 30, 2004 and 2003, respectively, an increase of approximately 13%. The increase in product revenue is primarily attributable to an 8% increase in the net selling price per unit of XOPENEX and a 5% increase in XOPENEX unit volume sales. The 8% net selling price per unit increase is due primarily to a gross unit price increase of approximately 8%. The 5% 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) state-by-state changes in the status of XOPENEX on Medicaid preferred drug lists, which resulted in a decrease in the number of Medicaid beneficiaries having access to XOPENEX without prior authorization from their state Medicaid agency.

        Royalties and other revenues were $19,959,000 and $17,687,000 for the three months ended September 30, 2004 and 2003, respectively, an increase of approximately 13%. The increase for the three months ended September 30, 2004 as compared with the same period in 2003 is partially due to an increase in MedPointe-related revenue which was $5,051,000 for the three months ended September 30, 2004 as compared with MedPointe-related revenue of $3,741,000 for the three months ended September 30, 2003. MedPointe revenue consists primarily of revenue related to the fair value of services performed pursuant to our agreement with MedPointe, for the co-promotion of ASTELIN. On October 1, 2004, we terminated our co-promotion agreement with MedPointe. Combined royalties earned on sales of CLARINEX® under our agreement with Schering-Plough, and on sales of ALLEGRA® under our agreement with Aventis, remained consistent for the three months ended September 30, 2004 as compared with the same period in 2003. However, we expect royalties earned from these products to continue to be adversely affected by decreased sales volume resulting from the availability of other allergy drugs without a prescription. Royalties earned on sales of XYZAL®/XUSAL™ under our agreement with UCB Farchim SA, increased by approximately $1,127,000 during the three months ended September 30, 2004 as compared with the same period in 2003.

Costs of Revenues

        Cost of product sold was $7,021,000 and $5,638,000 for the three months ended September 30, 2004 and 2003, respectively, an increase of approximately 24%. Cost of product sold as a percentage of product sales was approximately 11% for each of the three months ended September 30, 2004 and 2003.

        Cost of royalties and other revenues was $285,000 and $360,000 for the three months ended September 30, 2004 and 2003, respectively, a decrease of approximately 21%. Our cost of royalties and other revenues consists primarily of a royalty 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 September 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 $38,744,000 and $40,703,000 for the three months ended September 30, 2004 and 2003, respectively, a decrease of approximately 5%. The decrease for the three

17

months ended September 30, 2004 as compared with the same period in 2003 is primarily due to our reduced spending on our XOPENEX HFA MDI, arformoterol and tecastemizole programs. We submitted an NDA for XOPENEX HFA MDI to the FDA in May 2004, which was accepted for filing on July 14, 2004 and we discontinued our development of tecastemizole in December 2003. Our decreased spending in these programs was partially offset by our increased spending on Phase IIIB/IV studies of eszopiclone.

        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 NDA preparation stage 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 September 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 three months ended September 30, 2004, and the three product candidates listed accounted for approximately 88% of our direct project research and development spending during this period.

*

We received an "approvable" letter from the FDA in February 2004, and in July the FDA accepted our resubmission of our NDA for ESTORRA. The PDUFA date for ESTORRA is December 15, 2004.

**

We submitted the NDA for XOPENEX HFA MDI to the FDA in May 2004, and the FDA accepted the NDA for filing in July 2004. The PDUFA date for XOPENEX HFA MDI is March 12, 2005.

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        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 September 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.

        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 that the cost range to bring arformoterol from its current state to an NDA submission is $25,000,000 to $30,000,000 based on a targeted NDA submission of mid-2005, provided that no significant delays are imposed by internal resource constraints or unanticipated FDA requirements.

        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.

Selling, Marketing and Distribution

        Selling, marketing and distribution expenses were $82,843,000 and $42,462,000 for the three months ended September 30, 2004 and 2003, respectively, an increase of approximately 95%. The increase is primarily due to increases in salary, commission, travel and benefit costs as a result of having approximately 800 more sales representatives in the three months ended September 30, 2004 than in the same period ended September 30, 2003, in anticipation of the commercialization of ESTORRA, which we are planning to launch in January 2005, subject to receipt of final approval from the FDA in December 2004. We also incurred increased spending in the three months ended September 30, 2004 as compared to the three months ended September 30, 2003 for trade shows and promotions relating to preparation for the expected commercialization of ESTORRA.

