Paratek Pharmaceuticals, Inc. - FORM 10-Q

Paratek Pharmaceuticals, Inc. - FORM 10-Q - August 12, 2010

Attached files

Attached files

Paratek Pharmaceuticals, Inc. Reports

file	filename
EX-31.2 - CERTIFICATION OF CFO PURSUANT TO SECTION 302 - Paratek Pharmaceuticals, Inc.	dex312.htm
EX-32.1 - CERTIFICATION OF CEO AND CFO PURSUANT TO SECTION 906 - Paratek Pharmaceuticals, Inc.	dex321.htm
EX-31.1 - CERTIFICATION OF CEO PURSUANT TO SECTION 302 - Paratek Pharmaceuticals, Inc.	dex311.htm

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

x	QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended June 30, 2010

¨	TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from to

Commission File No. 000 – 51967

TRANSCEPT PHARMACEUTICALS, INC.

(Exact Name of Registrant as Specified in its Charter)


Delaware		33-0960223
(State or other jurisdiction of incorporation or organization)		(I.R.S. Employer Identification Number)

1003 W. Cutting Blvd., Suite #110 Pt. Richmond, California		94804
(Address of principal executive offices)		(Zip Code)

(510) 215-3500

Registrant’s telephone number, including area code

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 x No ¨

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate website, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or such other shorter period that the registrant was required to submit and post such files). Yes ¨ No ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ¨ No x

As of August 10, 2010, 13,437,972 shares of our common stock, $0.001 par value, were outstanding.

Index to Financial Statements

Transcept Pharmaceuticals, Inc.


Item No.		Page No.

PART I FINANCIAL INFORMATION

Item 1.	Financial Statements (unaudited)	1

	Condensed Consolidated Balance Sheets—June 30, 2010 and December 31, 2009	1

	Condensed Consolidated Statements of Operations—Three and Six Months Ended June 30, 2010 and 2009	2

	Condensed Consolidated Statements of Cash Flows—Six Months Ended June 30, 2010 and 2009	3

	Notes to Condensed Consolidated Financial Statements	4

Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	14

Item 3.	Quantitative and Qualitative Disclosures About Market Risk	24

Item 4T.	Controls and Procedures	24

PART II OTHER INFORMATION		25

Item 1.	Legal Proceedings	25

Item 1A.	Risk Factors	25

Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	44

Item 3.	Defaults Upon Senior Securities	44

Item 4.	(Removed and Reserved)	44

Item 5.	Other Information	44

Item 6.	Exhibits	44

	SIGNATURES	46

PART I

FINANCIAL INFORMATION

Item 1.

Financial Statements

Transcept Pharmaceuticals, Inc.

Condensed Consolidated Balance Sheets

(in thousands)


	June 30, 2010			December 31, 2009
	(Unaudited)			(Note 1)
Assets
Current assets:
Cash and cash equivalents	$	10,112		$	17,031
Marketable securities		68,763			71,871
Prepaid and other current assets		1,291			1,276
Restricted cash		200			200

Total current assets		80,366			90,378
Property and equipment, net		826			1,052
Goodwill		2,962			2,962
Other assets		826			826

Total assets	$	84,980		$	95,218

Liabilities and stockholders’ equity
Current liabilities:
Accounts payable	$	879		$	728
Accrued liabilities		1,399			2,383
Deferred revenue, current portion		12,500			12,500
Other current liabilities		467			474

Total current liabilities		15,245			16,085
Deferred revenue, non-current portion		1,042			7,292
Other non-current liabilities		517			770

Total liabilities		16,804			24,147
Stockholders’ equity:
Common stock		13			13
Additional paid-in capital		158,961			157,930
Accumulated deficit		(90,814	)		(86,911	)
Accumulated other comprehensive income		16			39

Total stockholders’ equity		68,176			71,071

Total liabilities and stockholders’ equity	$	84,980		$	95,218

See accompanying notes.

Transcept Pharmaceuticals, Inc.

Condensed Consolidated Statements of Operations

(in thousands, except per share amounts)

(Unaudited)


	Three Months Ended June 30,						Six Months Ended June 30,
	2010			2009			2010			2009
Revenue:
License fee revenue	$	3,125		$	—		$	6,250		$	—
Operating expense:
Research and development		2,407			2,250			4,767			4,472
General and administrative		2,769			5,019			5,373			9,233
Merger related transaction costs		—			—			—			2,224

Total operating expense		5,176			7,269			10,140			15,929

Loss from operations		(2,051	)		(7,269	)		(3,890	)		(15,929	)
Interest income		37			97			81			185
Interest expense		(4	)		(5	)		(7	)		(171	)
Other income (expense), net		(43	)		64			(87	)		264

Net loss	$	(2,061	)	$	(7,113	)	$	(3,903	)	$	(15,651	)

Basic and diluted net loss per share	$	(0.15	)	$	(0.54	)	$	(0.29	)	$	(1.42	)

Weighted average shares outstanding		13,402			13,070			13,397			11,048

See accompanying notes.

Transcept Pharmaceuticals, Inc.

Condensed Consolidated Statements of Cash Flows

(in thousands)

(Unaudited)


	Six Months Ended June 30,
	2010			2009
Operating activities
Net loss	$	(3,903	)	$	(15,651	)
Adjustments to reconcile net loss to net cash used in operating activities:
Depreciation and amortization		255			268
Stock-based compensation		914			551
Amortization of loan costs		—			28
Amortization of discount (warrants) on debt		—			47
Amortization of lease liability		(218	)		(97	)
Remeasurement of preferred stock warrants		—			(200	)
Loss on disposals of fixed assets		2			7
Gain on sale of marketable securities		—			(65	)
Amortization of premiums on available for sale securities		798			412
Changes in operating assets and liabilities:
Prepaid and other current assets		(15	)		40
Other assets		—			(18	)
Accounts payable		151			515
Accrued and other liabilities		(1,010	)		(1,075	)
Deferred revenue		(6,250	)		—

Net cash used in operating activities		(9,276	)		(15,238	)
Investing activities
Purchases of property and equipment, net		(31	)		(236	)
Purchases of marketable securities		(59,963	)		(68,091	)
Maturities and sales of marketable securities		62,250			44,581
Cash and cash equivalents received from the Merger		—			47,987

Net cash provided by investing activities		2,256			24,241
Financing Activities
Payments on long-term debt		—			(3,353	)
Proceeds from issuance of common stock, net		101			26

Net cash provided by (used in) financing activities		101			(3,327	)
Net (decrease) increase in cash and cash equivalents		(6,919	)		5,676
Cash and cash equivalents at beginning of period		17,031			4,432

Cash and cash equivalents at end of period	$	10,112		$	10,108

See accompanying notes.

Transcept Pharmaceuticals, Inc.

Notes to Condensed Consolidated Financial Statements

(Unaudited)

1. Organization and Summary of Significant Accounting Policies

Transcept Pharmaceuticals, Inc. (the “Company”) is a specialty pharmaceutical company focused on the development and commercialization of proprietary products that address important therapeutic needs in the field of neuroscience. The most advanced product candidate is Intermezzo^® (zolpidem tartrate sublingual tablet), for which a New Drug Application (“NDA”) was submitted to the U.S. Food and Drug Administration (“FDA”) in September 2008 seeking approval as a prescription sleep aid for use in the middle of the night at the time a patient awakens and has difficulty returning to sleep. In October 2009, the Company received a Complete Response Letter from the FDA on the Intermezzo^® NDA and is working to respond to issues raised in the letter. Transcept and Purdue Pharmaceutical Products, L.P. have entered into a collaboration agreement for the development and commercialization of Intermezzo^® in the United States. Transcept is also developing TO-2061, an ultra low dose ondansetron adjunctive therapy for patients with obsessive compulsive disorder (“OCD”) who have not adequately responded to treatment with selective serotonin reuptake inhibitors (“SSRIs”). The Company operates in one business segment.

Basis of Presentation

The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States for interim financial information and with the instructions to Form 10-Q and Rule 10-01 of Regulation S-X. Accordingly, they do not contain all of the information and footnotes required for complete consolidated financial statements. In the opinion of management, the accompanying unaudited condensed consolidated financial statements reflect all adjustments, which include only normal recurring adjustments, necessary to present fairly the Company’s interim financial information. The accompanying condensed consolidated balance sheet at December 31, 2009 has been derived from our audited financial statements at that date. The results for the three and six months ended June 30, 2010 are not necessarily indicative of the results to be expected for the full year ending December 31, 2010 or for any other interim period or any other future year.

The accompanying unaudited condensed consolidated financial statements and notes to consolidated financial statements should be read in conjunction with the Company’s audited consolidated financial statements in its Annual Report on Form 10-K for the year ended December 31, 2009, as filed with the United States Securities and Exchange Commission on March 30, 2010.

Need to Raise Additional Capital

As of June 30, 2010, the Company had cash, cash equivalents and marketable securities of $78.9 million, working capital of $65.1 million, and an accumulated deficit of approximately $90.8 million. Management expects to continue to incur additional losses in the foreseeable future as the Company continues its research and development activities and prepares for the potential commercialization of Intermezzo^®. Management believes that cash, cash equivalents and marketable securities balances on hand at June 30, 2010 will be sufficient to fund planned expenditures for at least the next twelve months. Management recognizes the potential need to raise additional funds in the future. There can be no assurance that the Company will be successful in consummating any such financing transaction, or if the Company does consummate such a transaction, that the terms and conditions of such transaction will be favorable. Any failure to obtain additional funding may have a material negative effect on the Company and will likely result in a substantial reduction in the scope of the Company’s operations.

Transcept Pharmaceuticals, Inc.

Notes to Condensed Consolidated Financial Statements—(Continued)

(Unaudited)

Use of Estimates

The preparation of financial statements in conformity with U.S. generally accepted accounting principles requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Management bases its estimates on historical experience and on assumptions believed to be reasonable under the circumstances. Actual results could differ materially from those estimates. Management makes estimates when preparing the financial statements including those relating to revenue recognition, clinical trials, and stock-based compensation.

Significant Accounting Policies

Principles of Consolidation

The accompanying condensed consolidated financial statements include the results of operations of Transcept Pharmaceuticals, Inc. and its wholly-owned subsidiary, Transcept Pharma, Inc. All significant intercompany accounts and transactions have been eliminated in the consolidation.

Revenue Recognition

The Company applies the revenue recognition criteria outlined in Staff Accounting Bulletin No. 104, Revenue Recognition in Financial Statements, and Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) Topic 605 Revenue Recognition, sub-topic 25 Multiple-Element Arrangements.

Revenue arrangements with multiple components are divided into separate units of accounting if certain criteria are met, including whether the delivered component has stand-alone value to the customer, and whether there is objective and reliable evidence of the fair value of the undelivered items. Consideration received is allocated among the separate units of accounting based on their respective fair values. Applicable revenue recognition criteria are then applied to each of the units.

Revenue is recognized when the four basic criteria of revenue recognition are met: (1) persuasive evidence of an arrangement exists; (2) transfer of technology has been completed or services have been rendered; (3) the fee is fixed or determinable; and (4) collectability is reasonably assured.

For each source of revenue, the Company complies with the above revenue recognition criteria in the following manner:

•

Up-front license payments are assessed to determine whether or not the licensee is able to obtain any stand-alone value from the license. Where this is not the case, the Company does not consider the license deliverable to be a separate unit of accounting, and the revenue is deferred with revenue recognition for the license fee assessed in conjunction with the other deliverables that constitute the combined unit of accounting. When the period of deferral cannot be specifically identified from the agreement, management estimates the period based upon provisions contained within the agreement and other relevant facts. The Company periodically reviews the estimated involvement period, which could impact the deferral period and, therefore, the timing and the amount of revenue recognized. It is possible that future adjustments will be made if actual conditions differ from the Company’s current plan and involvement assumptions.

•

Payments received that are related to substantive, performance-based “at-risk” milestones are recognized as revenue upon achievement of the milestone or event specified in the underlying contracts, which represents the culmination of the earnings process. Amounts received in advance, if any, are recorded as deferred revenue until the milestone is reached.

•

Royalty revenue from sales of the Company’s licensed products, if and when approved for marketing by the appropriate regulatory agency, will be recognized as earned in accordance with the contract terms when royalties from licensees can be reasonably estimated and collectability is reasonably assured.

Transcept Pharmaceuticals, Inc.

Notes to Condensed Consolidated Financial Statements—(Continued)

(Unaudited)

Stock-Based Compensation

The Company records stock-based compensation in accordance with ASC Topic 718 Compensation – Stock Compensation (“ASC Topic 718”) (formerly Statement of Financial Accounting Standards (“SFAS”) No. 123(R), Share-Based Payment). ASC Topic 718 requires an entity to measure the cost of employee services received in exchange for an award of equity instruments based on the fair value of the award on the date of grant and to recognize the cost over the period during which the employee is required to provide service in exchange for the award. Additionally, the Company is required to include an estimate of the number of awards that will be forfeited in calculating compensation costs, which are recognized over the requisite service period of the awards on a straight-line basis.

The Company recorded employee stock-based compensation costs of $477,000 and $914,000 for the three and six months ended June 30, 2010, respectively, and $286,000 and $497,000 for the three and six months ended June 30, 2009, respectively, in accordance with the provisions of ASC Topic 718. No related tax benefits of stock-based compensation costs have been recognized since the Company’s inception.

The Company accounts for equity instruments issued to non-employees in accordance with the provisions of ASC Topic 505, subtopic 50, Equity-Based Payments to Non-Employees (formerly Emerging Issues Task Force No. 96-18, Accounting for Equity Instruments That Are Issued to Other Than Employees for Acquiring, or in Conjunction with Selling Goods or Services), using a fair-value approach. The equity instruments, consisting of stock options and warrants granted to lenders and consultants, are valued using the Black-Scholes valuation model. The measurement of stock-based compensation is subject to periodic adjustments as the underlying equity instruments vest and is recognized as an expense over the term of the related financing or the period over which services are received.

Clinical Trials

The Company accrues and expenses costs for clinical trial activities performed by third parties, including clinical research organizations and clinical investigators, based upon estimates made of the work completed as of the reporting date, in accordance with agreements established with contract research organizations and clinical trial sites and the agreed upon fee to be paid for the services. The Company determines these estimates through discussion with internal personnel and outside service providers as to the progress or stage of completion of the trials or services. Costs of setting up clinical trial sites for participation in the trials are expensed immediately as research and development expenses. Clinical trial site costs related to patient enrollment are accrued as patients are entered into the trial and reduced by any initial payment made to the clinical trial site when the first patient is enrolled.

Recently Adopted Accounting Standards

In January 2010, the FASB issued additional disclosure requirements for fair value measurements. The guidance requires previous fair value hierarchy disclosures to be further disaggregated by class of assets and liabilities. A class is often a subset of assets or liabilities within a line item in the statement of financial position. In addition, significant transfers between Levels 1 and 2 of the fair value hierarchy are required to be disclosed. These additional requirements became effective January 1, 2010 for quarterly and annual reporting. These amendments did not have an impact on the consolidated financial results as this guidance relates only to additional disclosures. See Note 3, “Fair Value” for further information. In addition, the fair value disclosure amendments also require more detailed disclosures of the changes in Level 3 instruments. These changes will be effective January 1, 2011 and are not expected to have an impact on the consolidated financial results as this guidance only relates to additional disclosures.

Transcept Pharmaceuticals, Inc.

Notes to Condensed Consolidated Financial Statements—(Continued)

(Unaudited)

In September 2009, the FASB Emerging Issues Task Force reached a consensus on ASC Update 2009-13 (“Topic 605-25”), Multiple-Deliverable Revenue Arrangements, or (“ASC Update 2009-13”). ASC Update 2009-13 applies to multiple-deliverable revenue arrangements that are currently within the scope of ASC Topic 605-25. ASC Update 2009-13 provides principles and application guidance on whether multiple deliverables exist and how the arrangement should be separated and the consideration allocated. ASC Update 2009-13 requires an entity to allocate revenue in an arrangement using estimated selling prices of deliverables, if a vendor does not have vendor-specific objective evidence or third-party evidence of selling price. The update eliminates the use of the residual method and requires an entity to allocate revenue using the relative selling price method and also significantly expands the disclosure requirements for multiple-deliverable revenue arrangements. ASC Update 2009-13 should be applied on a prospective basis for revenue arrangements entered into or materially modified in fiscal years beginning on or after June 15, 2010, with earlier application permitted. As a result, ASC Update 2009-13 will be effective for the Company no later than the first quarter of fiscal year 2011. The Company is currently evaluating the impact of adopting this ASC Update 2009-13 on its financial position and results of operations.

