SEPRACOR INC /DE/ - SEPR Annual Report (10-K) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

The following is an excerpt from a 10-K SEC Filing, filed by SEPRACOR INC /DE/ on 4/1/2002.

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

A) Nature of the Business

Sepracor Inc. was incorporated in 1984 to research, develop and commercialize products for the synthesis, separation and purification of pharmaceutical and biopharmaceutical compounds. Sepracor Inc. is a research-based pharmaceutical company dedicated to treating and preventing human disease through the discovery, development, and commercialization of innovative pharmaceutical compounds, including product candidates directed toward serving unmet medical needs. Sepracor's drug development program has yielded an extensive portfolio of pharmaceutical compounds that are focused on the treatment of respiratory, urology, and central nervous system disorders. Sepracor's corporate headquarters are located in Marlborough, Massachusetts. Sepracor's 100% owned subsidiary, Sepracor Canada Ltd., supplies clinical material to Sepracor through its manufacturing facility in Windsor, Nova Scotia. Sepracor's approximately 25% equity investment in BioSphere Medical Inc. (which was majority owned through July 2, 2001) with operations in France and the United States, is committed to pioneering the use of patented and proprietary bioengineered microspheres as a new class of embolotherapy medical devices.

Sepracor and its subsidiaries are subject to risks common to companies in the industry including, but not limited to, the safety, efficacy and successful development and regulatory approval of product candidates, fluctuations in operating results, protection of proprietary technology, limited sales and marketing experience, dependence on third party collaboration agreements and third party sales efforts, limited manufacturing capacity, risk of product liability, compliance with government regulations and dependence on key personnel and collaborative partners.

B) Summary of Significant Accounting Policies

Principles of Consolidation: Consolidated financial statements include the accounts of Sepracor and all of its wholly- and majority-owned subsidiaries. All material intercompany transactions have been eliminated. Investments in affiliated companies, which are 50% owned or less, and where Sepracor does not exercise control, are accounted for using the equity method.

The Company accounts for the sale of subsidiary stock in different manners, depending on the life cycle of the entity. The Company offsets any gains or losses against additional paid-in capital for early development stage subsidiaries. For later stage subsidiaries where the Company sells shares of its subsidiary's stock, the Company records its gains and losses as other income or expense. For later stage subsidiaries selling additional shares of the subsidiary's stock, the Company records its gains or losses through additional paid-in capital.

Use of Estimates and Assumptions in the Preparation of Financial Statements: 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.

Reclassifications in the Preparation of Financial Statements: All references to share and per-share data for all periods presented have been adjusted to give effect for the two-for-one stock split effected in February 2000. Certain prior amounts have been reclassified to conform with current year presentation.

Translation of Foreign Currencies: The assets and liabilities of Sepracor's international subsidiaries are translated into U.S. dollars using current exchange rates. Statement of operations amounts are translated at average exchange rates prevailing during the period. The resulting translation adjustment

is recorded in accumulated other comprehensive income (loss). Foreign exchange transaction gains and losses are included in other income (expense).

Cash and Cash Equivalents: Cash equivalents are highly liquid, temporary cash investments having original maturity dates of three months or less.

Short and Long-Term Investments: Short and long-term investments include government securities and corporate commercial paper, which can be readily purchased or sold using established markets. Those investments with a maturity of less than one year are classified as short-term. Short and long-term investments are classified as either "available-for-sale" or "held-to-maturity". Available-for-sale investments are adjusted to their fair market value with unrealized gains and losses recorded as a component of accumulated other comprehensive income (loss). Realized gains and losses for securities classified as available-for-sale are included in earnings and are derived using the specific identification method for determining the cost of securities sold. Held-to-maturity investments are recorded at cost plus accrued amortization, which approximates fair value.

Concentration of Credit Risk: The Company has no significant off balance sheet concentration of credit risk such as foreign exchange contracts, option contracts or other foreign hedging arrangements. The Company maintains the majority of its cash balances with financial institutions. Financial instruments that potentially subject the Company to concentrations of credit risk primarily consist of the cash and cash equivalents, short and long-term investments and trade accounts receivable. The Company places its cash, cash equivalents and short-term and long-term investments with high credit quality financial institutions.

Revenues from significant customers are as follows:

Year Ended December 31,
2001 2000 1999
Customer A 17 % 16 % 15 % Customer B 15 % 9 % 11 % Customer C 17 % 3 % 16 % Customer D 12 % 9 % 11 % Customer E - 28 % -

Accounts Receivable and Bad Debt: Sepracor's trade receivables in 2001 and 2000 primarily represent amounts due to the Company from wholesalers, distributors and retailers of its pharmaceutical product. Sepracor performs ongoing credit evaluations of its customers and generally does not require collateral. Bad debt write-offs were not significant in 2001, 2000 and 1999; however the Company monitors its receivables closely due to few customers making up a large portion of the overall revenues.

Inventories: Inventories are stated at the lower of cost (first-in, first-out) or market. When the commercialization of a new product becomes probable, it is then capitalized. The Company writes down its inventory for expiry and probable quality assurance and quality control issues identified in the manufacturing process.

Property and Equipment: Property and equipment are stated at cost. Costs of major additions and betterments are capitalized; maintenance and repairs, which do not improve or extend the life of the respective assets are charged to operations. On disposal, the related cost and accumulated depreciation or amortization are removed from the accounts and any resulting gain or loss is included in the results of operations. Depreciation is computed using the straight-line method over the estimated useful lives of the assets. All laboratory, manufacturing and office equipment have estimated useful lives of three to ten years. The building has an estimated useful life of thirty years. Leasehold improvements are amortized over the shorter of the estimated useful lives of the improvements or the remaining term of

the lease. The Company has determined that in substance, under EITF 97-10, it is the owner of the building asset under construction and therefore has capitalized construction costs as construction in progress on the balance sheet.

Patents, Intangible Assets and Other Assets: Sepracor capitalizes significant costs associated with the filing of a patent application. Patent costs are amortized over their estimated useful lives, not to exceed 17 years. Deferred finance costs relating to expenses incurred to complete convertible subordinated debt offerings are amortized over five to seven years, the term of the debt. Capitalized license fees are amortized over the expected life of the licenses. Accumulated amortization was $6,849,000 and $6,317,000 at December 31, 2001 and 2000, respectively. Long-lived assets are reviewed for impairment by comparing the undiscounted projected cash flows of the related assets with their carrying amount. Any write-downs are treated as permanent reductions in the carrying amount of the assets.

The Company currently has long-lived assets relating to patents on drugs in late stages of clinical development but not yet approved. If these drugs fail to receive final FDA approval the Company could potentially have material write-downs of assets.

Revenue Recognition: Sepracor recognizes revenue from product sales when title to product and associated risk of loss has passed to the customer, and collectability is reasonably assured. All revenues from product sales are recorded net of applicable allowances for returns, rebates, and other applicable discounts and allowances.

Sepracor receives royalties related to the manufacture, sale or use of products or technologies under license arrangements with third parties. For those arrangements where royalties are reasonably estimable, Sepracor recognizes revenue based on estimates of royalties earned during the applicable period and adjusts for differences between the estimated and actual royalties in the following quarter. Historically, these adjustments have not been material. For those arrangements where royalties are not reasonably estimable, Sepracor recognizes revenue upon receipt of royalty statements from the licensee.

License fees and other revenue include non-refundable upfront license fees, milestones, and other revenues. Non-refundable upfront license fees are recorded as revenue over the related performance period or at such time when there are no remaining performance obligations. Milestones are recorded as revenue when achieved and only if there are no remaining performance obligations and the fees are non-refundable. Other revenue includes revenues recognized by BioSphere unrelated to its core EmboSphere Microsphere business.