General and Administrative

        General and administrative expenses were $7,465,000 and $5,869,000 for the three months ended September 30, 2004 and 2003, respectively, an increase of approximately 27%. The increase for the three months ended September 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.

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Other Income (Expense)

        Interest income was $2,039,000 and $1,136,000 for the three months ended September 30, 2004 and 2003, respectively. The increase for the three months ended September 30, 2004 as compared with the same period in 2003 is due primarily to higher average balances of cash and short- and long-term investments in 2004.

        Interest expense was $5,846,000 and $11,909,000 for the three months ended September 30, 2004 and 2003, respectively. The decrease for the three months ended September 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 third quarter of 2004 was $440,000,000 as compared to the average outstanding balance in the third quarter of 2003 of approximately $981,870,000.

        Loss on conversion of debt was $69,768,000 and $0 for the three months ended September 30, 2004 and 2003, respectively. During September 2004, we converted $177,200,000 of our 0% Series A notes due 2008 and $351,980,000 of our 0% Series B notes due 2010, respectively. The loss represents the cash payments of $23,868,250 and $45,899,900 that we paid to the holders of the 0% Series A notes due 2008 and 0% Series B notes due 2010, respectively, as an inducement to convert their notes.

        Equity in investee (losses) were ($508,000) and ($859,000) for the three months ended September 30, 2004 and 2003, respectively. The loss for the three-month periods ended September 30, 2004 and 2003 represents our portion of BioSphere losses.

Nine Month Periods ended September 30, 2004 and 2003

Revenues

        Product revenues were $202,628,000 and $186,603,000 for the nine months ended September 30, 2004 and 2003, respectively, an increase of approximately 9%. The increase in product revenue is due to an approximate 9% increase in unit volume sales of XOPENEX. The net selling price for each period remained consistent as a result of an approximate 6% increase in 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 6%. The increase in rebates is primarily attributable to an increase in supplemental Medicaid rebates that we provided in connection with the inclusion of XOPENEX on the Medicaid preferred drug lists in certain states. The 9% 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 for respiratory drugs generally during the period and (2) state-by-state changes in the status of XOPENEX on Medicaid preferred drug lists, which resulted in a decrease in the number of Medicaid beneficiaries having access to XOPENEX without prior authorization from their state Medicaid agency.

        Royalties and other revenues were $46,898,000 and $45,142,000 for the nine months ended September 30, 2004 and 2003, respectively, an increase of approximately 4%. The increase for the nine months ended September 30, 2004 as compared with the same period in 2003 is partially due to an increase in MedPointe-related revenue which was $8,946,000 for the nine months ended September 30, 2004 as compared with MedPointe-related revenue of $3,960,000 for the nine months ended September 30, 2003. MedPointe revenue consists primarily of revenue related to the fair value of services performed pursuant to our agreement with MedPointe, for the co-promotion of ASTELIN. On October 1, 2004, we terminated our co-promotion agreement with MedPointe. Royalties earned on sales of XYZAL/XUSAL under our agreement with UCB Farchim SA increased by approximately $2,038,000 during the nine months ended September 30, 2004 as compared with the same period in 2003. Offsetting the increase in MedPointe and UCB-related revenue is a decrease in royalties earned

20

on sales of CLARINEX under our agreement with Schering-Plough, and to a lesser extent, 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 in the United States.

Costs of Revenues

        Cost of product sold was $22,702,000 and $19,551,000 for the nine months ended September 30, 2004 and 2003, respectively, an increase of approximately 16%. Cost of product sales as a percentage of product sales was approximately 11% and 10% for the nine months ended September 30, 2004 and 2003, respectively. The increase for the nine months ended September 30, 2004 as compared with the same period in 2003 is primarily due to the increase in product sales of 9% and, to a lesser extent, to a reduction in the cost of products sold of $771,000 in the nine months ended September 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 nine months ended September 30, 2004 as compared with the same period in 2003.