2. Results of Operations

Net Loss Per Share

Basic net loss per share is computed by dividing net loss by the weighted average number of vested shares outstanding during the period. Diluted net loss per share is computed by giving effect to all potential dilutive common securities, including options, warrants and common stock subject to repurchase. For all periods presented in this report, stock options, warrants and common stock subject to repurchase were not included in the computation of diluted net loss per share because such inclusion would have had an antidilutive effect.

The following table presents the calculation of basic and diluted net loss per share (in thousands, except per share amounts):


	Three months ended June 30,						Six months ended June 30,
	2010			2009			2010			2009
Numerator:
Net loss	$	(2,061	)	$	(7,113	)	$	(3,903	)	$	(15,651	)

Denominator:
Weighted average shares outstanding		13,421			13,119			13,415			11,096
Less: Weighted average shares subject to repurchase		(19	)		(49	)		(18	)		(48	)

Denominator for basic and diluted net loss per share		13,402			13,070			13,397			11,048

Basic and diluted net loss per share	$	(0.15	)	$	(0.54	)	$	(0.29	)	$	(1.42	)

The following outstanding shares subject to options and warrants to purchase common stock and common stock subject to repurchase were antidilutive due to a net loss in the periods presented and, therefore, were excluded from dilutive securities computation as of the dates indicated below (in thousands):


	June 30,
	2010	2009
Excluded potentially dilutive securities (1):
Shares subject to options to purchase common stock	2,367	2,053
Shares subject to warrants to purchase common stock	156	156
Common stock subject to repurchase	13	38

Total	2,536	2,247

(1)	The number of shares is based on maximum number of shares issuable on exercise or conversion of the related securities as of the period end. Such amounts have not been adjusted for the treasury stock method or weighted average outstanding calculations as required if the securities were dilutive.

Transcept Pharmaceuticals, Inc.

Notes to Condensed Consolidated Financial Statements—(Continued)

(Unaudited)

Comprehensive Income (Loss)

Comprehensive income (loss) is comprised of net income (loss) and unrealized gains (losses) on available-for-sale securities. Total comprehensive income (loss) for the three and six months ended June 30, 2010 and 2009 are as follows (in thousands):


	Three months ended June 30,						Six months ended June 30,
	2010			2009			2010			2009
Net loss	$	(2,061	)	$	(7,113	)	$	(3,903	)	$	(15,651	)
Changes in unrealized gain (loss) on marketable securities		(5	)		39			(23	)		47

Comprehensive net loss	$	(2,066	)	$	(7,074	)	$	(3,926	)	$	(15,604	)

3. Fair Value

On January 1, 2008, the Company adopted ASC Topic 820, “Fair Value Measurements and Disclosures” (formerly SFAS No. 157) as it applies to its financial assets and financial liabilities. ASC Topic 820 defines fair value, establishes a framework for measuring fair value and expands disclosures about fair value measurements. Fair value is defined as the estimated exit price received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date rather than on an entry price which represents the purchase price of an asset or liability. ASC Topic 820 establishes a fair value hierarchy that prioritizes observable and unobservable inputs used to measure fair value into three broad levels, which are described below:

•

Level 1 - Quoted prices (unadjusted) in active markets that are accessible at the measurement date for assets or liabilities. The fair value hierarchy gives the highest priority to Level 1 inputs.

•

Level 2 - Inputs other than Level 1 that are observable, either directly or indirectly, such as quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities.

•

Level 3 - Unobservable inputs (i.e., inputs that reflect the reporting entity’s own assumptions about the assumptions that market participants would use in estimating the fair value of an asset or liability) are used when little or no market data is available. The fair value hierarchy gives the lowest priority to Level 3 inputs.

Transcept Pharmaceuticals, Inc.

Notes to Condensed Consolidated Financial Statements—(Continued)

(Unaudited)

In accordance with ASC Topic 820, the following table represents the Company’s fair value hierarchy for its financial assets (cash equivalents and marketable securities) measured at fair value on a recurring basis as of June 30, 2010 (in thousands):


			Fair Value Measurements at Reporting Date Using
	June 30, 2010		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
Assets
Certificates of deposit	$	200	$	200	$	—	$	—
Money market funds		9,033		9,033		—		—
U.S. Treasury securities		68,763		—		68,763		—

	$	77,996	$	9,233	$	68,763	$	—

The following table represents the Company’s fair value hierarchy for its financial assets (cash equivalents and marketable securities) measured at fair value on a recurring basis as of December 31, 2009 (in thousands):


			Fair Value Measurements at Reporting Date Using
	December 31, 2009		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
Assets
Certificates of deposit	$	200	$	200	$	—	$	—
Money market funds		16,228		16,228		—		—
U.S. Treasury securities		71,871		—		71,871		—

	$	88,299	$	16,428	$	71,871	$	—

No other assets or liabilities were carried at fair value as of June 30, 2010.

Level 2 securities are priced using quoted market prices for similar instruments, nonbinding market prices that are corroborated by observable market data, or discounted cash flow techniques. There were no transfers of assets between different fair-value levels during the periods presented.

Transcept Pharmaceuticals, Inc.

Notes to Condensed Consolidated Financial Statements—(Continued)

(Unaudited)

4. Cash, Cash Equivalents, and Marketable Securities

The following is a summary of cash, cash equivalents, restricted cash, and short-term marketable securities as of the respective dates (in thousands):


	June 30, 2010
	Amortized Cost		Unrealized Gains		Unrealized Losses		Estimated Fair Value
Cash	$	1,079	$	—	$	—	$	1,079
Certificates of deposit		200		—		—		200
Money market funds		9,033		—		—		9,033
U.S. Treasury securities		68,747		16		—		68,763

	$	79,059	$	16	$	—	$	79,075


	December 31, 2009
	Amortized Cost		Unrealized Gains		Unrealized Losses		Estimated Fair Value
Cash	$	803	$	—	$	—	$	803
Certificates of deposit		200		—		—		200
Money market funds		16,228		—		—		16,228
U.S. Treasury securities		71,832		39		—		71,871

	$	89,063	$	39	$	—	$	89,102

There were no sales of available-for-sale marketable securities during the first six months of 2010. During the first six months of 2009, proceeds from the sales of available-for-sale marketable securities totaled $32,080,000 with realized gains of $65,000. The amortized cost and estimated fair value of available-for-sale marketable securities at June 30, 2010 and December 31, 2009 were as follows (in thousands):


	June 30, 2010				December 31, 2009
	Cost		Fair value		Cost		Fair value
Cash and cash equivalents	$	10,112	$	10,112	$	17,031	$	17,031
Marketable securities		68,747		68,763		71,832		71,871
Restricted cash		200		200		200		200

	$	79,059	$	79,075	$	89,063	$	89,102

All of the Company’s marketable securities at June 30, 2010 had a maturity of one year or less.

5. Collaboration Agreement

On July 31, 2009, the Company signed the United States License and Collaboration Agreement (“Collaboration Agreement”) with Purdue Pharmaceutical Products L.P. (“Purdue”) that provides an exclusive license to Purdue to commercialize Intermezzo^® in the United States and pursuant to which:

•

On August 4, 2009, Purdue paid the Company a $25.0 million non-refundable license fee;

•

The Company is obligated to seek FDA approval of Intermezzo^® and to continue development of Intermezzo^® at its expense until FDA approval; and

Transcept Pharmaceuticals, Inc.

Notes to Condensed Consolidated Financial Statements—(Continued)

(Unaudited)

•

If Purdue does not elect to terminate the collaboration after its review of an FDA approval of Intermezzo^®, or otherwise:

•

Purdue is obligated to pay the Company an amount equal to $30.0 million, less $2.0 million for each 30-day period that the Company’s receipt of an NDA approval for Intermezzo^® is delayed beyond June 30, 2010;

•

The Company is obligated to transfer the Intermezzo^® NDA to Purdue and Purdue is obligated to assume the expense associated with maintaining the NDA and further development of Intermezzo^® in the United States, including any expense associated with post-approval studies;

•

Purdue is obligated to commercialize Intermezzo^® in the United States at its expense;

•

Purdue is obligated to pay the Company tiered double-digit base royalties on net sales of Intermezzo^® in the United States ranging up to the mid-twenty-percent level;

•

Purdue is obligated to pay the Company $10.0 million if either of two formulation patents are listed in the FDA’s Approved Drug Products with Therapeutic Equivalence Evaluations, or Orange Book; and

•

Purdue is potentially obligated to pay the Company up to an additional $80.0 million upon meeting an additional intellectual property milestone and upon the achievement of certain net sales targets for Intermezzo^® in the United States.

The Company retained an option to co-promote Intermezzo^® to psychiatrists in the United States as early as the first anniversary of commercial launch of Intermezzo^®. Upon entry into the market under the co-promotion option, the Company would receive an additional double-digit royalty from Purdue on sales generated by psychiatrists in the United States.

The Company also granted Purdue and an associated company the right to negotiate for the commercialization of Intermezzo^® in Mexico and Canada, respectively, and retained rights to commercialize Intermezzo^® in the rest of the world.

The Company’s co-promote option may be terminated by Purdue upon acquisition of the Company or in the event of entry of generic competition to Intermezzo^®. The royalty payments discussed above are subject to reduction in connection with, among other things, the entry of generic competition to Intermezzo^®.

The Company is recognizing revenue from the $25.0 million non-refundable license fee ratably over an estimated 24-month period starting August 1, 2009 and ending on July 31, 2011. This period represents the estimated period for which it has significant participatory obligations under the Collaboration Agreement. The revenue recognized in connection with the license fee during the three months and six months ended June 30, 2010 was $3.1 million and $6.2 million, respectively.

6. Restructuring

In August 2009, the Company implemented a reduction of approximately 30% of the Company’s workforce. The reduction plan carried out a realignment of the Company’s workforce and operations after a reassessment of the Company’s development activities and corporate objectives in connection with the Company’s entry into the Collaboration Agreement described in Note 5 above. The Company substantially completed the reduction plan at December 31, 2009. Employees subject to the workforce reduction plan were eligible for one-time severance benefits that included severance pay of approximately $511,000 in total and one year accelerated vesting on outstanding options upon signing a separation and release agreement with the Company. Further, the affected employees were given the choice to extend the exercise period of their options to one year following termination. Total expense related to the modification of these stock option awards is expected to be approximately $79,000.

Additionally, the Company recorded a charge of approximately $309,000 related to the fair value of the remaining lease payments on 12,257 square feet of surplus general office space in Point Richmond, California. This liability is being amortized over the remaining life of the lease, which expires on May 31, 2011. This expiration date reflects the exercise of the Company’s acceleration option in accordance with the lease.

Transcept Pharmaceuticals, Inc.

Notes to Condensed Consolidated Financial Statements—(Continued)

(Unaudited)

The Company records restructuring activities in accordance with ASC Topic 420 Exit or Disposal Cost Obligations (formerly SFAS 146, Accounting for Costs Associated with Exit or Disposal Activities.). The following tables summarize the charges recorded during the three and six months ended June 30, 2010 related to the restructuring plan by type of activity (no such charges were recorded in the comparable prior year period) (in thousands):


	Severance benefits		Stock option modification		Contract termination costs		Total
Three months ended June 30, 2010
Research and development	$	—	$	—	$	—	$	—
General and administrative		9		4		—		13

	$	9	$	4	$	—	$	13

Six months ended June 30, 2010
Research and development	$	—	$	—	$	—	$	—
General and administrative		22		10		—		32

	$	22	$	10	$	—	$	32

Cumulative costs through June 30, 2010
Research and development	$	205	$	24	$	—	$	229
General and administrative		294		51		309		654

	$	499	$	75	$	309	$	883

From the inception of its restructuring plan through June 30, 2010, the Company has incurred approximately $499,000 of the estimated $511,000 of severance benefits expected to be incurred.


	Severance benefits
	(in thousands)
Restructuring reserves as of January 1, 2009	$	—
Expense		477
Payments		(361	)

Restructuring reserves as of December 31, 2009		116
Expense		13
Payments		(5	)

Restructuring reserves as of March 31, 2010		124
Expense		9
Payments		—

Restructuring reserves as of June 30, 2010	$	133

The severance benefit liability is included in accrued liabilities while the contract termination costs are included in lease liabilities included in other liabilities on the balance sheet.

Transcept Pharmaceuticals, Inc.

Notes to Condensed Consolidated Financial Statements—(Continued)

(Unaudited)

7. Commitments and Contingencies

Legal proceedings

From time to time, the Company may be involved in litigation relating to claims arising out of its operations. The Company is not currently involved in any material legal proceedings.

SPI Pharmaceuticals, Inc., the sole supplier of Pharmaburst^®, a key excipient used in Intermezzo^®, is the defendant in a lawsuit brought by Roquette Frères, or Roquette, in the Federal District Court of Delaware on August 31, 2006 that alleges that certain of SPI’s products infringe one or more claims of a Roquette patent and seeks monetary damages and injunctive relief. The Company has not been named in, and is not a party to, the lawsuit. Although not specifically identified in the original complaint, press releases have indicated that Pharmaburst^® products are among the accused products. SPI has informed the Company that Roquette’s patent rights are not infringed by Pharmaburst^® and that it intends to defend its rights vigorously. Because Pharmaburst^® is a key excipient in Intermezzo^®, the interruption of supply of Pharmaburst^® through an injunction could materially harm the Company’s ability to supply Intermezzo^® and its business. SPI has agreed to indemnify the Company against certain damages related to any such infringement suit under the terms of its agreement with SPI.

Item 2.

Management’s Discussion and Analysis of Financial Condition and Results of Operations

This report contains forward-looking statements that are based upon current expectations within the meaning of the Private Securities Litigation Reform Act of 1995. Transcept Pharmaceuticals, Inc., or Transcept, intends that such statements be protected by the safe harbor created thereby. Forward-looking statements involve risks and uncertainties and actual Transcept results and the timing of events may differ significantly from those results discussed in the forward-looking statements. Examples of such forward-looking statements include, but are not limited to, statements about or relating to:

•

expectations regarding completion of a highway driving study and modification of the Intermezzo^® package presentation, and the sufficiency of such steps to support the potential resubmission of a New Drug Application, or NDA, with the U.S. Food and Drug Administration, or FDA, for Intermezzo^®;

•

expectations regarding our timing for the announcement of data from the Intermezzo^® driving study, our ability to resubmit the Intermezzo^® NDA, the expected timing of any such resubmission, and the expected timing of FDA review of any such resubmission;

•

expectations with regard to our TO-2061 development program with respect to the anticipated completion of Phase 1 studies and commencement of a Phase 2 study;

•

expectations for the design and power of our planned Phase 2 study of TO-2061 to potentially serve as one of two Phase 3 pivotal studies to be submitted in support of FDA approval;

•

the potential for Intermezzo^® to be the first sleep aid approved specifically for use for middle of the night awakenings;

•

expected activities and responsibilities of us and Purdue Pharmaceutical Products L.P., or Purdue, under our United States License and Collaboration Agreement, or the Collaboration Agreement;

•

our potential receipt of revenue under the Collaboration Agreement, including milestone and royalty revenue;

•

the satisfaction of conditions under the Collaboration Agreement with Purdue required for continued commercialization, and the payment of potential milestone payments, royalties and fulfillment of other Purdue obligations under the Collaboration Agreement;

•

whether the FDA approved label for Intermezzo^®, if approved, will be sufficiently attractive for Purdue to continue with our collaboration;

•

the potential benefits of, and markets for, Intermezzo^® and other product candidates;

•

our plans for the manufacturing of Intermezzo^®;

•

potential competitors and competitive products;

•

expectations with respect to our ability to carry out plans to promote Intermezzo^® to psychiatrists in the United States through our co-promote option, if exercised, under the Collaboration Agreement;

•

our ability to satisfy liquidity requirements for at least the next twelve months;

•

losses, costs, expenses, expenditures and cash flows, including the period of time over which we expect to recognize the revenue associated with the up-front payment under the Collaboration Agreement;

•

capital requirements and our needs for additional financing;

•

the ability and degree to which we may obtain and maintain market exclusivity from the FDA for Intermezzo^® under Section 505(b)(2) of the Federal Food and Drug Cosmetic Act;

•

our ability to obtain and maintain patent protection for Intermezzo^® and our TO-2061 program without violating the intellectual property rights of others; and

•

expected future sources of revenue and capital.