Sepracor records collaborative research and development revenue from research and development contracts over the term of the applicable contract, as it incurs costs related to the contract.

Rebate and Return Reserves: Certain product sales qualify for rebates from standard list pricing due to government sponsored programs or other contractual agreements. The Company also allows for return of its product for up to one year after product expiration. Reserves for product returns and rebates are derived through an analysis of historical experience updated for changes in facts and circumstances as appropriate and by utilizing reports obtained from external, independent sources. If government contracts change materially, the associated reserves estimated for those programs can change significantly. Estimates of reserves for returns are impacted by the extended return cycle, and by other factors such as introduction of a new competitive product, or other change in market conditions leading to a change in historical return patterns.

Research and Development: All costs associated with internal research and development, research and development conducted for others and research and development services for which the Company has been contracted are expensed as incurred.

Income Taxes: The Company recognizes deferred tax liabilities and assets for the expected future tax consequences of events that have been included in the financial statements or tax returns. Under

this method, deferred tax liabilities and assets are determined based on the difference between the financial statement and tax basis of assets and liabilities using enacted tax rates in effect for the year in which the differences are expected to reverse.

Derivatives: In June 2000, the Financial Accounting Standards Board ("FASB") issued Statement of Financial Accounting Standard ("SFAS") No. 138, "Accounting for Certain Derivative Instruments and Certain Hedging Activities"-An Amendment to "FASB Statement No. 133." This statement establishes accounting and reporting standards for derivative instruments embedded in other contracts (collectively referred to as "derivatives") and for hedging activities. The statement requires companies to recognize all derivatives as either assets or liabilities, with the instruments measured at fair value. The accounting for changes in fair value, and resulting gains or losses, depends on the intended use of the derivative and its resulting designation. The Company adopted this new accounting standard effective January 1, 2001 and the impact of adoption was not material.

Comprehensive Income (Loss): Comprehensive income (loss) consists of net income (loss) and other comprehensive income (loss), which includes foreign currency translation adjustments and unrealized gains and losses on available-for-sale investments.

Basic and Diluted Net Loss Per Common Share: Basic earnings (loss) per share ("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 exercises 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.

For the years ended December 31, 2001, 2000 and 1999, 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 years ended December 31, 2001, 2000 and 1999 because they would have an anti-dilutive effect due to net losses for such periods. These securities include the following:

Options to purchase shares of common stock:

(In Thousands, Except
Price Per Share Data) 2001 2000 1999
Number of options 11,915 9,757 10,940 Price range per share $ 2.50 to $125.44 $ 2.50 to $125.44 $ 0.75 to $59.13

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

(In Thousands) 2001 2000 1999
6.25% convertible subordinated debentures due 2005 - 3,921 8,000 7% convertible subordinated debentures due 2005 4,804 4,804 4,805 5% convertible subordinated debentures due 2007 4,979 4,979 - 5.75% convertible subordinated notes due 2006 8,333 - - 18,116 13,704 12,805

Other:

In June 2001, the Financial Accounting Standards Board, or FASB, issued Statement of Financial Accounting Standards, or SFAS No. 141, "Business Combinations" and SFAS No. 142, "Goodwill and Other Intangible Assets." SFAS No. 141 requires that all business combinations be accounted for under the purchase method and that certain acquired intangible assets in a business combination be recognized as assets apart from goodwill. SFAS No. 142 requires that ratable amortization of goodwill and certain intangible assets be replaced with periodic tests of the goodwill's impairment and that intangible assets be amortized over their useful lives. SFAS No. 141 is effective for all business combinations initiated after June 30, 2001 and for all business combinations accounted for by the purchase method for which the date of acquisition is after June 30, 2001. The provisions of SFAS No. 142 will be effective for fiscal years beginning after December 15, 2001, and will thus be adopted by us in fiscal year 2002. However, for goodwill and intangible assets acquired after June 30, 2001, certain provisions of SFAS No. 142 will be effective from the date of acquisition. The Company notes that SFAS No. 141 does not currently have any effect on the reported financial results and does not expect the adoption of SFAS No. 142 to have a material impact on the Company's financial statements and related disclosures

In June 2001, the FASB issued SFAS No. 143, "Accounting for Asset Retirement Obligations." This statement addresses financial accounting and reporting for obligations associated with the retirement of tangible long-lived assets and the associated asset retirement costs. This statement applies to all entities. It applies to legal obligations associated with the retirement of long-lived assets that result from the acquisition, construction, development and/or the normal operation of a long-lived asset, except for certain obligations of lessees. This statement is effective for financial statements issued for fiscal years beginning after June 15, 2002. The Company does not believe that the adoption of this standard will have a material impact on the Company's financial statements and related disclosures.

In August 2001, the FASB issued SFAS No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets," which supercedes SFAS No. 121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of." SFAS No. 144 further refines the requirements of SFAS No. 121 that companies (1) recognize an impairment loss only if the carrying amount of a long-lived asset is not recoverable based on its undiscounted future cash flows and (2) measure an impairment loss as the difference between the carrying amount and fair value of the asset. In addition, SFAS No. 144 provides guidance on accounting and disclosure issues surrounding long-lived assets to be disposed of by sale. The Company will adopt SFAS No. 144 during the first quarter of 2002 and does not believe that the adoption of this standard will have a material impact on the Company's financial statements and related disclosures.

C) Sepracor Investments in Affiliates

Investment in Biosphere:

BioSphere was a consolidated subsidiary of Sepracor from 1994 through July 2, 2002. In May 1999, BioSphere sold a substantial portion of its business and assets to complete a transition from a chromatography and media company to a medical device company. (See Note I-Discontinued Operations.)

In February 2000, BioSphere completed a private placement of approximately $5,900,000 of BioSphere common stock and warrants. Investors purchased 653,887 shares of BioSphere common stock and warrants to purchase 163,468 shares of BioSphere common stock. The transaction resulted in Sepracor recording a net gain of approximately $2,771,000 through additional paid-in capital.

In July 2000, BioSphere sold approximately $13,000,000 of its common stock in a private equity placement of its common stock. Sepracor purchased approximately $5,000,000 of BioSphere common

stock in this transaction. The transaction resulted in Sepracor recording a net gain of approximately $1,702,000 through additional paid-in capital.

In July 2001, Sepracor sold 2,000,000 shares of BioSphere common stock held by it in a public offering in which BioSphere also sold 2,000,000 shares of its common stock at a price to the public of $11.00 per share. On August 2, 2001, the underwriters exercised their over-allotment option to purchase an additional 600,000 shares of BioSphere common stock from Sepracor at a price to the public of $11.00 per share. Sepracor received net proceeds, after offering costs, from the sales of approximately $26,526,000 and has recognized a gain of approximately $23,034,000 in 2001. Sepracor recorded approximately $5,590,000 through additional paid-in capital as its gain on BioSphere's sale of 2,000,000 shares of BioSphere common stock. As a result of the public offering, Sepracor's ownership in BioSphere has been reduced from approximately 55% to 25% as of December 31, 2001. Sepracor no longer consolidates the results of BioSphere and now records its investment in BioSphere under the equity method, effective July 3, 2001. Sepracor has recorded $1,601,000 as its share of BioSphere losses for the period ended December 31, 2001.

Investment in HMSR, Inc (Formerly Hemasure, Inc):

HemaSure has been an equity investment of Sepracor since 1995. In February 1999, the Company entered into an agreement with HemaSure pursuant to which Sepracor invested $2,000,000 in exchange for 1,333,334 shares of HemaSure common stock and warrants to purchase approximately 667,000 of additional shares of HemaSure common stock. In October 1999, HemaSure completed a private placement financing which resulted in Sepracor recording a gain of $820,000, which was recorded through additional paid-in capital. At December 31, 1999, Sepracor's ownership of HemaSure was approximately 27%.