        Cost of royalties and other revenues was $634,000 and $1,060,000 for the nine months ended September 30, 2004 and 2003, respectively, a decrease of approximately 40%. Our cost of royalties and other revenues consists primarily of a royalty 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 nine months ended September 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 $121,117,000 and $142,141,000 for the nine months ended September 30, 2004 and 2003, respectively, a decrease of approximately 15%. The decrease for the nine months ended September 30, 2004 as compared with the same period in 2003 is primarily due to our decreased spending on our XOPENEX HFA MDI, tecastemizole, arformoterol and (S)-oxybutynin programs. We submitted an NDA for XOPENEX HFA MDI to the FDA in May 2004, which was accepted for filing in July 2004. 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 Phase IIIB/IV studies under our ESTORRA program.

        Below is a summary of our product candidates representing 10% or more of our direct project research and development spending during the nine months ended September 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

21

the nine months ended September 30, 2004, and the three product candidates listed accounted for approximately 84% of our direct project research and development spending during this period.

*

We received an "approvable" letter from the FDA in February 2004, and on July 15, 2004 we announced that the FDA had accepted our resubmission of our NDA for ESTORRA. The PDUFA date for ESTORRA is December 15, 2004.

**

We submitted the NDA for XOPENEX HFA MDI to the FDA in May 2004, and the FDA accepted the NDA for filing in July 2004. The PDUFA date for XOPENEX HFA MDI is March 12, 2005.

        Below is expenditure information related to our product candidates representing 10% or more of our direct project research and development spending during the nine months ended September 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.

        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 that the cost range to bring arformoterol from its current state to an NDA submission is $25,000,000 to $30,000,000 based on a targeted NDA submission of mid-2005, provided that no significant delays are imposed by internal resource constraints or unanticipated FDA requirements.

        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.

        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 $253,632,000 and $114,960,000 for the nine months ended September 30, 2004 and 2003, respectively, an increase of approximately 121%. Of the

22

121% increase, 27% 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 94% is primarily due to increases in salary, commission, travel and benefit costs as a result of having approximately 800 more sales representatives in the nine months ended September 30, 2004 than in the same period ended September 30, 2003, in anticipation of the commercialization of ESTORRA, which we expect to launch in January 2005, subject to receipt of final approval from the FDA in December 2004. We also incurred increased spending in the nine months ended September 30, 2004 as compared to the nine months ended September 30, 2003 for trade shows and promotions relating to preparation for the expected commercialization of ESTORRA. Additionally, as a result of the increase in sales of XOPENEX for the nine months ended September 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 expenses were $22,398,000 and $17,474,000 for the nine months ended September 30, 2004 and 2003, respectively, an increase of approximately 28%. The increase for the nine months ended September 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 $4,718,000 and $4,941,000 for the nine months ended September 30, 2004 and 2003, respectively. The decrease for the nine months ended September 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 $17,800,000 and $39,220,000 for the nine months ended September 30, 2004 and 2003, respectively. The decrease for the nine months ended September 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 nine months ended September 30, 2004 was $655,000,000 as compared to the average outstanding balance for the nine months ended September 30, 2003 of approximately $925,935,000.

        Loss on debt redemption was $7,022,000 and $4,645,000 for the nine months ended September 30, 2004 and 2003, respectively. The loss in the nine months ended September 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. The loss in the nine months ended September 30, 2003 resulted from our redemption of the remaining outstanding $111,870,000 face value of our 7% convertible subordinated debentures due 2005 for aggregate cash consideration of $115,226,000, excluding accrued interest. Included in the loss of $4,645,000 is the write-off of $1,289,000 of deferred financing costs related to the debentures.

        Loss on conversion of debt was $69,768,000 and $0 for the nine months ended September 30, 2004 and 2003, respectively. During September 2004, we converted $177,200,000 of our 0% Series A notes due 2008 and $351,980,000 of our 0% Series B notes due 2010, respectively. The loss represents the cash payments of $23,868,250 and $45,899,900 that we paid to the holders of the 0% Series A notes due 2008 and 0% Series B notes due 2010, respectively, as an inducement to convert their notes.