Transcept undertakes no obligation to, and expressly disclaims any obligation to, revise or update the forward-looking statements made herein or the risk factors whether as a result of new information, future events or otherwise. Forward-looking statements involve risks and uncertainties, which are more fully discussed in the “Risk Factors” section and elsewhere in this Quarterly Report, including, but not limited to, those risks and uncertainties relating to:

•

whether additional data exists or can be generated from existing or new clinical studies to demonstrate sufficiently to the FDA that Intermezzo^® would not present an unacceptable risk of residual effects, including residual effects that impair next day driving ability;

•

our ability to sufficiently demonstrate to the FDA that we can reduce inadvertent dosing errors of Intermezzo^® in the middle of the night or that such dosing errors will not lead to unacceptable next day residual effects;

•

the potential for delays in or the inability to complete commercial partnership relationships, including additional marketing alliances for Intermezzo^® outside the United States;

•

results in our clinical trials being insufficient to obtain FDA regulatory approval of Intermezzo^® or to grant marketing exclusivity for Intermezzo^® under Hatch-Waxman;

•

potential termination of the Collaboration Agreement by Purdue, even if Intermezzo^® is approved;

•

our satisfaction of conditions under the Collaboration Agreement with Purdue required for Purdue to carry out its obligations under such agreement;

•

difficulties or delays in building a sales organization in connection with any exercise of our co-promote option to psychiatrists under the Collaboration Agreement;

•

physician or patient reluctance to use Intermezzo^®, if approved;

•

changing standards of care and the introduction of products by competitors, including generic products whose introduction could reduce our royalty rates under the Collaboration Agreement, or alternative therapies for the treatment of indications we target;

•

unexpected adverse side effects or inadequate therapeutic efficacy of our product candidates that could slow or prevent product approval or approval for particular indications;

•

inability to obtain additional financing, if necessary;

•

the uncertainty of protection for our intellectual property, through patents, trade secrets or otherwise;

•

potential infringement of the intellectual property rights or trade secrets of third parties; and

•

other difficulties or delays in development, testing, obtaining regulatory approval for, and undertaking production and marketing of Intermezzo^®, TO-2061 and our other product candidates.

Intermezzo^®, Bimucoral^®, and Transcept Pharmaceuticals, Inc.^TM are registered and unregistered trademarks of ours in the United States and other jurisdictions. Other trademarks and trade names referred to in this Quarterly Report on Form 10-Q are the property of their respective owners.

Company Overview

We are a specialty pharmaceutical company focused on the development and commercialization of proprietary products that address important therapeutic needs in the field of neuroscience.

Intermezzo^® (zolpidem tartrate sublingual tablet)

Our most advanced product candidate, Intermezzo^®, is a sublingual low dose formulation of zolpidem that is being developed for use in the middle of the night at the time a patient awakens and has difficulty returning to sleep. We submitted a new drug application, or NDA, for Intermezzo^® to the U.S. Food and Drug Administration, or FDA, in September 2008. In October 2009, we received a Complete Response Letter from the FDA regarding our NDA indicating that it was not approved.

In the Complete Response Letter, the FDA stated that it believes we had submitted substantial evidence of effectiveness for the use of Intermezzo^® for its proposed indication. However, the FDA indicated that the intended use of Intermezzo^® in the middle of the night represents a unique insomnia indication and dosing strategy for which safety has not been previously established and that we did not adequately demonstrate that Intermezzo^® could reliably be used safely. Our originally proposed label for Intermezzo^® indicates that Intermezzo^® should only be taken when patients have at least four hours remaining in bed before being active again. The FDA recognized in the Complete Response Letter that the Intermezzo^® data we submitted did not indicate significant next day residual effects at four hours after use. However, the FDA requested additional data demonstrating that Intermezzo^® would not present an unacceptable risk of residual effects, with particular reference to next day driving ability. The FDA also expressed two concerns regarding the possibility of patient dosing errors in the middle of the night that could lead to next day residual effects with particular reference to next day driving ability. Specifically, the FDA has asked us to address methods to avoid inadvertent dosing with less than four hours of bedtime remaining, and inadvertent re-dosing in a single night.

Based on communications with the FDA, we are conducting a highway driving study to assess the effect of Intermezzo^® on next morning driving ability beginning at approximately three hours and four hours after dosing Intermezzo^® in the middle of the night. As part of our planned resubmitted NDA, we also plan to submit new Intermezzo^® bedside, single unit-dose packaging and patient instructions designed to reduce the possibility of inadvertent patient dosing errors.

The FDA and Transcept also discussed whether a pre-approval patient use study might help to assess patient ability to properly follow instructions under actual conditions of use. We have no current plans to conduct a patient use study because of the challenges and limitations of such a study, and have submitted to the FDA our position in this regard. The FDA indicated that it would consider our position on patient use studies as part of the overall resubmission of the Intermezzo^® NDA. We also plan to include data from studies of patient comprehension of label instructions in our planned resubmission.

We expect to announce top-line results from our Intermezzo^® highway driving study in the fourth quarter of 2010, and plan to resubmit the Intermezzo^® NDA in the first quarter of 2011. Because our planned resubmission will include additional clinical data, we expect that our resubmitted Intermezzo^® NDA will result in a six-month review period at the FDA under the Prescription Drug User Fee Act, or PDUFA.

In July 2009, we entered into the United States License and Collaboration Agreement, or the Collaboration Agreement, with Purdue Pharmaceutical Products, L.P., or Purdue, that provides for an exclusive license to Purdue to commercialize Intermezzo^® in the United States and pursuant to which:

•

On August 4, 2009, Purdue paid us a $25.0 million non-refundable license fee;

•

We are obligated to seek FDA approval of Intermezzo^® and to continue development of Intermezzo^® at our expense until FDA approval; and

•

If Purdue does not elect to terminate our collaboration after its review of an FDA approval of Intermezzo^®, or otherwise:

•

Purdue is obligated to pay us an amount equal to $30.0 million, less $2.0 million for each 30-day period that our receipt of an NDA approval for Intermezzo^® is delayed beyond June 30, 2010;

•

We are obligated to transfer the Intermezzo^® NDA to Purdue and Purdue is obligated to assume the expense associated with maintaining the NDA and further development of Intermezzo^® in the United States, including any expense associated with post-approval studies;

•

Purdue is obligated to commercialize Intermezzo^® in the United States at its expense;

•

Purdue is obligated to pay us tiered double-digit base royalties on net sales of Intermezzo^® in the United States ranging up to the mid-twenty-percent level;

•

Purdue is obligated to pay us $10.0 million if either of two formulation patents is listed in the FDA’s Approved Drug Products with Therapeutic Equivalence Evaluations, or Orange Book; and

•

Purdue is potentially obligated to pay us up to an additional $80.0 million upon meeting an additional intellectual property milestone and upon the achievement of certain net sales targets for Intermezzo^® in the United States.

We retained an option to co-promote Intermezzo^® to psychiatrists in the United States as early as the first anniversary of commercial launch of Intermezzo^®. Upon entry into the market under the co-promotion option, we would receive an additional double-digit royalty from Purdue on sales generated by psychiatrists in the United States.

We also granted Purdue and an associated company the right to negotiate for the commercialization of Intermezzo^® in Mexico and Canada, respectively, and retained rights to commercialize Intermezzo^® in the rest of the world.

We plan to enter into one or more development and marketing alliances to develop and commercialize Intermezzo^® with established pharmaceutical companies in major markets outside the United States.

TO-2061: Ultra Low Dose Ondansetron as Adjunctive Therapy in Patients with Obsessive Compulsive Disorder

We recently advanced the development of TO-2061, our second internally developed pipeline program. TO-2061 employs ultra low doses of ondansetron as adjunctive therapy in patients with obsessive compulsive disorder, or OCD, who have not adequately responded to treatment with a selective serotonin re-uptake inhibitor, or SSRI. Our Investigational New Drug application, or IND, for TO-2061 was accepted by the FDA during the second quarter of 2010. We expect to complete related Phase 1 trials in the first half of 2011. Subject to the results of our planned Phase 1 studies and discussion with the FDA, we plan to begin a full-scale, Phase 2 double-blind placebo controlled study of SSRI augmentation with TO-2061 in 2011. We plan to design and power this Phase 2 study so that it may potentially serve as one of two Phase 3 pivotal studies to be submitted in support of FDA approval.

Net Loss and Profitability

We have incurred net losses since inception as we have devoted substantially all of our resources to research and development, including contract manufacturing and clinical trials. As of June 30, 2010, we had an accumulated deficit of $90.8 million. Our net loss for the years ended December 31, 2009, 2008 and 2007 was $21.8 million, $20.0 million and $20.4 million, respectively. Our net loss for the three and six months ended June 30, 2010 was $2.1 million and $3.9 million, respectively. As of June 30, 2010, we had cash, cash equivalents, and marketable securities of $78.9 million and working capital of $65.1 million.

Our only source of revenue has been the receipt in August 2009 of a $25.0 million non-refundable license fee received pursuant to our Collaboration Agreement with Purdue, which we currently recognize ratably at $3.1 million per quarter over an estimated 24-month period that commenced in August 2009 and ends in July 2011. Our ability to generate additional near term revenue is dependent upon our ability to license the development and commercialization of Intermezzo^® outside the United States and the receipt of milestone and royalty payments under our Collaboration Agreement with Purdue, which payments are dependent upon the regulatory approval by the FDA of Intermezzo^®.

Our ability to achieve profitable operations depends upon the development and commercial success of Intermezzo^® and TO-2061, and possibly the identification, development and commercialization of additional product candidates.

Financial Operations Overview

Revenue

We recognize revenue from the $25.0 million non-refundable license fee received pursuant to our Collaboration Agreement with Purdue ratably over an estimated 24-month period that commenced in August 2009 and ends in July 2011. This period represents the estimated period for which we have significant participatory obligations under the Collaboration Agreement. The revenue recognized in connection with the license fee during the three and six months ended June 30, 2010 was $3.1 million and $6.2 million, respectively.

Research and Development Expense

Research and development expense has represented approximately 47% and 31% of total operating expense for the three months ended June 30, 2010 and 2009, respectively, and 47% and 28% of total operating expense for the six months ended June 30, 2010 and 2009, respectively. Research and development costs are expensed as incurred. Research and development expense consists of expenses incurred in identifying, researching, developing and testing product candidates. These expenses primarily consist of the following:

•

Salaries, benefits, travel and related expense of personnel associated with research and development activities;

•

Fees paid to professional service providers for services related to the conduct and analysis of clinical trials;

•

Contract manufacturing costs for formulations used in clinical trials and pre-commercial manufacturing and packaging costs;

•

Fees paid to consultants related to continued development of Intermezzo^®;

•

Laboratory supplies and materials;

•

Depreciation of equipment; and

•

Allocated costs of facilities and infrastructure.

General and Administrative Expense

General and administrative expense consists primarily of salaries and related expense for personnel in executive, marketing, finance and accounting, information technology and human resource functions. Other costs include facility costs not otherwise included in research and development expense and professional fees for legal and accounting services.

In the first half of 2009, we increased spending on our sales and marketing infrastructure, including increased headcount and marketing expense necessary to prepare for the commercialization of Intermezzo^®. Following our entry into the Collaboration Agreement with Purdue, the majority of our sales and marketing activities were transitioned to Purdue.

Interest Income

We receive interest income from cash, cash equivalents, restricted cash and marketable securities held with certain financial institutions.

Interest Expense

During 2009, we incurred interest expense on the outstanding balance from a $10.0 million venture debt facility agreement, which was repaid in full during the first quarter of 2009. We also incur interest expense on a $0.3 million loan for tenant improvements, payable to the landlord of our corporate facility in Point Richmond, California.

Other Income (Expense), Net

Other income (expense), net relates to the change in fair value of preferred stock warrants, gains or losses on sales of marketable securities and other miscellaneous items. In connection with our January 2009 merger (under our pre-merger name, Novacea, Inc.) with Transcept Pharmaceuticals, Inc., a privately-held Delaware corporation (which is currently a wholly-owned subsidiary named Transcept Pharma, Inc.), or the Merger, the outstanding preferred stock warrants became outstanding common stock warrants and therefore are no longer treated as a liability requiring remeasurement to fair market value at each balance sheet date.

Results of Operations

Comparison of the Three Months Ended June 30, 2010 and 2009

The following table summarizes results of operations with respect to the items set forth below for the three months ended June 30, 2010 and 2009, together with the percentage change in those items (dollars in thousands).


	For the Three Months Ended June 30,
							$			%
	2010			2009			Change			Change
Revenue	$	3,125		$	—		$	3,125		—
Research and development expense		2,407			2,250			157		7	%
General and administrative expense		2,769			5,019			(2,250	)	(45	%)
Interest income		37			97			(60	)	(62	%)
Interest expense		(4	)		(5	)		1		20	%
Other income (expense), net		(43	)		64			(107	)	(167	%)

Revenue

Revenue for 2010 relates to recognition of a portion of the $25.0 million non-refundable license fee we received from Purdue in connection with our entry into the Collaboration Agreement. We recognize revenue over an estimated 24-month period that commenced in August 2009 and ends in July 2011 as we have continuing participatory obligations under the agreement for the commercialization of Intermezzo^®.

Research and Development Expense

Research and development expense increased 7% to $2.41 million for the three months ended June 30, 2010 from $2.25 million for the comparable period in 2009. The increase of approximately $0.16 million for the three months ended June 30, 2010 is primarily attributable to our Intermezzo^® highway driving study currently underway, partially offset by payroll related savings due to the reduction in force implemented in the third and fourth quarters of 2009.

General and Administrative Expense

General and administrative expense decreased 45% to $2.77 million for the three months ended June 30, 2010 from $5.02 million for the comparable period in 2009. The decrease of approximately $2.25 million for the three months ended June 30, 2010 as compared to June 30, 2009 is attributable to the following:

•

Professional fees, including third party consulting and legal fees, decreased by $0.85 million and were primarily attributable to transitioning more of these functions in-house as compared to the quarter ended June 30, 2009 following our Merger with Novacea on January 30, 2009;

•

Marketing related expense declined by $0.83 million as Purdue assumed its responsibilities in the latter half of 2009 in accordance with our Collaboration Agreement; and

•

Other general and administrative expense decreased by $0.57 million.

Interest Income

Interest income decreased 62% to $37,000 for the three months ended June 30, 2010 from $97,000 for the comparable period in 2009. The decrease of approximately $60,000 for the three months ended June 30, 2010 is primarily attributable to changing the mix of investments toward lower risk, lower yield investments.

Interest Expense

Interest expense decreased 20% to $4,000 for the three months ended June 30, 2010 from $5,000 for the comparable period in 2009. The $1,000 decrease for the three months ended June 30, 2010 was due to a lower average outstanding debt during the 2010 period as compared to the same period in the prior year.

Other Income (Expense), Net

Other income (expense), net decreased 167% to expense of $43,000 for the three months ended June 30, 2010 from income of $64,000 for the comparable period in 2009. Other expense for the three months ended June 30, 2010 primarily consisted of an increase in Delaware franchise taxes. Other income for the three months ended June 30, 2009 consisted of a realized gain on the sale of marketable securities.