In March 2000, HemaSure sold 3,730,000 shares of common stock in a private placement, thereby reducing Sepracor ownership to approximately 22%. Sepracor recorded a gain of approximately $1,417,000 through additional paid-in capital as a result of the transaction. Sepracor accounts for its investment in HemaSure using the equity method of accounting. At December 31, 2001 and 2000, Sepracor's ownership in HemaSure was approximately 23% and 22%, respectively and its investment in HemaSure was recorded at zero.

In February 2001, HemaSure signed an asset purchase agreement with Whatman plc. Under the terms of the agreement, Whatman agreed to purchase HemaSure's assets, except for cash, cash equivalents and marketable securities of HemaSure, subject to certain exceptions as defined in the agreement. On May 29, 2001, HemaSure completed the sale to Whatman Bioscience Inc., a Massachusetts corporation and a subsidiary of Whatman plc. Following the sale, HemaSure changed it corporate name to HMSR, Inc.

In November 2001, HMSR, Inc. announced that it had signed a definitive agreement to merge with Point Therapeutics, Inc. Following the merger, HMSR's current stockholders will own approximately 23% of the combined company.

Investment in Versicor:

Versicor, established as a subsidiary of Sepracor in 1995, completed various private equity transactions in April 1999, including the issuance of preferred stock, which reduced Sepracor's ownership in Versicor to approximately 18%. As a result of these transactions, Sepracor recorded a gain of $1,077,000, which was recorded through additional paid-in capital and began accounting for its investment in Versicor under the cost method. In October 1999, Versicor completed a private placement financing for approximately $40,000,000 in which Sepracor paid $1,000,000 to Versicor for Versicor preferred stock. As a result of this transaction, Sepracor's ownership of Versicor was approximately 10% at December 31, 1999. In August 2000, Versicor completed an initial public offering

of 5,290,000 shares of its common stock. Since Versicor's stock is now publicly traded, Sepracor considers its investment in Versicor as an available-for-sale security and as such Sepracor marks-to- market its investment at the end of each reporting period. At December 31, 2001 and 2000, the market price of Versicor's common stock was $20.25 and $8.625 per share, respectively, which resulted in the recording of unrealized gains of approximately $22,889,000 and $10,688,000, as a separate component of stockholders' equity as of December 31, 2001 and 2000, respectively.

As of December 31, 2001, Sepracor owns 1,809,143 shares, or approximately 8%, of Versicor's outstanding common stock. Sepracor also has warrants to purchase an additional 76,250 shares of Versicor common stock at $5.00 per share, which expire in December 2002. Sepracor recognized $1,252,000 as other income in 2001 for changes in the valuation of the warrants at December 31, 2001.

D) Cash, Cash Equivalents and Short-Term and Long-Term Investments

Cash, cash equivalents and short-term and long-term investments consist of the following at December 31:

(In Thousands) 2001 2000
Cash and Cash Equivalents:
Cash and money market funds $ 637,010 $ 41,321 Corporate and Government commercial paper 78,072 312,737 Total cash and cash equivalents $ 715,082 $ 354,058

Short and long-term investments classified as available-for-sale or held-to-maturity consist of the following at December 31:

2001 2000
Available- Held-to- Available- Held-to- (In Thousands) For-Sale Maturity For-Sale Maturity
Due within 1 year
Corporate commercial paper $ - $ 116,063 $ 5,069 $ 243,749 Due in greater than 1 year
Corporate commercial paper 27,678 45,566 26,641 4,962 Total short-term and long-term $ 27,678 $ 161,629 $ 31,710 $ 248,711 investments

Unrealized gains on available-for-sale securities at December 31, 2001 and 2000 were approximately $23,000 and $60,000, respectively. Held-to-maturity securities are recorded at cost plus accrued amortization, which approximates fair value. Realized gains and losses on available-for-sale and held-to-maturity securities were insignificant in 2001 and 2000.

The Company also has an investment in Versicor, which it began classifying as an available-for-sale security in August 2000, upon Versicor's initial public offering. The Company has marked to market its investment in Versicor at December 31, 2001 and has recorded an unrealized gain of approximately $22,889,000, which is included as a separate component of stockholders' equity.

E) Financial Instruments

Financial instruments consist of the following at December 31:

2001 2000
Carrying (In Thousands) Carrying Amount Fair Value Amount Fair Value
6.25% convertible subordinated
debentures, due 2005 $ - $ - $ 92,858 $ 317,054 7% convertible subordinated
debentures, due 2005 $ 299,960 $ 313,188 $ 299,960 $ 424,263 5% convertible subordinated
debentures, due 2007 $ 460,000 $ 399,050 $ 460,000 $ 481,160 5.75% convertible subordinated
notes, due 2006 $ 500,000 $ 545,200 $ - $ - $ 1,259,960 $ 1,257,438 $ 852,818 $ 1,222,477

The fair value of all the convertible subordinated debt is from a quoted market source.

F) Accounts Receivable

Sepracor's trade receivables in 2001 and 2000 primarily represent amounts due to the Company from wholesalers, distributors and retailers of its pharmaceutical product. Sepracor performs ongoing credit evaluations of its customers and generally does not require collateral. The allowance for doubtful accounts and payment term discounts related to accounts receivable was $585,000 and $378,000 at December 31, 2001 and 2000, respectively.

Customers with amounts due to the Company that represent greater than 10% of the accounts receivable balance are as follows:

Year Ended December 31,
2001 2000
Customer A 30 % 24 % Customer B 18 % 11 % Customer C 9 % 11 %

G) Inventories

Inventories consist of the following at December 31:

(In Thousands) 2001 2000
Raw materials $ 1,231 $ 2,322 Work in progress 103 432 Finished goods 8,439 3,244 $ 9,773 $ 5,998

H) Property and Equipment and Patents, Intangible and Other Assets

Property and equipment consist of the following at December31:

(In Thousands) 2001 2000
Land $ 85 $ 85 Building 2,586 2,967 Laboratory and manufacturing equipment 17,884 15,812 Office equipment 18,986 15,349 Leasehold improvements 5,179 5,239 44,720 39,452 Accumulated depreciation and amortization (22,047 ) (16,950 ) 22,673 22,502 Construction in progress-Building(1) 18,672 - Construction in progress-Software and computers 2,501 174 $ 43,846 $ 22,676

Depreciation expense was $6,246,000, $5,139,000 and $4,487,000 for the years ended December 31, 2001, 2000 and 1999, respectively.

(1) The Company has signed a lease to occupy a new building, which is being constructed. The lease has a term of 15 years, and will begin on the occupancy date contingent upon the completion of the building, expected to be June 2002. Sepracor is financing the construction of the building through two interest bearing, secured loans totaling up to approximately $27,000,000, to be loaned by Sepracor to the developer of the site. Sepracor will have first right to purchase the entire property from the developer beginning in June 2002 and extending through January 2004. At December 31, 2001, Sepracor has incurred $18,672,000 of building costs, which have been capitalized as construction in progress on the balance sheet in accordance with EITF 97-10.

Patents, intangible assets and other assets, net consist of the following at December 31:

(In Thousands) 2001 2000
Deferred finance costs, net(1) $ 30,087 $ 20,734 Intangible assets and patents, net 29,504 31,789 Other assets 788 1,568 $ 60,379 $ 54,091

º (1)
º The 2001 balance includes $14,500,000 of costs associated with the $500,000,000 in principal amount of 5.75% convertible subordinated notes due 2006, issued in 2001. The 2001 and 2000 balance includes $14,033,000 of costs associated with the $460,000,000 in principal amount of 5% convertible subordinated debentures due 2007, issued in 2000.