        Equity in investee (losses) were ($1,013,000) and ($1,701,000) for the nine months ended September 30, 2004 and 2003, respectively. The loss for the nine-month periods ended September 30, 2004 and 2003 represents our portion of BioSphere losses.

23

Liquidity and Capital Resources

        Cash, cash equivalents and short- and long-term investments totaled $791,030,000 at September 30, 2004, compared to $840,388,000 at December 31, 2003.

        The net cash used in operating activities for the nine months ended September 30, 2004 was $175,168,000. The net cash used in operating activities includes a net loss of $261,933,000 adjusted by non-cash charges of $92,124,000, which includes a loss on debt conversion of $69,768,000 and loss on early debt extinguishment of $7,022,000. Accounts receivable decreased by $9,671,000 due primarily to the decreased sales of XOPENEX during September 2004 as compared to December 2003 due to customary seasonal fluctuations. Inventory increased by $9,341,000 due to lower than expected sales volume, shifts in product mix and inventory build-up in anticipation of fourth quarter sales growth. On a combined basis, accounts payable and accrued expenses decreased by $15,010,000 primarily due to lower research and development costs. Other current liabilities increased by $2,863,000 primarily due to additional accruals for product revenue rebates and return reserves related to XOPENEX revenues. Other liabilities increased by $31,304,000 due to an accrual for $31,304,000, which represents the present value of a termination payment we will make to Ross.

        The net cash used in investing activities for the nine months ended September 30, 2004 was $125,193,000. Cash was used for net sales and maturities of short- and long-term investments of $116,732,000. We also made purchases of property and equipment of $8,498,000.

        The net cash provided by financing activities for the nine months ended September 30, 2004 was $136,293,000. 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. In January 2004, we received proceeds of $150,000,000, from the exercise of an option granted to the initial purchasers of our 0% Series A notes due 2008 and 0% Series B notes due 2010, to purchase an additional $50,000,000 of 0% Series A notes due 2008 and $100,000,000 of 0% Series B notes due 2010. Net of issuance costs, our proceeds were approximately $145,875,000. We received $500,000,000 from the issuance in September 2004 of 0% notes due 2024. Net of issuance costs, our proceeds were approximately $481,685,000. We received proceeds of $50,006,000 from the settlement of a portion of our call spread options. We also received proceeds of $36,745,000 from the issuance of common stock upon the exercise of stock options issued under our stock option plans. We used $100,321,000 to purchase 1,933,200 shares of our common stock. We paid $47,342,000 of the $69,768,000 we used as an inducement to convert $177,200,000 face value of our 0% Series A notes due 2008 and $351,980,000 face value of our 0% Series B notes due 2010 into an aggregate of 17,353,591 shares of our common stock. The remaining amount of $22,426,000 was paid during October 2004. We also used $771,000 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, which we terminated on October 1, 2004. 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:

•

regulatory approval of our late-stage product candidates, including ESTORRA, for which we received an "approvable" letter from the FDA on February 27, 2004, and have a PDUFA date of December 15, 2004 for our resubmitted NDA; and XOPENEX HFA MDI, for which we submitted an NDA to the FDA in May 2004 and which was accepted for filing in July 2004 and has a PDUFA date of March 12, 2005;



•

the progress of our preclinical, clinical and research programs;

24

•

the number and breadth of these programs;



•

achievement of milestones under our strategic alliance arrangements;



•

sales of our products;



•

acquisitions;



•

our ability to establish and maintain additional strategic alliances and licensing arrangements; and



•

the progress of our development efforts and the development efforts of our strategic partners.

        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 materially changed since we filed that report, as follows:

•

on January 9, 2004, we redeemed the remaining outstanding $430,000,000 face value of our 5.75% convertible subordinated notes due 2006, which was listed as a current liability at December 31, 2003;



•

on January 15, 2004, we issued $150,000,000 in aggregate principal amount of 0% Series A notes due 2008 and 0% Series B notes due 2010 as discussed in Note 7 in the Notes to Consolidated Interim Financial Statements;



•

during September 2004, we converted $177,200,000 and $351,980,000 of our 0% Series A notes due 2008 and 0% Series B notes due 2010, respectively, into an aggregate of 5,556,104 and 11,797,483 shares of our common stock, respectively, as discussed in Note 7 in the Notes to Consolidated Interim Financial Statements;



•

on September 22, 2004, we issued $500,000,000 in 0% notes due 2024 as discussed in Note 7 in the Notes to Consolidated Interim Financial Statements;



•

during the first half of 2004 we acquired approximately $4,707,000 of computer equipment under a capital lease. Payments on the capital lease are approximately $163,000 per month through December 2006; and

25

•

in March 2004, we amended our agreement with Ross for the co-promotion of XOPENEX brand levalbuterol HCl inhalation solution. 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.