Comparison of the Six Months Ended June 30, 2010 and 2009

The following table summarizes results of operations with respect to the items set forth below for the six months ended June 30, 2010 and 2009, together with the percentage change in those items (dollars in thousands).


	For the Six Months Ended June 30,
							$			%
	2010			2009			Change			Change
Revenue	$	6,250		$	—		$	6,250		—
Research and development expense		4,767			4,472			295		7	%
General and administrative expense		5,373			9,233			(3,860	)	(42	%)
Merger related transaction costs		—			2,224			(2,224	)	(100	%)
Interest income		81			185			(104	)	(56	%)
Interest expense		(7	)		(171	)		164		96	%
Other income (expense), net		(87	)		264			(351	)	(133	%)

Revenue

Research and Development Expense

Research and development expense increased 7% to $4.77 million for the six months ended June 30, 2010 from $4.47 million for the comparable period in 2009. The increase of approximately $0.30 million for the six months ended June 30, 2010 is primarily attributable to expenses associated with Intermezzo^® packaging design changes, the manufacture of materials for the highway driving study as well as clinical trial costs incurred to date on the highway driving study, partially offset by payroll related savings due to the reduction in force implemented in the third and fourth quarters of 2009.

General and Administrative Expense

General and administrative expense decreased 42% to $5.37 million for the six months ended June 30, 2010 from $9.23 million for the comparable period in 2009. The decrease of approximately $3.86 million for the six months ended June 30, 2010 as compared to June 30, 2009 is attributable to the following:

•

Professional fees, including third party consulting and legal fees, decreased by $1.75 million and were primarily attributable to transitioning more of these functions to personnel hired late in the first quarter of 2009;

•

Marketing related expense declined by $1.39 million as Purdue assumed these responsibilities in accordance with the Collaboration Agreement; and

•

Other general and administrative expense decreased by $0.72 million.

Merger related transaction costs

Merger related transaction costs consisted primarily of $2.0 million in financial and advisory fees and $0.2 million in legal fees incurred in connection with the close of the Merger, in January 2009. There were no comparable costs incurred during the six months ended June 30, 2010.

Interest Income

Interest income decreased 56% to $81,000 for the six months ended June 30, 2010 from $185,000 for the comparable period in 2009. The decrease of approximately $104,000 for the six months ended June 30, 2010 is primarily attributable to changing the mix of investments toward lower risk, lower yield investments.

Interest Expense

Interest expense decreased 96% to $7,000 for the six months ended June 30, 2010 from $171,000 for the comparable period in 2009. The $164,000 decrease for the six months ended June 30, 2010 was primarily attributable to lower average outstanding debt during the 2010 period as compared to the same period in the prior year due to the repayment in full of our debt under a Loan and Security Agreement with Hercules Technology Growth Capital, Inc., or Hercules, during the first quarter of 2009.

Other Income (Expense), Net

Other income (expense), net decreased 133% to expense of $87,000 for the six months ended June 30, 2010 from income of $264,000 for the comparable period in 2009. Other expense for the six months ended June 30, 2010 primarily consisted of an increase in Delaware franchise taxes. Other income for the six months ended June 30, 2009 consisted of a decline in the fair value of warrants for preferred shares which resulted in recording other income as well as a realized gain on the sale of marketable securities.

Liquidity and Capital Resources

At June 30, 2010, we had cash, cash equivalents and marketable securities of $78.9 million.

Sources of Liquidity

From our inception through the completion of the Merger, we financed our operations primarily through private placements of preferred stock, debt financing and interest income. Through June 30, 2010, we received net proceeds of $71.0 million from the sale of preferred stock, all of which was converted to common stock upon completion of the Merger. In January 2009, through the Merger, we acquired an additional $80.9 million in cash, cash equivalents and marketable securities. On August 4, 2009, we received a $25 million non-refundable license fee from Purdue in connection with our entry into the Collaboration Agreement.

In April 2006, we entered into a $10.0 million venture debt facility agreement with Hercules and drew down $4.0 million in May 2006 and $6.0 million in December 2006, against which interest accrued at rates of 10.69% and 10.94%, respectively. Outstanding principal, accrued interest, and unpaid interest under the loan and security agreement became due and payable on certain change-in-control transactions. In conjunction with the Merger and pursuant to an agreement with Hercules, on February 3, 2009 we repaid in full all amounts outstanding related to this loan.

The following table summarizes our cash provided by (used in) operating, investing and financing activities (in thousands):


	Six Months Ended June 30,
	2010			2009
Net cash used in operating activities	$	(9,276	)	$	(15,238	)
Net cash provided by investing activities		2,256			24,241
Net cash provided by (used in) financing activities		101			(3,327	)

Operating Activities

Net cash used in operating activities was $9.3 million for the six months ended June 30, 2010, compared to $15.2 million for the six months ended June 30, 2009. Net cash used in operating activities for both periods consisted primarily of our net loss adjusted for noncash items such as depreciation, amortization, stock-based compensation charges and noncash interest expense, as well as net changes in working capital.

Investing Activities

Net cash provided by investing activities was $2.3 million for the six months ended June 30, 2010, compared to $24.2 million for the six months ended June 30, 2009. Net cash provided by investing activities during the first half of 2010 was primarily attributable to maturities of marketable securities, net of purchases. $48.0 million of net cash provided by investing activities during the first half of 2009 relates to the cash and cash equivalents that came from the Merger. This was partially offset by $23.5 million used in investing activities for the six months ended June 30, 2009 due to purchases of marketable securities, net of sales and maturities, during the period. Uses of cash in investing activities for both periods also included net purchases of property and equipment.

Financing Activities

Net cash provided by financing activities during the six months ended June 30, 2010 was $101,000 and consisted of stock issuances. Net cash used in financing activities during the six months ended June 30, 2009 was $3.3 million and consisted primarily of debt repayment, as the outstanding debt with Hercules was fully repaid during the first quarter of 2009.

Capital Resources

We expect our cash, cash equivalents, and marketable securities of $78.9 million at June 30, 2010, will be sufficient to satisfy our liquidity requirements for at least the next twelve months. We believe our investments in cash equivalents and marketable securities are highly rated and highly liquid.

Our future capital requirements will depend on, and could increase significantly as a result of, numerous forward-looking factors, including:

•

the extent to which we continue to develop internally, acquire or in-license new products, technologies or businesses;

•

the rate of progress and cost of our clinical trials, the need to conduct additional clinical trials and other development activities;

•

the costs and timing of regulatory approval for Intermezzo^® in and outside the United States;

•

the costs of establishing or contracting for sales and marketing capabilities if Intermezzo^® is approved in the United States and we exercise our option to co-promote Intermezzo^®, and potential costs of being required to engage in contracting for replacements for such capabilities if our existing arrangement with Purdue is terminated;

•

the receipt of milestone payments, if any, from Purdue under the Collaboration Agreement;

•

the terms and timing of any licensing arrangements that we may establish for Intermezzo^® outside the United States;

•

the cost of filing, prosecuting, defending and enforcing any patent claims and other intellectual property rights; and

•

the effect of competing technological and market developments.

If at any time our prospects for the commercialization of Intermezzo^® diminish, we may decide to reduce operating expenses by limiting research and development efforts with respect to TO-2061 or other potential product candidates or otherwise reduce our expenses. Alternatively, we may decide to raise funds through public or private financings, collaboration relationships or other arrangements. There can be no assurance that funding, if needed, will be available on attractive terms, or at all. Furthermore, any additional equity financing may be dilutive to stockholders and debt financing, if available, may involve restrictive covenants. Similarly, financing obtained through future collaborations may require us to forego certain commercialization and other rights to our drug candidates. Our failure to raise capital as and when needed could have a negative impact on our financial condition and our ability to successfully pursue our business strategy.

Critical Accounting Policies

There were no changes to our critical accounting policies since we filed our 2009 Annual Report on Form 10-K for the year ended December 31, 2009 with the Securities and Exchange Commission, or SEC. For a description of our critical accounting policies, please refer to our 2009 Annual Report.

Off-Balance Sheet Arrangements

Since inception, we have not engaged in any off-balance sheet financing activities, including the use of structured finance, special purpose entities or variable interest entities.

Inflation

We do not believe that inflation has had a significant impact on our results of operations since inception.

Item 3.

Quantitative and Qualitative Disclosures About Market Risk

Our exposure to market risk is confined to cash, cash equivalents and marketable securities which have contractual maturities of eighteen months or less, bear interest rates at fixed rates and are denominated in, and pay interest in, U.S. dollars. The goals of our investment policy are preservation of capital, fulfillment of liquidity needs, and fiduciary control of cash and investments. We also seek to achieve income from investments consistent with our investment policy. Investments are classified as available-for-sale. We do not use derivative financial instruments in our investment portfolio. To achieve our goals, we invest excess cash in securities with different maturities to match projected cash needs and limit concentration of credit risk by diversifying investments among a variety of high credit-quality issuers, including U.S. government agencies, commercial paper, corporate bonds and money market funds. The portfolio includes marketable securities with active secondary or resale markets to ensure portfolio liquidity, and we regularly review our portfolio against our policy. Our policy was further amended during 2009 to limit investments to U.S. Treasury debt or SEC registered money market funds effective September 30, 2009. A hypothetical 100 basis point increase in interest rates would result in a decrease of approximately $241,000 in the fair value of our marketable securities at June 30, 2010.

Item 4T.

Controls and Procedures

(a) Evaluation of disclosure controls and procedures

Our management evaluated, with the participation and under the supervision of our Chief Executive Officer and our Chief Financial Officer, the effectiveness of our disclosure controls and procedures as of the end of the period covered by this Quarterly Report on Form 10-Q. Based on this evaluation, our Chief Executive Officer and our Chief Financial Officer have concluded, subject to the limitations described below, that our disclosure controls and procedures were effective to ensure that information we are required to disclose in reports that we file or submit under the Securities Exchange Act of 1934 is recorded, processed, summarized and reported within the time periods specified in SEC rules and forms, and that such information is accumulated and communicated to management as appropriate to allow timely decisions regarding required disclosures.

(b) Changes in internal control over financial reporting

There were no changes in our internal controls over financial reporting during the quarter ended June 30, 2010 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

(c) Limitations on the effectiveness of controls

A control system, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the controls are met. Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues, if any, within a company have been detected. Accordingly, our disclosure controls and procedures are designed to provide reasonable, not absolute, assurance that the objectives of our disclosure control system are met.

PART II.

OTHER INFORMATION

Item 1.

Legal Proceedings

From time to time, we may be involved in litigation relating to claims arising out of our operations. We are not currently involved in any material legal proceedings.

SPI Pharmaceuticals, Inc., the sole supplier of Pharmaburst^®, a key excipient used in Intermezzo^®, is the defendant in a lawsuit brought by Roquette Frères, or Roquette, in the Federal District Court of Delaware on August 31, 2006 that alleges that certain of SPI’s products infringe one or more claims of a Roquette patent and seeks monetary damages and injunctive relief. We have not been named in, and are not a party to, the lawsuit. Although not specifically identified in the original complaint, press releases have indicated that Pharmaburst^® products are among the accused products. SPI has informed us that Roquette’s patent rights are not infringed by Pharmaburst^® and that it intends to defend its rights vigorously. Because Pharmaburst^® is a key excipient in Intermezzo^®, the interruption of supply of Pharmaburst^® through an injunction could materially harm our ability to supply Intermezzo^® and our business. SPI has agreed to indemnify us against certain damages related to any such infringement suit under the terms of our agreement with SPI.

Item 1A.

Risk Factors

Investing in our common stock involves a high degree of risk. You should carefully consider the risks and uncertainties described below and all information contained in this report before you decide to purchase our common stock. If any of the possible adverse events described below actually occurs, we may be unable to conduct our business as currently planned and our financial condition and operating results could be harmed. In addition, the trading price of our common stock could decline due to the occurrence of any of the events described below, and you may lose all or part of your investment.

We have had a brief operating history that may make it difficult for you to evaluate the potential success of our business and we have a history of incurring losses.

We were founded in January 2001 under our former name Novacea, Inc., and in January 2009 underwent a merger with Transcept Pharmaceuticals, Inc., a privately held company, or TPI, founded in 2002 whose business is currently conducted by us. Our operations to date have been limited to organizing and staffing, acquiring, developing and securing technology and undertaking preclinical studies and clinical trials. We have not yet demonstrated the ability to obtain regulatory approval and manufacture marketed products to the U.S. Food and Drug Administration, or FDA. We have also not demonstrated the ability to meet and adhere to other regulatory standards applicable to an FDA approved product, to conduct sales and marketing activities or to support commercialization efforts of a collaboration partner, such as our collaboration partner in the United States, Purdue Pharmaceutical Products L.P., or Purdue. Consequently, any predictions you make about our future success or viability may not be as accurate as they would be if we had a longer operating history.

Furthermore, our business is not profitable and has incurred losses in each year since the inception of TPI in 2002. Our net loss for the years ended December 31, 2009, 2008 and 2007 was $21.8 million, $20.0 million and $20.4 million, respectively. Our net loss for the six months ended June 30, 2010 was $3.9 million. As of June 30, 2010, we had an accumulated deficit of $90.8 million. We expect to continue to incur losses for the foreseeable future unless Intermezzo^® is approved by the FDA and we receive milestone and royalty revenue from our collaboration with Purdue that exceed our expenses. For the foreseeable future, we expect our accumulated deficit to increase as we continue our research, development, regulatory and pre-approval and pre-commercialization efforts with respect to Intermezzo^® both in support of our collaboration partner in the United States and potential collaboration partners worldwide, and with respect to other product candidates, such as TO-2061. If Intermezzo^® or our other product candidates do not gain regulatory approval, are not commercialized or do not achieve market acceptance, we may not be able to generate any revenue. We cannot assure you that we will ever be profitable even if Intermezzo^® or any other product candidate is commercialized or that we can sustain profitability, even if achieved. If we fail to achieve and maintain profitability, or if we are unable to fund our continuing losses, investors could lose all or part of their investment.

Our success depends substantially on our ability to obtain regulatory approval in the United States for our lead product candidate, Intermezzo^®.

Our success depends substantially on obtaining regulatory approval for our most advanced product candidate, Intermezzo^®, for use as needed for the treatment of insomnia when a middle of the night awakening is followed by difficulty returning to sleep, or middle of the night awakening. Regulatory approval to market pharmaceutical products in the United States requires the completion of extensive non-clinical and clinical evaluations of a product candidate, referred to as clinical trials, to demonstrate substantial evidence of both safety and efficacy of the candidate, as well as development of manufacturing processes that demonstrate the ability to reliably and consistently produce the candidate under current Good Manufacturing Practice, or cGMP, regulations. Each of these elements requires pharmaceutical development companies to exercise certain judgments concerning applicable regulatory requirements and to predict what the regulatory authority will ultimately deem acceptable. There can be no assurance that the results of the clinical trials or manufacturing processes for Intermezzo^® will satisfy the regulatory requirements for approval. A failure to meet these requirements would significantly delay or prevent FDA approval of Intermezzo^® and seriously harm our ability to generate revenue.

Our success in obtaining regulatory approval in the United States for Intermezzo^® depends substantially on overcoming issues presented by the FDA in response to our New Drug Application.

In September 2008, we submitted a New Drug Application, or NDA, to the FDA for Intermezzo^®. On October 28, 2009, we received a Complete Response Letter from the FDA formally responding to our Intermezzo^® NDA. The Complete Response Letter indicated that the FDA did not believe we adequately demonstrated that Intermezzo^® could be reliably used safely. The NDA was therefore not approved.

In the Complete Response Letter, the FDA noted that we are seeking to gain approval of Intermezzo^® in a unique insomnia indication for which safety has not previously been established, specifically, the as needed treatment for difficulty returning to sleep after a middle of the night awakening. The FDA’s Complete Response Letter noted that data presented in the Intermezzo^® NDA indicated no significant residual effects four hours after dosing, as measured by both the Digit Symbol Substitution Test, a commonly used test to measure the impairment of patients taking sedative hypnotics, and next day patient questionnaires. However, the FDA requested additional data demonstrating that Intermezzo^®, when taken as directed in the middle of the night, would not present an unacceptable risk of residual effects, with particular reference to a patient’s ability to drive the next morning.