I) Discontinued Operations

On May 17, 1999, BioSphere sold substantially all of its assets and business, other than such assets and business relating to intracorporeal and on-line extracorporeal therapies or any autologous treatment, for approximately $11,000,000 in cash, and the assumption of certain liabilities. Upon the consummation of the sale, BioSepra Inc. changed its name to BioSphere Medical, Inc. BioSphere utilized a portion of the proceeds to pay approximately $880,000 of transaction costs, to repay approximately $2,000,000 of outstanding bank debt, and to repay approximately $143,000 due to Sepracor.

The net assets included in the sale had a net book value of approximately $10,500,000 on May 17, 1999, which was included in calculating a net loss for the sale of approximately $70,000. The operations, assets and liabilities of the business have been presented in accordance with Accounting Principles Board (APB) Opinion No. 30, Reporting the Results of Operations-Reporting the Effects of Disposal of a Segment of a Business, and Extraordinary, Unusual and Infrequently Occurring Events and Transactions in the accompanying financial statements. Accordingly, the operating results of the discontinued business for the year ended December 31, 1999 have been segregated from the continuing operations and reported as a separate line item on the consolidated statements of operations.

J) Accrued Expenses

Accrued expenses consist of the following at December 31:

(In Thousands) 2001 2000
Research and development costs $ 41,321 $ 31,114 Sales and marketing costs 25,465 7,115 Interest on convertible subordinated debt 13,030 11,616 Compensation costs 11,678 9,707 Other 11,104 6,008 $ 102,598 $ 65,560

K) Notes Payable and Long-Term Debt

Notes payable and long-term debt consist of the following at December 31:

(In Thousands) 2001 2000
Government grant from Nova Scotia Department of Economic Development $ 779 $ 830 Loan from Atlantic Canada Opportunities Agency, non-interest bearing, repayable in 60 equal installments commencing March 15, 1998 78 150 French Franc bank loan bearing interest at 5.4% payable in monthly installments through March 2005, secured by certain assets of BioSphere - 124 Obligations under capital leases (See Note M) 1,203 138 2,060 1,242 Less current portion (624 ) (144 ) Total $ 1,436 $ 1,098

Sepracor's wholly-owned subsidiary, Sepracor Canada Limited, has an interest free credit agreement with a Canadian provincial business development agency for approximately $370,000 in term debt. At December 31, 2001, Sepracor Canada Limited had received approximately $370,000 of such term debt, of which approximately $78,000 remains outstanding. Sepracor Canada Limited also has a Canadian Government grant which may be repayable if Sepracor Canada Limited fails to meet certain conditions. The grant is recorded as debt and is being amortized over the useful lives of the related capital assets. The unamortized balance as of December 31, 2001 was approximately $779,000.

In December 2001, Sepracor amended its revolving credit agreement (the "Revolving Credit Agreement") with a commercial bank to remove BioSphere as a party to the Revolving Credit Agreement and extend the term to March 31, 2002. The Revolving Credit Agreement provides for borrowing of up to $25,000,000. Interest is payable monthly in arrears at prime (4.75% at December 31, 2001) or the LIBOR rate (1.9% at December 31, 2001) plus .75%. All borrowings are collateralized by certain assets of the company. The Revolving Credit Agreement contains covenants relating to minimum tangible capital base, minimum cash or cash equivalents, minimum liquidity ratio

and maximum leverage. At December 31, 2001 and 2000, there was $0 outstanding under this agreement.

Minimum annual principal repayment of notes payable and long-term debt, excluding capital leases is as follows: 2002-$67,000, 2003-$11,000, none thereafter.

L) Convertible Subordinated Debt

In February 1998, Sepracor issued $189,475,000 in principal amount of 6.25% convertible subordinated debentures due 2005 (the "6.25% Debentures"). The 6.25% Debentures were convertible into Sepracor common stock, at the option of the holder, at a price of $23.685 per share and bore interest at 6.25% payable semi-annually, commencing on August 15, 1998. The 6.25% Debentures were redeemable by the Company commencing February 2001. As part of the sale of the 6.25% Debentures, Sepracor incurred approximately $6,105,000 of offering costs, which were recorded as other assets and were being amortized over seven years, the term of the 6.25% Debentures. The net proceeds to the Company after offering costs were approximately $183,370,000.

In February 2000, Sepracor converted $96,424,000 in principal amount of its 6.25% Debentures. Costs related to the conversion of the 6.25% Debentures, including inducements and other costs of approximately $7,497,000, were recorded as other expense. As a result of the conversion, Sepracor issued 4,071,176 shares of Sepracor common stock and wrote off approximately $2,373,000 of deferred finance costs against additional paid-in capital.

In January 2001, the Company announced that on February 21, 2001 it would redeem the $92,858,000 in principal amount of 6.25% Debentures that remained outstanding. On February 20, 2001, prior to the redemption, all outstanding 6.25% Debentures were converted. As a result of the conversion, Sepracor issued 3,920,608 shares of Sepracor common stock and wrote off approximately $1,525,000 of deferred finance costs against additional paid-in capital.

In December 1998, Sepracor issued $300,000,000 in principal amount of 7% convertible subordinated debentures due 2005 (the "7% Debentures"). The 7% Debentures are convertible into Sepracor common stock, at the option of the holder, at a price of $62.4375 per share and bear interest at 7% payable semi-annually, commencing on June 15, 1999. The 7% Debentures were not redeemable by the Company until December 20, 2001. The Company may be required to repurchase the 7% Debentures at the option of the holders if there was a change in control of the Company. As part of the sale of the 7% Debentures, Sepracor incurred approximately $9,919,000 of offering costs, which were recorded as other assets and are being amortized over seven years, the term of the 7% Debentures. The net proceeds to the Company after offering costs were approximately $290,081,000.

In February 2000, Sepracor issued $400,000,000 in principal amount of 5% convertible subordinated debentures due 2007 (the "5% Debentures"). On March 9, 2000, Sepracor issued an additional $60,000,000 in principal amount of 5% Debentures pursuant to an option granted to the initial purchaser of the 5% Debentures. The 5% Debentures are convertible into Sepracor common stock, at the option of the holder, at a price of $92.38 per share and bear interest at 5% payable semi-annually, commencing on August 15, 2000. The 5% Debentures are redeemable by the Company prior to February 15, 2003 if the trading price of Sepracor common stock exceeds 150% of the conversion price ($138.57) for 20 trading days in a period of 30 consecutive trading days. The 5% Debentures are redeemable by the Company on or after February 15, 2003 if the trading price of Sepracor common stock exceeds 120% of the conversion price ($110.86) for 20 trading days in a period of 30 consecutive trading days. The Company may be required to repurchase the 5% Debentures at the option of the holders if there is a change in control of the Company. As part of the sale of the 5% Debentures, Sepracor incurred approximately $14,033,000 of offering costs, which were recorded as other assets and are being amortized over seven years, the term of the 5% Debentures. The net proceeds to the Company after offering costs were approximately $445,967,000.

In November 2001, Sepracor issued $400,000,000 in principal amount of 5.75% convertible subordinated notes due 2006 (the "5.75% Notes"). In December 2001, Sepracor issued an additional $100,000,000 in principal amount of 5.75% Notes pursuant to an option granted to the initial purchaser of the 5.75% Notes. The 5.75% Notes are convertible into Sepracor common stock, at the option of the holder, at a price of $60.00 per share. The 5.75% Notes bear interest at 5.75% payable semiannually, commencing on May 15, 2002. The 5.75% Notes are convertible at the option of the Company prior to maturity if the closing price of Sepracor common stock exceeds 145% of the conversion price ($87.00) for at least 20 out of 30 consecutive trading days ending within five trading days prior to notice of conversion. The Company may be required to repurchase the 5.75% Notes at the option of the holders if there is a change in control of the Company. As part of the sale of the 5.75% Notes, Sepracor has incurred offering costs of approximately $13,982,000 and expects to incur total costs of $14,500,000 which have been recorded as other assets and are being amortized over five years, which is the term of the 5.75% Notes. The estimated net proceeds to the Company after offering costs are expected to be approximately $485,500,000.

