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SEPRACOR INC. INDEX

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 April 30, 2004 was: 85,586,673 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

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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 March 31, 2004 and 2003. Certain prior amounts have been reclassified to conform to current year presentation.

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

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

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

2. Recent Accounting Pronouncements

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

3. Basic and Diluted Net Loss Per Common Share

        Basic earnings (loss) per share, or EPS, excludes dilution and is computed by dividing income available to common shareholders by the weighted-average number of common shares outstanding for the period. Diluted EPS is based upon the weighted average number of common shares outstanding during the period plus the additional weighted average common equivalent shares during the period. Common equivalent shares are not included in the per share calculations where the effect of their inclusion would be anti-dilutive. Common equivalent shares result from the assumed conversion of preferred stock, convertible subordinated debt and the assumed exercise of outstanding stock options,

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the proceeds of which are then assumed to have been used to repurchase outstanding stock options using the treasury stock method. Purchased call options are also not included in the per share calculations because including them would be anti-dilutive.

        For the three months ended March 31, 2004 and 2003, basic and diluted net loss per common share is computed based on the weighted-average number of common shares outstanding during the period because the effect of common stock equivalents would be anti-dilutive. Certain securities were not included in the computation of diluted earnings per share for the three months ended March 31, 2004 and 2003 because they would have an anti-dilutive effect due to net losses for such periods. These excluded securities include the following:

        Options to purchase shares of common stock:

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

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 income and earnings 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 Other Intangible Assets

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

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

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7. Convertible Subordinated Debt

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

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

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

8. Comprehensive Loss

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

9. Commitments and Contingencies

        We enter into standard indemnification agreements in our ordinary course of business where we indemnify and hold harmless certain parties against claims, liabilities and losses brought by a third party to the extent that the claims arise out of (1) injury or death to person or property caused by defect in our product or product candidates, (2) negligence in the manufacture or distribution of our product or product candidates or (3) a material breach by us. We have no liabilities recorded for these guarantees at March 31, 2004. If liabilities were incurred, we have insurance policies covering product liabilities, which should mitigate, but may not eliminate, losses.

        We have agreements whereby we indemnify our officers and directors for certain events or occurrences while the officer or director is, or was, serving at our request in such capacity. The term of the indemnification period is for the officer's or director's lifetime. The maximum potential amount of

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future payments we could be required to make under these indemnification agreements is unlimited; however, we believe the fair value of these indemnification agreements is minimal.

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

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

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

10. Ross Agreement Amendment

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

11. Subsequent Event

        On April 30, 2004, we announced an amendment to our agreement with MedPointe Inc., or MedPointe, for the co-promotion of ASTELIN® brand azelastine HCl for the treatment of allergic rhinitis. Under the terms of the amendment, which becomes effective on July 1, 2004, we will only be responsible for providing sample coverage for ASTELIN under a fee-based compensation program. If we meet the sample coverage requirement for the three months ended September 30, 2004, we will earn $1,000,000. In addition, effective October 1, 2004, both parties have the unilateral right to terminate the agreement without cause. If the agreement is terminated by either party, we will receive a termination payment from MedPointe of $6,950,000, less any amount we earned prior to October 1, 2004 related to the sample coverage.

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

Significant 2004 Developments

        On April 30, 2004, we announced an amendment to our agreement with MedPointe Inc., or MedPointe, for the co-promotion of ASTELIN® brand azelastine HCl for the treatment of allergic rhinitis. Under the terms of the amendment, which becomes effective on July 1, 2004, we will only be responsible for providing sample coverage for ASTELIN under a fee-based compensation program. If we meet the sample coverage requirement for the three months ended September 30, 2004, we will earn $1,000,000. In addition, effective October 1, 2004, both parties have the unilateral right to terminate the agreement without cause. If the agreement is terminated by either party, we will receive a termination payment from MedPointe of $6,950,000, less any amount we earned prior to October 1, 2004 related to the sample coverage.