The FDA also expressed two concerns in the Complete Response Letter regarding the possibility of patient dosing errors in the middle of the night that could lead to next day residual effects, with particular reference to next day driving ability. Specifically, the FDA asked us to address methods to avoid inadvertent dosing with less than four hours of bedtime remaining, and inadvertent re-dosing of Intermezzo^® in a single night.

We are conducting a highway driving study to measure the potential for next day driving impairment after dosing Intermezzo^® in the middle of the night, four and three hours before driving the next day. We believe the general risks of study design and execution are heightened by the fact that, to our knowledge, this is the first study of residual effects on driving ability to be conducted in support of FDA approval of a new sleep agent. Therefore, commonly accepted protocols, study endpoints and statistical evaluation methodologies have not been established. Further, as a study designed to assess a drug candidate’s safety profile, the driving study does not have a pre-specified endpoint that can be used to judge success or failure. We expect that the FDA will analyze the data generated by the study in different ways to understand the safety profile of Intermezzo^® before making a decision as to whether to grant marketing approval. Thus, we cannot assure you that our planned study will generate results that will be readily translated into success or failure or be sufficient to demonstrate the safety of Intermezzo^®. Additional studies in support of the NDA, if later determined to be required, may also or alternatively include studies to assess other measurements of drug safety.

We also need to determine how best to demonstrate to the FDA that Intermezzo^® would be used in a manner consistent with the proposed label. We have discussed with the FDA our proposed plan to minimize inadvertent dosing errors through our change in packaging from a multi-dose unit package to a bedside, single unit-dose package with revised instructions designed to reduce such dosing errors. We have also discussed with the FDA how to assess the adequacy of the proposed new packaging to address FDA concerns regarding the potential for inadvertent dosing errors. The FDA expressed continuing concern about the risk of inadvertently dosing with less than four hours of time remaining in bed. If an evaluation of a new product presentation is required in support of FDA approval of Intermezzo^®, there also can be no assurance that we will be able to effectively design or carry out such an evaluation in a cost-effective manner, or at all, or that the FDA will find any data arising from such an evaluation to be supportive of our efforts to gain approval for Intermezzo^®. Accordingly, if the FDA believes that our new single unit-dose package with revised patient instructions does not adequately reduce inadvertent dosing errors, our planned resubmission of the Intermezzo^® NDA could be denied and our business would be materially harmed.

The FDA also discussed with us whether a pre-approval patient use study might help to assess patient ability to properly follow instructions under actual conditions of use. We have no current plans to conduct a patient use study because of the challenges and limitations of such a study and have submitted to the FDA our position in this regard. Problems with pre-approval use studies include the inability to replicate actual in-use conditions and study subjects’ altering their behavior because they are under observation. The risks associated with designing and conducting such an evaluation are heightened by the fact that recognized standards for such evaluations have not been established. The FDA indicated that it would consider our position on the challenges and limitations of a pre-approval use study as part of the overall resubmission of the Intermezzo^® NDA. The FDA may not agree with our proposal and may require us to conduct such a use study. If we are required to conduct a pre-approval patient use study, notification of such requirement may not be delivered to us until after review of our resubmitted NDA for Intermezzo^®. If the FDA does not agree with our proposal to not conduct a use study, approval of a resubmitted Intermezzo^® NDA could be denied and our business would be materially harmed.

Our proposed driving study has been designed, in part, to characterize the effect on driving of dosing Intermezzo^® in the middle of the night with at least three and four hours before driving. The label we proposed to the FDA requires patients dose with at least four hours remaining in bed. We believe the FDA will consider the adequacy of our new proposed packaging to minimize dosing errors in the context of the data from our proposed highway driving study that may reflect the presence or absence of impairment of driving ability from residual effects of Intermezzo^®. However, even if our study shows the absence of residual effect on driving ability when Intermezzo^® is dosed in the middle of the night three hours before driving the next day, the FDA may still request that we demonstrate the extent to which patients inadvertently use Intermezzo^® in the middle of the night in a manner inconsistent with the proposed label.

If our proposed new packaging is not acceptable to the FDA, we may need to develop a new presentation of the proposed product that may include new dosing instructions, packaging and/or dispensing methods for Intermezzo^® designed to maximize the likelihood that Intermezzo^® would be taken as directed. Any such new presentation could make Intermezzo^® a less attractive commercial product and more costly to produce. There can be no assurance that we will be able to identify a new product presentation that will address the FDA’s concerns regarding inadvertent mis-dosing of Intermezzo^® by patients to a degree sufficient to warrant FDA approval of Intermezzo^®. We cannot assure you that any such new presentation, if identified or developed, will be cost-effective or easy to manufacture, and if the Intermezzo^® NDA is approved after meeting FDA requirements, that such new presentation will not make Intermezzo^® a less commercially attractive product.

Additionally, despite the FDA’s statement in the Complete Response Letter finding that we presented substantial evidence of effectiveness of Intermezzo^®, there can also be no assurance that the FDA will not come to a different interpretation of our previously submitted clinical trial data, including data from our two pivotal Phase 3 clinical trials that served as the basis for our Intermezzo^® NDA, or otherwise alter its view and conclude that Intermezzo^® is not sufficiently effective to warrant approval.

Because the FDA has not approved a pharmaceutical product specifically to treat middle of the night awakening, there can be no assurance that the FDA will approve this new indication within the insomnia category. While we expect to continue our efforts to obtain and to follow FDA guidance in order to obtain approval of Intermezzo^®, the FDA may not agree that any new data or trial results we submit will be sufficient to support Intermezzo^® approval or may reconsider its guidance, require more clinical trials or otherwise require additional data or studies to justify a new middle of the night awakening indication in the insomnia market.

In addition, we have limited experience in preparing, submitting and prosecuting regulatory filings, including NDAs and other applications necessary to gain regulatory approvals. Unless we receive regulatory approval from the FDA, Intermezzo^® cannot be commercialized in the United States. Significant delay or the inability to commercialize Intermezzo^® in the United States would significantly harm our business and financial prospects.

Our clinical trials may fail to demonstrate adequately the safety and efficacy of our product candidates, which could prevent or delay regulatory approval and commercialization.

Before obtaining regulatory approvals for the commercial sale of our product candidates, we must demonstrate through lengthy, complex and expensive preclinical testing and clinical trials that the product candidate is both safe and effective for use in each target indication. Our trial results may be negatively affected by factors that had not been fully anticipated prior to commencement of the trial. Such trials may fail to demonstrate efficacy in the treatment of the intended disorder or may fail to demonstrate that a product candidate is safe when used as directed or even when misused. The results obtained in completed clinical trials and non-clinical studies may not be predictive of results from ongoing or future trials. For example, we previously conducted a Phase 1 pharmacokinetic and pharmacodynamic study of Intermezzo^® that demonstrated rapid bioavailability and also indicated that sedation levels returned to baseline within about three hours by most measures, suggesting that patients may be able to awaken without residual sedative effects four hours after taking a middle of the night dose of Intermezzo^®. These study results should not in any way be construed as predictive of the outcome of any future studies, including, without limitation, a repeat of the same or similar studies or the current study to assess the effect of Intermezzo^® on study subjects’ ability to drive or to be predictive of the sufficiency of current or future data that may be generated to support FDA approval of Intermezzo^® for its intended indication. Actual results of any future studies may differ materially from past studies due to various risks and uncertainties, including, but not limited to,

•

identical study designs evaluating identical endpoints may produce different study results;

•

different study designs intended to measure the same or similar endpoints may produce different results;

•

different studies in different or progressively larger patient populations could reveal more frequent, more severe or additional side effects that were not seen in earlier studies; and

•

the unpredictable nature of clinical trials generally.

Although we seek to design our clinical trial protocols to address known factors that may negatively affect results, there can be no assurance that protocol designs will be adequate or that factors that we may or may not be aware of or anticipate will not have a negative effect on the results of our clinical trials. Once a study has commenced, we may voluntarily suspend or terminate the study if at any time we believe that there is an unacceptable safety risk to patients.

Further, side effects could interrupt, delay or halt clinical trials of our product candidates and could result in the FDA or other regulatory authorities stopping further development of or denying approval of our product candidates. Based on results at any stage of clinical trials, we may decide to repeat or redesign a trial, modify our regulatory strategy or even discontinue development of one or more of our product candidates.

If our product candidates are not shown to be both safe and effective in clinical trials, the resulting delays in developing other compounds and conducting associated non-clinical testing and clinical trials, as well as the potential need for additional financing, would have a material adverse effect on our business, financial condition and results of operations.

Delays in the commencement or completion of clinical testing could result in increased costs to us and delay our ability to generate revenue.

We do not know whether future clinical trials will begin on time or be completed on schedule, if at all. The commencement and completion of clinical trials can be disrupted for a variety of reasons, including difficulties in:

•

addressing issues raised by the FDA or other regulatory authorities regarding safety, design, scope and objectives of clinical studies;

•

recruiting and enrolling patients to participate in a clinical trial;

•

obtaining regulatory approval to commence a clinical trial;

•

reaching agreement on acceptable terms with prospective clinical research organizations and trial sites;

•

manufacturing sufficient quantities of a product candidate; and

•

obtaining institutional review board approval to conduct a clinical trial at a prospective site.

A clinical trial may also be suspended or terminated by us or the FDA or other regulatory authorities due to a number of factors, including:

•

failure to conduct the clinical trial in accordance with regulatory requirements or in accordance with our clinical protocols;

•

inspection of the clinical trial operations or trial site by the FDA or other regulatory authorities resulting in the imposition of a clinical hold;

•

unforeseen safety issues; and

•

inadequate patient enrollment or lack of adequate funding to continue the clinical trial.

The general risks of study design and execution applicable to our highway driving study are heightened by the fact that, to our knowledge, this is the first study of residual effects on driving ability to be conducted in support of FDA approval, and that standards for evaluating such a study and data generated from such a study have not been established.

In addition, changes in regulatory requirements and guidance may occur and we may need to amend clinical trial protocols to reflect these changes, which could impact the cost, timing or successful completion of a clinical trial. If we experience delays in the commencement or completion of our clinical trials, the commercial prospects for our product candidates and our ability to generate product revenue will be harmed. Many of the factors that cause, or lead to, a delay in the commencement or completion of clinical trials may also lead to the denial of regulatory approval of a product candidate.

Our success depends on meeting the conditions for approval and market exclusivity under Section 505(b)(2) of the Federal Food, Drug and Cosmetic Act, or FFDCA.

We are seeking approval for Intermezzo^® under Section 505(b)(2) of the FFDCA, enacted as part of the Drug Price Competition and Patent Restoration Act of 1984, otherwise known as the Hatch-Waxman Act, which permits applicants to rely in part on clinical and non-clinical data generated by third parties. We also plan to rely on the Hatch-Waxman Act to seek approval of TO-2061, which is in earlier stages of development, for the use of ultra low doses of ondansetron as adjunctive therapy in patients with OCD who have not adequately responded to treatment with an SSRI.

Specifically, with respect to Intermezzo^®, we are relying in part on third party data on zolpidem, which is the active ingredient in Intermezzo^® and the previously approved insomnia products Ambien^® and Ambien CR^®. There can be no assurance that the FDA will not require us to conduct additional non-clinical or clinical studies or otherwise obtain new supplementary data with respect to some or all of the data upon which we may rely prior to approving an Intermezzo^® NDA.

Our NDA also relies on prior FDA findings of safety and effectiveness of previously-approved products, and we have made certifications in our NDA under Section 505(b)(2) requirements based on the listed patents in the FDA publication “Approved Drug Products with Therapeutics Equivalence Evaluations,” or the Orange Book, for certain of these referenced products. Currently, there are no unexpired patents for immediate release zolpidem products listed in the Orange Book. In the event that one or more patents is listed in the Orange Book for the referenced product after our submission of additional information in support of our NDA for Intermezzo^®, we may also be required to evaluate the applicability of these patents to Intermezzo^® and submit additional certifications. A paragraph III certification, stating that a listed patent has not expired, but will expire on a particular date, may delay the approval of Intermezzo^® until the expiration of the patent. A paragraph IV certification, stating that a listed patent is invalid, unenforceable, or not infringed by Intermezzo^® may require us to notify the patent owner and the holder of the NDA for the referenced product of the existence of the Intermezzo^® NDA, and may result in patent litigation against us and the entry of a 30-month stay of FDA ability to issue final approval of the 505(b)(2) NDA for Intermezzo^®.

Our success also relies, in part, on obtaining Hatch-Waxman marketing exclusivity in connection with any approval of our NDA for Intermezzo^®. Such exclusivity protection would preclude the FDA from approving a marketing application for a duplicate of Intermezzo^®, a product candidate that the FDA views as having the same conditions of approval as Intermezzo^® (for example, the same indication, the same route of delivery and/or other conditions of use), or a 505(b)(2) NDA submitted to the FDA with Intermezzo^® as the reference product, for a period of three years from the date of Intermezzo^® approval, although the FDA may accept and commence review of such applications. This form of exclusivity may not prevent FDA approval of an NDA that relies only on its own data to support the change or innovation. Similarly, if, prior to approval of the Intermezzo^® NDA, another company obtains approval for a product candidate under, in the view of the FDA, the same conditions of approval that we are seeking for Intermezzo^®, Intermezzo^® could be blocked until the other company’s three-year Hatch-Waxman marketing exclusivity expires.

We are dependent upon the efforts of Purdue for commercializing Intermezzo^® in the United States, and will be dependent on the efforts of other collaboration partners if we enter into additional strategic collaborations outside the United States.

The success of sales of Intermezzo^® in the United States will be dependent on the ability of Purdue to successfully launch and commercialize Intermezzo^®, if approved by the FDA, pursuant to the Collaboration Agreement we entered into in July 2009. The terms of the Collaboration Agreement provide that Purdue has the ability to terminate such arrangement for any reason at any time upon 180 days notice and within 10 business days after review of documentation we receive from the FDA in connection with any approval of Intermezzo^® in the United States. Thus, for example, even if the measures taken to address FDA concerns on the safety of Intermezzo^® are successful to obtain FDA approval, Purdue may determine that such measures, or the outcome of any clinical trials from such measures, have made Intermezzo^® a less attractive commercial product for Purdue and terminate our collaboration. If the Collaboration Agreement is terminated, our business and our ability to generate revenue from sales of Intermezzo^® will be substantially harmed and we will be required to develop our own sales and marketing organization or enter into another strategic collaboration in order to commercialize Intermezzo^® in the United States. Such efforts may not be successful and, even if successful, would require substantial time and resources to carry out.

The manner in which Purdue launches Intermezzo^®, including the timing of launch and potential pricing, will have a significant impact on the ultimate success of Intermezzo^® in the United States, and the success of the overall commercial arrangement with Purdue. If launch of commercial sales of Intermezzo^® in the United States by Purdue is delayed or prevented, our revenue will suffer and our stock price will decline. Further, if launch and resulting sales of Intermezzo^® are not deemed successful, our stock price will decline. Also, if Intermezzo^® does not receive FDA approval on or before July 31, 2011, Purdue is no longer obligated to meet certain minimum spending obligations related to its sales and marketing efforts in support of Intermezzo^®, assuming it continues with our collaboration after any such approval. Any lesser effort by Purdue in its Intermezzo^® sales and marketing efforts may result in lower revenue and thus lower royalties paid to us. The outcome of Purdue commercialization efforts could also have an effect on investors’ perception of potential sales of Intermezzo^® outside of the United States, which could also cause a decline in our stock price and may make it more difficult to enter into strategic collaborations outside the United States.

The Collaboration Agreement provides for Purdue to be responsible for conducting any post-approval studies of Intermezzo^®, both if such studies are required or requested in connection with FDA approval of Intermezzo^®. The planning and execution of these studies will be primarily the responsibility of Purdue, and may not be carried out in accordance with our preferences, or could yield results that are detrimental to Purdue’s sales of Intermezzo^® in the United States or detrimental to our efforts to develop or commercialize Intermezzo^® outside the United States.