M) Commitments and Contingencies

Future minimum lease payments under all noncancelable leases in effect at December 31, 2001, are as follows (in thousands):

Year Operating Leases Capital Leases
2002 $ 1,247 $ 579 2003 899 575 2004 832 130 2005 809 - 2006 809 - Thereafter 404 - Total minimum lease payments $ 5,000 $ 1,284 Less amount representing interest - (81 ) Present value of minimum lease payments $ 5,000 $ 1,203

Future minimum lease payments under operating leases relate primarily to Sepracor's principal office, laboratory and production facilities. Most of the lease terms provide options to extend the leases and require Sepracor to pay its allocated share of taxes and operating costs in addition to the annual base rent payments. Capital leases relate primarily to telephone systems and computer equipment purchased under capital lease agreements. Rental expense under these and other leases amounted to $1,384,000, $1,576,000 and $1,683,000 for the years ended December 31, 2001, 2000 and 1999, respectively.

N) Litigation

Currently, Sepracor is not party to any material legal proceedings.

O) Stockholders' Equity (Deficit)

In July 2001, Sepracor completed the sale of 2,000,000 shares of BioSphere common stock held by it in a public offering in which BioSphere also sold 2,000,000 shares of its common stock at a price to the public of $11.00 per share. On August 2, 2001, the underwriters exercised their over-allotment option to purchase an additional 600,000 shares of BioSphere common stock from Sepracor at a price to the public of $11.00 per share. Sepracor received net proceeds, after offering costs, from the sales of approximately $26,526,000 and has recognized a gain of approximately $23,034,000 in 2001. Sepracor recorded approximately $5,590,000 through additional paid-in capital as its gain on BioSphere's sale of

2,000,000 shares of BioSphere common stock. As a result of the public offering, Sepracor's ownership in BioSphere has been reduced from approximately 55% to 25% as of December 31, 2001. Sepracor no longer consolidates BioSphere and now records its investment in BioSphere under the equity method, effective July 3, 2001. Sepracor has recorded $1,601,000 as its share of BioSphere losses for the period ended December 31, 2001.

In January 2001, the Company announced that on February 21, 2001 it would redeem the $92,858,000 in principal amount of 6.25% convertible subordinated debentures due 2005 that remained outstanding. On February 20, 2001, prior to the redemption, all outstanding 6.25% Debentures were converted. As a result of the conversion, 3,920,608 shares of Sepracor common stock were issued and deferred financing costs of approximately $1,525,000 were written off against additional paid-in capital.

In August 2000, Versicor completed an initial public offering of 5,290,000 shares of its common stock. Since Versicor's stock is now publicly traded, Sepracor considers its investment in Versicor as an available-for-sale security and as such Sepracor marks-to-market its investment at the end of each reporting period and records the investment as investment in affiliates on the balance sheet. At December 31, 2001 and 2000, the market price of Versicor's common stock was $20.25 and $8.625 per share, respectively, which resulted in the recording of unrealized gains of approximately $22,889,000 and $10,688,000, as a separate component of stockholders' equity as of December 31, 2001 and 2000, respectively. Sepracor's ownership in Versicor at December 31, 2001 and 2000 was approximately 8%.

In July 2000, BioSphere completed the sale of approximately $13,000,000 of its common stock in a private equity placement. Of this amount, Sepracor purchased approximately $5,000,000 of BioSphere common stock. As a result of the transaction, Sepracor recorded a net gain of approximately $1,702,000 through additional paid-in capital.

In May 2000, the stockholders of Sepracor approved an amendment to Sepracor's Restated Certificate of Incorporation, as amended, increasing from 140,000,000 to 240,000,000 the number of authorized shares of common stock.

In March 2000, HemaSure completed a $28,000,000 private placement of common stock, consisting of 3,730,000 shares of HemaSure common stock. The transaction resulted in Sepracor recording a gain of approximately $1,417,000 through additional paid-in capital.

In January 2000, Sepracor's Board of Directors approved a two-for-one stock split. The stock split was effected in the form of a 100% stock dividend on February 25, 2000, to stockholders of record on February 1, 2000. All share data and stock prices have been adjusted to reflect the stock split for all periods presented.

In August 1999, Sepracor paid Georgetown University $10,000,000 in cash and issued 200,000 shares of Sepracor common stock to obtain all rights, title and interest held by Georgetown relating to terfenadine carboxylate, norastemizole (tecastemizole), intraconazole enantiomers and ketoconazole enantiomers. The intellectual property rights purchased from Georgetown are being amortized over a ten-year period.

Sepracor has recorded unearned compensation expense related to stock options granted to certain consultants. The table below summarizes the unearned compensation activity for the years ended December 31, 2001, 2000 and 1999.

Unearned Compensation

(In Thousands) 2001 2000 1999
Balance at January 1, $ (189 ) $ (217 ) $ (144 ) Stock option grants - (40 ) (129 ) Amortization expense 69 68 56 Balance at December 31, $ (120 ) $ (189 ) $ (217 )

P) Stock Plans

The Company has stock-based compensation plans, which are described below. The Company records the issuance of stock options using APB Opinion 25 and related interpretations in accounting for its plans. However, if compensation cost for the Company's stock-based compensation plans had been determined based on the fair value at the grant dates, the Company's net loss and basic and diluted loss per share for the years ended December 31, 2001, 2000 and 1999 would have been increased to the pro forma amounts indicated in the following table:

2001 2000 1999

(In
Thousands,
Except Loss Basic and Basic and Basic and Per Share Net Diluted Loss Net Loss(1) Net Diluted Loss Amounts) Loss Per Share Loss(1) Per share Loss(1) Per Share
As reported $ (224,015 ) $ (2.89 ) $ (204,017 ) $ (2.80 ) $ (183,059 ) $ (2.77 ) Pro forma $ (280,761 ) $ (3.62 ) $ (247,187 ) $ (3.40 ) $ (213,279 ) $ (3.23 )

º (1)
º Net loss represents net loss applicable to common shares.

The fair value of each stock option is estimated on the date of grant using the Black-Scholes option-pricing model with the following weighted average assumptions:

2001 2000 1999
Expected option life 6 years 6.70 years 5.66 years Expected volatility 75% 70% 55% Risk-free interest rate 4.88% 6.28% 5.81% Dividends None None None

The 1991 Restated Stock Option Plan (the "1991 Plan") provides for the granting of Incentive Stock Options ("ISOs") to officers and key employees of Sepracor and nonstatutory stock options ("NSOs") to officers, employees, consultants and directors of Sepracor. ISOs and NSOs granted under the Plan have a maximum term of ten years from the date of grant and have an exercise price not less than the fair value of the stock on the date of grant and vest generally over five years. In 1999, the stockholders approved an amendment to the 1991 Plan increasing the number of shares of common stock, which may be granted to 18,000,000. In 2001, the 1991 Plan expired.

The 1991 Directors Stock Option Plan (the "1991 Directors Plan") provides for the granting of NSOs to directors of Sepracor who are not officers or employees of Sepracor. The options granted under the 1991 Directors Plan have a maximum term of ten years from date of grant and have an exercise price of not less than the fair market value of the stock on the date of grant and vest over five years. In May 1998, the stockholders approved an amendment to the 1991 Directors Plan increasing the number of shares of common stock, which may be granted to 1,000,000. In 2001, the 1991 Directors Plan expired.