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

        On February 27, 2004, we received an "approvable" letter from the United States Food and Drug Administration, or FDA, for our New Drug Application, or NDA, for ESTORRA™ brand eszopiclone for the treatment of insomnia characterized by difficulty falling asleep, and/or difficulty maintaining sleep during the night and early morning. Contingent upon approval from the FDA, we would expect the recommended dosing to achieve sleep maintenance to be 2 mg or 3 mg for adult patients and 2 mg for elderly patients, and for elderly patients whose primary complaint is difficulty falling asleep, we would expect the recommended dosing to be 1 mg. The FDA has not requested additional clinical or

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

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

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

Critical Accounting Policies

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

Three Month Periods ended March 31, 2004 and 2003

Revenues

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

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

Costs of Revenues

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

        Cost of royalties and other revenues was $240,000 and $256,000 for the three months ended March 31, 2004 and 2003, respectively, a decrease of approximately 6%. Our cost of royalties and other revenues consists primarily of an obligation to a third-party as a result of royalties we receive from Schering-Plough Corporation based upon its sales of CLARINEX. The decrease for the three months ended March 31, 2004 as compared with the same period in 2003 resulted from the decrease in royalties we earned on sales of CLARINEX.

Research and Development

        Research and development expenses were $37,296,000 and $53,183,000 for the three months ended March 31, 2004 and 2003, respectively, a decrease of approximately 30%. The decrease for the three months ended March 31, 2004 as compared with the same period in 2003 is partially due to our decreased spending on ESTORRA brand eszopiclone, for which we submitted an NDA to the FDA in January 2003. The decrease is also due to our reduced spending on our tecastemizole and (S)-oxybutynin programs. We discontinued our development of tecastemizole in December 2003, and we have elected not to fund the (S)-oxybutynin clinical program at this time. Our decreased spending in these programs was partially offset by our increased spending on the XOPENEX hydrofluoroalkane metered-dose inhaler, or HFA MDI, and arformoterol programs.

        Drug development and approval in the United States is a multi-step process regulated by the FDA. The process begins with the filing of an Investigational New Drug Application, or IND, which, if successful, allows the opportunity for study in humans, or clinical study, of the potential new drug. Clinical development typically involves three phases of study: Phases I, II and III. The most significant costs in clinical development are in the Phase III clinical trials as they tend to be the longest and largest studies in the drug development process. Following successful completion of Phase III clinical trials, an NDA must be submitted to, and accepted by, the FDA, and the FDA must approve the NDA, prior to commercialization of the drug. As further discussed below, we currently have two product candidates in Phase III clinical trials and one NDA submitted in January 2003 and currently under FDA review. The successful development of our product candidates is highly uncertain. Product

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completion dates and completion costs can vary significantly for each product candidate and are difficult to predict. The lengthy process of seeking FDA approvals, and the subsequent compliance with applicable statutes and regulations, require the expenditure of substantial resources. Any failure by us to obtain, or delay in obtaining, regulatory approvals could materially adversely affect our business. We cannot assure you that we will obtain any approval required by the FDA on a timely basis, if at all.

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

        Below is a summary of our product candidates representing 10% or more of our direct project research and development spending during the three months ended March 31, 2004. The "Estimate of Completion of Phase" column contains forward-looking statements regarding timing of completion of product development phases. Completion of product development, if successful, culminates in the submission of an NDA to the FDA. The actual timing of completion of phases could differ materially from the estimates provided in the table. The table is sorted by highest to lowest spending amounts for the three months ended March 31, 2004, and the three product candidates listed accounted for approximately 87% of our direct project research and development spending during this period.

*

We expect to complete our Phase III trials of arformoterol in 2004. However, we do not anticipate filing an NDA for arformoterol before the first quarter of 2005.

**

We received an "approvable" letter from the FDA in February 2004.

        Below is expenditure information related to our product candidates representing 10% or more of ou