Our ability to receive any significant revenue from our product candidates covered by a strategic collaboration, such as the Collaboration Agreement with Purdue, will be dependent on the efforts of the collaboration partner and may result in lower levels of income than if we marketed or developed our product candidates entirely on our own. The collaboration partner may not fulfill its obligations or carry out marketing activities for our product candidates as diligently as we would like. We could also become involved in disputes with our partner, which could lead to delays in or termination of commercialization programs and time-consuming and expensive litigation or arbitration. If a collaboration partner terminates or breaches its agreement, or otherwise fails to complete its obligations in a timely manner, the chances of successfully developing or marketing our product candidates would be materially and adversely affected.

Our plan is to enter into additional strategic collaborations for the development and commercialization of Intermezzo^® outside the United States. We may not be able to enter into additional collaborations on acceptable terms, if at all. Our establishment of Purdue as our commercial partner for Intermezzo^® in the United States could also limit the potential collaboration options we have outside the United States or could render potential collaborators less inclined to enter into an agreement with us because of such relationship. Further, we have granted Purdue and an associated company an option to negotiate with us for a license to commercialize Intermezzo^® in Mexico and Canada. While these options and subsequent negotiation periods continue, we are prevented from negotiating with and being able to enter into commercialization agreements with other potential strategic partners for development or commercialization of Intermezzo^® in such countries.

If we choose to exercise our co-promotion option and are unable to establish a sales and marketing infrastructure in the United States, our potential revenue could be substantially harmed.

In order to commercialize Intermezzo^® or any other product candidates successfully, we must enter into and maintain strategic collaborations to perform, and/or acquire or internally develop a sales, marketing and distribution infrastructure. We have entered into a strategic collaboration for commercialization of Intermezzo^® in the United States with Purdue and may develop our own sales force and marketing infrastructure for Intermezzo^® to co-promote Intermezzo^® to psychiatrists in the United States. However, we have no experience in building a sales and marketing organization. If we exercise our co-promotion option and are unable to develop our own sales, marketing and distribution infrastructure to effectively commercialize Intermezzo^®, our ability to generate additional revenue from potential sales of Intermezzo^® to psychiatrists would be substantially harmed.

The development of sales, marketing and distribution infrastructure is difficult and time consuming, and requires substantial financial and other resources. Factors that may hinder our efforts to develop an internal sales, marketing and distribution infrastructure include:

•

inability to recruit, retain and effectively manage adequate numbers of effective sales and marketing personnel;

•

the inability of sales personnel to obtain access to or convince adequate numbers of physicians to prescribe our products;

•

the lack of complementary products to be offered by sales personnel, which may put us at a competitive disadvantage relative to companies with more extensive product lines; and

•

unforeseen delays, costs and expenses associated with creating a sales and marketing organization.

We may require substantial additional funding and may need to curtail operations if we are unable to raise capital when needed.

We have no current source of product revenue. We have a limited operating history and have not yet commercialized any products. We had cash, cash equivalents and marketable securities of $78.9 million at June 30, 2010. We expect our negative cash flows from operations to continue for the foreseeable future as we determine and undertake activities to support the planned resubmission of the Intermezzo^® NDA, pursue the regulatory approval and commercialization of Intermezzo^® internationally and develop TO-2061 and other product candidates. We do not know how long it will take to obtain regulatory approval of Intermezzo^®, or if such approval is obtainable. We also expect negative cash flows beyond any potential regulatory approval and product launch of Intermezzo^®. As a result, we will need to generate significant revenue to pay these costs and achieve profitability. We do not know whether or when we will become profitable because of the significant uncertainties with respect to our ability to gain regulatory approval of Intermezzo^® and generate revenue from the sale of our products and from our existing and potential future collaborations.

If the timing of potential product approval and launch is significantly delayed as a result of FDA or other regulatory approval delays, the Collaboration Agreement with Purdue is terminated or other factors arise, our cash, cash equivalents and marketable securities may prove insufficient to fund our operations through the commercial launch of Intermezzo^®. In particular, Purdue may be obligated to pay us a milestone payment if it elects to continue with the Collaboration Agreement after an FDA approval of Intermezzo^®. This potential payment would have been $30 million if Intermezzo^® approval were received before July 31, 2010, but is now being reduced by $2.0 million for each 30-day period that our receipt of an NDA approval for Intermezzo^® is delayed beyond June 30, 2010. Further, the development and potential regulatory approval of additional product candidates will likely require additional funding which may not be available at and as of the time needed on commercially reasonable terms, if at all.

We currently believe that our available cash, cash equivalents and marketable securities and interest income will be sufficient to fund our anticipated levels of operations for at least the next twelve months. However, our future capital requirements will depend on many factors, including:

•

the extent to which we develop internally, acquire or in-license new products, technologies or businesses;

•

the terms and timing of any licensing arrangements that we may establish for Intermezzo^® outside the United States;

•

the costs and timing of regulatory approval in and outside the United States;

•

the receipt of milestone payments, if any, from Purdue under the Collaboration Agreement;

•

the rate of progress and cost of our clinical trials, the need to conduct additional clinical trials and other development activities;

•

the effect of competing technological and market developments; and

•

the cost of filing, prosecuting, defending and enforcing any patent claims and other intellectual property rights.

Accordingly, we may require additional funding to continue our operations. If we are unable to obtain adequate financing on a timely basis, we may be required to significantly curtail one or more of our development, licensing or acquisition programs.

Raising additional funds by issuing securities or through licensing arrangements may cause dilution to existing stockholders, restrict our operations or require us to relinquish proprietary rights.

Additional financing may not be available to us when we need it or may not be available on favorable terms. To the extent that we raise additional capital by issuing equity securities, our existing stockholders’ ownership will be diluted and the terms of any new equity securities may have preferences over our common stock. Any debt financing we enter into may involve covenants that restrict our operations. These restrictive covenants may include limitations on additional borrowing and specific restrictions on the use of our assets, as well as prohibitions on our ability to create liens, pay dividends, redeem our stock or make investments. In addition, if we raise additional funds through licensing arrangements, it may be necessary to relinquish potentially valuable rights to potential products or proprietary technologies, or grant licenses on terms that are not favorable to us.

Intermezzo^® and our other product candidates may not achieve market acceptance even if we obtain regulatory approvals.

Even if we receive regulatory approvals for the commercial sale of Intermezzo^® or our other product candidates, the commercial success of these product candidates will depend upon, among other things, acceptance by physicians and patients. Market acceptance of, and demand for, any product that we develop and that are commercialized by us or our collaboration partner will depend on many factors, including:

•

the ability to provide acceptable evidence of safety and efficacy of Intermezzo^® or future products for their respective indications;

•

the ease of use of Intermezzo^®;

•

the existence of generic or branded competition for Intermezzo^®;

•

the ability to obtain adequate pricing and sufficient insurance coverage and reimbursement;

•

the availability, relative cost and relative efficacy and safety of alternative and competing treatments;

•

the effectiveness of our or a collaboration partner’s sales, marketing and distribution strategies; and

•

the ability to produce commercial quantities sufficient to meet demand.

If Intermezzo^® or our other product candidates fail to gain market acceptance, we may be unable to earn sufficient revenue to continue our business.

We will face substantial competition from companies with established products.

We plan to seek approval of Intermezzo^® for use as needed for the treatment of insomnia when a middle of the night awakening is followed by difficulty returning to sleep, an indication that we believe represents an opportunity in the broader insomnia therapeutic market. The insomnia market is large, deeply commercialized and characterized by intense competition among large, established pharmaceutical companies with well funded and staffed and experienced sales and marketing organizations and far greater name recognition than us or our collaboration partner.

If Intermezzo^® receives marketing approval, it will compete in this large market against well-established branded products with significant advertising support, as well as with new market entrants and generic competitors selling zolpidem and other sleep aids at a fraction of the price at which we or our collaboration partner will most likely seek to sell Intermezzo^®.

We believe that if Intermezzo^® is approved on a timely basis, and with the label we have requested from the FDA, it will be the first sleep aid approved by the FDA specifically for use in the middle of the night when patients awaken and have difficulty returning to sleep. However, currently approved and marketed seven to eight hour therapeutics can also treat this condition when used to deliver a prophylactic dose of a sleep aid at the beginning of the night. The most directly competitive approved products in the United States are Ambien^® and Ambien CR^®, marketed by sanofi-aventis, and generic forms of zolpidem available from multiple manufacturers. Additionally, Zolpimist^TM, an orally administered spray for which NovaDel Pharma, Inc. received marketing approval from the FDA in December 2008, and Edluar^TM, a sublingual tablet for which Orexo AB received marketing approval from the FDA in March 2009, employ the same 5mg and 10mg zolpidem doses as generic Ambien^® and are designed to be used in the same manner at bedtime to produce seven to eight hours of sleep. Zolpidem, in both its branded and generic forms, is the most widely-prescribed drug in the United States for treatment of insomnia.

Additionally, Lunesta^® (eszopiclone), marketed by Dainippon-Sumitomo Pharma Co. Ltd. and Rozerem^® (ramelteon), marketed by Takeda Pharmaceuticals Company Limited, can similarly treat middle of the night awakenings by providing a prophylactic dose at bedtime in order to avoid a middle of the night awakening, and short duration products such as Sonata^®, which utilizes the active ingredient zaleplon and marketed by King Pharmaceuticals, Inc., have been used off-label for the as-needed treatment of middle of the night awakenings. In March 2010, Somaxon Pharmaceuticals, Inc. announced FDA approval of Silenor^®, a low dose doxepin formulation intended for use at bedtime, for the treatment of both transient (short term) and chronic (long term) insomnia characterized by difficulty with sleep maintenance in both adults and elderly patients. In clinical trials, Silenor^® demonstrated maintenance of sleep into the 7th and 8th hours of the night, with no meaningful evidence of next day residual effects. Somaxon recently announced that it entered into an agreement with a third party to provide for a contract sales force to promote Silenor^® in the United States and plans to launch the product in September 2010. In January 2010, Vanda Pharmaceuticals Inc. received an orphan drug designation from the FDA for VEC-162 (tasimelteon), a melatonin agonist similar to ramelteon, for treatment of non-24 hour sleep/wake disorder in blind individuals without light perception. Vanda may seek approval for additional, broader insomnia indications for this product, or such product, if approved by the FDA, may be used off-label to treat other insomnia indications. Other drugs, such as the antidepressant generic trazodone, are also widely prescribed off-label for the treatment of insomnia.

Other companies may develop products to compete with Intermezzo^®.

We are aware of several products currently in development which are seeking indication statements from the FDA for the treatment of middle of the night awakenings. Neurocrine Biosciences, Inc. received an approvable letter, pending additional clinical and pre-clinical studies, from the FDA for its product candidate, indiplon, proposed to be used for sleep initiation and middle of the night dosing. NovaDel Pharma, Inc. has announced that it commenced development of a low-dose version of Zolpimist™ for the treatment of middle of the night awakenings with the intent to enter such product candidate into clinical trials, and Somnus Therapeutics Inc. has indicated that it is similarly targeting treatment of middle of the night awakenings with development of its controlled-release zaleplon formulation, SKP-1041. Additionally, Alexza Pharmaceuticals, Inc. announced that it is developing AZ-007, immediate release Staccato zaleplon, for its ability to treat middle of the night awakenings.

There are many other companies working to develop new products and other therapies to treat insomnia, including but not limited to Eli Lilly and Company, Merck and Co., Inc., and GlaxoSmithKline plc in conjunction with Actelion Pharmaceuticals Ltd. Several of these products are in late stage clinical trials.

Furthermore, new developments, including the development of other drug technologies and methods of treating conditions, occur in the biopharmaceutical industry at a rapid pace. Any of these developments may negatively affect the commercial prospects of Intermezzo^®.

Many potential competitors, either alone or together with their partners, have substantially greater financial resources, research and development programs, clinical trial and regulatory experience, expertise in prosecution of intellectual property rights, and manufacturing, distribution and sales and marketing capabilities than us and our collaboration partner. As a result of these factors, these competitors may:

•

develop product candidates and market products that are less expensive, safer, more effective or easier to use than our current product candidates and contemplated future products;

•

commercialize competing products before Intermezzo^® or other product candidates can be launched;

•

initiate or withstand substantial price competition more successfully than we can;

•

have greater success in recruiting skilled scientific workers and experienced sales and marketing personnel from the limited pool of available talent;

•

more effectively negotiate third-party licenses and strategic collaborations; and

•

take advantage of acquisition or other opportunities more readily than us or our collaboration partner.

Governmental and third-party payors may impose restrictions or reimbursement or pricing controls that could limit product revenue.

The continuing efforts of government and third-party payors to contain or reduce the costs of health care through various means may reduce potential revenue we may receive from sales of Intermezzo^®, if approved. In particular, third-party insurance coverage may not be available to patients for Intermezzo^® or our other products, especially in light of the availability of low-cost generic zolpidem therapeutics, regardless of the fact that such products are not specifically designed or indicated to specifically treat middle of the night awakening. Government and third-party payors could also impose price controls and other conditions that must be met by patients prior to providing coverage for use of our products. For example, insurers may establish a “step-edit” system that requires a patient to utilize a lower price alternative product prior to becoming eligible for reimbursement of a higher price product. If government and third-party payors do not provide adequate coverage and reimbursement levels for our products, or if price controls, prior authorization or step-edit systems are enacted, our product revenue will suffer.

Negative publicity and documented side effects concerning products used to treat patients in the insomnia market may harm commercialization of Intermezzo^® or our other product candidates.

Products containing zolpidem, the active ingredient in Intermezzo^®, are widely marketed. Zolpidem use has been linked to negative effects, such as sleepwalking and amnesia, and has the potential to cause physical or psychological dependence. Furthermore, zolpidem is classified as a Schedule IV substance under the Comprehensive Drug Abuse and Prevention Control Act of 1970, and is subject to certain packaging, prescription and purchase volume limitations. There can be no assurance that additional negative publicity or increased governmental controls on the use of zolpidem or other compounds used in products for the insomnia market would not inhibit or prevent commercialization of Intermezzo^® or our other product candidates. Furthermore, negative publicity concerning zolpidem and other hypnotic pharmaceuticals could cause the FDA to make approval of new products for the insomnia market more difficult, by requiring additional or different non-clinical or clinical studies or taking other actions, out of safety or other concerns, or could lead to reduced consumer usage of sleep aids, including zolpidem products and Intermezzo^®.

Even if our product candidates receive regulatory approval, they will be subject to ongoing regulatory requirements and may face regulatory or enforcement action.

Any product candidate for which we receive regulatory approval, together with related third-party manufacturing facilities and processes, post-approval clinical data, and advertising and promotional activities for the product, will be subject to significant review, oversight and ongoing and changing regulation by the FDA and other regulatory agencies. Failure to comply with regulatory requirements may subject us to administrative and judicially-imposed sanctions. These may include warning letters, adverse publicity, civil and criminal penalties, injunctions, product seizures or detention, product recalls, total or partial suspension of production, and refusal to approve pending product marketing applications.

Even if we receive regulatory approval to market a particular product candidate, the approval could be conditioned on our conducting additional costly post-approval studies or could limit the indicated uses included in our labeling. Moreover, the product may later cause adverse effects that limit or prevent its widespread use, force us to withdraw it from the market or impede or delay the ability to obtain regulatory approvals in additional countries.

The FDA has also requested that all manufacturers of sedative-hypnotic pharmaceutical products modify their product labeling to include strong language concerning potential risks. These risks include severe allergic reactions and complex sleep-related behaviors, which include sleep-driving. The FDA also recommended that pharmaceutical manufacturers conduct clinical studies to investigate the frequency with which sleep-driving and other complex behaviors occur in association with individual drug products. We have not conducted such studies, and it is unclear how and to what extent, if any, these requests and recommendations will affect Intermezzo^® or our other product candidates.

If manufacturers supplying our product candidates fail to produce in the volumes and quality that are required on a timely basis, or to comply with stringent regulations applicable to pharmaceutical manufacturers, there may be delays in the development and commercialization of, or an inability to meet demand for, our products, if any, and we may lose potential revenue.