The 1997 Stock Option Plan (the "1997 Plan") permits the Company to grant ISOs and NSOs to purchase up to 1,000,000 shares of common stock to employees and consultants of the Company.

Executive officers are not entitled to receive stock options under the 1997 Plan. ISOs and NSOs granted under the 1997 Plan have a maximum term of ten years from the date of grant and generally vest over five years. ISOs may not be granted at an exercise price less than fair market value.

The 1999 Director Stock Option Plan (the "1999 Director Plan") permits the Company to grant NSOs to purchase 1,800,000 shares of common stock to non-employee directors of the Company. Options granted under the 1999 Director Plan have a maximum term of ten years from the date of grant and have an exercise price not less than the fair value of the stock on the date of grant and vest over a period of one to five years.

The 2000 Stock Option Plan (the "2000 Plan") permits the Company to grant ISOs, NSOs and restricted stock awards to purchase 2,500,000 shares of common stock to employees, officers, directors and consultants of the Company. Stock options granted under the 2000 Plan have a maximum term of ten years from the date of grant, have an exercise price not less than the fair value of the stock on the grant date and generally vest over five years.

The following tables summarize information about stock options outstanding at December 31, 2001 (in thousands, except for per share amounts and contractual life):

Options Exerciable Options -------------------------------- Outstanding Weighted Average Range of Remaining Exercise Number of Contractual Weighted-Average Number of Weighted-Average Price Options Life Exercise Price Per Options Exercise Price Per Per Share Outstanding (Years) Share Exercisable Share
$2.50 - 8.56 1,253 3.9 $ 6.64 1,239 $ 6.65 11.25 - 19.00 2,313 6.1 16.14 1,331 16.28 20.00 - 28.01 1,872 8.2 23.83 500 22.74 31.13 - 39.06 2,300 8.2 35.18 554 35.35 41.59 - 48.52 1,224 7.9 44.92 447 43.61 50.50 - 59.13 1,526 7.7 57.76 356 58.47 71.88 - 73.88 303 8.8 72.19 61 72.19 87.31 - 87.50 861 8.3 87.34 159 87.45 92.25 - 92.25 142 8.2 92.25 28 92.25 125.44 - 121 8.6 125.44 24 125.44 125.44

$2.50 - 125.44 11,915 7.3 $ 36.89 4,699 $ 26.61

2001 2000 1999

Average Average Average Number of Price Number of Price Number of Price Options Per Share Options Per Share Options Per Share
Balance at January 1, 9,757 $ 37.05 10,940 $ 25.37 9,870 $ 14.65 Granted 2,687 34.91 1,534 88.90 3,251 47.16 Exercised (238 ) 12.99 (2,235 ) 14.37 (1,920 ) 6.11 Cancelled (252 ) 50.35 (482 ) 30.10 (261 ) 33.99 Expired (39 ) 48.52 - - - - Balance at
December 31, 11,915 $ 36.89 9,757 $ 37.05 10,940 $ 25.37 Options exercisable
at December 31, 4,699 2,576 2,275 Weighted-average fair
value of options
granted during the
year $ 24.77 $ 63.28 $ 28.86

There were 2,128,000 options available for future grant as of December 31, 2001.

The 1996 Employee Stock Purchase Plan (the "1996 ESPP") permits an aggregate of 240,000 shares of common stock to be purchased by employees at 85% of market value on the first or last day of each six month offering period, whichever is lower, through accumulation of payroll deductions ranging from 1% to 10% of compensation as defined, subject to certain limitations. Employees purchased approximately 59,000, 33,000 and 48,000 shares for a total of $1,666,000, $1,701,000 and $1,284,000, during the years ended December 31, 2001, 2000 and 1999, respectively. At December 31, 2001, there were no shares of common stock authorized for future issuance under the 1996 ESPP.

The 1998 Employee Stock Purchase Plan (the "1998 ESPP") permits an aggregate of 600,000 shares of common stock to be purchased by employees at 85% of market value on the first or last day of each six month offering period, whichever is lower, through accumulation of payroll deductions ranging from 1% to 10% of compensation as defined, subject to certain limitations. Employees purchased approximately 12,000 shares for a total of $350,000, during the year ended December 31, 2001. At December 31, 2001, there were 588,000 shares of common stock authorized for future issuance under the 1998 ESPP.

Q) Income Taxes

Sepracor's statutory and effective tax rates were 34% and 0%, respectively, for the years 2001, 2000 and 1999. The effective tax rate was 0% due to net operating losses ("NOL") and nonrecognition of any deferred tax asset.

Deferred tax assets and liabilities are recognized for the estimated future tax consequences attributable to tax benefit carryforwards and to differences between the financial statement amounts of assets and liabilities and their respective tax basis. Deferred tax assets and liabilities are measured using enacted tax rates. A valuation reserve is established if it is more likely than not that all or a portion of the deferred tax asset will not be realized. Accordingly, a valuation reserve has been established for the full amount of the deferred tax asset. Of the total valuation allowance, approximately $60,600,000 relates to stock option compensation deductions. The tax benefit associated with the stock option compensation deductions will be credited to equity when realized.

At December 31, 2001, Sepracor had federal and state tax NOL carryforwards of approximately $693,000,000 and $558,000,000, which will expire through 2021 and 2006, respectively. Based upon the Internal Revenue Code and changes in Company ownership, utilization of the NOL may be subject to an annual limitation. Sepracor also has an NOL from its operation in Canada of approximately $2,700,000, which may be carried forward indefinitely. At December 31, 2001, Sepracor had federal and state research and experimentation credit carryforwards of approximately $27,000,000 and $21,000,000, respectively, which will expire through 2021 and 2016, respectively. Sepracor also had Canadian research and experimentation credits of $2,000,000, which begin to expire in 2004.

The components of Sepracor's net deferred taxes were as follows at December 31:

2001 2000

Assets
NOL carryforwards $ 289,979 $ 277,432 Reserves 7,730 4,382 Tax credit carryforward 50,119 35,225 Patent (2,470 ) 926 Accrued expenses 36,535 16,562 Research and development capitalization 56,361 15,461 Intangibles 2,595 2,915 Property and equipment 1,225 742 Other 1,413 1,437 Liabilities
Basis difference of subsidiaries (5,956 ) (3,781 ) Valuation Allowance (437,531 ) (351,301 ) Net deferred taxes $ - $ -

R) Agreements

Revenue-related Agreements

Tecastemizole. Effective January 1998, Sepracor and Janssen Pharmaceutica, N.V., a wholly-owned subsidiary of Johnson & Johnson ("Janssen"), entered into an agreement (the "Tecastemizole Agreement"; formerly referred to as the "Norastemizole Agreement"), relating to the development and marketing of tecastemizole (formerly norastemizole), a third generation nonsedating antihistamine. Under the terms of the Tecastemizole Agreement, the companies agreed to jointly fund the development of tecastemizole, and Sepracor granted to Janssen an option to acquire certain rights regarding the product in the United States and abroad. In May 1999, Sepracor announced that Johnson & Johnson elected not to exercise its option to co-promote tecastemizole under the Tecastemizole Agreement. Sepracor continued to fund clinical development and marketing of the drug and submitted an NDA to the FDA for SOLTARA brand tecastemizole in March 2001. Under the terms of the Tecastemizole Agreement, Sepracor has worldwide rights to make, use, and sell prescription tecastemizole products under all Johnson & Johnson intellectual property rights relating to tecastemizole, including the right to reference Johnson & Johnson's data for astemizole, in exchange for royalty payments on sales of tecastemizole. Sepracor anticipates selling SOLTARA, if approved, through its own expanded sales force.