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 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 $261.9 million for the nine months ended September 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:

•

results of clinical trials may not be consistent with preclinical study results;



•

results from later phases of clinical trials may not be consistent with the results from earlier phases;

26

•

results from clinical trials may not demonstrate that the product candidate is safe and efficacious;



•

we and/or our development partners may elect not to continue funding the development of our product candidates; and



•

funds may not be available for development of all of our product candidates.

        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. The PDUFA date for our ESTORRA NDA is December 15, 2004. 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. The PDUFA date for this NDA is March 12, 2005. If the FDA delays or denies approval of our NDA or trademark for ESTORRA or XOPENEX HFA MDI, or any other NDA that we file in the future, or if the FDA delays or denies approval of our use of the trademarks we propose to use in connection with the sale of our products, 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 the FDA approves ESTORRA, XOPENEX HFA MDI or any other NDA that we may file in the future, it may set unexpected limitations on the indication for which the product may be marketed, which could result in us failing to realize, or being delayed in realizing, expected product revenues.

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

27

the FDA for XOPENEX HFA MDI in May 2004 and the FDA accepted the NDA for filing 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.

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.

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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:

•

be developed successfully;



•

be proven safe and efficacious in clinical trials;



•

offer therapeutic or other improvements over comparable drugs;



•

meet applicable regulatory standards;



•

be approved for commercialization by the FDA;



•

be capable of being produced in commercial quantities at acceptable costs; or



•

be successfully marketed.

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 nine months ended September 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 and generic albuterol account for the majority of beta-agonist inhalation solution prescriptions. 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. Unit volume sales of XOPENEX for the three and nine months ended September 30, 2004 did not increase at the same rate as in prior periods. If XOPENEX does not continue to be viewed favorably by physicians relative to generic albuterol, our business will not be successful.

        A significant proportion of prescriptions for beta-agonist inhalation solutions (such as XOPENEX) are dispensed to patients who are eligible for Medicaid benefits. Many state Medicaid authorities are implementing preferred drug lists, or PDLs. XOPENEX's status on PDLs will vary from state to state and from time to time. We may be required to provide significant supplemental rebates for Medicaid utilization when and where XOPENEX is on the PDL. Where XOPENEX is not on the PDL, utilization of the product by Medicaid beneficiaries may decrease because physicians will be required to receive authorization from the Medicaid authority before XOPENEX may be prescribed.

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If we fail to adequately protect or enforce our intellectual property rights, then we could lose revenue under our collaboration 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, 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.

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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 eszopiclone, or the trademark we propose to use in connection with the product, or XOPENEX HFA MDI, or delays or denies acceptance or approval of 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 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:

•

results of clinical trials may not be consistent with preclinical study results;



•

results from later phases of clinical trials may not be consistent with the results from earlier phases; and



•

products may not be shown to be safe and efficacious.

        Even if the FDA or similar foreign agencies grant us regulatory approval of a product, including ESTORRA and XOPENEX HFA MDI, 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 may be required to expend additional funds to advance the drugs to commercialization;



•

revenue from product sales could be delayed; or



•

we may elect not to commercialize the drugs.

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        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 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, or GMP, regulations. The failure by us, our collaborative development partners or third-party manufacturers to maintain current GMP 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.