We do not manufacture our product candidates, and we do not plan to develop the capacity to do so. We have a primary manufacturing and supply agreement with Patheon, Inc. to manufacture a commercial supply of Intermezzo^®. We also have agreements with Mikart, Inc. to qualify it as a backup commercial supplier of finished product, as well as a backup commercial manufacturer of a key excipient used in the manufacture of Intermezzo^®. We currently have arrangements to use Anderson Packaging, Inc. as a primary packager of Intermezzo^® and Sharp Corporation to supply sample packaging. We plan to amend our agreements with Anderson and Sharp or enter into packaging and supply agreements with new suppliers as we plan to change the packaging of Intermezzo^®. We rely upon SPI Pharma, Inc. as a supplier for certain key excipients contained within Intermezzo^®, for one of such excipients, Pharmaburst^®, as the sole source, and upon Plantex USA, Inc. as our sole source for a special form of zolpidem tartrate. These agreements have set terms of duration, some of which automatically renew for successive one or three year periods. The first to expire among these agreements, the Packaging and Supply Agreement with Anderson Packaging, Inc., has a term that ends in September of 2011, although such agreement automatically renews for one-year periods thereafter. Purdue is similarly dependent on these manufacturers for the commercial supply of Intermezzo^® and has entered into direct agreements with certain of such manufacturers in connection with entry into the Collaboration Agreement that would take effect soon after an FDA approval of Intermezzo^® if Purdue elects to continue with our collaboration. Any of the risks that we face with respect to these manufacturers are therefore similarly applicable to Purdue, and the realization of these risks by Purdue would have a significant impact on Purdue commercialization efforts and our ability to generate revenue under the Collaboration Agreement.

The manufacture of pharmaceutical products requires significant expertise and capital investment, including the development of advanced manufacturing techniques and process controls. Manufacturers of pharmaceutical products often encounter difficulties in production, particularly in scaling up initial production. These problems include difficulties with production costs and yields, quality control, including stability of the product candidate and quality assurance testing, shortages of qualified personnel, as well as compliance with strictly enforced federal, state and foreign regulations. Third-party manufacturers and key suppliers may not perform as agreed, may terminate their agreements, or may experience manufacturing difficulties due to resource constraints or as a result of labor disputes, unstable political environments at foreign facilities or financial difficulties. For example, our supplier of zolpidem tartrate with its manufacturing facility in Israel may face geopolitical risk that could prevent it from providing supplies from such facility. Additionally, third-party manufacturers and key suppliers may become subject to claims of infringement of intellectual property rights of others, which could cause them to incur substantial expenses, and, if such claims were successful, could cause them to incur substantial damages or cease production of our products or product components. For example, SPI, the sole supplier of Pharmaburst^®, a key excipient used in Intermezzo^®, is the defendant in a lawsuit alleging patent infringement that may involve Pharmaburst^®. In addition, several of our suppliers have only one facility qualified to supply key components of Intermezzo^®, and transferring such supply to an alternate site could take substantial time and resources. Any interruption of supply from such facilities could materially impair our ability to manufacture and generate revenue from Intermezzo^®. These manufacturers and suppliers may also choose, or be required, to seek licenses from the claimant, which may not be available on acceptable terms or at all. If these manufacturers or key suppliers were to encounter any of these difficulties, or otherwise fail to comply with their contractual obligations, ability to launch Intermezzo^® or any other product candidate, if approved, would be jeopardized. Even if we were able to launch a product, these difficulties could cause increases in the prices we or our collaborators pay for supply of such product and its components which could substantially hinder or prevent commercialization efforts.

In addition, all manufacturers and suppliers of pharmaceutical products must comply with current Good Manufacturing Practice, or cGMP, requirements enforced by the FDA through its facilities inspection program. The FDA is likely to conduct inspections of third-party manufacturer and key supplier facilities as part of its review of any of our NDAs. If third-party manufacturers and key suppliers are not in compliance with cGMP requirements, it may result in a delay of approval, particularly if these sites are supplying single source ingredients required for the manufacture of Intermezzo^®. These cGMP requirements include quality control, quality assurance and the maintenance of records and documentation. Furthermore, regulatory qualifications of manufacturing facilities are applied on the basis of the specific facility being used to produce supplies. As a result, if one of these manufacturers shifts production from one facility to another, the new facility must go through a complete regulatory qualification process and be approved by regulatory authorities prior to being used for commercial supply. Manufacturers may be unable to comply with these cGMP requirements and with other FDA, state and foreign regulatory requirements. A failure to comply with these requirements may result in fines and civil penalties, suspension of production, suspension or delay in product approval, product seizure or recall, or withdrawal of product approval. If the safety of any quantities supplied is compromised due to a third-party manufacturer or key supplier failure to adhere to applicable laws or for other reasons, we may not be able to obtain regulatory approval for our product candidates and, even if such approval is obtained, any resulting products may not be successfully commercialized.

There are no alternate manufacturers qualified at this time with respect to the commercial supply of Intermezzo^®, nor are there alternate manufacturers identified or qualified with respect to the commercial supply of several of the key ingredients and packaging materials used in Intermezzo^®. If manufacturers are required to be changed, prior approval by the FDA and comparable foreign regulators will be required. In addition, we or Purdue would likely have to incur significant costs and expend significant efforts to educate the new manufacturer with respect to, or to help the new manufacturer independently develop, the processes necessary for production. Manufacturing and supply switching costs in the pharmaceutical industry can be very high, and switching manufacturers or key suppliers can frequently take 12 to 18 months to complete, although in certain circumstances such a switch may be significantly delayed or prevented by regulatory and other factors.

Any of these factors could cause the delay or suspension of regulatory submissions, required regulatory approvals or commercialization of Intermezzo^® or any other product candidate that we develop, entail higher costs or result in an inability to effectively commercialize our products, if any are approved. Furthermore, if manufacturers fail to deliver the required commercial quantities of raw materials, including the active pharmaceutical ingredient, key excipients or finished product on a timely basis and at commercially reasonable prices, we or our strategic partners would be unable to meet demand for our products and we would lose potential revenue.

We rely on third parties to conduct our non-clinical and clinical trials. If these third parties do not perform as contractually required or otherwise expected, we may not be able to obtain regulatory approval for our product candidates.

We do not currently conduct non-clinical and clinical trials on our own, and instead rely on third parties, such as contract research organizations, medical institutions, clinical investigators and contract laboratories, to assist us with our non-clinical and clinical trials. We, and our third parties, are also required to comply with regulations and standards, commonly referred to as Good Clinical Practice, for conducting, recording and reporting the results of clinical trials to assure that data and reported results are credible and accurate and that the trial participants are adequately protected. If these third parties do not successfully carry out their duties with regard to Intermezzo^® or TO-2061 development or fail to successfully carry out their duties to us as they relate to meeting future regulatory obligations or expected deadlines, if the third parties need to be replaced, or if the quality or accuracy of the data these third parties obtained during the development of Intermezzo^®, TO-2061 or future product candidates is compromised due to the failure to adhere to our clinical protocols or regulatory requirements or for other reasons, our non-clinical development activities or clinical trials may be extended, delayed, suspended or terminated, and we may not be able to obtain regulatory approval for Intermezzo^® or other product candidates.

We may face potential product liability exposure, and if successful claims are brought against us, we may incur substantial liability for a product candidate and may have to limit such candidate’s commercialization.

The use of our product candidates in clinical trials and the sale of any products for which we obtain marketing approval exposes us to the risk of product liability claims. Product liability claims might be brought against us by consumers, health care providers, pharmaceutical companies or others selling our products. If we cannot successfully defend ourselves against these claims, we will incur substantial liabilities. We are also obligated under certain circumstances to indemnify suppliers and others with whom we have contractual relationships for product liability claims such entities might incur with respect to our products and product candidates. Regardless of merit or eventual outcome, liability claims may result in:

•

decreased demand for our products;

•

impairment of our business reputation;

•

withdrawal of clinical trial participants;

•

costs of related litigation;

•

substantial monetary awards to patients or other claimants;

•

loss of revenue; and

•

the inability to commercialize our product candidates.

Although we currently have product liability insurance coverage for our clinical trials with limits that we believe are customary and adequate to provide us with coverage for foreseeable risks associated with our development efforts, this insurance coverage may not reimburse us or may be insufficient to reimburse us for the actual expenses or losses we may suffer. Moreover, insurance coverage is becoming increasingly expensive and, in the future, we may not be able to maintain insurance coverage at a reasonable cost or in sufficient amounts to protect us against losses due to liability. We intend to expand our insurance coverage to include the sale of commercial products if we obtain marketing approval for Intermezzo^® , but we may be unable to obtain such product liability insurance on commercially reasonable terms.

We depend on key personnel and if we are not able to retain them our business will suffer.

We are highly dependent on the principal members of our management and scientific staff, including but not limited to Glenn A. Oclassen, our President and Chief Executive Officer, and Nikhilesh N. Singh, Ph.D., our Senior Vice President and Chief Scientific Officer. The competition for skilled personnel among biopharmaceutical companies in the San Francisco Bay Area is intense and the employment services of our scientific, management and other executive officers may be terminated at-will. If we lose one or more of these key employees, our ability to implement and execute our business strategy successfully could be seriously harmed. Replacing key employees may be difficult and may take an extended period of time because of the limited number of individuals in the biopharmaceutical industry with the breadth of skills and experience required to develop, gain regulatory approval of and commercialize products successfully. We do not carry key man life insurance on any of our key personnel other than Dr. Singh.

The commercial success, if any, of Intermezzo^® and TO-2061 depends, in part, on the rights we are seeking through certain patent applications.

The potential commercial success of Intermezzo^® depends in part on two issued patents from the U.S. Patent and Trademark Office, or USPTO, covering the formulation of Intermezzo^® and patents that may issue covering methods of use of zolpidem. In addition, we have pending certain foreign equivalent patent applications with respect to formulations and manufacture of zolpidem for use in treatment of middle of the night awakening. We also have a pending application covering methods of treating OCD with ondansetron, as well as an application covering combinations and methods of use of ondansetron in conjunction with atypical antipsychotic drugs.

There can be no assurance that our pending patent applications and applications we may file in the future, or those applications we may license from third parties, will result in patents being issued in a timely manner, or at all. Even if patents issue, the claims in such patents may not issue in a form that will be advantageous to us, may not encompass Intermezzo^®, TO-2061 or our other product candidates and their unique features, and may not provide us with proprietary protection or competitive advantages. For instance, with Intermezzo^®, competitors may be able to engineer around our formulation patent applications with alternate formulations that deliver therapeutic effects similar to potential products covered by our zolpidem formulation patent applications. Other drug companies may also be able to develop generic versions of our products if we are unable to maintain our proprietary rights. For example, drug makers may attempt to introduce low dose zolpidem or ondansetron products similar to our products immediately after the expiration of Hatch-Waxman marketing exclusivity and prior to the expiration of patents that may be issued relating to our respective products. Furthermore, among other limitations, the method of use patent applications that have been filed to encompass Intermezzo^® are limited in scope to certain uses of zolpidem, so potential competitors could develop similar products using active pharmaceutical ingredients other than zolpidem. Any patents that have been allowed, we have obtained or do obtain may be challenged by re-examination, opposition, or other administrative proceeding, or may be challenged in litigation, and such challenges could result in a determination that the patent is invalid.

The active, and many of the inactive, ingredients in Intermezzo^® and TO-2061, including generically manufactured zolpidem and ondansetron, respectively, have been known and used for many years and, therefore, are no longer subject to patent protection. Accordingly, certain of our patents for Intermezzo^® are directed to the particular formulations of its ingredients. Also, for both Intermezzo^® and TO-2061, we have patent applications that are directed toward new uses of such compounds. Although we believe our formulations and the use of our product candidates are patentable, and patents arising from such product candidates will provide a competitive advantage, such patents may not prevent others from marketing formulations using the same active and inactive ingredients in similar but different formulations. Moreover, if our patents were successfully challenged and ruled to be invalid, we would be exposed to a greater risk of direct competition.

Failure to obtain effective patent protection for Intermezzo^®, TO-2061 and our other product candidates would allow for products to be marketed by competitors that would undermine sales, marketing and collaboration efforts for our product candidates, and reduce or eliminate our revenue. In addition, both the patent application process and the process of managing patent disputes can be time consuming and expensive.

If we are unable to maintain and enforce our proprietary rights, we may not be able to compete effectively or operate profitably.

Our commercial success will depend, in part, on obtaining and maintaining patent protection, trade secret protection and regulatory protection of our proprietary technology and information as well as successfully defending against third-party challenges to our proprietary technology and information. We will be able to protect our proprietary technology and information from use by third parties only to the extent that we have valid and enforceable patents, trade secrets or regulatory protection to cover them and we have exclusive rights to utilize them.

Our commercial success will continue to depend in part on the patent rights we own, the patent rights we have licensed, the patent rights of our suppliers and the patent rights we plan to obtain related to future products we may market. Our success also depends on our and our licensors’ and suppliers’ ability to maintain these patent rights against third-party challenges to their validity, scope or enforceability. Further, we do not fully control the patent prosecution of the patents and patent applications we have licensed. There is a risk that licensors to us will not devote the same resources or attention to the prosecution of the licensed patent applications as we would if we controlled the prosecution of the patent applications, and the resulting patent protection, if any, may not be as strong or comprehensive as if we had prosecuted the applications ourselves. The patent positions of biopharmaceutical companies can be highly uncertain and involve complex legal and factual questions for which important legal principles remain unresolved. No consistent policy regarding the breadth of claims allowed in such companies’ patents has emerged to date in the United States. The patent situation outside the United States is even more uncertain. Changes in either the patent laws or in interpretations of patent laws in the United States or other countries may diminish the value of our intellectual property. Accordingly, we cannot predict the breadth of claims that may be allowed or enforced in our patents or in third-party patents. For example:

•

we or our licensors might not have been the first to make the inventions covered by pending patent applications and issued patents;

•

we or our licensors might not have been the first to file patent applications for these inventions;

•

others may independently develop similar or alternative technologies or duplicate any of our technologies;

•

it is possible that none of our pending patent applications or any pending patent applications of our licensors will result in issued patents;

•

our patents, if issued, and the issued patents of our licensors may not provide a basis for commercially viable products, or may not provide us with any competitive advantages, or may be challenged and invalidated by third parties;

•

we may not develop additional proprietary technologies or product candidates that are patentable; or

•

the patents of others may have an adverse effect on our business.

We also rely on trade secrets to protect our technology, especially where we do not believe patent protection is appropriate or obtainable. However, trade secrets are difficult to protect. While we seek to protect confidential information, in part, by confidentiality agreements with our employees, consultants, contractors, or scientific and other advisors, they may unintentionally or willfully disclose our information to competitors. If we were to enforce a claim that a third party had illegally obtained and was using our trade secrets, it would be expensive and time consuming, and the outcome would be unpredictable. In addition, courts outside the United States are sometimes less willing to protect trade secrets.

If we are not able to defend the patent or trade secret protection position of our technologies and product candidates, then we will not be able to exclude competitors from developing or marketing competing products, and we may not generate enough revenue from product sales, if any, to justify the cost of development of our product candidates and to achieve or maintain profitability.

If we are sued for infringing intellectual property rights of other parties, such litigation will be costly and time consuming, and an unfavorable outcome would have a significant adverse effect on our business.