Fexofenadine. In September 1999, Hoechst Marion Roussel Inc. (now Aventis) and Sepracor settled patent issues with respect to fexofenadine, marketed by Aventis as ALLEGRA, and amended their existing agreement (as so amended, the "Aventis Fexofenadine Agreement"). Under the terms of the U.S. Aventis Fexofenadine Agreement, Aventis received all rights to Sepracor's patents with respect to fexofenadine and obtained an exclusive license to various Sepracor U.S. patent applications related to fexofenadine. In October 1999, upon effectiveness of the amended Aventis Fexofenadine Agreement, Sepracor recognized license fee revenue of $1,875,000 from a milestone payment that had been previously deferred. Sepracor has earned royalties on fexofenadine sales in the United States since February 2001. Under the terms of a separate ex-U.S. Aventis Fexofenadine Agreement, Aventis obtained an exclusive license to Sepracor's patents related to fexofenadine, that had been the subject of litigation in Europe, as well as various other patent oppositions between the two companies outside the United States. Sepracor has been entitled to royalties on fexofenadine product sales since March 1, 1999 in countries where Sepracor has patents related to fexofenadine. The Company recorded

$25,379,000, $2,495,000 and $1,746,000 of royalty revenues under the Aventis Fexofenadine Agreement in 2001, 2000 and 1999, respectively.

Levocetirizine. In June 1999, Sepracor entered into a licensing agreement with UCB Farchim SA, an affiliate of UCB ("UCB"), relating to levocetirizine, an isomer of cetirizine, which is marketed by UCB as ZYRTEC (the "UCB Agreement"). Under the terms of the UCB Agreement, Sepracor has exclusively licensed to UCB all of Sepracor's issued patents and pending patent applications relating to levocetirizine in all countries, except the United States and Japan. Sepracor is entitled to receive royalties under the UCB Agreement upon first product sales and royalties will escalate upon achievement of sales volume milestones. In September 2001, UCB announced that European Union Member States granted a positive opinion for levocetirizine, a single isomer of ZYRTEC, for the treatment of symptoms of seasonal allergic rhinitis (SAR), perennial allergic rhinitis (PAR) and chronic idiopathic urticaria (CIU), or hives of unknown cause, in adults and children aged 6 years and older. UCB has marketed levocetirizine under the brand names XUSAL and XYZAL in Germany since February 2001, and in 4 other European countries during the fourth quarter of 2001. UCB has received regulatory approval in 9 other countries where Sepracor expects to earn royalties upon launch in 2002.

Desloratadine. In December 1997, Sepracor licensed to Schering Plough Corporation ("Schering") exclusive worldwide rights to Sepracor's patents covering desloratadine (the "DCL Agreement"), an active metabolite of loratadine, which is used as an antihistamine. In 1998, Schering paid Sepracor an initial license fee of $5,000,000. Under the terms of the DCL Agreement, Sepracor is entitled to receive royalties on desloratadine sales, beginning at product launch. Royalties will escalate over time upon achievement of sales volume and other milestones. On January 19, 2001, Schering received an approvable letter for desloratadine from the FDA, which indicated that the product could be approved pending final approval by the FDA. On February 15, 2001, Schering announced that the FDA had issued reports citing deficiencies concerning Schering's compliance with current Good Manufacturing Processes, or GMPs, and that the FDA had advised Schering that GMP deficiencies must be resolved prior to the FDA granting approval of desloratadine. In December 2001, Schering announced that CLARINEX (desloratadine) 5mg tablets had received marketing clearance from the FDA and Schering commercially launched CLARINEX in 2002.

Eszopiclone. In October 1999, Sepracor entered into an agreement with Rhone-Poulenc Rorer SA (now Aventis) under which Sepracor 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 United States (the "Aventis Eszopiclone Agreement"). Under the Aventis Eszopiclone Agreement, Aventis assigned all U.S. patent applications relating to zopiclone to Sepracor, and Aventis retained the right under the licensed data package to manufacture (S)-zopiclone in the U.S. for non-U.S. markets. In addition, Sepracor paid a $5,000,000 license fee to Aventis in 1999 and will pay a royalty to Aventis on eszopiclone product sales in the U.S., if any. Sepracor recognized expense of $1,000,000 in 2000 based on the initiation of Phase III clinical trials of eszopiclone and may be required to pay additional milestone payments to Aventis.

(R)-Fluoxetine. In December 1998, Sepracor entered into an agreement with Eli Lilly and Company ("Lilly") under which Sepracor granted to Lilly exclusive worldwide rights to Sepracor's patents covering (R)-fluoxetine, a modified form of an active ingredient found in fluoxetine, marketed by Lilly as PROZAC (the "Lilly Agreement"). In April 2000, following completion of the Federal Trade Commission review of the Lilly Agreement, the Company received an initial milestone payment and license fee of $20,000,000, which was recorded as license fee revenue in 2000. The Company also recorded $3,573,000 of collaborative research and development revenue in 2000 related to previous costs incurred in the development of (R)-fluoxetine under the Lilly Agreement. In October 2000, the Company was notified by Lilly that Lilly had terminated the exclusive license agreement covering

(R)-fluoxetine. In accordance with the Lilly Agreement, Lilly has returned the existing scientific data on the project to Sepracor.

Ticalopride. In July 1998, Sepracor entered into a license agreement with Janssen (the "Ticalopride Agreement"; formerly referred to as the "Norcisapride Agreement") giving Janssen exclusive worldwide rights to Sepracor's patents covering ticalopride (formerly known as (+)-norcisapride), an isomer of the active metabolite of Janssen's PROPULSID. Under the terms of the Ticalopride Agreement, Sepracor has exclusively licensed to Janssen rights to develop and market the ticalopride product worldwide. Under the Ticalopride Agreement, Janssen has agreed to pay Sepracor royalties on ticalopride sales, if any, beginning at product launch in those countries where Sepracor has issued patents covering Janssen's approved indications. Under the terms of the Ticalopride Agreement, the royalty rate to be paid to Sepracor will escalate upon the achievement of sales volume milestones. In April 2001, the Company was notified by Janssen that clinical investigators were informed that two Phase II trials to evaluate the efficacy and safety of ticalopride in subjects with symptoms of GERD, or gastroparesis, were being suspended pending further analysis of a small number of adverse events reported in GERD and diabetic patients.

Other Agreements

In January 2001, Sepracor signed a lease to occupy approximately 192,600 square feet of office and research and development space in a facility to be built in Marlborough, Massachusetts. The lease has a term of 15 years, and will begin on the occupancy date contingent upon the completion of the building, expected to be June 2002. In addition, Sepracor has an option to lease two additional buildings, totaling approximately 232,400 square feet, which may be constructed on the same site in the future. Sepracor is financing the construction of the first building through two interest bearing, secured loans totaling up to approximately $27,000,000, loaned by Sepracor to the developer of the site. At December 31, 2001, Sepracor has loaned approximately $13,093,000 to the developer of the new building which has been included in construction in progress. Sepracor will have first right to purchase the entire property from the developer beginning in June 2002 and extending through January 2004. The developer has the right to require Sepracor to purchase the site based on a contractual amount less the amount of any loans outstanding from the developer to Sepracor, if Sepracor's cash and cash equivalents fall below $137,000,000 before substantial completion of the building. At December 31, 2001, Sepracor has incurred $18,672,000 of building costs, which have been capitalized as construction in progress on the balance sheet in accordance with EITF 97-10.

S) Employees' Savings Plan

Sepracor has a 401(k) savings plan (the "401(k) Plan") for all domestic employees. Under the provisions of the 401(k) Plan, employees may voluntarily contribute up to 15% of their compensation, up to the statutory limit. In addition, Sepracor can make a matching contribution at its discretion. Sepracor matched 50% of the first $3,000 contributed by employees up to $1,500 maximum per employee during 2001, 2000, and 1999. Sepracor incurred expenses of $575,000, $391,000 and $337,000 in 2001, 2000 and 1999, respectively, as its matching contribution.