        On October 22, 2004 we commenced notifying drug wholesalers, hospitals and pharmacies of a manufacturer-initiated voluntary Class III recall of one component of our XOPENEX product line, XOPENEX Inhalation Solution Concentrate (1.25mg/0.5mL), which we had introduced in August 2004. The recall, which affects only XOPENEX Concentrate and no other components of our XOPENEX product line, was necessitated by packaging process validation issues relating to the automated process of placing the finished vials into a foil pouch. We have suspended manufacture and sale of XOPENEX Concentrate until the issues giving rise to the recall have been fully addressed. If our manufacturer cannot remedy the GMP deficiencies giving rise to the recall of XOPENEX Concentrate, or if these or similar deficiencies are found to extend to other components of our XOPENEX product line, our

32

ability to supply product to the market may be limited or interrupted indefinitely, which would have a material adverse effect on our business.

        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.

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

33

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 September 30, 2004, our total long-term debt excluding the current portion, was approximately $1.2 billion and our stockholders' equity (deficit) was ($379.6 million). None of the 5% convertible subordinated debentures due 2007, which we refer to as the 5% debentures due 2007, the 0% Series A notes due 2008, the 0% Series B notes due 2010 nor the 0% notes due 2024 restricts our ability or our subsidiaries' ability to incur additional indebtedness, including debt that ranks senior to the notes. The 0% notes due 2024 are senior to our 0% Series A notes and 0% Series B notes, which are senior to our 5% debentures due 2007. 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 due 2007, 0% Series A notes due 2008, 0% Series B notes due 2010 and 0% notes due 2024 are $92.38, $31.89, $29.84 and $67.20, 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 nine months ended September 30, 2004, net cash used in operating activities was approximately $175.2 million. Our annual debt service through 2006, assuming none of our outstanding convertible debt is 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 September 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 due 2007, future cash interest payments, we may, from time to time, depending on market conditions, repurchase

34

additional outstanding convertible debt for cash; pay debt holders cash in order to induce them to convert their debt into shares of common stock; 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 those 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:

•

patent developments;



•

licensing or acquisition opportunities;



•

relationships with collaboration partners;



•

the FDA regulatory process;



•

our capital requirements; and



•

selling, marketing and manufacturing expenses in connection with commercialization of products.

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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.

        XOPENEX and generic albuterol account for the majority of beta-agonist inhalation solution prescriptions. 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 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 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.

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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:

•

the results of clinical trials with respect to products under development;



•

the success and timing of regulatory filings and approvals for products developed by us or our collaboration partners or for collaboration agreements;



•

the success and timing of collaboration agreements for development of our pharmaceutical candidates and development costs for those pharmaceuticals;



•

the termination of development efforts of any product under development or any collaboration agreement;



•

the timing of receipt of upfront, milestone or royalty payments under collaboration agreements;



•

the timing of product sales and market penetration;



•

the mix of product sales and the related rebates and allowances;



•

the timing of operating expenses, including selling and marketing expenses and the costs of expanding and maintaining a direct sales force; and



•

the timing of expenses we may incur with respect to any license or acquisitions of products or technologies.

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:

•

preferred stock that could be issued by our board of directors to make it more difficult for a third party to acquire, or to discourage a third party from acquiring, a majority of our outstanding voting stock;



•

classification of our directors into three classes with respect to the time for which they hold office;



•

non-cumulative voting for directors;



•

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



•

limitations on the ability of stockholders to call special meetings of stockholders;



•

inability of our stockholders to take any action by written consent; and



•

advance notice requirements for nominations of candidates for election to our board of directors or for proposing matters that can be acted upon by our stockholders at stockholder meetings.

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        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 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 November 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.

        The amount that we will be able to realize from the exercise of our remaining outstanding call spread options is specifically tied to the market price of our common stock at the expiration of those options. The table below shows the effect a 10% increase or a 10% decrease in the price of our common stock would have on the value of the options, based on the closing price of our common stock on November 1, 2004 ($45.94).

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 September 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 September 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 September 30, 2004 that has materially affected, or is reasonably likely to materially affect, our internal controls over financial reporting.

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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 cooperated with the investigation, and plan to 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 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 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.

ITEM 2. ISSUER PURCHASES OF EQUITY SECURITIES

        This table provides information with respect to purchases we made of our Common Stock during the third quarter of 2004:

ITEMS 3-5. NONE

ITEM 6. EXHIBITS

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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.

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Exhibit Index

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