Although we believe that we would have valid defenses to allegations that our current product candidates, production methods and other activities infringe the valid and enforceable intellectual property rights of any third parties of which we are aware, we cannot be certain that a third party will not challenge our position in the future. Other parties may own patent rights that might be infringed by our products or other activities, or other parties may claim that their patent rights are infringed by excipients manufactured by others and contained in our products. For example, SPI, the sole supplier of Pharmaburst^®, a key excipient used in Intermezzo^®, is the defendant in a lawsuit that alleges that certain of SPI’s products infringe one or more patents of a third party. Although not specifically identified in the original complaint, subsequent press releases have indicated that Pharmaburst^® products allegedly infringe such patents. SPI has informed us that the third party’s patent rights are not infringed by Pharmaburst^® and that it intends to defend its rights vigorously. However, because Pharmaburst^® is a key excipient in Intermezzo^®, the interruption of supply of Pharmaburst^® through an injunction or through voluntary cessation of production could materially harm our ability to supply Intermezzo^®. There has been, and we believe that there will continue to be, significant litigation and demands for licenses in the life sciences industry regarding patent and other intellectual property rights. Competitors or other patent holders may assert that our products and the methods we employ are covered by their patents. These parties could bring claims against us that would cause us to incur substantial expenses and, if successful against us, could cause us to pay substantial damages or possibly prevent us from commercializing our product candidates. Further, if a patent infringement suit were brought against us, we could be forced to stop or delay research, development, manufacturing or sales of the product or product candidate that is the subject of the suit.

As a result of patent infringement claims, or in order to avoid potential claims, we may choose to seek, or be required to seek, a license from the third party and would most likely be required to pay license fees or royalties or both. These licenses may not be available on acceptable terms, or at all. Even if we were able to obtain a license, the rights may be non-exclusive, which would give competitors access to the same intellectual property. Ultimately, we could be prevented from commercializing a product, or be forced to cease some aspect of our business operations if, as a result of actual or threatened patent infringement claims, we or our collaborators are unable to enter into licenses on acceptable terms. This could harm our business significantly.

These risks of intellectual property infringement are similarly faced by our suppliers and collaborators, which could hinder or prevent them from manufacturing or commercializing our products.

We may incur substantial costs as a result of litigation or other proceedings relating to patent and other intellectual property rights.

In the event a competitor infringes upon one of our patents or other intellectual property rights, litigation to enforce our intellectual property rights or to defend our patents against challenge, even if successful, could be expensive and time consuming and could require significant time and attention from management. We may not have sufficient resources to enforce our intellectual property rights or to defend our patents against challenges from others.

The pharmaceutical industry is characterized by extensive litigation and administrative proceedings over patent and other intellectual property rights. We could therefore become subject to litigation that could be costly, result in the diversion of management’s time and efforts, and require us to pay damages. Whether a product infringes a patent involves complex legal and factual issues, the determination of which is often uncertain. Our competitors may assert that they own U.S. or foreign patents containing claims that cover our products, components of our products, or the methods we employ in making or using our products. In addition, we may become a party to an interference proceeding declared by the USPTO to determine the priority of inventions. Because patent applications can take many years to issue, and in many instances, at least 18 months to publish, there may be applications now pending of which we are unaware, which may later result in issued patents that contain claims that cover our products. There could also be existing patents, of which we are unaware, that contain claims that cover one or more components of our products. As the number of participants in our industry increases, the possibility of patent infringement claims against us also increases.

Any interference proceeding, litigation, or other assertion of claims against us may cause us to incur substantial costs, could place a significant strain on our financial resources, divert the attention of management from our core business and harm our reputation. If the relevant patents were upheld as valid and enforceable and we were found to infringe, we could be required to pay substantial damages and/or royalties and could be prevented from selling our products unless we could obtain a license or were able to redesign our products to avoid infringement. Any such license may not be available on reasonable terms, if at all. If we fail to obtain any required licenses or make any necessary changes to our products or technologies, we may be unable to make, use, sell, or otherwise commercialize one or more of our products. In addition, if we are found to willfully infringe, we could be required to pay treble damages, among other penalties.

If we fail to comply with our obligations in the agreements under which we license rights to products or technology from third parties, we could lose license rights that are important to our business.

We are a party to a number of agreements that include technology licenses that are important to our business and expect to enter into additional licenses in the future. For example, we hold licenses from SPI relating to key excipients used in the manufacture of Intermezzo^®. If we fail to comply with these agreements, the licensor may have the right to terminate the license, in which event we and our collaboration partners would not be able to market products covered by the license, including Intermezzo^®.

We may be subject to damages resulting from claims that we or our employees have wrongfully used or disclosed alleged trade secrets of former employers.

Many of our employees were previously employed at universities or other biotechnology or pharmaceutical companies, including competitors or potential competitors. Although no claims against us are currently pending, we may be subject to claims that these employees or we ourselves have inadvertently or otherwise used or disclosed trade secrets or other proprietary information of former employers. Litigation may be necessary to defend against these claims. If we fail in defending such claims, in addition to paying monetary damages, we may lose valuable intellectual property rights or personnel. A loss of key research personnel or their work product could hamper or prevent our or a collaboration partner’s ability to develop or commercialize certain potential products, which could severely harm our business. Even if we are successful in defending against these claims, litigation could result in substantial costs and be a distraction to management.

If our agreements with employees, consultants, advisors and corporate partners fail to protect our intellectual property, proprietary information or trade secrets, it could have a significant adverse effect on us.

We have taken steps to protect our intellectual property and proprietary technology by entering into confidentiality agreements and intellectual property assignment agreements with our employees, consultants, advisors and corporate partners. However, such agreements may not be enforceable or may not provide meaningful protection for our trade secrets or other proprietary information in the event of unauthorized use or disclosure or other breaches of the agreements, and we may not be able to prevent such unauthorized disclosure. Monitoring unauthorized disclosure is difficult, and we do not know whether the steps we have taken to prevent such disclosure are, or will be, adequate. Furthermore, the laws of some foreign countries may not protect our intellectual property rights to the same extent as do the laws of the United States.

Our stock price is expected to be volatile.

The market price of our common stock could be subject to significant fluctuations. Market prices for securities of early-stage pharmaceutical, biotechnology and other life sciences companies have historically been particularly volatile. The volatility of the market price of our common stock is exacerbated by the low trading volume of our common stock and the high proportion of our shares held by insiders. Some of the factors that may cause the market price of our common stock to fluctuate include:

•

our ability to obtain regulatory approvals for Intermezzo^®, TO-2061 or other product candidates, and delays or failures to obtain such approvals;

•

the termination of key commercial partner agreements, such as our Collaboration Agreement with Purdue;

•

failure of any product candidates, if approved, to achieve commercial success;

•

issues in manufacturing approved products, if any, or product candidates;

•

the results of current and any future clinical trials of our product candidates;

•

the entry into, or termination of, key agreements, including additional commercial partner agreements;

•

the initiation of, material developments in, or conclusion of litigation to enforce or defend our intellectual property rights or defend against the intellectual property rights of others;

•

announcements by commercial partners or competitors of new commercial products, clinical progress or the lack thereof, significant contracts, commercial relationships or capital commitments;

•

adverse publicity relating to the insomnia market, including with respect to other products and potential products in such market;

•

the introduction of technological innovations or new therapies that compete with our potential products;

•

the loss of key employees;

•

changes in estimates or recommendations by securities analysts, if any, who cover our common stock;

•

future sales of our common stock;

•

general and industry-specific economic conditions that may affect our research and development expenditures;

•

changes in the structure of health care payment systems; and

•

period-to-period fluctuations in financial results.

Moreover, the stock markets in general have experienced substantial volatility that has often been unrelated to the operating performance of individual companies. These broad market fluctuations may also adversely affect the trading price of our common stock.

In the past, following periods of volatility in the market price of a company’s securities, stockholders have often instituted class action securities litigation against those companies. Such litigation, if instituted, could result in substantial costs and diversion of management attention and resources, which could significantly harm our profitability and reputation.

Anti-takeover provisions in the Collaboration Agreement with Purdue, in our charter documents and under Delaware law could make an acquisition of us more difficult and may prevent attempts by stockholders to replace or remove management.

Provisions in the Collaboration Agreement with Purdue, certificate of incorporation and bylaws may delay or prevent an acquisition or a change in management. These provisions include an agreement with Purdue that prevents Purdue from acquiring above a certain percentage of our stock and engaging in certain other activities that may lead to an acquisition of our company. Such provisions in our charter documents include a classified board of directors, a prohibition on actions by written consent of stockholders and the ability of the board of directors to issue preferred stock without stockholder approval. In addition, because we are incorporated in Delaware, we are governed by the provisions of Section 203 of the Delaware General Corporation Law, which prohibits stockholders owning in excess of 15% of our outstanding voting stock from merging or combining with us. Although we believe these provisions collectively will provide for an opportunity to receive higher bids by requiring potential acquirers to negotiate with our board of directors, they would apply even if the offer may be considered beneficial by some stockholders. In addition, these provisions may frustrate or prevent any attempts by stockholders to replace or remove the then-current management by making it more difficult for stockholders to replace members of the board of directors, which is responsible for appointing the members of management.

We have never paid dividends on our capital stock, and do not anticipate that we will pay any cash dividends in the foreseeable future.

We have not paid cash dividends on any of our classes of capital stock to date, and our current expectation is that we will retain our future earnings to fund the development and growth of our business. As a result, capital appreciation, if any, of our common stock will be the sole source of gain, if any, as a result of holding shares of our common stock, for the foreseeable future.

Future sales of our common stock may cause our stock price to decline and impede our ability to raise capital.

Our common stock is closely held and our trading volume is low. Our executive officers, directors and their affiliates beneficially own approximately 57% of our approximately 13.4 million outstanding shares of common stock as of June 30, 2010. Significant portions of these shares are held by a small number of stockholders. In addition, two investors otherwise unaffiliated with us beneficially own an additional approximately 14% of our common stock as of June 30, 2010 based on filings made with the Securities and Exchange Commission, or SEC. The average daily trading volume of shares of our common stock on The NASDAQ Stock Market during the six months ended June 30, 2010 was less than 30,000 shares.

All of our outstanding shares of common stock are freely tradable without restriction or further registration under the federal securities laws, unless held or purchased by our “affiliates” as that term is defined in Rule 144 under the Securities Act of 1933, as amended, or the Securities Act. Also, some stockholders affiliated with our directors maintain rights with respect to the registration of the sale of their shares of common stock with the SEC. The shares authorized for issuance under our stock option plans and employee stock purchase plan are registered under the Securities Act and can be freely sold in the public market upon issuance, subject to restrictions imposed on our affiliates under Rule 144.

Sales into the public market by our officers, directors and their affiliates, or other major stockholders, of a substantial number of shares, or the expectation that such sales may occur, could significantly reduce the market price of our common stock.

In addition, certain of our directors, executive officers and large stockholders may establish predetermined selling plans under Rule 10b5-1 of the Securities Exchange Act of 1934 for the purpose of effecting sales of common stock.

If any such sales occur, are expected to occur or a large number of our shares are sold in the public market, the trading price of our common stock could decline. Further, any such decline or expectation could impede our ability to raise capital in the future through the sale of equity securities under terms that are favorable to us.

The highly concentrated ownership of our common stock may prevent stockholders from influencing significant corporate decisions and may result in conflicts of interest that could cause our stock price to decline.

Our executive officers, directors and their affiliates beneficially own or control approximately 57% of the outstanding shares of our common stock as of June 30, 2010. Accordingly, these executive officers, directors and their affiliates, acting as a group, will have substantial influence over the outcome of corporate actions requiring stockholder approval, including the election of directors, any merger, consolidation or sale of all or substantially all of our assets or any other significant corporate transactions. These stockholders may also delay or prevent a change of control of us, even if such a change of control would benefit the other stockholders. The significant concentration of stock ownership may adversely affect the trading price of our common stock due to investors’ perception that conflicts of interest may exist or arise.

Item 2.

Unregistered Sales of Equity Securities and Use of Proceeds

None.

Item 3.

Defaults Upon Senior Securities

Not applicable.

Item 4.

(Removed and Reserved)

Item 5.

Other Information

Not applicable.

Item 6.

Exhibits

(a)

Exhibits:


Exhibit No.		Description of Exhibit

3.1(1)		Amended and Restated Certificate of Incorporation of Transcept Pharmaceuticals, Inc.

3.2(1)		Bylaws of Transcept Pharmaceuticals, Inc., as amended.

4.1(2)		Specimen Common Stock certificate of Transcept Pharmaceuticals, Inc.

4.2(2)		Form of Preferred Stock Purchase Warrant issued to certain TPI investors as of March 21, 2005.

4.3(2)		Preferred Stock Purchase Warrant issued by TPI to Hercules Technology Growth Capital, Inc., dated as of April 13, 2006.

4.4(3)		2005 Amended and Restated Investor Rights Agreement, dated as of December 21, 2005, by and between Novacea and purchasers of Novacea Series A, Series B and Series C Preferred Stock.

4.5(4)		Amended and Restated Investor Rights Agreement, dated as of February 27, 2007, by and between TPI and purchasers of TPI Series A, Series B, Series C and Series D Preferred Stock.

4.6(4)		Termination Agreement, dated as of January 26, 2009, by and between TPI and purchasers of TPI Series A, Series B, Series C and Series D Preferred Stock.

10.1(5)		Amended and Restated 2006 Incentive Award Plan.

31.1		Certification of the Company’s Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.

31.2		Certification of the Company’s Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.

32.1		Certification of the Company’s Chief Executive Officer and Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

(1)	Incorporated by reference from the first Current Report on Form 8-K filed with the Securities and Exchange Commission on February 5, 2009.

(2)	Incorporated by reference from the second Current Report on Form 8-K filed with the Securities and Exchange Commission on February 5, 2009.

(3)	Incorporated by reference from the Registration Statement on Form S-1, Securities and Exchange Commission file number 333-131741, filed on February 10, 2006.

(4)	Incorporated by reference from the Quarterly Report on Form 10-Q filed with the Securities and Exchange Commission on May 14, 2010.

(5)	Incorporated by reference from the Current Report on Form 8-K filed with the Securities and Exchange Commission on June 3, 2010.

SIGNATURES

Pursuant to the requirements of the Securities and Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized as of the 12^th day of August 2010.

Transcept Pharmaceuticals, Inc.

/S/ THOMAS P. SOLOWAY

Thomas P. Soloway

Senior Vice President, Operations and Chief Financial Officer

(Principal Financial Officer)

Exhibits:


Exhibit No.		Description of Exhibit

3.1(1)		Amended and Restated Certificate of Incorporation of Transcept Pharmaceuticals, Inc.

3.2(1)		Bylaws of Transcept Pharmaceuticals, Inc., as amended.

4.1(2)		Specimen Common Stock certificate of Transcept Pharmaceuticals, Inc.

4.2(2)		Form of Preferred Stock Purchase Warrant issued to certain TPI investors as of March 21, 2005.

4.3(2)		Preferred Stock Purchase Warrant issued by TPI to Hercules Technology Growth Capital, Inc., dated as of April 13, 2006.

4.4(3)		2005 Amended and Restated Investor Rights Agreement, dated as of December 21, 2005, by and between Novacea and purchasers of Novacea Series A, Series B and Series C Preferred Stock.

4.5(4)		Amended and Restated Investor Rights Agreement, dated as of February 27, 2007, by and between TPI and purchasers of TPI Series A, Series B, Series C and Series D Preferred Stock.

4.6(4)		Termination Agreement, dated as of January 26, 2009, by and between TPI and purchasers of TPI Series A, Series B, Series C and Series D Preferred Stock.

10.1(5)		Amended and Restated 2006 Incentive Award Plan.

31.1		Certification of the Company’s Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.

31.2		Certification of the Company’s Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.

32.1		Certification of the Company’s Chief Executive Officer and Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

(1)	Incorporated by reference from the first Current Report on Form 8-K filed with the Securities and Exchange Commission on February 5, 2009.

(2)	Incorporated by reference from the second Current Report on Form 8-K filed with the Securities and Exchange Commission on February 5, 2009.

(3)	Incorporated by reference from the Registration Statement on Form S-1, Securities and Exchange Commission file number 333-131741, filed on February 10, 2006.

(4)	Incorporated by reference from the Quarterly Report on Form 10-Q filed with the Securities and Exchange Commission on May 14, 2010.

(5)	Incorporated by reference from the Current Report on Form 8-K filed with the Securities and Exchange Commission on June 3, 2010.

Large accelerated filer

Accelerated filer

Non-accelerated filer

x (Do not check if a smaller reporting company)

Smaller reporting company