T) Business Segment and Geographic Area Information

For "Disclosures about Segments of an Enterprise and Related Information" segments represent the Company's internal organization as used by management for making operating decisions and assessing performance as the source of business segments. Sepracor operates in one business segment, which is the discovery, research and development, and commercialization of pharmaceutical products.

Financial information by geographic area is presented below:

Geographic Area Data

(In Thousands) 2001 2000 1999
Revenues
United States:
Unaffiliated customers $ 152,095 $ 82,550 $ 20,393 Europe:
Unaffiliated customers - 1,290 2,266 Related parties - 1,405 - Total revenues $ 152,095 $ 85,245 $ 22,659 Long-lived assets:
United States $ 139,490 $ 82,567 $ 49,439 Europe - 412 251 Canada 7,824 7,534 6,905 Total long-lived assets $ 147,314 $ 90,513 $ 56,595

Sepracor had no export sales to the Far East for the years ended December 31, 2001, 2000 and 1999. Revenues are attributed to geographic locations based on the selling location.

U) Quarterly Consolidated Financial Data (Unaudited)

For the Quarter Ended
September December (In Thousands, Except Per Share March 31, June 30, 30, 31, Data) 2001 2001 2001 2001
Net revenues $ 33,940 $ 44,210 $ 36,692 $ 37,253 Gross profit 28,669 40,278 33,464 33,780 Net loss applicable to common (48,030 ) (37,272 ) (36,444 ) (102,269 ) shares
Basic and diluted loss per $ (.63 ) $ (.48 ) $ (.47 ) $ (1.31 ) common share

For the Quarter Ended
September December (In Thousands, Except Per Share March 31, June 30, 30, 31, Data) 2000 2000 2000 2000
Net revenues $ 15,133 $ 34,252 $ 11,483 $ 24,377 Gross profit 10,163 31,121 8,949 20,678 Net loss applicable to common (54,037 ) (31,308 ) (45,226 ) (73,446 ) shares
Basic and diluted loss per $ (.76 ) $ (.43 ) $ (.62 ) $ (1.00 ) common share

V) Subsequent Events

On January 7, 2002, Sepracor and 3M Drug Delivery Systems Division announced initiation of a scale-up and manufacturing collaboration for XOPENEX hydrofluoroalkane (HFA) metered-dose inhaler (MDI). The collaboration will combine Sepracor's short-acting beta-agonist, XOPENEX, and 3M's expertise in manufacturing MDIs, the device most commonly used by patients for the treatment of asthma and chronic obstructive disease, using HFA technology.

On January 31, 2002, Sepracor announced that the FDA had approved XOPENEX brand levalbuterol HCl inhalation solution for the treatment or prevention of bronchospasm in children 6 to 11 years old with reversible obstructive airway disease, such as asthma. XOPENEX will be marketed for use in a nebulizer at dosage strengths of 0.31 mg and 0.63 mg for pediatric patients. XOPENEX inhalation solution has been marketed at dosage strengths of 0.63 mg and 1.25 mg for patients 12 years of age and older since May 1999.

On March 7, 2002, the FDA issued a "not-approvable" letter for the NDA filed for SOLTARA™ brand tecastemizole at dosage strengths of 15 mg and 30 mg for the treatment of allergic rhinitis. A "not approvalable" letter is issued if the FDA believes that the application contains insufficient information for an approval. The Company has requested a meeting with the FDA to discuss requirements for the resolution of the issues identified by the FDA concerning the NDA, and will assess its plans with respect to development of SOLTARA after that meeting.

In March 2002, through March 27, 2002, Sepracor exchanged approximately $97,000,000 of its convertible subordinated debt in privately negotiated transactions, for approximately 3,541,000 shares of its common stock. The associated inducement costs charged to other expense in the first quarter of 2002, are expected to be approximately $41,000,000.

Annual Meeting Information

The Annual Meeting of Stockholders will be held at 9:00 a.m. on May 22, 2002 at the offices of Hale and Dorr LLP, Sixty State Street, Boston, MA.

Common Stock

The common stock of Sepracor Inc. is traded on the NASDAQ Stock Market under the symbol SEPR.

Primary Outside Legal Counsel

Hale and Dorr LLP, Boston, MA

Independent Accountants

PricewaterhouseCoopers LLP, Boston, MA

Corporate Headquarters

Sepracor Inc.
111 Locke Drive
Marlborough, MA 01752
Telephone: (508) 481-6700
Facsimile: (508) 357-7499

Transfer Agent and Registrar

Questions regarding accounts, address changes, stock transfer and lost certificates should be directed to:

EquiServe Trust Company, N.A.
P.O. Box 43010
Providence, RI 02940-3010
Phone: (781) 575-3120

Directors

James G. Andress
Former Chairman, Beecham Pharmaceuticals, Former President and COO, Sterling Drug Inc.

Timothy J. Barberich
Chairman of the Board and Chief Executive Officer, Sepracor Inc.

Digby W. Barrios
Former President and CEO, Boehringer Ingelheim Corporation

Robert J. Cresci
Managing Director, Pecks Management Partners Ltd.

Keith Mansford, Ph.D.
Former Chairman, R&D, SmithKline Beecham plc

James F. Mrazek
Former Vice President and General Manager, Healthcare Division of Johnson & Johnson Products Inc.

Alan A. Steigrod
Former Executive Vice President, Glaxo Holdings plc

Officers

Timothy J. Barberich
Chairman of the Board and Chief Executive Officer

William J. O'Shea
President and Chief Operating Officer

David P. Southwell
Executive Vice President; Chief Financial Officer and Secretary

Paul D. Rubin, M.D.
Executive Vice President, Drug Development and ICE Research

Robert F. Scumaci
Executive Vice President, Finance and Administration and Treasurer

James R. Hauske, Ph.D.
Senior Vice President, Discovery

Douglas E. Reedich, Ph.D., J.D.
Senior Vice President, Legal Affairs and Chief Patent Counsel

Stephen A. Wald
Senior Vice President, Chemical Research and Development

SOLTARA and ESTORRA are trademarks and ICE and XOPENEX are registered trademarks of Sepracor Inc. EmboSphere is a registered trademark of BioSphere. XUSAL is a trademark and XYSAL and ZYRTEC are registered trademarks of UCB, Societe Anonyme. ADVAIR and VENTOLIN are registered trademarks of Glaxo Group Limited. CLARINEX is a registered trademark of Schering Corporation. FORADIL is a registered trademark of Ciba-Geigy Corporation. ATOCK is a trademark of Yamanouchi, Inc. DITROPAN is a registered trademark of Marion Laboratories, Inc. ALLEGRA is a registered trademark of Merrell Pharmaceuticals. PROZAC is a registered trademark of Dista. PROPULSID is a registered trademark of Johnson & Johnson. IMOVANE and AMOBAN are registered trademarks of Rhone-Poulenc Rorer S.A. MERIDIA is a registered trademark of Knoll Pharmaceutical Company. SONATA is a registered trademark of American Home Products Corporation. AMBIEN is a registered trademark of Synthelabo

QuickLinks

MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
INVESTOR RELATIONS SEPRACOR INC. 111 LOCKE DRIVE MARLBOROUGH, MA 01752 SEPRACOR INC. CONSOLIDATED BALANCE SHEETS SEPRACOR INC. CONSOLIDATED STATEMENTS OF OPERATIONS SEPRACOR INC. CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (DEFICIT) AND COMPREHENSIVE INCOME
SEPRACOR INC. CONSOLIDATED STATEMENTS OF CASH FLOWS NOTES TO CONSOLIDATED FINANCIAL STATEMENTS